Monday, February 2, 2015

Volatility, Deflation and Manipulation: A Response to Bitcoin's Critics

By Jon Matonis
Monday, January 26, 2015

Bitcoin has its share of critics and skeptics, and opposition to the emerging technology – especially among the intelligentsia – shows no sign of abating.

Notable commentators on the topic range from author Jeffrey Robinson to finance blogger Karl Denninger, Boston University professor Mark Williams, rabid Keynesian Paul Krugman, Austrian economist Gary North and FT Alphaville's Izabella Kaminska.

Generously, I'm assuming that the pundits listed above have a thorough and accurate understanding of the bitcoin protocol that facilitates its native token's dual role of currency and commodity.

Typically, the arguments put forth by an elite group of critics like this could be easily attributed to a lack of economic credentials or real-world experience in sophisticated financial markets. But that is simply not the case here – which makes it all the more puzzling to comprehend. Since the various critiques fall short on any convincing economic analysis, I suppose one could put it down to mere philosophical differences on the origin and nature of money.

With the resilience of distributed peer-to-peer networks amplified by powerful public key cryptography, we are all in new territory now; the world stands on the precipice of a fundamental realignment in the transfer of value. At its root, bitcoin is a value transfer protocol. We may voluntarily choose to utilize it or not. Most importantly, there is no coercion imposed through legal tender laws.

Value is subjective

Perhaps most disturbing to the bitcoin critics is the fundamental myth that bitcoin exposes – the myth that the State confers value on money and that we need 'kings' to coin our money.

We are constantly reminded by the critics that money can only be a legal creature of the State and that it is the "civil society system which puts the value into currency". Expounding on the thesis advanced by German economist Georg Friedrich Knapp in The State Theory of Money (1924), an exposé advocating the Chartalist approach to monetary theory claiming that money must have no intrinsic value and strictly be used as tokens issued by the government, these modern-day chartalists promote the notion that only governments and sovereign issuers have the ability to confer legitimacy to money.

A belief in central banking is also a belief in the central planning of an economy. Additionally, it represents central planning of the highest order, because it interferes with the market's price discovery process for money – the rate of interest.

As the antithesis of central planning in money, bitcoin gradually achieves more and more market-based legitimacy. Institutional and government legitimacy are not required for bitcoin to serve as store of value, medium of exchange and unit of account.

Kaminska's first piece on bitcoin in early 2013 highlighted a fairly good interaction between Chris Cook and an Austrian economist on the intrinsic value debate. Here's more on subjective and intrinsic value with Willem Buiter, chief economist at Citi.

Volatility is a red herring

But wait, isn't all this volatility damaging bitcoin and its reliability as a store of value and medium of exchange?

As bitcoin grows and matures, multi-jurisdictional exchanges will emerge which also include specialized derivatives products for hedging risk and this will have the effect of increasing market capitalization and smoothing out price volatility. Bitcoin swaps are already being conducted over swap execution facilities.

Although important, the speculative volatility is actually a sideshow to the main event of bitcoin establishing a footing in the financial world. Even at a mere six years old, bitcoin exhibits no more volatility than the luminary Swiss franc or North Sea Brent crude oil, with the latter losing more than 50% of its value in about six months.

Fear not deflation

But what about the hoarding of bitcoin? Isn't that bad for its use as money?

I prefer to call it savings and maybe it's time to unlearn all those lessons taught in school. Savings and deflation are not bad for an economy. As Jörg Guido Hülsmann once said: "We should not be afraid of deflation. We should love it as much as our liberties."

Contrary to the central banking and political class insistence that deflation must be prevented at all costs, an economy with a monetary unit that increases in value over time provides significant economic benefits such as near-zero interest rates and increasing demand through lower prices.

Ultimately, the market will reach an equilibrium between investment and savings because in the absence of an equilibrium the benefits of a savings-only strategy would evaporate. Proper economic growth through sound investments will lead to a productivity-driven deflation.

Ironically, it's the store of value function for bitcoin which enables and reinforces its use as a medium of exchange. According to Daniel Krawisz of the Satoshi Nakamoto Institute, hoarders give bitcoin value and he states that "the initial price of bitcoin was caused by people who wanted to hold it, not people who wanted to spend it. Furthermore, each subsequent step in bitcoin’s advance must begin with more holders, not more spenders."

No naked shorts, so far

I am continually amazed by those who shout "market manipulation" yet fail to see the very blatant manipulation they abhor present in the naked short selling of precious metals and in the Plunge Protection Team. We all know the world's most important trading desk sits on the 9th floor of 33 Liberty Street.

Kaminska writes: "Bitcoin markets are a hotbed for unscrupulous market practices. Everything from HFT, front-running, rebating, preferential order flow, poor margining, naked shorting, and now the truly popular one – active 'collusion' by big players. It’s all there."

In reading this, you would be forgiven in thinking that Kaminska might also be referring to highly-regulated markets populated by the likes of MF Global and the interest rate rigging cartel of RBS, Citigroup and JP Morgan. She is not. Certainly Kaminska doesn't condone that type of market activity, but that's not really the point.

The point is that we have a brand new marketplace, for a digital bearer instrument no less, germinating in parallel to the entrenched incumbents and along the way battling the retail and wholesale payments oligarchy as well as the vested interests of legal tender threatening bans. Of course, the bitcoin exchange markets experience illiquidity, lack of market depth, and a few bad actors willing to exploit such conditions. They are in the vanguard of cryptographic security architecture for dynamically-connected bearer wallets.

