“Money was the sizzle”: Blockchain pioneer W. Scott Stornetta assesses Satoshi’s work

Cryptographer colleagues W. Scott Stornetta and Stuart Haber’s paper “How to Time-Stamp a Digital Document,” published in 1991, is what many consider to be the first incarnation of blockchain technology. Stornetta and Haber set out to create an immutable ledger, and in doing so, they came across what they deemed “a naïve solution.” That solution relied on a central authority, a “digital safety-deposit box” that could record the date and time a certain document was created and also store a copy of it. The main problem with this method came down to trust. “Nothing in this scheme prevents the time-stamping service from colluding with a client,” Stornetta and Haber wrote.

They’d hit a dead end—or so they thought. Since their original mission seemed undoable, they attempted instead to disprove the possibility of creating an immutable ledger. In doing so, they came up with one that wouldn’t require a trusted central authority. In other words, they ended up creating a distributed immutable ledger.

At the time, the two men were working at Bellcore, a telecom research company. Three years after releasing their time-stamping paper, they went on to found Surety, the main focus of which was to offer time-stamping services using the first-ever blockchain. Instead of a purely digital ledger, however, Surety posted customer hashes in a different sort of immutable public record. It printed them in the “Notices & Lost and Found” section of the New York Times.

Today, Stornetta is the chief scientist at Yugen Partners, a private equity firm that invests in companies using blockchain technology. We recently met up with Stornetta outside of Columbia University’s business school, where he will contribute to a blockchain course for executives, to talk about Satoshi Nakamoto, cypherpunks, LUMAscapes, dairy cows, sizzle, and FOMO—not to mention what he believes is the biggest mistake blockchain project architects keep making.

You were on the cypherpunk mailing list back in the day.

I was sort of in that community, sure.

How did you wind up a part of that?

I was very inspired, for example, by David Chaum and what he was trying to achieve very early on—way before Satoshi [Nakamoto, the pseudonymous inventor of bitcoin]—with digital cash. And not just digital cash, but the whole zero knowledge proof space. In a sense, it was really the RSA people who kicked that off—the concept that one can have both a public and a private key, something that could be widely broadcast and yet no one would be able to create the same thing using the same key. That whole move to asymmetric encryption itself is a very liberating idea.

To me, that was the zeitgeist of the time. I spent a lot of time thinking about the kinds of problems that were posed, but interestingly enough, even after the “blockchain” work we did, I didn’t immediately see the connection between it and money.

How do you feel about the fact that your 1991 paper about time-stamping ended up inspiring this whole movement, which is really what blockchain is now?

That is quite frankly very humbling. It was a series of papers and a series of patents. It’s unfortunate that so few people actually read all the papers and patents, because there are quite a few ideas that can be mined from there that some have since reinvented because they never read the papers.

Any ones in particular?

I want to focus on the positive. But I guess I can capture one moment a couple of years ago when someone sent me a poster of the blockchain space. It was talking about how several billion dollars had been allocated into all of these different areas. You know, it’s one of those posters where they have the logos of all the firms…? They look very attractive…


Is that what it’s called? You learn something new every day. It was almost like a punch in the chest. All of these people are doing stuff, and I was feeling very humbled that Stuart [Haber] and I had been at the right place at the right time to have a useful insight that laid the foundation. I don’t want to take credit for all of their work, but it did in fact play an important role.

Is digital currency a surprising thing to have come out of your papers? Would you have expected any other use cases to emerge before that?

It’s funny—my wife is very good at keeping records of things. She found a slide deck of a presentation we had given in the early ‘90s to an investment firm. It lists all of the industries and examples that we thought could be affected by this [technology]. It was remarkable to me how little updating needed to be done to something that was as old as that slide. We thought what we had done [with the 1991 time-stamp paper] was pretty exciting, and yet it was hard to get a party going around it.

Slide from a presentation Stornetta and Haber gave for an investment firm in 1993 listing the areas where their distributed immutable ledger could apply. Courtesy of Marcia Stornetta.

Slide from a presentation Stornetta and Haber gave for an investment firm in 1993 listing the areas where their distributed immutable ledger could apply. Courtesy of Marcia Stornetta.

