Crypto Thoughts; proclaimed benefits vs. current crypto downsides

May 16, 2018

 

The revolutionary technology of blockchain and the interlinked crypto-economics could prove to be revolutionary. In some respects, it already is; never before have we witnessed mathematically based currencies sprung up, not by central governmental authorities but instead by entrepreneurs and developers and be traded too. 

 

On the other hand, crypto economics and blockchain certainly has a long way to go yet in order really prove itself. The ICO’s and new digital currencies’ current value is mostly based on what ‘it could become’, not on ‘what it already is’. It is a bet on an idea, a vision, a code, and the team that sets all this together. In the below I will write first about the proclaimed benefits (PB) followed by the current downsides of these arguments (CD) of crypto currencies. 

 

  1. Crypto currencies are decentral and therefore democratic. 

 

(PB)Indeed, they are: 

  • There is no central authority that decides whether funds will be used for, or not used for. As an example, if a trade ban on a certain country, like Iran, will cut the country off from the international banking system, the citizens will feel this pain. We might, or we might not agree with this ban, but in a crypto environment there is no such political intervention that can dictate these restrictions. 

 

(CD) Or perhaps not so democratic in the end:

  • Miners, who get rewarded in coins for their work as code calculators, are for a sizable part pooled. These pools are run by pool managers. This has the advantage that system upgrades can be easier and the variance in mining rewards will be reduced. On the other hand, it directly contradicts the democratic and decentralized vision of crypto economics.  Bitcoin, the supposed super decentral currency, is in fact controlled for nearly half by only four pools. 

  • Who actually decides upon what happens with the coin, if it is not authorities; is it then all of us, as should in the theoretic perfect democratic monetary system? Not really. The developers and founders of the coin have a lot of power. Most holders of the coins generally do not hold the coding knowledge which therefore remains in both figuratively and literally in the hands of the developers and founders. How democratic is that?

  • Now let’s say that the founders and developers make either willingly or not tremendous mistakes, who will hold them accountable, or what institute does? None would, since they do not hold accountability like the central banks and other institutes do, nor are there similar rules on what they should publish. In short, there is a potential, but tremendous, lack of accountability. 

  • We all know that solving the crypto puzzles requires hardware that unfortunately costs energy. But it is really getting out of hand now. Bitcoin mining has already taken over the equivalent of the total energy consumption of a variety of countries, currently at the size of the Czech Republic (digiconomist.net). Now however, we are talking about the fact that Bitcoin mining will in the near future use the equivalent of electricity as the United States of America. There are some coins who have alternative approaches using less electricity, but having gone towards the stage we are now, when did we actually all agree with this tremendous waste? In particular in this time where we are talking about all kinds of measures to reduce electricity consumption. Envion is a coin that proclaimed to set up a sustainable energy infrastructure in order to do something against the energy waste problem. After raising over slightly over $100 million with their ICO beginning 2017, they managed with internal struggles, non-communication and progress, and yet-to-be investigated outright fraught, destroy investors confidence leading the coin to drop to currently around 15% of it's starting value. Not so much of a relieve yet therefore unfortunately. 

  • Finally, bitcoin and other coins are supposed to be an opportunity to redistribute wealth perhaps even more equally, different than the current capitalistic and centralized system where wealth is too unequally distributed. However, who in East Timor or the Central African Republic has recently been euphoric about their crypto transactions? Not just less developed countries with a population that is less aware of these innovative financial systems, with internet facilities (which the transactions require) that aren’t yet supporting all of this to thrive, but also the people in developed countries that are less in touch with the latest developments in crypto economics miss the opportunity to gain in wealth. Too bad for them we could say, the frontrunners and innovators should be richly rewarded. Perhaps they should indeed. However, this then again, is quite centralistic and capitalistic, quite how it was in fact. Then what is new?

 

   2.    Crypto currencies are more secure. 

 

(PB) Great, so my assets will be completely safe:

  • The blockchain allows the free transfer of crypto trough a decentralized environment. All this data is held in an interlinked network of computers which are both owned and run by all the users of the blockchain. 