Fraud on any level, whether State-sponsored or from malicious principals, has no excuse and should not be tolerated. The solution is not to ensconce the new exchanges in the straight-jacket of the perceived level playing field with too-big-to-fail benefits and socialized losses, but to encourage multiple competitive exchanges across multiple jurisdictions. We wouldn't have the COMEX tail wagging the spot market dog if we had robust precious metals derivatives markets on every continent.

With bitcoin and exchanges, it's all about jurisdictional arbitrage.

Should we really believe that the two young founders of Bitstamp match the antics of Jon Corzine? After all, episodes like Bitstamp are not due to an orchestrated crisis of liquidity.

But who will protect the people?

The European Banking Authority published their report on virtual currencies complete with a risk drivers chart of 70 bitcoin risks, which was promptly hailed by the FT Bitcoinmania crowd.

For a sane and thoughtful response, we turn to Ken Tindell, who believes that the "EBA’s considered opinion is that European financial institutions should shun bitcoin like a dead skunk and go nowhere near it until the 'scheme operators' are persuaded to change bitcoin to be managed by a wise and omniscient regulator." He concludes that the EBA doesn't really understand bitcoin and they exaggerate the risks to support a mandate which deters financial innovation unless it fits into their limited construct.

In the United States, the Consumer Financial Protection Bureau did the same thing with the publishing of its advisory warning to consumers about the risks of virtual currencies.

To better assist consumers, I described some of bitcoin's superior attributes in the area of financial protection, because when the words 'financial protection' are in your agency's official name, it appears disingenuous to omit features from what may be one of the world's most protective financial instruments ever designed.

In no particular order, bitcoin provides protection from counterfeit bank notes, protection from financial surveillance, protection from identity theft, protection from physical loss of assets, protection from cross-border restrictions and excessive fees, protection from payments blockades, protection from government-sponsored inflation, and protection from confiscation. Can your currency do all that?

Furthermore, without a central bank and without taxpayer-funded deposit insurance, it is somewhat comforting to know that bitcoin's lender of last resort is the same as the lender of last resort for gold – those silly believers of subjective value.

In the province of financial journalism, bitcoin unmasks the Statists.

Saturday, November 29, 2014

Bitcoin Needs an Aggressive Legal Defense

By Jon Matonis
Monday, November 24, 2014

Across the board, bitcoin requires forceful and aggressive legal defense, not complicity with governments in crafting policy and regulations. It's going to get a lot rougher for bitcoin in the months and years ahead. We have to be prepared.

As Rick Falkvinge, author of Swarmwise, states, "The copyright monopoly war wasn't the war, it was the tutorial mission. The Internet generation is using technology to assert its values and its place in society, the old industrial generation is pushing back hard against irrelevance. Things are about to get much worse."

It is a superb analogy. Legal tender is essentially an unearned copyright privilege over the production of money. It is unlikely to be easily disrupted.

Only the naive can delude themselves into thinking that governments will embrace bitcoin in the name of monetary innovation or a modern techno-transition to the 'Internet of Things'. What government permits with one hand, it restricts and strangles with the other. Therefore, any regulatory gains by the bitcoin community are elusive, because they are designed to appease, while government enforcement actions reveal a contradictory agenda.

The real battle lies elsewhere, beyond the public policy debate.

There hasn't been a judicial test case for bitcoin legal issues yet, primarily because at least two candidates that got sufficiently close to a legal challenge elected to comply with authorities rather than risk the uncertain outcome of a test case.

On November 27, 2013, Mike Caldwell of Casascius Coins suspended the operations that made his branded coins the global standard for physical bitcoin rather than adopt a legal stand. While writing Bitcoin Ideology and Tale of Casascius Coins, I had the opportunity to consult with Caldwell and his attorney personally, so I fully understand their decision.

Also more recently, Las Vegas-based Robocoin capitulated to FinCEN pressure and started requiring all ATM operators to obtain customer information in an effort to comply with know-your-customer (KYC) regulations.

In my opinion, this was a missed opportunity to determine the legal categorization of a bitcoin vending machine and to set solid precedent. What if bitcoin vending machines dispensed only candy bars with 'paper wallet' wrappers or soda cans with removable wallet decals?

Recommended bitcoin legal areas for mounting a strong, concerted defense include: mandatory key disclosure, restrictions on freedom of transaction, attacks on bitcoin fungibility via blacklisting and whitelisting, and denying the principle of code as protected speech.

Mandatory key disclosure

Key disclosure laws may become the single most important government tool in asset seizures and the war on money laundering. These refer to the ability of the government to demand that you surrender your private encryption keys that decrypt your data when charged with a criminal offense. If your data is currency, such as access control to various amounts of bitcoin on the blockchain, then you have surrendered your financial transaction history and potentially the value itself.

Jail time for refusing to comply with mandatory key disclosure hasn’t occurred in the US yet. But, it’s already happening in jurisdictions such as the UK, where a 33-year-old man was incarcerated for refusing to turn over his decryption keys and a youth was jailed for not disclosing a 50-character encryption password to authorities.

Key disclosure will become increasingly important in civil assets seizures, since Kim Dotcom's pretrial legal funds would have been safe with bitcoin.

It is very likely that a significant key disclosure case will make it to the US Supreme Court, where it is far from certain that the Fifth Amendment privilege, as it relates to a refusal to decrypt bitcoin assets, will be universally upheld.

Freedom of transaction

In support of an individual's freedom to transact without requiring a license to operate a 'money services business', the Bitcoin Foundation filed an amicus brief in a Florida state criminal case tied to alleged bitcoin transactions. In that case, an individual faces one count of being an unauthorized money transmitter under state law and two counts of money laundering.

