Caveat Emptor: Lessons from Mt Gox Collapse

Caveat Emptor: Lessons from Mt Gox Collapse

Mt Gox presents an interesting view into the world of Bitcoin. Here is a company that helped raise Bitcoin to where it is today, the CEO was on the board of directors of the Bitcoin Foundation, and Mt Gox is a “Gold” level contributor to the foundation. Why then was it that of all organizations did Mt Gox blame their woes on transaction malleability, when they were likely informed of the the issue existing back in 2011. I think to some extent they didn’t think of it as that big of a problem, or were not impacted by it. But this is not the issue I want to raise. Instead, I want to talk about venture capital investment in bitcoin.

There is some concern of the capital being invested in bitcoin that they think of Bitcoin as a polished and finished project where they have the sort of support of a well paid development team. Mt Gox perhaps felt this way too, based on their reaction to a long known problem. One of my favorite Latin quotes is caveat emptor, buyer beware. By all indications, Mt Gox contributed a non trivial cash flow to the development team, they just didn’t head the warnings the development team gave them. Oh well, they won’t do that again. But what about the influx of capital into the Bitcoin ecology? I am not confident that they see funding development as important. It’s called the free rider problem.

There are consequences for not participating, developers are not cheap. They have many opportunities available to them, what incentive do they face to put their creative effort into something without being paid? What level of support will a venture capital start up get if it doesn’t pay for the service and assume somebody else will foot the bill for development? I assume that not listening to advice given is equivalent to not getting advice period. Information not acted upon is information not at hand. Let’s look at Mt Gox.

Mt Gox Price DeclineIf I were a VC, and I saw my capital having the potential half life of a week, I would take great pause. Burning the cash would be more effective. So what can I do to be comfortable with my investment? Well, I could pay someone for their advice. But who is an expert on Bitcoin. There is this foundation, but they just develop the code.

Let’s pretend for a moment that the Bitcoin Foundation does a little more than develop code for free. We’ll imagine that they take a fee. That fee is structured so that it provides a service, software support, and some surplus. Since the foundation is a non-profit they have to donate a significant portion of their revenue in lieu of payments to shareholders. Their payment can be a payment in kind of funding their developers time in maintaining the source code.

Some might ask, “Hey, Cal, aren’t you suggesting that we hand over Bitcoin to corporations? We want the foundation to be free of corporate influence to benefit us all.”

Not at all. Constraints matter. Bitcoin is an open source project. because of this access to the network is non-rivalrous. This means that anyone can provide the support and development service, even as a for profit enterprise. If they forked the development and forked the block chain, they would loose access to the rest of the ecosystem. If somebody provided a better service there is no coercive force saying they must use the Bitcoin Foundation or any other entity.

Software support is a service and is an insurance policy against service interruption. Let’s treat it as such. Oh and by the way it can be used as a means of aiding the code development.

Power for the People: A Cryptographic and Nuclear Renaissance

I am grateful to see the Bill and Melinda Gates foundation identify three myths that affect the global poor. I will clarify the first myth–providing additional insights. If our goal is to end global poverty there are two things that we must do, unfortunately both are not included in the Gates Letter. We must increase global energy consumption and we must increase individual liberty. I provide a technical justification for cryptography and nuclear energy as paired solutions to end global poverty. I also show how these are fundamental drivers for human progress.

We begin with the global income distribution.

The poverty curve from two humps to one. ( via Gates Foundation)

Figure 1: The poverty curve from two humps to one. ( via the Gates Foundation)

Examining the chart we see that the income distribution in 2000 is p\left(I\right)\sim\mathrm{ln}\mathcal{N}\left(\mu,\sigma\right). where \mu=4.6 and \sigma=1.4. When we look at that transition of the income distribution from a mixture to a non mixture we should take great solace. Globalization and global communication united the world. As Hans Rosling says, there is no us and them there is we. In a previous post, I hypothesized that the world reached an equilibrium state. This figure when in consideration with the entropy of the United States shows our world clearly as being in equilibrium, \frac{\mathrm{d}S}{\mathrm{d}t}\approx0.

Figure 2. United States entropy from 1990–2012 using various deflators.

Figure 2. United States entropy from 1990–2012 using various deflators.