 

(CD) Not sure, if this is that safe though:

  • Numerous hacks have already taken place, mainly on the exchanges that hold cryptos for customers. The Mount Gox hack has cost $450,000,000 and decreased confidence in the overall ecosystem for a while. True, this was a wallet, and not the blockchain system itself. 

  • The above-mentioned mining pools have become quite sizable in many digital currencies already. Worse, we are not as intended dependent on mathematical systems alone at these pools, but dependent upon the ethics of the pool manager. If more than 51% of the network’s hash rate is under one single entity, this entity could destroy the decentralized nature of the network by; 

    • double spending; spending the coin more than once 

    • random forks; a divergence into chains where a part of the network has a different perspective on the history of transactions, and thus the blockchain

    • selfish mining; miners mine for coins by both discovering and adding blocks to the blockchain by solving increasingly hard cryptographic (mathematical) puzzles. The majority of the network needs to recognize and approve the outcome of, and the calculation itself. With 51% of the hash rate, there is off course no need any more to wait for approval of the majority, since it is already owned by you, as the dominant entity

    • cancelling various transactions; not accepting (any) transactions to any of their blocks owned by the 51% majority 

If any of the above where to happen however, it is not in the long-term interest of the data pool manager to have an ecosystem that no longer functions, and a currency that decreases in value due to its lack in trust. In fact, this situation has already happened with Bitcoin when the Ghash pool exceeded 51%. Ghash voluntarily split and with current Bitcoin prices the amount of capital required to do a 51% is extremely high. But again, the former depends upon human rational when the 51% majority is passed, and not upon sound mathematics alone. 

  • Inherent (hypothetical) flaws/risks in crypto design include amongst others;

    • P+Epsilon attack; translating towards an election as Ethereum coin creator Vitalik Buterin did with a briber. The briber lays down a condition that if people vote of a particular individual just like everybody else is, they get a payoff. If they don’t they will not receive the payoff either. If you vote, and others do not vote, you will get a payoff; P+e. Hence, the standard payoff plusthe bribe of e on top of that. Since, if you do not vote, you will for sure not get a pay-out, consequentially everybody will vote. Best thing for the briber is that, he does not even have to pay the bribe per se, rather he has to convince everybody to vote. In the big currencies however, the bribe needs to be extremely high for something like this to happen, however, theoretically it is a major vulnerability, according to Buterin even the biggest of the entire proof of work system. The solution to this would be that miners will have to use a portion of their personal fortune and invest it in future blocks. 

    • block withholding; sabotage the revenue of a pool in which the attacker mines normally while he or she does not send the gained blocks to the pool. This in turn could lead to block destruction while the attacker is paid more or less as usual. There is considerable debate on whether this is profitable or beneficial to the attacker. 

    • cannibalizing pools; distribute 1% of your coins equally among all other pools and withhold valid blocks. This way you still receive your reward and get slightly more than when mining honestly. 

    • time jacking, malleability, blacklisting, double spend bribery, pool hopping, and others. 

  • Beyond the mathematical and design risks of above, let’s look at more practical safety concern. Imagine you are a retailer and accepts payments in Bitcoin, Ethereum or any of the other crypto coins. One day you sell a car for one or two Bitcoins (end 2017), fast forward a couple of months (February 2018) and you need to ask for 7 for the same car. The opposite has occurred too. This tremendous volatility does in fact the opposite what a stable and safe transaction should provide; a robust and reliable form of exchange. 

 

    3.   Crypto currencies are cheaper to transfer worldwide vs. the conventional banking system. 

 

(PB) That’s what we all deserve:

 

We are paying between 2-3% on credit and debit card payments, arguably way too much for foreign cash withdrawals that can get up to 12$ per transaction, not to speak of the international transfer rates of Moneygram and Western Union, which can charge close to 10% of transfers below 50$. Taken into account both time and cost (where the time to transfer a particular amount of funds is money too) Ethereum is by far the least expensive as well as the fastest way to send money followed by Bitcoin, a wire transfer (for large amounts), an automated clearing house (ACH) transaction, credit/debit card payments and finally a check. This is in fact a tremendous decrease in costs from on average35-75$ by wire transfer, 15-20$ by check or $0.25 plus 2-3% by credit/debit card, to $1.1 by Bitcoin or less than $0.1 with Ethereum.