The charges against the individual were filed in March 2014 and it is the first known state criminal case involving the alleged buying and selling of bitcoin. Another defendant was arrested at the same time based on similar alleged conduct and has been separately charged. This Florida case has received wide-spread media attention, such as from Bloomberg.

The foundation’s amicus brief supports the individual defendant’s motion to dismiss the count charging him with being an unauthorized money transmitter based on the core position that state prosecutors are improperly applying Florida statutes regulating 'money services businesses' to individuals conducting peer-to-peer sales of bitcoin.

This case is a big deal because it specifically targets high-dollar-value transactions and prosecutions like these could shut down one of the last remaining avenues for purchasing bitcoin anonymously.

Denying an individual's freedom to transact violates freedom of choice in currency, which is similar to an outright ban on bitcoin. In a ban, government authorities prohibit pricing or use of a currency other than the nation's 'official' currency, as witnessed in Bolivia, Ecuador, Kyrgyzstan, Bangladesh and Russia.

The ban in Bangladesh extended to even informing or educating others about bitcoin, prompting the nonprofit and educational Bitcoin Foundation Bangladesh to suspend operations temporarily.
In a slightly more positive development this month, Russia’s Ministry of Finance reduced potential fines facing both individual and institutional bitcoin users who create, issue or promote digital currencies.

The draft bill, which still seeks to outlaw the use of 'money surrogates' like bitcoin, decreases penalties for individuals to 50,000 rubles ($1,050) from 60,000 ($1,314). Legal entities would now face a maximum fine of 500,000 rubles ($10,781) for this action, down from 1m rubles ($21,563).


Fungibility refers to the concept that every unit or subunit remains equivalent and identical to any other unit or subunit. It is the property of a good or commodity whose individual units are capable of mutual substitution.

Fungibility is a complex issue, because it can be described in economic terms, cryptographic terms and policy-based terms.

Hashcash inventor Adam Back states that cryptographic fungibility is stronger than policy-based fungibility. Cryptocurrency expert Jonathan Levin replies that there is actually no cryptographic fungibility in bitcoin and that the best suggestion of this is simultaneous creation and destruction. Zooko Wilcox-O'Hearn, a computer security specialist, asserts that policy-based fungibility ends at the jurisdictional border.

While bitcoin public addresses do have a traceable history, the sub-unit components that make up a single bitcoin transaction do not have unique identifiers, such as the serial numbers on paper bank notes. Since individual transactions are able to be broken apart, each component unit can only be traced realistically to its creating miner. This complicates reliable ownership and thus provides an element of  plausible deniability for the entire infrastructure.

I maintain that the US Marshal Service's first, and now second sale, of seized bitcoin demonstrates current fungibility at least in the US jurisdiction. Just as the government doesn't spend confiscated dollars at a discount, they don't sell 'tainted' bitcoin at a discount and, furthermore, none of the offered coins are blacklisted or whitelisted. A commercial precedent has been set.

Varying tax treatments for bitcoin may have an impact on bitcoin fungibility within certain geographic areas, however. Also, read what a landmark legal case from mid-1700s Scotland tells us about monetary fungibility.

As governments attempt to steer bitcoin deployment to small and microtransactions and wholesale payment networks become politicized, the issue of international fungibility looms large, because large cross-border and permission-less value transfers may become bitcoin's sweet spot. Now, that's a sweet spot for a strong legal defense too.

Code as speech

Transmitting a bitcoin message to the network blockchain is the same as sending an encrypted, private email message and, as such, is protected under the First Amendment to the US Constitution. This important principle extends to both the development and usage of the code.

For the last 24 years, the Electronic Frontier Foundation (EFF) has been at the forefront of defending civil liberties in the digital age, championing user privacy and free expression. Activism director Rainey Reitman's brilliant editorial opposing New York's proposed 'BitLicense' scheme is a powerful declaration of privacy rights.

"Digital currencies such as bitcoin strengthen privacy and are resistant to censorship. We should consider this a feature, not a bug," Reitman said in a statement.

The EFF also defended MIT student bitcoin developers in a New Jersey court to oppose a subpoena issued over their prize-winning bitcoin mining program. The program known as Tidbit was designed to serve as an alternative to viewing online advertising by allowing website users to help mine bitcoins for the site they're visiting instead.

In a move that could strengthen bitcoin-related privacy, Senator Rand Paul of Kentucky recently introduced a bill to extend Fourth Amendment protections to include electronic communications.

Also, anticipating potential Fourth Amendment-related challenges, the Bitcoin Foundation's global policy counsel Jim Harper compared New York's BitLicense regulation to an inspection of an entrepreneur's garage:
"The comprehensive financial surveillance that the 'BitLicense' proposal requires at proposed sections 200.12(a)(1) and 200.15 is unwarranted, and the Department has put forth no evidence or argument that it is calibrated to cost-effectively achieve any public interest goal. Requiring businesses to maintain detailed surveillance of their customers anticipating later law enforcement seizure is itself a constructive seizure, which is unconstitutional under a proper interpretation of the Fourth Amendment to the US Constitution."
Now, if India had Fourth Amendment protections, egregious office raids, such as the ones carried out last December against two bitcoin exchanges, could have been effectively challenged. India may need to seek out alternative avenues for defense.

The way forward

I am hopeful that with criminal defense and trial attorney Brian Klein more closely associated with the Bitcoin Foundation, other defense attorneys will be encouraged to engage with the bitcoin community, domestically and internationally.

Taking a principled stand in Bangladesh, for instance, will send a strong message to the entire world. When it comes to impact litigation, the EFF cannot do it all. We should view this as an opportunity for bitcoin advocacy groups to grow a backbone.