The bitcoin white paper started the party?

Yeah, somehow it added the sizzle. In the investing world, we talk about sizzle and steak. I am still of a mind that we created some meaningful steak. But maybe it didn’t have the sizzle that it needed. Bitcoin was all about how you could get rich quick. Not that that was Satoshi’s goal, but it became that. You either write about sex or money if you want to attract immediate attention.

So money was the sizzle.

Money was the sizzle. And the fact that one could mine, that’s a very powerful marketing metaphor. It creates that apparent analogue with gold, when in fact it’s really got nothing to do with that. One of the best things Satoshi did was his branding. I’m sure it was unintentional, but the whole idea that I could use my computer to get in early on mining coins created a great—what I guess we would call a FOMO. A fear of missing out.

Yes, I’m familiar with FOMO.

I think that’s one of the threads that explains bitcoin’s rise. Certainly, there’s also a libertarian thread, of which I’m a big subscriber. But as someone that works at a private equity firm, we’re looking for great ideas that can become self-sustaining rather than just being a hope for something. We have to look at things through a lens that celebrates the libertarian aspirations, but also asks how actual economic value is unlocked in the here and now.

What does being a libertarian mean to you?

I guess I really like the idea of us all sort of being middle-class—and being in a peer-to-peer, free-exchange market and not seeing such concentrations of power and capital as we have today. It’s not that I’m opposed to them because I think only evil people are in those bastions, but it’s an inefficiency in the market. When power and capital get too concentrated, it leads to not treating people as peers.

You don’t think it’s only evil people in those “bastions,” but do you think it’s easier to get to those top tiers if you are evil?

Not necessarily. The problem is that good people get there, and they are easily corrupted. We all are easily corrupted. What’s that Socrates quote? “With virtue comes wealth, but virtue does not come from wealth.”

I noticed that you tend to quote a variety of sources when you’re writing. I believe you quoted The Princess Bride in a piece you wrote for Coindesk in December?

The Princess Bride definitely figures into my worldview, that’s for sure—as does Monty Python and the Holy GrailStar Wars figures in. My training is as a physicist, on the theoretical side of physics. There’s a joke that’s told about physicists, both at their expense and told with delight by physicists. Maybe I can just tell the joke and then draw the conclusion about why you ask why I quote from different sources?


There is a dairy farmer that is not getting the milk production he’s expecting from his cows. He decides to call in three experts to solve the problem. One is a psychologist, one is an engineer, and one is a physicist. First the psychologist goes in and writes up her report. She says the cows need to relax, and to do that you need to paint the barn’s interiors with more pastoral settings. The engineer comes in and says that the diameter of the tubes leaving the udders is too narrow, causing turbulent flow. Making the tubes bigger will increase the flow of milk. Then the physicist comes in and analyzes the situation, and says, “Well, I’ve got a perfect solution, but we’re going to have to assume a spherical cow.”

Physicists tend to want to look for a deep, underlying solution that abstracts out the details, because if you consider all the details, then you’re not really getting at what the essence of the problem is. As a result, I think that many quotations help to get at the essence of issues.

How do you think that sort of thinking applied to your 1991 paper “How to Time-Stamp a Digital Document”?

I think it very much applied to it because our original intent was to create a kind of immutable record. We found our original solution unsatisfactory because it relied on having a central authority that one had to trust. While in a pragmatic sense it was for many uses an adequate solution, it seemed to lack any elegance that spherical cow thinkers would like, or that Stuart as a mathematician would find satisfying.

After reaching that level, we went on a quest to see if there was a way we could eliminate the trusted central authority. In fact, what happened—I’ve told this story, but it’s one of the few good stories I know, so I have to keep repeating it—was we finally decided it couldn’t be done. To make sure we could get a publication out of our work, we said, “Why don’t we prove it can’t be done?”

It was in the course of proving that it couldn’t be done that we stumbled upon the solution. If you have two parties involved in a transaction and they want to collude, then you need a third party to detect the collusion. But then what if that third party becomes part of that collusion? Then you’d need a fourth party, and so on and so forth. Our proof was saying this problem can’t be solved because it would involve a conspiracy so large that the whole world would be in on it.

