Crypto is down, so why am I smiling?

This post originally appeared in CoinDesk’s “2018 Year in Review.”

Inigo Montoya: You are wonderful!
Man in Black: Thank you. I’ve worked hard to become so.
Inigo Montoya: I admit it. You are better than I am.
Man in Black: Then why are you smiling?
Inigo Montoya: Because I know something you don’t know.
Man in Black: And what is that?
Inigo Montoya: I am not left-handed! [switches to fighting with his right hand]

The Princess Bride (1987)

Let’s admit it. This year was a bit chaotic for blockchain efforts. Cryptocurrencies crashed. The SEC rained on the ICO parade. Many corporate projects, announced with elaborate fanfare, seemed to progress at a snail’s pace.

On top of it all, someone claiming to be Satoshi threatened to take the price of bitcoin down to $1,000, while a related faction threatened what amounted to a DDoS attack on a rival fork by planning to mine worthless blocks. (With blockchain friends like these last two, who needs a six-fingered man for an enemy?) And on a more somber note, we lost Tim May, who provided early inspiration for me and many others with crypto-libertarian aspirations.

So why am I smiling? It would be presumptuous to say that I know something that informed readers do not. But perhaps I have a longer-term perspective. For while as a community we celebrated the 10th anniversary of Satoshi’s white paper, next year is another anniversary for me. Namely, 2019 will mark 30 years since Stuart Haber and I began working on a contributing thread to what has become the blockchain.*

From that perspective, the disturbances of this past year are transitory issues that distract from value creation fundamentals. From financial services to social media, from crypto-based banking services to making real assets liquid, opportunities abound. And as Chief Scientist at a blockchain venture capital firm, I am prepared to recommend how to invest tens of millions of dollars in blockchain efforts this coming year.

The movie Jerry Maguire made famous the line “show me the money.” Let me suggest four “show me”s.

Follow these in 2019 and perhaps I can show you the investment money.

1. Show me the community

Successful blockchain efforts don’t begin with technology. Instead they begin with a community.

Indeed, Tim May and others of the cypherpunk community who helped create that community’s sense of shared purpose had as much to do with bitcoin’s early rise as did the technical merits of Satoshi’s work. This point, often lost on those who didn’t live through the pre-bitcoin days, leads many to draw the wrong conclusions about the reason for bitcoin’s early rise. Its community was primed to embrace a peer-to-peer currency and was thus willing to accept bitcoin weaknesses along with its strengths.

New blockchain efforts should begin with a community that shares a common interest and purpose. This is the fundamental promise of the blockchain: a shared, immutable record that allows communities to achieve their collective hopes in a peer-to-peer, transparent and efficient way.

2. Show me the solution to today’s problems

Successful blockchain efforts will not offer solutions in search of needs, but rather should solve current, pressing problems. And these “products” should provide immediate benefits to their earliest users, even without the benefit of scale.

Far too many blockchain enthusiasts in 2018 simply railed against the incumbents, the evils of the current systems, and the greed of their actors. They convinced themselves that because their blockchain-based solutions were different from the wrong answers, their solutions must of necessity be the right answer.

Such sloppy logic will no longer work. Blockchain aspirants should ask themselves a difficult question. Namely, is their solution truly a current “must have,” providing benefit to even the earliest users and then growing in value with network effects? Or is it just a “nice to have” convenience, the value of which will become evident only when the community reaches scale? Or even worse, is it merely a clever technology that solves a problem developers simply wish the entire world will someday have?

History demonstrates that successful revolutionaries focus less on what they fight against and more on what solutions they propose. The best visionaries have incremental, largely self-sustaining plans that grow over time to achieve radically improved results.

In 2019, efforts that fit this near-term/long-term dynamic will be well positioned. The financial services industry presents many such opportunities, as it is straightforward to quantify benefits that can be realized from reductions in reconciliation, settlement costs and times, even in the early stages. And as these networks scale, features can be added that provide additional utility.