Sunday, October 26, 2014

Why Bitcoin Needs an ISO-Certified Currency Code

By Jon Matonis
Tuesday, October 21, 2014

A formal ISO currency code will spur global mainstream adoption of bitcoin more than any other single action.

When a new currency code becomes adopted by the independent and nonpolitical International Organization for Standardization (ISO), it immediately enters the database tables upon which Visa, MasterCard, PayPal, SWIFT and other clearing networks rely.

ISO 4217 is a standard published by the ISO, which delineates currency designators, country codes (alpha and numeric) and references to minor units in three separate tables.

Now, a distributed currency having an identifiable code in a centralized database may not seem like much of an accomplishment.

However, when we consider what this means for integration into existing networks, trading systems and software accounting systems, it becomes much more significant. All the more so when we consider that a code prefix of 'X' denotes a non-national affiliation or a monetary metal such as gold or silver.

Instantly, bitcoin as XBT will be available as a selectable clearing and settlement unit for any business that chooses to offer and implement bitcoin. Of course, designing and managing the necessary settlement and hedging mechanisms will be a different matter altogether. Certain clearing networks may effectively become bitcoin exchanges.

With the three-character code having been in informal usage since early 2013, a formal application for XBT is nearing completion by the Financial Standards Working Group within the Bitcoin Foundation. This effort has its origins in a petition submitted by Emelyne Weiss that circulated on, the world's platform for change. The petition closed with 836 supporters.

Since the decentralized bitcoin has a peer-to-peer block chain rather than an 'official' currency manager, a central bank or an existing institution such as SWIFT may also be necessary to support the ISO application for XBT. As leaders of financial innovation through their Innotribe initiative, early indications from SWIFT senior management are that they would be supportive of such an application, if required.

Recently, the topic of XBT and the need to standardize various subunits has been much debated on Reddit and other social media outlets, unfortunately causing more confusion than clarification. Let's examine some of the top-level issues.

Why was XBT selected and what happens to BTC?

The code XBT was selected because the prefix 'X' denotes a non-national affiliation or a monetary metal such as gold or silver. Technically, BTC would be unavailable due to the fact 'BT' already represents the country of Bhutan.

The first two letters of the code are the two letters of the country code (as with national top-level domains on the Internet) and the third is the initial of the currency itself. In the case of the dollar (USD), US represents the country and D represents the initial of the currency.

Most likely, BTC would still remain in colloquial usage because it is already widely recognized by the community. Just as slang terms for money exist around the world, BTC shorthand would be used similar to how 'bucks' or 'quid' are used for other currencies. In this scenario, I expect BTC to continue to represent one full bitcoin unit.

Why does XBT have to represent a full unit of bitcoin?

One XBT unit as listed and recorded within ISO 4217 would have eight subunits or decimal places to the right of the decimal point. The rationale for this is that a neutral global default for bitcoin around the world cannot deviate from the unit's representation on the block chain (as expressed in the reference implementation) and the bitcoin integer in the core protocol is not changing.

One bitcoin on the block chain must equal one bitcoin in the formal standards world or else processing errors would be potentially catastrophic.

Even though eight decimals was selected as the starting point for the bitcoin integer, that number may need to be increased over time and increasing the amount of decimal places for bitcoin would hardly be a contested issue by the miners when the time comes.

The code representation within ISO 4217 cannot be changed up and down due to the varying number of decimal places in the core protocol. It must remain static.

Bitcoin is correctly placed, alongside gold, as a digital cryptographic commodity. So, just as gold (XAU) may trade in some areas as kilos or kilograms, the global default standard for pricing and measuring quantities of gold bullion remains the troy ounce.

One troy ounce is currently defined as 31.1034768 grams and is equivalent to approximately 1.09714 avoirdupois ounces. XAU denotes one troy ounce of gold and 'XAU/USD' means the price of 1 troy ounce of gold in US dollars.

How are the subunits related to XBT and the ISO standard?

Despite the fact that several names for bitcoin's minor units have been proposed, only three of the minor units, or subunits, have achieved a consensus within the bitcoin economy.

The third space after the decimal point (10−3) is commonly referred to as 'millibit' or mBTC. The sixth space after the decimal point (10−6) is commonly referred to as 'bit' or μBTC. The eighth space after the decimal point (10−8) is commonly referred to as a 'satoshi', the smallest available amount of bitcoin today.

These existing minor units of bitcoin will be submitted in the ISO application for XBT and it is not required for all of the individual minor units to be submitted.

To better facilitate consumer applications, some bitcoin operators may elect to provide a choice for display preferences. Several applications and web sites, such as BitcoinAverage, already permit toggling between bitcoin and millibit for display purposes.

Recently, some exchange operators have also expressed an interest and willingness to display prices in bits, so that only two decimal places exist to the right of the integer. For instance, KnCMiner embraced the bits display option for its wallet app. These moves could be especially useful for accounting packages that typically accommodate only two decimal points.
Strong opinions exist on all sides for going to a bits display, a millibits display, or remaining with a full bitcoin display.

As a consensus emerges, it is also perceived as useful to utilize one expression for retail consumers and to maintain a full bitcoin expression for wholesale level or institutional trading. This structure is entirely achievable because dual display options can be easily adopted by software providers.

Thursday, October 2, 2014

12 Ways to Measure the Bitcoin Network's Health

By Jon Matonis
Sunday, September 27, 2014

The ultra-resilient bitcoin network is the world's largest distributing computing project in terms of raw computational power, having long ago surpassed 1 exaFLOPS (1,000 petaFLOPS) – over eight times the combined speed of the top 500 supercomputers.