 

Adding inflation into the equation, which due to the limited supply nature of both Bitcoin, Ethereum, any other coins, gives them much lower inflation vs. monetary funds and thus less expensive to hold. And when talking of inflation, we are just to ask questions regarding manipulations of central banks that try to dictate the percentages by printing money or a dozen of other tricks.

 

But what we still don’t get:

 

The only way to complain on this is by those cases Bitcoin is still more expensive than certain credit and debit transactions, and for Ethereum, that it is still not free, but well some people always find something to complain. There was however plenty to complain not very long ago (end 2017) when Bitcoin fees where skyrocketing due to network overloads and where on average $9, up even to an average high of 28$ (19/12/2017) making Bitcoin transactions for small payments absolutely useless. 

 

Talking about inflation, this actually serves a purpose in the capitalistic centralized system; help people spend money that will hold just a little bit less value tomorrow than it has today. For the crypto coins, the reverse could very well be true, in particular for spending with marginal benefit, but than again, cryptos don't care about the old system. 

 

   4.  Crypto currencies are faster vs. the conventional banking system. 

 

(PB) Finally, I was already wondering why transfers can sometimes take so long in this digital age:

  • The traditional financial system does not know any real-time electronic methods of payments. Even though credit card transactions are recorded in a few seconds, the actual settlement takes days. With a wire transfer, the fastest of them all at the moment, takes only 24h. However, it is also the most expensive one. With crypto all of this can go faster since there are no intermediaries given its peer to peer nature. Bitcoin takes on average 10 minutes while Ether takes just seconds and even faster coins are (trying to-) being established. 

 

(CD) Well, I don’t think this is fast at all;

  • Similar as to the problems mentioned for the costs, the paste of in particular Bitcoin was overloaded not long ago leading to even days or weeks before transactions where confirmed. When the bitcoin network traffic becomes high due to increased demand for transactions per block, with block sizes limited, transactions get stuck in a que for confirmation; the bitcoin mempool. Fortunately, this mempool has decreased and confirmations are back at reasonable speeds of around 10 minutes, however they are still slow in comparison with many other crypto coins that could in this regard therefore be argued to be better. Furthermore, the Lightning Network aims to shift most payments not to be recorded in the bitcoins ledger, but in private channels between users, where the blockchain only serves as a secure fall-back. As with many of the other promises and visions of solutions in this space, the Lightning Network is far from mature currently as well. 

 

In short. 

 

Bitcoin, but in particular Ethereum, and other coins are indeed cheaper to use than almost all of the traditional ways of paying with the exception of some transactions under $200. However, this has not always been the case. And when you really take time into the equation, shouldn't we also add the time to actually execute the transaction ourselves? That includes writing down (or scanning) the long codes, validating that a payment has taken place and perhaps even the process of opening a wallet and understanding the crypto economics space. Cost would be quite significant then, in particular for small payments. Furthermore to freeze a particular transaction does not exist in crypto economics, hence we are empowered to become banks ourselves subject to mathematical rules made for, however, by developers who therefore have quite some power.

 

The fact that the mathematical transactions actually work, on a sound system that is the blockchain, empowering people to do more direct trade unhampered by restrictions, not even mentioning the other use cases of the coins and software or infrastructure they envision to build (like IOTA, EOS and others) is by itself revolutionary. In fact, it has the power and ability to revolutionize much, much more even. And fortunately the crypto coin environment continues to evolve, with improved versions of cryptocurrencies continuing to pop-up.  

 

However, crypto payments are not the all-encompassing holy grail and actually have serious defaults as elaborated above. In addition, they are certainly not as anarchistic and libertarian as they claim to be. There is undoubtably a hype around this topic, and rightly so, since the space is tremendously exciting and it does indeed provide us with a world of opportunities to discover. We should however be wary of anything that is a hype since it bring with it considerable risks due to its overly rosy picture of what something can do and will become. The best way not to be taken by surprise by these risks is to be aware of them.

 

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