3. Show me the incentives

Successful blockchain applications avoid creating destabilizing incentives, while allocating value to the participants within the ecosystem who actually create value. Creating that value via non-centrally governed communities can be especially challenging. Unlike classical corporations that rely on conventional, hierarchical command and control, successful blockchain systems require internal incentives that cultivate communal growth and stable peer-to-peer governance.

Successful incentives and related governance mechanisms avoid the kind of behavior demonstrated this past year at the hard fork of BCH-SV and BCH-ABC. Questioning pure proof of work might seem tantamount to breaking faith with the core tenets of decentralization. Yet I am convinced that proof of work can be improved upon in order to avoid these sorts of behaviors without relinquishing its useful incentives.

Fundamentally, decentralized communities require incentives for its community members to hold and validate the tamper-evident records, making them collectively immutable. With that as a secure foundation, they can then consider whether a token, representing an actual stake in the community’s common assets and purpose, fits the circumstances. If it does make sense, then one must ensure that the differential equation for reward redistributes tokens along the gradients of value creation and long-term stability.

In this regard, community-based social media platforms continue to offer a large but still largely unrealized opportunity. Tens of millions or even billions of suitably incentivized users would be a force with which to be reckoned.

But claimants to the Facebook/LinkedIn/Reddit/etc. throne must also demonstrate how well they understand the community and provide a compelling solution.

4. Show me flexibility, not rigid orthodoxy

Successful blockchain applications are no different from any other class of startup venture in that they need to adapt to the needs of their user communities. It is the records, not one’s approach to problem-solving, that must remain immutable.

Because Satoshi was legitimately concerned that governments might want to shut down competitors to their fiat currencies, he invoked massive computational redundancy as part of decentralization.

Today, however, most blockchain applications operate in a different environment. It’s hard to imagine the military hunting down providers of shared medical records, for example. Thus, as blockchain applications extend beyond bitcoin, it is worth reexamining when, where, and how users’ needs require different classes of solutions. In these early days of blockchain, in which a dominant design has yet to emerge, innovators must be flexible enough to explore new possibilities informed by their users and thinking from first principles.

More generally, an inappropriate focus on fighting the last war is symptomatic of leaders unwilling to change even as conditions evolve. Initial plans almost never work. Successful leaders listen to what users are saying and pivot accordingly.

The promise of decentralized trust has come a long way from its early beginnings in the late 1980s. Yet to give due respect to the significant work done by Tim, David, Nick, Satoshi, J.R., David, Blythe, Caitlin, Vitalik, Joe, Dan, Ned, and many, many others, blockchain communities must not fail to learn from the lessons of this past year.

To realize the promise of a fairer, more transparent, peer-to-peer world, we must put community first, focus on solving present-day problems, continue to refine incentives and governance, and respond with flexibility as needs and circumstances change.

Those who do so should find themselves smiling with me in 2019, as we know something others do not know: we know the fundamental promise of the blockchain.

* Now let’s be clear that what Stuart and I created was a sort of proto-blockchain, and we are not claiming credit for any of the many welcome innovations that have followed. But even 30 years ago, many of the basic elements were in place: a system of blocks cryptographically chained together whose wide distribution via appropriate incentives led to eliminating the need for a trusted third party. What else would one call that if not a blockchain?

A founder of the blockchain discusses new research on inherent limitations to Bitcoin

This post originally appeared on ProMarket.

In the latest Stigler Center working paper, Chicago Booth’s Eric Budish argues that game-theoretic constraints imply there are “intrinsic economic limits to how economically important [Bitcoin] can become.” In this review essay, W. Scott Stornetta—a co-inventor of the early blockchain—highlights the paper’s contributions while raising some exceptions with its broader generalizations.

Eric Budish’s new paper is a nice opening salvo in what we hope will be a series of papers to explore the game-theoretic constraints that different configurations of the blockchain impose on cryptocurrencies. It is focused on the currently most prominent species in the cryptocurrency family, namely Speculatatus nakamotus (Bitcoin). 