Although since increasing to an amazing 3.2 zettaFLOPS (3,200 exaFLOPS), the project was quietly removed from Wikipedia's list of distributed computing projects. This is probably due to the fact that the exaFLOPS estimate breaks down with bitcoin's specialized ASICs, since they are not capable of floating-point operations.

Instead, the estimate may be used for estimating how well other supercomputers and distributed networking projects would be able to mine bitcoin, since supercomputers have the capability to perform the integer operations used in hashing.

Therefore, today's fastest supercomputer, China's Tianhe-2 with a performance of 33.86 Pflop/s, would measure at about 0.001% of the bitcoin network.

Monitoring network health

As bitcoin matures and starts to compete with legacy retail payments networks like Visa and MasterCard, and wholesale networks like Swift, the health of the decentralized network becomes vital to its performance capabilities.

Community site does an excellent job of maintaining the historical archive of network status alerts and vulnerabilities.

The assembled report below lists the critical statistics for monitoring the ongoing health of the distributed bitcoin network, covering the measurements important for reachability, scalability, security and transaction processing speed.

1. The Bitnodes Project

Bitnodes estimates the size of the bitcoin network by finding all the reachable nodes in the network. The current methodology involves sending getaddr message recursively to find all the reachable nodes in the network starting from a set of seed nodes. It performs this polling every 24 hours and displays the results on a world heat map of countries, including rankings and version of bitcoin reference client.

Source: Bitnodes
The Bitnodes Project launched in April 2013 with the Bitcoin Foundation’s sponsorship as a community resource. The project's latest report can be seen here.

2. Data Propagation

Data propagation
Source: BitcoinStats
The information exchange in the bitcoin network is all but instantaneous. Exactly how fast is information being propagated in the network though? Maintained by BitcoinStats, the propagation evolution chart shows the 50th percentile of the inv-messages received by peers (ie: the plot shows the time since a transaction or block enters the network until a majority of nodes has received and processed it).

3. DNS Bootstrap Servers

DNS seeds are used by almost all bitcoin clients to identify a set of nodes to connect to when starting. The seeds are run by volunteers using a multitude of mechanisms to ensure the returned seeds represent a good sample of nodes currently online.

DNS servers
Source: BitcoinStats
Except for, the seeds aim to return nodes that are currently online and reachable. Also provided by BitcoinStats, the chart shows results from regular bootstrap attempts using the seeds with the plot representing the average hourly connection success rate for each of the seeds. The closer to 100%, the better the seed is.

An auxiliary chart with response time of DNS seeds to queries is also provided, which indicates the response times in milliseconds (ms) elapsed between sending the query and receiving a response.

4. Network Hashing Rate

Provided by developer Pieter Wuille, this series of graphs display hashing difficulty and the estimated number of terahashes per second (computation speed) that the network is performing for various time windows (1 terahash equals 1,000 gigahashes).
Hashing rate
Calculated by dividing maximum target by current target where target is a 256-bit number, difficulty measures how difficult it is to find a new block compared to the easiest it can ever be. Difficulty adjusts every 2,016 blocks (or two weeks) and to find a block, the SHA-256 hash of a block’s header must be lower than or equal to the current target for the block to be accepted by the network.

5. Hash Rate Distribution

This pie chart from Organ Ofcorti is an estimation of hash rate distribution amongst the largest mining pools at a weekly interval. It is important to monitor because the integrity of the network depends on a single actor not exceeding 50% of the overall hashing power.

Network blocks
Source: Organ OfCorti
A table of solved block statistics lists all statistics that can be derived from the number of blocks a hash rate contributor has solved for the past week. Block attributions are either from primary sources such as those claimed by a particular pool website, or secondary sources such as coinbase signatures, or known generation addresses.

When dependent on secondary sources only, data may be inaccurate and miss some blocks if a particular block-solver has gone to some trouble to hide solved blocks and this will result in an underestimate of the block-solver hash rate.

An alternate chart across 24-hour, 48-hour and four-day time horizons is provided by Blockchain.

6. Selfish Mining Indicator

Produced by Coinometrics, this metric attempts to measure the likelihood and prevalence of bitcoin miners engaged in a subset behavior of the 'Selfish Mining' strategy, as described by Ittay Eyal and Emin Gün Sirer in their paper, Majority is not Enough: Bitcoin Mining is Vulnerable.

selfish mining indicator
Source: Coinometrics
Since the bitcoin protocol relies on miners following the rules laid out by the software, as soon as miners have found a block they need to announce it to the network.

Selfish mining defies this rule, because certain miners, once they have found a block, can withhold it from the network and start working on their next block. Once they have a number in their hidden chain, they can release them to invalidate the blocks that the network thought were part of the main chain.

The lower the probability that at least k (actual distribution) blocks will be found in the time represented by the first bucket, the more likely that miners are engaging in quick succession behavior under the Selfish Mining strategy.

Coinometrics explains:
"One way to estimate the likelihood of such a strategy being implemented is to measure the distribution of the time between blocks against the expected distribution. The rate of creation of bitcoin blocks is determined by how quickly the first miner solves for a hash meeting the difficulty requirements of the protocol. Every attempt to meet this difficulty has a set probability of being correct. By definition, the probability is independent between hashes. As a result the rate at which blocks are generated should follow an exponential distribution."

7. Orphaned Blocks

orphaned blocks
Source: Blockchain
Orphaned blocks are valid blocks which are not part of the main bitcoin block chain. They can occur naturally when two miners produce blocks at similar times or they can be caused by an attacker with enough hashing power attempting to reverse transactions.

Initially accepted by the majority of the network, orphaned blocks are those that are rejected after proof of a longer block chain is received that doesn't include that particular block. In other words, a user could see a transaction as having one confirmation and then revert to zero confirmations if a longer blockchain was received that didn't include the transaction.