It was then that we realized that was in fact the solution. Because if the whole world is in on a particular agreement about what is real, then that’s what’s real. By linking the record and then widely distributing it, we could have all the world as witness of a common ledger, a common record.

How well do you think bitcoin lives up to that?

I think [Satoshi’s] done a great job, but it’s just a particular application. Vitalik [Buterin] comes along and says, “Well, this shouldn’t just be about money. I read Nick Szabo’s paper, and we should incorporate smart contracts, and we should have a general purpose computing machine.” I think that’s a great idea, but I think that he drank too deeply from the bitcoin view. That, I think, has constrained Ethereum a little bit.

How would you suggest he go about building Ethereum in a way that departs more from bitcoin?

It’s not my place to tell other people how to do their research, but I think there are lots and lots of people exploring this space. It’s a space I would describe as threefold. But first, we have to establish a set of cryptographically interlinked records that are widely distributed. That’s the baseline—an immutable foundation. Then there are three dimensions to explore built on that foundation. One, where and what computation should we be doing? Two, what incentives need to be offered to keep the system operational? And three, how should consensus be achieved?

Going back to when you and Stuart used the New York Times to publish customer hashes as part of the time-stamping service you offered at Surety—I’m wondering, are there any use cases today where an at least partially analog blockchain would be more useful than a fully digital one?

The first thing I want to emphasize is that the concept of embedding the document in the New York Times, which was widely published, is not truly essential to the idea. What’s essential to the idea is that the people who wanted the service became holders themselves of part of the record.

It’s that community of people that have an incentive to hold the record that is the essence of the blockchain. In a sense, Satoshi creates an artificial community. I don’t mean artificial to be derogatory to him. He’s creating an artificial community by creating the mining incentive. All we really need to do is have a self-sustaining system where there’s an incentive for users to naturally want to hold the record for their own self-interest, which benefits others using the system. In that regard, there are lots of examples of historical blockchains that predate the digital world.

Like what?

Apparently, there’s a true historical event where two neighboring tribes had a dispute about their boundary. They came together and agreed on where the boundary would be, and as a memorial to that, they put together a pile of rocks. Then the community had a ceremony where they all witnessed their agreement. Right there, you have the essence of the blockchain, because you have an event that is widely witnessed and memorialized as a shared view of the world. That’s what the blockchain is.

I was very intrigued by the analog aspects of your early ideas about time-stamping. You also brought up the option of writing a letter, mailing it to yourself, and keeping it enclosed in the envelope to show that it was written before a certain date. Are there other methods like that that you think are maybe better or just as good as a digital immutable ledger?

On that front I would say no. But here’s the thing—you keep talking about analog, a-n-a-l-o-g, analogues, a-n-a-l-o-g-u-e. Fundamentally, it’s not the protocol that is the essence of the solution. It’s the organizing of society via the protocol that creates a consensus. All of the analogues are really about us as people and how we relate to each other. If people are looking for advice, technology can provide solutions, but the key is to make sure that you’re solving the right problem. The key is to have good taste in recognizing what is possible in social relationships at large.

I feel like social relationships are what a lot of blockchain projects are struggling with now. For example, people involved in Ethereum are really trying to get something done as a community, and it’s caused some issues

People go a little sideways [by thinking], “Community has to be the solution, now let’s a find a problem.” You can’t do that. You have to sneak up on a problem on its own terms. You have to try to think what the real essence of the problem is before throwing a particular piece of technology at it, or concluding that community has to be the answer. I’m making a distinction between community and solving problems about the inner relationships among people.

Since we were talking about Ethereum, would you define a specific problem there?

This is nothing against Vitalik or Joe [Lubin]. I question whether what the world wants is a universal computer. I think it’s clear to me that the world definitely wants a universal record, and that it wants to be able to perform computations on that record, but I’m not quite sure that the alignment is perfectly right. Having said that, please understand, we’re all just poking around and trying to figure out how to get this right. Ethereum is a huge advance, and it stimulated all sorts of other thinking. I’m not suggesting that it’s bad. It’s just, we’re not there yet.

I’m curious about your thoughts on the blockchain communities that rely on consensus or voter majorities and basically trust in other individuals, because when you were trying to disprove the possibility of an immutable ledger, you had to deal a lot with  ideas about people trusting each other.