Bitcoin[1] has burst upon the public consciousness in part because it suggests that there can be a new kind of money, based not on the dictates of a sovereign government, or reliance on a precious metal, but on mathematical principles and computers: digital money! Its allure in the public mind has been further fueled by the Midas touch—ordinary people across the globe, possessed of nothing more than a personal computer and an Internet connection, seem to have become millionaires simply by getting in early on this bandwagon. Short of adding sex to the mix, it’s hard to think of something more likely to attract the public’s attention. 

Budish systematically considers the underpinnings of Bitcoin to place constraints on this seemingly free-lunch dream. His conclusion is that there are built-in, inherent limitations to Bitcoin and similar cryptocurrencies that suggest they will never constitute a significant part of the global monetary system. 

Your humble reviewer will handle this assignment in two parts. First, we’ll outline and then weigh in on the author’s key arguments. Then we’ll attend to the broader significance of the work. 

The author’s first constraint is one imposed by the cost of mining. In a brilliant metaphor worthy of the best advertising agencies, the author(s) of Bitcoin chose to give the name of “mining” to an incentive for participation via the creation of a stake in the value of the overall system. By calling this process mining, it creates the impression of a digital analog to the mining of precious metals such as silver and gold, which have a long history of association with money and striking it rich. Hence it helps to legitimize the notion that Bitcoin is a kind of digital commodity-based money. Technical details aside, it is sufficient for this review to know that mining creates a need to perform a calculation that is deliberately compute-intensive, but serves no intrinsic purpose other than to decide who amongst the system’s users gets to claim an additional monetary stake in the system. Its negative consequence—and a very significant one it is—is that it creates an escalating arms race among miners for using enormous amounts of computing power. The amount of computing power devoted to this intrinsically wasteful effort is so great that it begins to raise environmental concerns on a global scale for the amount of electricity it consumes.[2] It also has fed much of the speculation in Bitcoin, the sort that has led Warren Buffett to declare Bitcoin and its ilk “rat-poison squared.”[3]

Budish’s second constraint is related to so-called 51-percent attacks (and other related attacks), where a collusion between miners possessing even a slight majority of the computing power can game the system to their benefit and the detriment of the non-colluding holders of Bitcoin “currency.” 

Third, and finally, Budish combines the previous two constraints to suggest an equilibrium condition. It is this combining which leads to the author’s suggestion that “there are intrinsic economic limits to how economically important [Bitcoin] can become in the first place.”  

We have little to quibble with concerning the basic arguments of the first two constraints, other than to note that (1) this is well-trod ground, as the author acknowledges, and (2) there are even more attacks that the author has not considered (see footnote).[4]

One particularly interesting notion relating to Budish’s constraint equation (2) has to do with shorting Bitcoin currency. In this regard, the cryptocurrency behaves much like a shorted equity. Shorting not only can depress a stock price, it can lead to highly volatile situations (short squeezes and the like). What is uniquely pernicious, however, about shorting Bitcoin currency is that it increases the attractiveness and economic incentives to computationally sabotage the value. So, even if we aren’t talking about “rat-poison squared,” this could make for volatility squared. Those hoping for a smooth ride of gradually appreciating value of Bitcoin are in for some bumps in the road. While these concerns are oft-discussed in the professional investment community, for “retail” investors in Bitcoin, Budish raises an important warning. 

More generally, the author’s larger contribution lies in casting the two core constraints in more formal terms suitable to game-theoretic economic analysis, as well as combining them to create the equilibrium condition, which underscores the supposedly self-limiting economic importance of Bitcoin and similar systems.

That’s a pretty big concern being raised. After all, many, many of the cryptocurrencies today follow this same mining model, and it is the mining in a winner-take-all competition that leads to the limitations he cites. That is a powerful and provocative prediction indeed.

So is this the end for the cryptocurrency gravy train? In a word, no. We must take exception with some of the generalizations Budish suggests: First, that the Bitcoin protocol and simple variations on it are the essence of an “anonymous decentralized trust blockchain.” And second “that the security of the blockchain actually relies on its use of scarce, non-repurposable technology.”