8. Double Spends Monitor

Blockchain maintains a real-time monitor for double spends detected in the last 500,000 transactions utilizing a 10-minute cache. This could be used to alert users to potentially malicious transactions on the network.

9. Unconfirmed Transactions

unconfirmed transactions
Source: Blockchain
Blockchain also maintains this live updating list of new bitcoin transactions waiting to be included in a block. The monitor displays total number of unconfirmed transactions, including total fees and total size in kilobytes.

10. Average Transaction Confirmation Time

Confirmation time
Source: Blockchain
This measures the average (mean) amount of time in minutes that it takes for a transaction to be accepted into a block. Reasonable estimates differ on the amount of time and confirmations for a transaction to be considered cleared and ‘good’, but that appropriate risk level would be associated with the transaction’s value.

11. Block Chain Total Size

Block chain size
Source: Blockchain
The block chain total size is important because of the storage space considerations as it grows as well as the time it takes for initial synchronization after installing the reference client for the first time. This measurement shows total size of all block headers and transactions not including database indexes.

12. Average Block Size

Block size
Source: Blockchain
Measured here in fractions of a megabyte, the block size will become a heated debate once the bitcoin network starts approaching its current throughput limit of approximately seven transactions per second.

Ultimately important for scalability, the stated block size limit will have to be increased, linked to another variable, or remain the same with more confirmations pushed off chain, each path having corresponding implications for decentralization of the system.

Please let us know in the comments section below if we have omitted any measurement critical to network operations or if any references are out-dated.

Saturday, August 23, 2014

CFPB Warning Ignores Bitcoin’s Consumer Protections

By Jon Matonis
Monday, August 18, 2014

Last week's advisory from the US Consumer Financial Protection Bureau (CFPB) warning consumers about the risks of virtual currencies such as bitcoin diligently listed several obvious risks, but simultaneously omitted the very consumer protections provided by certain cryptographic monies.

Citing malicious hackers, potentially high mark-up fees, exchange-rate volatility, lack of governmental insurance, and risk of private key loss is laudable given that so few market participants conduct proper due diligence before jumping in to a new alternative. The majority of companies involved in the bitcoin ecosystem have been highlighting these risks for years.

To be fair, the CFPB charter may not include stressing the particular benefits of some payment methods over others. However, when the words 'financial protection' are in your agency's official name, it appears disingenuous to intentionally omit features from what may be one of the world's most protective financial instruments ever designed.

Who benefits most?

Bootstrapping a competing free-market alternative in a field of national currencies with so many pre-existing and unfair legal tender advantages resembles the solving of the great chicken-or-the-egg debate: which came first, the merchant or the consumer?

A recent New York Times article on bitcoin merchants sparked an instructive debate about whether bitcoin was mostly a payment method benefiting merchants or if consumers also gained substantial benefits from the digital currency.

Merchants need an incentive to accept the new currency before consumers can spend the new currency. And similarly, consumers need reasons to hold the new currency before merchants can accept it. The CFPB advisory warning does little to instill confidence in the latter.

Therefore, in order to better assist consumers, I will describe some of bitcoin's superior attributes in the area of financial protection:

1. Protection from counterfeit bank notes
As the most counterfeit-proof currency in existence today, bitcoin protects consumers from the risk of accepting or receiving counterfeit bank notes in commerce, which continues to plague the world's fiat note issuers. By virtue of the innovative bitcoin block chain, transactions are chronologically recorded in a shared database preventing double-spending and it is computationally impractical to modify once recorded in the chain.

2. Protection from financial surveillance
Just as massive digital surveillance of our email correspondence, telephone conversations, instant messaging, and web surfing habits has escalated in the last 20 years, so has surveillance of our income, spending, and financial transactions. Individuals and corporations are under the financial microscope now more than at any time in history – a fact that has significantly eroded any remaining vestiges of financial privacy. As we move from a paper money world to a digital money world, maintaining our analog equivalent rights becomes a necessity.

Governments crave this information in the name of preventing money laundering, fighting terrorism, collecting taxes, and fighting the drug, gambling and pornography wars. Bitcoin restores the balance with financial privacy and financial sovereignty by placing responsibility for how transparent we want to be in the hands of the user where it belongs, hence user-defined privacy. This is also permission-less privacy and, if opted for, it includes total balance privacy in addition to transaction date, type, amount, and recipient privacy.

3. Protection from identity theft
Bitcoin provides excellent protection from both identity theft and fraudulent charges, primarily because it functions as a push-method rather than a pull-method for personal financial details. Since account details and identity are not transferred to the merchant for payment purposes, the potential for malicious hackers and internal corporate security breaches are reduced to zero. With current payment methodologies, however, identity theft and resulting consequences to the victims are significant negative issues.

4. Protection from physical loss of assets
In this sense, bitcoin is virtual, however the comparison is to trusting the safekeeping of your assets to a third party like a financial institution or wallet provider. Of course, when utilizing a third-party, a host of new risks is introduced which government regulation and government deposit insurance seek to address. But, not using bitcoin because it doesn't come with government assurances is like not flying because you might fall out of the sky.

Bitcoin possesses the option of simply not having to trust a third-party intermediary and, in this way, it resembles a digital bearer instrument such as gold or paper cash. However, bitcoin's unique exceptions include the ability to safely backup your assets multiple times and to transfer them digitally without sacrificing their bearer nature.

5. Protection from cross-border restrictions and excessive fees
Some money services businesses and financial institutions charge exorbitant fees just to execute a simple monetary transfer often preying upon those that are most financially vulnerable. Other countries severely restrict the amount and type of national currencies that may enter their borders causing hardship for many American citizens and residents needing to transfer living funds to family members overseas. Without requiring an intermediary, bitcoin insulates individuals and businesses from these detrimental restrictions and fees.

