Bitcoin, set out to replace currency, settles as a global commodity. The qualities Bitcoin expresses in abundance, security, scarcity, and reliability, push a powerful narrative which certainly may increase its market value on a global stage. But this positioning as digital gold sacrifices qualities necessary for an everyday currency, and supports the acceleration of institutional control. No longer a protestation of the fraudulent state-backed financial system, bitcoin provides a chance for clever institutions and investors to ensure their status for the digital age. The main problems revolve around stagnant technological progress, especially in the face of costly barriers for users, network (mining, asset ownership, technical development) dominance by institutional players, and a communal failure to challenge core functions of the banking system.
Commodity VS Currency
I am prefacing the bitcoin analysis with some words on the differences between commodities vs currencies and how I apply the distinction to btc.
The label commodity vs currency means nothing in practice (besides legal interpretations), but understanding how bitcoins behaviour fits commodities helps us understand the dominant narrative of ‘digital gold’. The line between commodities and currencies blurs all the time, but the basic differentiation follows: commodities are generally materials to be used for production and often have corresponding tradable financial instruments. Oil, grains and metals represent traditional commodities. Currencies on the other hand denominate assets and act as an accepted medium of exchange for most if not all financial interactions.
Commodities certainly can be used as currencies in certain situations or cultures, but they do not tend to denominate a diverse range of assets or financial contracts. For instance, Gold, once a common currency and medium of exchange, today mostly acts as a commodity. Gold bullion denominates few financial contracts, nor is accepted in general commerce. Industry specific production strongly determines supply dynamics for commodities, but modern currency does not directly depend on the geophysical industrial shifts of one industry.
While quite different in mechanism, bitcoins production ultimately works with similar patterns as traditional commodities. Mining for bitcoin in any consequential capacity requires a secure building, wide array of computer infrastructure, knowledge/skills for maintenance/optimizations and access to energy. Just like with any industrial enterprise, bitcoin mining operations must balance costs of infrastructure with production capacity. The enterprise bets that future demand for the product exceeds costs required for operation. With bitcoin, where does this demand originate from and for what purpose? Let's look at the primary narratives pushed by those investing the most capital.
The social narrative from institutional bitcoin investors communicate bitcoin as ‘digital gold’, a hedge against excessive money printing from central (and commercial) banks. One telling tweet from the founder of MicroStragies shows the mind set in relation to scaling concerns:
The groups investing hundreds of millions of dollars into BTC, do so believing Bitcoin will at least retain purchasing power. Some bitcoin elites, names like Simon Dixon, Max Keiser, and other common bitcoin names often purport this view. As a practical matter, network fees do not inhibit the wealthiest to use the technology. When all they need is a dozen transactions every year, then 100$ transaction fees could be manageable. As a medium of exchange however, this is obviously prohibitively expensive. While I wont talk about ethereum here beyond this, the same basic truth holds, there the wealthiest can use complex financial mechanisms to earn yield, while also pricing out smaller holders accessing arbitraging. Without an effective technological solution, then bitcoin will never be able to reach the masses in its effective form and banks and other institutions will continue to mediate finance. Commodity or currency, reality continues to unfold and bitcoin grows along with it.
Later on we will look at some controlling influences throughout the ecosystem, but next I’ll examine some of the issues around bitcoin technological infrastructure.
Bitcoin retains a highly conservative security model. Every change takes careful deliberation, and security usually takes precedence over minor advantages or perceived uncertainty. People's interpretation of security differs, but generally the less changes the better. New code introduces new structure whose behaviour is unknown in the wild. This security focused conservative mindset expresses a level of maturity for the network, yet also reduces technological advantage over time, leaving it more reliant on established network effects and vulnerable to innovative competition. |
The integrity of bitcoin depends on people's ability to mine blocks and run full nodes. These are largely separate entities. Full nodes hold the entire state of the bitcoin blockchain, initiate all transactions, and verify blocks. Miners compete for blocks and then fill them with transactions from the mem pool (a transaction waiting list of sorts). No monetary incentive to run a full node exists, and miners incentivized through block rewards, originate and sell btc.
Within full nodes we have two main categories, open and closed nodes. New nodes need nodes with open ports to download the blockchain, without open nodes, new nodes could not join the network. Closed nodes isolate themselves from other nodes, increasing their capacity and securing themselves from some possible attack. Closed nodes also lose access to unconfirmed transactions in the mem pool (3).