Getting back to the global income distribution, we need to consider Adam Smith’s statement that “[w]herever there is a great property, there is great inequality”. We see that globally we have a great property and that as a result we have inequality. I am of Smith’s mind, that inequality is. It does not in and of itself carry a value judgement. If we apply a normative value that everyone should have the same income we see that we destroy wealth, property and freedom. I derive these consequences in Various Properties of the Log–Normal Distribution. Let me say this again just to make sure that you heard correctly.

When we adopt Rawl’s position of distributive justice, we demand the destruction of wealth, private property, and freedom. I believe that humanity is fundamentally a good in the world. I am a humanist, and as such I adopt the normative principle that humanity should be preserved and not destroyed. We can avoid such normative judgements and accept a positive one, that the dynamical systems tend to the point of maximum entropy. My basis in this is well founded, it is also the “most honest” assumption that assumes nothing beyond the data given. [Jaynes 2006]

The entropy of a log-normally distributed variable is given by:

S=\frac{1}{2}\mathrm{ln}\left[2\pi e\sigma^2 e^{\frac{\sigma^2}{2}}\right]+\mathrm{ln}\left[E\left(I\right)\right]

We see that for any given E\left(I\right) that entropy is maximized by \sigma=1. Our global \sigma=1.4 in 2000. This suggests some stark realities that we face. First is that our global carrying capacity is structurally suppressed, based on observed trends in society, I think this is best explained by reduced economic freedom globally. There are various explanations as to why, but it all comes back to government intervention in our lives. Government is an entity that is logically independent from the governed, formally government is orthogonal to the people around the globe. Thus government can act on society exerting force (literal and figurative) on the citizens. Such forces can only exist outside of the system being observed, which is why I reach this conclusion. Said differently, people will act to maximize their freedom given the constraints that they face. Government, by definition, is a constraint on society.

There is a reason why liberty is now a global issue and why we are seeing revolutions and rebellion around the world. The world’s population wants \sigma=1 government  wants \sigma\approx \mathrm{Constant} as it can use the entropy difference to extract wealth from society. It is, as it always was, about control.

Rawl’s philosophy formally justifies \sigma<1. While this gets us in the direction towards \sigma\to1 it does so at the expense of our liberty. Rawls’ philosophy (progressivism) and that of our current governments (conservativism), are fundamentally limited, both resulting in lower overall societal entropy.

After we acknowledge the canonical trend of \sigma\to1, we are left with one alternative for increasing entropy, increasing average global income. Governments around the world recognize this which is why they print so much money. Don’t be fooled. increasing the money supply without actually increasing individual productivity, actually is a net harm to society cooling individual action. It is theft at the grandest scale.

Armed with that understanding we need to answer, “how do we increase individual productivity?” First we need to understand the natural constraints that we face. Our world is governed by the laws of thermodynamics. If we want to increase the amount that we do, we have no option other than to increase the energy consumed by society. This is a first law statement. We can make second law (efficiency) improvements, but these are limited by our knowledge, materials and capital; only resulting in marginal improvements.

Let’s provide a lower bound for the amount of energy we need to raise average global income from the $5.6/day (2000 dollars) to say $56/day (2000 dollars). Because of the second law we know that we have to supply more energy (heat) than is needed to increase the useful work output. Part of this is necessary to overcome hysteresis (stable dynamical systems tend to resist change). We assume the lower bound of energy needed to increase global wealth a factor of 10 to be a factor of 10 from what it was in 2000.

In 2000 the 6 billion people on the planet consumed 120 PW-hr, or 20 MW-hr/person. For a global population of say 10 billion with an average daily income of $56/day (2000 dollars) the world would have to consume  2,000 PW-hr every year! To provide context to this number, in 2008 the world consumed 117 PW-hr of fossil fuels, which is just off the peak fossil fuel consumption of the world. 117PW-hr/year is a daily consumption of 190 million barrels of oil equivalent (MMbbloe/day), or 68 billion bbloe every year.

Scaling fossil fuels to be 82% of a global energy consumption of 2,000 PW-hr/yr is one trillion bbloe/yr. This scale of energy consumption is not possible for fossil fuels. If it is not possible for fossil fuels then it is certainly not possible for renewable energy. We have one option left, nuclear energy.