6. Protection from payment blockades
Blockades such as these are typically enacted in the name of 'political correctness' as witnessed by the aggressive payment blockade against WikiLeaks in 2011. As the US government leaned strongly on payment processors Visa, MasterCard, and PayPal to discontinue donations to the whistle-blowing site, donations in bitcoin continued to provide a valuable method for WikiLeaks to maintain an ongoing financial stream for operations.

7. Protection from government-sponsored inflation
As the so-called 'hidden tax', inflation represents one of the most insidious methods ever devised by governments to boost their wealth at the expense of the fleeced middle-class. Without significant assets to appreciate and keep pace with government-induced inflation, it is the poor and middle-class that suffer the most during inflation, despite the fact that the decline in purchasing power may only be noticeable over a longer time horizon. Bitcoin, with its fixed and predictable supply, provides a store of value alternative to the currency of nations with printing presses run amok.

8. Protection from confiscation
Arbitrary and capricious confiscation of assets has emerged as a new trend among debt-saddled countries in the euro zone. Cyprus and Spain are two examples, but any government with control over its banking system assets has the potential to enact a 'deposit levy' or a 'wealth tax' if revenues from taxation are insufficient to meet ongoing government obligations. The protections afforded by bitcoin in this area prevent loss of wealth due to random government asset seizures.

Let the buyer beware

Today, I was reminded that Confucius once said: "The beginning of wisdom is to call things by their proper name." So, let's not forget the ongoing bitcoin word game played by governments and other wordsmiths.

Confucious said, “The beginning of wisdom is to call things by their proper name.” - See more at:
Confucious said, “The beginning of wisdom is to call things by their proper name.” - See more at:
Confucious said, “The beginning of wisdom is to call things by their proper name.” - See more at:
Confucious said, “The beginning of wisdom is to call things by their proper name.” - See more at:
While we should definitely heed the risks within a digital currency environment, just as we heed the risks inherent with physical money, we should be equally aware of the additional financial protections provided by bitcoin that are so critical for maintaining a free society. Caveat emptor!

Tuesday, August 5, 2014

Bitcoins Affected by New York's BitLicense May Trade at Discount

By Jon Matonis
Wednesday, July 30, 2014

With New York's BitLicense scheme officially three months away, sophisticated traders are already devising strategies to profit from the potential arbitrage opportunities.
If implemented in the regulation's final version, the physical address and identification requirements (Sections 200.12 and 200.15) for both sides of a transaction will dilute the inherent privacy of the overall bitcoin network.

Due to potential IP address blocking and other techniques to identify and block New York-based traders, the exchanges operating within the jurisdiction may end up 'ring-fencing' themselves and their customers' bitcoin.

Of course, this was not New York's intention, but if other parties begin to shun 'New York' bitcoins, then those parties that do choose to accept them may only accept them at a discount, making it costly to transfer 'non-private' bitcoins out of New York.

Tainted by government

Typically, we refer to a loss of essential fungibility occurring as a result of some type of positive coin validation required by the government. In this case, it would be the government-approved coins that would be tainted. Perhaps, New York could mandate complete fungibility of their exchanges' coins through legislation, but that would imply subsidizing the exchange rate.

Arthur Hayes, CEO and co-founder of BitMEX (Bitcoin Mercantile Exchange), who has strong derivatives experience with an institutional trading background, explained:
"These regulations are going to make some savvy traders a lot of money. Because there is a premium placed on privacy, the 'clean' coins trading on exchanges with BitLicenses will trade at a discount to coins trading on exchanges that operate in more laissez-faire jurisdictions. Traders with the ability and risk appetite will be able to arbitrage the price differential."
Based in Hong Kong, Hayes is launching a bitcoin futures and options exchange similar to the currency futures exchanges that sprouted up in Chicago after the 1971 collapse of Bretton Woods.

Hayes recently participated on CoinSummit's derivatives panel in London, where he said he is counting on large speculators and commercial hedgers to utilize exchange-traded futures and options as a risk management tool for bitcoin.

Jurisdictional differential

Just as WTI (West Texas Intermediate) crude oil contracts vs North Sea Brent crude oil contracts trade at a differential and Chicago wheat contracts vs Kansas City wheat contracts trade at a differential, certain jurisdictional bitcoins can trade with a differential. For now, only a single-type bitcoin futures contract will be traded on BitMEX.

Indeed, newly mined 'virgin' bitcoin have commanded a premium for some time now in certain circles. In 2013-14, Mt. Gox coins frequently traded at either a premium or discount to other bitcoin depending on politics and exchange liquidity.

With physical bitcoin over the counter or with person-to-person trading, Hayes describes a likely scenario:
"The best example would be citizens of New York who wish to anonymously buy Bitcoin. Buyers will need to pay an increased fee to a trader who does not possess a BitLicense. The fee will cover his or her costs of acquiring coins outside of New York, and extra profit for the trader compensating him or her for the extra risks taken."

Bitcoin black market

Free markets solve political and structural problems to increase liquidity, and currencies are no different.

Today, one of the best examples of this is the 'blue dollar' exchange rate in peso-ravaged Argentina, which trades at a 60% premium to the official US dollar exchange rate with the central bank.

The BitLicense-based exchange rate may be the closest thing to an official central bank rate for bitcoin and maybe this is a conscious attempt to develop an institutional wholesale market.

Ultimately, it could be a bonanza for those that find themselves with the unofficial bitcoin, just like the happy tourists to Argentina.