Again, without meaning to be critical, my general observation is that they are focusing a little prematurely or overly much on the trust mechanism for solving a general problem. They would be more likely to prosper if they could apply their ideas to a particular problem.

Do you have any thoughts on the best way for a group of people to get together in a room and make sure that they trust each other? Say they’re all guarding treasure together, and they have to trust each other not to steal it.

I kind of like the Panopticon inverted. It’s a circular prison with glass walls so that you can have a couple of people in the middle keeping an eye on a very large group of people. I think the problem you’ve posed needs a reverse panopticon. Namely, the community is on the outside, and the treasure’s in the middle.

Is there a digital system you could translate that to?

Fundamentally, you have to create a set of incentives that is self-sustaining. Very clearly that is what Satoshi was attempting, and it was a bold attempt. It was a bravura performance. But getting those incentives right is very, very hard.

It seems like money is what most people come up with.

That is because money is a universal medium of exchange. You have an idea of what you think you want, and much of it can be purchased with money. Although, there is a declining effect. After you have a certain amount of money you start to find that it’s preventing you from getting what you want. You’re right—it’s a universal incentivizer. If you read Adam Smith’s The Theory of Moral Sentiments, you find that what people really want is people that will empathize with them. It’s creating a set of empathetic self-interest that is where an important solution lies. And, I might just mention in passing, we’re working on that problem at Yugen.

Well, since you mentioned it, tell me more.

All I can tell you at this point is that the project is currently called Gazillion. The reason we chose Gazillion as a name was to make it clear that Google was not the only big number.

Fair enough. At Yugen, what kind of projects do you point investors toward?

There are a number of [types of projects]: improving the integrity and transparency of existing corporations, improving the efficiency of systems of organizations that interact with each other, including in the financial services industry, just to be a little bit concrete. We think there are opportunities in creating assets that are more liquid, so that they are more broadly available to others. I think creating social systems with token-based economies built on blockchain-based incentives are very promising, and I think systems that tend to distribute capital and the benefits of participating in the systems more evenly among people are also promising—that’s five areas.

Are there any particular projects that really excite you that are happening in the blockchain space right now?

There are things that we are starting to place investments in. Those will be more public information shortly. We’re not trying to be coy for the sake of being coy. I’ve identified five areas, and I think you’ll see us putting our money where our mouth is.

My very last question: Who do you think Satoshi Nakamoto is?

[Pauses.] Yeah… [Stornetta covers his face with one hand.] I think I’m not going to respond.

This interview has been edited and condensed. Main photo courtesy of W. Scott Stornetta.

Crypto is down, so why am I smiling?

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

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. http://www.Bitcoin.org/Bitcoin.pdf. October 2008.

  2. https://www.theguardian.com/technology/2018/jan/17/Bitcoin-electricity-usage-huge-climate-cryptocurrency

  3. https://www.cnbc.com/2018/05/05/warren-buffett-says-Bitcoin-is-probably-rat-poison-squared.html

  4. See much of the work discussed on Emin Gün Sirer’s blog, Hacking Distributed, http://hackingdistributed.com/. In particular, see the disussion of “selfish mining” at http://hackingdistributed.com/2013/11/04/Bitcoin-is-broken/.

  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, https://en.wikipedia.org/wiki/Cryptographic_hash_function.

  6. http://surety.com

  7. https://www.coindesk.com/federal-reserve-bank-vp-protocol-just-like-Bitcoin/

  8. https://www.coindesk.com/federal-reserve-bank-vp-protocol-just-like-Bitcoin/

  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 https://block.one/ and https://dfinity.org/ as among the most prominent examples of work already being done to mitigate the issues raised in this paper. In addition, https://steemit.com/ offers an interesting example of a radical alternative to proof of work.

  11. http://www.chrisrodda.education/Thinking%20like%20an%20economist.html

  12. https://en.wikipedia.org/wiki/On_the_Internet,_nobody_knows_you%27re_a_dog

  13. https://www.wsj.com/articles/the-eureka-moment-that-made-Bitcoin-possible-1527268025

Blockchain founder on this new asset class

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.