In fact, in the broadest sense, neither of these notions is justified. But to understand why we must briefly address two questions. First, what is the blockchain, and second, what is money/currency?

First, what is the blockchain? The blockchain is an immutable[5] ledger—a record of dealing that can be added to, record by record, but on which no erasures can be performed. The first blockchain open to the public and capable of handling anonymous (by which the author means non-trusted user) transactions in a way that all verification and possibility of manipulation is decentralized began operating in the mid-1990s (and, for that matter, continues to this day).[6] Note that this precedes the publication of the Nakamoto/Bitcoin paper by more than a decade, and is hence clearly not subject to the peculiarities of the Bitcoin implementation of the blockchain. In particular, while this review is not the proper place to go into the technical details, we note that such blockchains do not require mining and are not subject to 51-percent attacks, while allowing “anonymous, decentralized trust” ledgers.

Second, what is money? Perhaps the simplest definition of money comes from a piece on an interview with Federal Reserve Bank of St. Louis Vice President and Research Director David Andolfatto:[7]

Perhaps most surprising was Andolfatto’s assertion that the Bitcoin network is similar to the Federal Reserve, but he elaborated at length on the subject and why he believes all money is just a ledger. [Emphasis mine.]

In this context, he explained that all money attempts to perform a simple function, debiting an account and crediting another.

While Andolfatto may be the most recent prominent figure to contend that all money is just a ledger, he is far from the first.[9] With these two definitions in place, we combine them to realize that money can be built on an anonymous decentralized ledger which neither requires mining nor is subject to 51-percent and related attacks.

The confusion of many on this point is likely related to the assumption that without the mining aspect of the Nakamoto blockchain, one cannot have a currency. This problem is further compounded by the lingering sense that one cannot have a currency without some commodity, such as gold or silver, somehow connected with it. Of course, fiat currencies are prima facie denials of the latter, while the rise of blockchains which do not require mining or seek to minimize it are refutations of the former.[10]

Given these limitations, why is your reviewer so interested in this paper? Because this is just the type of analysis that should be applied to the growing body of blockchains, including non-Bitcoin-style blockchains. Economists often lament that the dismal science is an observational one, wherein they cannot perform large-scale experiments at will. They can rarely perform double-blind, controlled experiments of their choosing outside of small-scale studies.[11] (It is akin to the situation with astrophysicists, who, for safety reasons, are not allowed to collide two neutron stars in the lab, but must patiently wait for such a rare event to occur somewhere else in the universe.)

But the next best thing is at hand. Namely, there is currently underway a veritable Cambrian explosion of blockchain-based large-scale experiments on new species of specie. It is as if everybody and their dog[12] gets to play at being their own Federal Reserve. What is needed is someone with a background such as Budish’s to acquaint themselves with this cornucopia of opportunities and analyze them in a credible game-theoretic sense. 

So what’s the bottom line? Does the author’s result put in question the viability of Bitcoin and other cryptocurrencies becoming a dominant force? Well, yes. Unless and until those of his concerns that are legitimate are addressed. But then again, no. Because these very concerns have driven the rapid pace of innovation in this community. Schumpeter’s creative destruction is alive and well here, giving us all, economist and layperson alike, a ring-side seat at the rebirth of money.

We look forward to the author’s next paper.

  1. Bitcoin: A peer-to-peer electronic cash system. Satoshi Nakamoto. October 2008.



  4. See much of the work discussed on Emin Gün Sirer’s blog, Hacking Distributed, In particular, see the disussion of “selfish mining” at

  5. The immutability is of course subject to the condition of the underlying hash functions themselves being “collision-resistant.” Were collisions to become easy, the ledger could in fact by modified. See, for example,




  9. Those interested may wish to consider Felix Martin’s Money, the Unauthorized Biography (Alfred A. Knopf, 2014) for an historical survey of both money and theories on its fundamental nature. The book, though academic in nature, is still accessible to the general reader.