New unique addresses with small amounts have been up on bitcoin, but the number of nodes remains on the floor, approximately ~42,000 total nodes and ~4000 open nodes (1). This indicates that the new addresses rely on current nodes rather than spinning up new ones. Perhaps wallet providers or exchanges have seen bitcoin demand, but these new customers don’t want to run nodes themselves. This also supports the premise that institutional money, relying on a custodian, may be on the rise as well.
The classic argument, found on reddit and the bitcoin wiki, for the non monetary incentivisation for running nodes, believes that logical users will want to maintain their own store of the blockchain in order to verify the history and send transactions (3). While true for early adopters and enthusiasts, it's highly possible that a large portion of the newer users hold little interest or ability in running a full node in light of the numerous costs. A user spinning up a full node today is conceivable, despite the costs and clunkiness, but an increasingly dwindling number of individuals could possibly manage to mine a block today by themselves.
Instead of taking bigger risks, and adopting changes that enhance bitcoins ability to grow with adoption and technological progress, controlling groups decided to build protocols on top of bitcoin to help grow capacity. The lightning network and liquid network, both developed through blockstream, represent the biggest ‘solutions’ to the network's ceiling.
So far these second layer protocols exhibit poor growth and potential security flaws (2). Fundamentally, by Introducing an auxiliary payment function, you invoke complexity and risk. The lightning network currently contains ~1000 BTC while liquid holds ~2500 (4, 6). Evidence of high routing costs resulting in economically irrational nodes was presented by Ferenc B´eres, et al (11). Through a mix of public data and simulation software the team found that LN nodes apparently underprice routing costs and behaviour in an economical irrational manner.
Privacy, if desired, also strains routing costs.“Strong Statistical evidence” can be gleaned from transaction participants because of large central routing nodes . However, By choosing a deliberately longer and more costly path, nodes can still hide information. Several implementations of lightning already do this(11).
Liquid sidechain, created by blockstream is the other major layer two bitcoin solution. Created by blockstream, Liquid follows a similar pattern to Lighting Network, but the two are built for different audiences. Lightning Network is bitcoin's public scaling solution, while the Liquid network enables asset creation, tokenized securities, tokenized fiat, but is controlled through a federation of exchanges. A recent ‘bug’ left 8M usd worth of L-btc in control of the blockstream emergency multisig (5). The network contains almost twice as much btc as Lightning, but completely falls flat compared to tokenized btc on other chains. WBTC, the largest issuer on ethereum has released over 75K of tokenized bitcoin.
Both solutions rely on centralization of nodes external to the main Bitcoin chain. Instead of fixing the scaling problem through innovation and rearcitecturing, the major influencers doubled down on a conservative strategy. Now we’ll explore a main player in the Bitcoin sphere.
(2) Jona Harris, Aviv Zohar Flood & Loot: A Systemic Attack On The Lightning Network
15 Jun 2020 (v1), last revised 27 Aug 2020 (this version, v4) https://arxiv.org/abs/2006.08513
Ownership and Control
Okay now time for a tougher, more subjective, conversation about control and influence in the Bitcoin ecosystem. Due to Bitcoin's meteoric rise, many of the original institutional investors gained fourtanes and set the foundation for corporate empires. One of the most influential companies in the entire crypto ecosystem, Digital Currency Group, founded by Barrey Silbert, deserves special attention. Much like a miniature Kochtopus, referring to the Koch Brothers massive empire, one can find Digital Currency Group’s tentacles all over crypto. Silbert and co provide a major connection between crypto and the traditional financial industry .
Silbert himself is a key to understanding the connection. As a former banker, Silbert worked on some headline bankruptcies such as Enron and Worldcom. Afterwards he formed his own investment company which specializes in dealing illiquid assets such as restricted stock, mortgage backed securities and collateralized loan obligations. Eventually to be known as SecondMarket, this company positioned itself quite well for the financial crisis when billions of assets were becoming illiquid. SecondMarket also proved valuable to growth tech companies, Facebook and Zynga employees both used SecondMarket as liquidity to sell stock options pre IPO. Since around 2012 Silbert had personally been buying Bitcoin (~200,000 usd around 5-10 per btc) and eventually started using SecondMarket to buy BTC as well, setting the stage for the eventual Digital Currency Group (13).