It's quite possible that, at the end of the day, we will see a three-tier rate structure for bitcoin:
  1. Virgin bitcoin
  2. Free market bitcoin
  3. Tainted jurisdiction official bitcoin
Hayes added, "At the end of the day these regulations will do nothing but push more trading off exchange and make it more expensive for honest people to obtain financial privacy."

Tuesday, July 29, 2014

Beyond New York: What Lies Ahead for Bitcoin

By Jon Matonis
Thursday, July 24, 2014

According to the proposed 17th July bitcoin regulation from New York State, the public now has 45 days to comment and then a 45-day grace period prior to full adoption. But what's after 17th October? More importantly, what's after New York?

The poor regulators are in a quandary. It's hard not to be sympathetic sometimes. They are practically in a no-win situation, because regulators must use their tools to regulate, but the more they do, the more they inadvertently encourage market-based responses.

With the New York framework for bitcoin businesses, financial regulators need to demonstrate that they have not ceded control of the payments mechanism and the wholesale money transfer business, while simultaneously trying not to be accused of squashing technological innovation.

If improved financial privacy is considered a bitcoin innovation, then, yes, government choke points do stifle innovation.

Sitting on a razor's edge, their actions can either propel bitcoin more into an off-the-books counter-currency or retard US monetary progress for decades as more nimble jurisdictions exploit the economic benefits of cryptographic money. However, in the regulator's mind, they have no good options and permitting unimpeded bitcoin growth is unacceptable  so act they must.

Regulators and their red herrings

It is this general desire for enforcement action that so fatally misses the mark, because it blindly ignores the societal consequences of the great cryptocurrency wealth transfer and the temporary turmoil for the wave of people caught ill-prepared.

If anything, governments should encourage greater bitcoin savings and user-friendly open-source software. Seismic shifts that will transform existing financial and political institutions are now occurring directly underneath our feet.

And, while all of that happens, what do New York regulators choose to focus on?

Among many red herrings, they focus on perceived problems, like identifying physical addresses of bitcoin transactional parties and prohibiting bitcoin-related companies from maintaining profits in bitcoin.

Contrary to what the alarmist Perianne Boring states, bitcoin's fate will not be decided by lawmakers and regulators in the next 18 months. The only fate that will be decided is that of New York and any other regions that would adopt such a harsh line of regulatory thinking. In other words, the New York Department of Financial Services (NYDFS) doesn't harm bitcoin, it harms only the citizens of that jurisdiction who suddenly become disadvantaged relative to citizens in the rest of the world.

Here's what happens on 17th October: bitcoin continues to be a juggernaut, rolling over the promiscuous money printers and corrupt kingpins of the centrally planned banking system, albeit with some market-based adjustments. Markets perceive regulation as 'damage' and route around it. This is true with Internet-related damage and it is equally true with bitcoin-related damage.

Ultimately, the market will provide solutions to cases of bitcoin privacy 'damage', so I provided two handy reference guides: 'Why Bitcoin Fungibility is Essential and 'A Taxonomy of Bitcoin Mixing Services for Policymakers.

Bitcoin, Tor and Financial Privacy

For starters, don't be discouraged by the New York regulatory proposal, because while exchanges and banking interfaces are useful for price discovery, they are optional for everyday bitcoin usage.

Government attempts to exploit systemic choke points is all part of the natural transition process.

Similar to the Electronic Frontier Foundation's Tor Challenge to circumvent government censorship, the bitcoin community needs a challenge to support and encourage true financial privacy, compared to the sanctioned privacy permitted under the guise of consumer protection. Privacy is claimed  it is not sanctioned.

Without privacy by default in the original Satoshi bitcoin client software, additions and workarounds for various wallet implementations have been the norm.

Writing in Forbes, Andy Greenberg explains that an upcoming version of bitcoinj the software that powers many of the most popular bitcoin apps like Multibit and Bitcoin Wallet  will route all connections to the bitcoin network over Tor’s anonymity network before reaching another bitcoin node.

Bitcoinj creator Mike Hearn said:
"The fact I use bitcoin isn’t a secret, but I don’t want all my transactions in an NSA database. When I use bitcoin in a bar, I don’t want someone on the local network to learn my balance. The way bitcoin is used today, both those things are possible."
Thanks to IP tracking, it’s "possible that the NSA and GCHQ have de-anonymized most of the block chain by now," he added.

Also, various implementations of the CoinJoin method have emerged recently, including Shared Coin from Blockchain and the Dark Wallet alpha release from developers Cody Wilson and Amir Taaki.

Relying only on bitcoin for operations and avoiding the regulatory glare implicit via banking relationships, Blockchain's modern uniqueness is in tune with bitcoin's principles, including user-defined privacy.

Despite some prior user claims to the contrary, Blockchain does not block Tor exit nodes  although individual account owners can block Tor IP access. Denial-of-service defenses may also cause some Tor exit nodes to be blocked temporarily.

In an enormously important three-minute interview, political theorist and global resilience guru Vinay Gupta recognizes that "[bitcoin] cannot be divorced from pre-existing political theory."
Gupta goes into explicit detail on the meaning of power and the significance of property rights:
"The vast majority of the people using bitcoin are politically shallow. The problem is that bitcoin has succeeded technically and is midway through the process of failing politically."
Gupta explains that the fundamental underlying issue for bitcoin and its future success is how to do strong property rights within the system and no property rights to operate the system as whole. The answer lies in what we already know about political theory and similar economic arrangements.

Foreshadowing the coming slew of ambitious regulatory restrictions, he surmises that "until the bitcoin community admits that it's got political problems rather than technical problems, they're trapped".