  10. In addition to the simplest example given herein, readers should be aware of the enormous amount of research and implementation activity in the blockchain space on minimizing the very valid concerns the author raises. For example, one should consider the works of and as among the most prominent examples of work already being done to mitigate the issues raised in this paper. In addition, offers an interesting example of a radical alternative to proof of work.




Blockchain founder on this new asset class

This post originally appeared on Cuffelinks.

Seventeen years before there was Bitcoin, my colleague Stuart Haber and I developed the basic elements of the blockchain, as described in the Journal of Cryptology, January 1991. Namely, using cryptography, we found a way to create an immutable, shared ledger. Its integrity was based, not on some trusted third party, but on the democratisation of trust across all participants in the ledger. This is the blockchain: an immutable record, witnessed and vouchsafed by all mankind.

And so while I find little to quibble with in recent blockchain-related Cuffelinks articles by Joe Davis of Vanguard and Carlos Gill of Microequities, I can nevertheless bring an historical perspective to the subject.

A new asset class?

For superannuation managers, perhaps the most pertinent question to ask is this: Is the blockchain space a new asset class? If so, what portion of a portfolio should be allocated to it? Or is it simply an internet version of the Dutch tulip craze, an emotional bubble to be avoided at all costs?

Some would say that of course blockchain is a new asset class. After all, the combined market capitalisation of all cryptocurrencies is in excess of a quarter of a trillion dollars. Cryptocurrencies and their related derivatives are traded on several exchanges, tracked breathlessly by well-established companies, and analyzed by hundreds of analysts.

But all of those trappings of credibility also accompanied the collateralised debt obligations of subprime mortgages, broken into tranches rated as high as AAA by our unerring guardians of the galaxy, Fitch, S&P and Moody’s. And we all know how well that turned out.

To answer the question, let’s begin by observing how diverse the blockchain economy has become. Five years ago, blockchain and Bitcoin were all but synonymous. However, since then there has been what Scott Rosenberg called a Cambrian-Era explosion of use cases.

The largest criticism of Bitcoin is the enormous energy consumption and instability that mining and proof of work create. But let’s not confuse the particular volatile mix of incentives Satoshi created with the full range of possibilities that the Haber-Stornetta paradigm allows for.

There is more than one blockchain

There are blockchains that completely disavow proof of work as an incentive mechanism. Or Ethereum, whose raison d’être is smart contracts, which aim to make many business transactions, currently requiring tedious paperwork and accountant and attorney fees, frictionless. Then there is the class of asset-backed stable cryptocurrencies (of which Australia’s own Havven is a leading example), whose prime directive is to eliminate the volatility so often associated with Bitcoin. There are also utility tokens, which don’t aim to be currencies at all, but simply measure prepaid deposits into a system for which work can be claimed. And Australia’s own ASX, which is transitioning from CHESS to a blockchain-based solution, simply on the merits of settling transactions more inexpensively, quickly and reliably than its predecessor – hardly the stuff of a speculative bubble.

One way to examine how meaningful blockchain might be in the future is to consider its effects in the present. The emergence of Initial Coin Offerings (ICOs) has already begun to disrupt the venture capital industry. This is a particularly poignant example as the VC industry traditionally views itself as the ones in charge of disrupting other industries. What’s good for the goose . . .

Where will blockchain take us?

Will blockchain disintermediate the banks? Commoditise attorneys and accountants? Threaten fiat currencies? Some think this last idea is particularly preposterous. Perhaps. But fiat currencies have only really undergirded the world’s financial system since the abandonment of the gold standard. Not much more than a century. This is something about which another eminent Australian, Shann Turnbull, has written quite incisively(That’s the third Australian reference to blockchain in this article. Is there a pattern here?)

So to finally answer the original question.

Yes. Blockchain is, in fact, an emerging asset class. Certainly with its own set of risks, but in the midst of all the hoopla, it is finding footholds of genuine value creation. And with value creation will come appreciation in price. Hence, those who invest responsibly can expect above average risk-adjusted returns. The trouble, as always, is how to invest wisely in the blockchain space. But that is a Cuffelinks column for another day.