Assume for the sake of argument the entirety of the 2,000 PW-hr/yr comes form nuclear. How much uranium is needed? Not as much as you might think, 300,000 metric tonnes of heavy metal (MTHM). Known reserves of uranium total 5 million MTHM at <$130/kg. This is terrestrial energy with conventional mining in existing mines. Once price increases far enough there are billions of tonnes of uranium in the oceans.

We have thousands of years of uranium available and as much if not more thorium. Accessing the fuel needed to sustain humanity, support global population, and increase human wealth is not a problem. It never was a problem, nor will it be a problem for any foreseeable future.

If we want to make the poorest amongst us (globally) as rich as the global mean, we need as much power every year as humanity ever consumed in its entire history.  We have the capability to access that power today!

I think the term of a “Nuclear Renaissance” is quite fitting. I talked about humanity at the cusp of a second social Renaissance due to recent cryptographic advances. As I understand the world cryptography and nuclear power are going to be the fundamental drivers of humanity. They will end this neo-feudal fossil era. We live in interesting times.

The Second Renaissance: Bitcoin in Historical Perspecitve

“History never repeats itself but it rhymes.”

-Mark Twain

What is it like to live during a formative change in humanity? I think the answer is much like it is today. After a tip off to read Book III of Adam Smith’s The Wealth of Nations, and reflecting some upon Weingast’s interpretation of the role of violence in the historical development of modern Europe. The rhyme that I see is in the relative equilibrium we’ve had with modern governance to that of the equilibrium that existed in feudal Europe and the shocks that we are seeing with Bitcoin and the shocks of emergent trade in the coastal towns of Medieval Europe. I am not a historian, and have not read a great deal on this subject, and as such invite any comments and feedback that you may have. Continue reading

Peer to Peer Government: Guarding the Guardians

Ideas come and ideas go. And some ideas, you just can’t shake. For about a year, I’ve been working on sketching out a framework for how to use contracts based on Bitcoin (capital B is the protocol). I call them bitcerts. Unfortunately, I have only rudimentary coding ability, and the bitcert remains a theoretical construct. I came across this article on twitter (HT Jon Waller) about Ethereum. This appears to have the attributes needed to create contracts. The uses they have (stocks and derivatives and such) are only really the tip of the iceberg. The big Kahuna is actually the ability to make contracts… It is the non financial contracts that are perhaps the most important, and this will be the bulk of the discussion here.

A week ago I was on vacation with my family and was rather depressed about the extent of the NSA spying, as revealed by Der Spiegel and discussed by Jacob Applebaum (@ioerror) in his To Protect and Infect, Part 2 presentation at the 30c3 conference. If you have not seen it watch it! Stop reading this post and watch it. You will not feel sufficiently violated until you do and my perspective will seem like that of a clueless crank. While I may be both, on this issue I am and as you will be sufficiently justified in our anger.

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My Response to Bitcoin: The Sexiest Non-Solution of All Time?

Alt-Market posted a critique about Bitcoin that I thought was myopic and missed the key attributes of the protocol and currency and the movement that surrounds it. Please read the original here.

My comments,

Bitcoin’s Origin and More

I want to address a key point in your critique of bitcoin, our lack of knowledge of who Satoshi Nakamoto is. You are right to assert that this individual or group of individuals could be a member of the establishment. This is not important. There are two things that are important. First is that participation is voluntary, second is that Bitcoin’s constitution (source code) is publicly available. If one were so inclined, you could sit down, read, and understand how the code operates. The rules are patent. If the rules change, then there is a risk that not all members will stay with bitcoin and it will fork into multiple branches.

This brings up another point that you discussed, that of non exclusive nature of crypto currencies. Yes any Joe Schmo (whomever that is) off the street can sit down and implement their own version of a cryptographic currency.  The cat is afterall out of the bag. This is a tremendous advantage. This means that there is and will always be competition to find which protocol is the best. This allows each new and existing currency to copy features from one another. This includes Bitcoin, as development has not stopped. There is a part of Bitcoin that cannot be duplicated and that is the established network. This is the part that takes the most time to grow and develop. What is beautiful about this is that this process is entirely emergent and is what makes Bitcoin robust.