Created through a fusion of Silberts own assets, greyscale investment fund and genesis OTC trading (at that time owned and operated by SecondMarket) The company's formation, initial investors, and advisory figures elucidates some of the direction behind one of the giants of this industry. The published participants in DCG’s undisclosed fundraising round comprises: Bain Capital Ventures, CIBC, CME Ventures, FirstMark Capital, MasterCard, New York Life, Novel TMT, Oak HC/FT, RRE Ventures, Solon Mack Capital and Transamerica Ventures (17). I do not know a ton about each of these operations, but a few names stick out, Mastercard, New York Life and CIBC. So here we have a global financial services company, life insurance company, and one of the largest commercial banks in Canada investing in a company built around cryptocurrencies. Global financial players want to leverage technology to their advantage of course, so just think how banks might want to shape cryptocurrencies to work in a framework profitable to them. Hint it is not through scalable public blockchains and accessible financial tools.
Larry Summers also sits as the solely listed board advisor. Quite a catch for the nascent crypto space, Larry Summers, for those unfamiliar, perhaps best represents the entrenched traditional global financial system in America. Summers served in several US administrations (notably as secretary treasury for Bill Clinton) and as president of the world bank. Between serving in the Clinton and Obama administrations he amassed millions in speaking fees for companies he used to regulate, and worked cozy jobs in private finance. His personal net worth between the administrations changed from around 400K to 10-30M. Summers maintained a “special” relationship to Jeffery Epistien, which began before his time in the Clinton administration (15). They both held seats on the Trilateral commission and Council of Forgien affairs, two infamous think tanks. He also participated in the steering commissions of the Bilderberg group(12).
Fast forward to 2020 and Digital Currency Group serves as one of the largest players in the game. Digital Currency Group operates as a company, owning several subsidiaries, maintaining a portfolio of digital assets and stakes in hundreds of crypto companies. Some of the big names they initially invested in include Coinbase, Ripple Labs, Blockstream, Bitpay, Bitgo and many others. An informal, very loose valuation by Messari folks in 2019 placed DCG near 2 Billion(16). They operate the largest digital asset management firm in the world through their subsidiary Grayscale investments, whose btc trust fund (4.7B under management) was the first to become an SEC reporting company. DCG also owns coindesk, one of the main media outlets in crypto. They formed the leading blockchain lobbying force in the United States, named the Blockchain Association (9).
One of DCG newer subsidiaries Foundries, specifically focuses on the mining industry. The CEO maintains three focus, miner operation financing, advisory and consulting services, and foundry labs which will focus on staking. They also claim to have procured over half of the mining equipment imported into North America. DCG committed around 100M to Foundry through 2021. A recent partnership with Bitmain was announced, with Foundry helping Bitmain’s North American customers secure financing. Mining, as one of the critical pillars of blockchain, represents the integrity of the network. The more groups looking to Foundry for financing, means more influence DCG has on the sector's development in general.
Digital Currency Group, between its founder’s perspective, the initial investors, and the company's origins, works towards bank adoption and (preferably) control of cryptocurrency. Building off chain payment networks keeps users in costly situations. We see that beneficiaries of DCG’s investment pursue these networks. The prime culprit in Bitcoin is Blockstream. In the section above we learned about some of the failings of the Lightning and Liquid networks.
Blockstream plays a major role in attempting to bring Bitcoins volume off the main chain between its support of Lightnight network and Liquid. Bitmex published a helpful blog post into funding sources for Bitcoin developers. With two approaches Bitmex looked ‘top down’ and ‘bottom up’. Top down looked at organizations funding developers working on Bitcoin core. Blockstream and Lightning labs lead this category with 8 devs a piece. Bottom up approach focused on commits by individual developers then matched them to their funding source. “Independent” devs lead all organizations, Chainnode follows with blockstream a far third (7).
The current distribution of developers appears relatively healthy, however ultimately miners and nodes determine the network's iteration. This feature(problem?) with Bitcoins governance involves a slightly complex situation where developers write the possible additions or modifications to the protocol, but the groups who actually compose the network hold the power to implement whatever version they want.
There is plenty of overlap between groups and generally their interests align, but sometimes major divides occur.I won't comment on the many great divides which broke apart bitcoin, but unfortunately a long history of censorship on social media platforms exists for the bitcoin community (8) Certain powerful organizations hold political, financial and intellectual collateral against competition and have an outsized impact on development focus. Digital Currency Group remains a central player, but by no means holds complete control of anything, especially as the so-called altcoin market continues to take market dominance away from bitcoin.
This introduction offers a brief incomplete analysis of Bitcoin present condition and some of the forces driving its behaviour. Next I will focus on the burgeoning Nexus Protocol and explore how it solves some of the trickiest problems with cryptocurrencies.
(8)A (brief and incomplete) history of censorship in /r/Bitcoin