As for me, I am an engineer and Navy vet. I own many firearms. I reload my own ammunition. I own gold, silver, and bitcoin. I have a stash of cash too. I am not afraid to defend my rights or the rights of those around me from others. I also abhor violence. None of these attributes makes me ideal. I am a product of my own experience. There is no one way to exemplify Liberty. Liberty is about plurality. It is about having many different views with some ideas being coincident and others not. Liberty is about respecting and allowing another’s viewpoint to exist and allowing my own. Liberty is more about acceptance.  For those kids who have not been scared by violence, having to fight and kill, I hope they never have to experience the pain it takes to get those scars. I remember very distinctly the moment I accepted my need to kill another human being and acted accordingly. Demanding that as a prerequisite for defining a liberty movement is overly narrow and misses the purpose of Liberty. Liberty is not about violence, nor does it exclude violence.

As for what happens if the world goes to hell, how do you know that the network at some level will not be maintained? One of the most important aspects of warfare is to maintain as much infrastructure as possible. While it enables the enemy, it also enables you. This saved many bridges in countless wars. It is where we get the saying about burning bridges. The internet is such a network, but only more so.

Many of the cypherpunks that you readily deride are engaged in active warfare on the internet. In case you weren’t aware the NSA overran our camp while we were asleep. These few vigilant sentries are trying to reorganize our efforts and take back our camp. War is fought on many levels. As we speak there are partisans fighting statism on the web. They are in a fight that by your statements here, you do not understand as a fight.

In Liberty,

Cal Abel

Measuring the Complexity of Bitcoin

I looked at the distribution of transactions of 1 hour of the block chain (269609 to 269618). I parsed the blockchain into two sets of transactions: originating and receiving addresses. I examined both sets independently and together, attempting to fit the three different trials to Gamma distributions. The receiving addresses proved to have the easiest to interpret set of data, and did not follow a Gamma distribution. Instead, the receiving transactions followed a Log-Normal distribution. Figure 1 shows the results of the data and the resulting fit. The data in figure 1 was parsed into blocks that are 2dB wide (every decade of transactions size is 5 bins, the first bin is 10^{-6}BTC, 1BTC is the 30th bin)

Figure 1, Receiving address distribution of bitcoin transactions blocks 269609 to 269618 with Log-Normal fit

Figure 1, Receiving address distribution of bitcoin transactions blocks 269609 to 269618 with Log-Normal fit

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Theft at the Grandest Scale

Theft is a strong word. It requires two things, desire and a lack of consent. One party desires something from another and takes it without their consent. Simple. My current project is developing an understanding of macroeconomics based on a formal aggregation of microeconomics. I did not anticipate the understanding that I found. This last weekend I worked on understanding claims against wealth inequality. I began by looking at the distribution of income derived form the Average Wage Index (AWI) from 1990-2012. Plotted on a Log-Log scale the distribution appeared to follow a canonical distribution Figure 1.

Figure 1 distribution of wealth (# people/$ v. income) in United States (2012)

Figure 1 distribution of wealth (# people/$ v. income) in United States (2012)

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Russell Brand and a Call for Revolution

Russell Brand made an audacious call for revolution in his New Statesman editorial. I share many of his concerns for the current state of affairs and see that if unchecked we will unfortunately have a revolution. However, I do not see his proposed solution as an effective one. It will lead to a greater tragedy within any society that adopts his well intentioned action. His interview with Jeremy Paxman is informative and entertaining to watch.

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Regulatory Applications for Bitcoin: Environmental and Spectrum Allocation

I recently wrote a post about using property rights to avoid the tragedy of the commons.  Jesse Jenkins, of The Energy Collective, responded to my draft post that he thought my idea of allocating property rights based off of land use was too complex. I assured him that it was not and gave a logical and concise rebuttal. However, his challenge to me left me thinking about how to simplify the regulatory approach. This post is my effort to sketch out such a simplified approach. Continue reading

A Network Analogy for Currency

Continuing my recent currency posts, I want to provide an analogy for what Bitcoin is as I understand it. This analogy may exist elsewhere on the web. To those authors who’s ideas I may be infringing upon it is not intentional and please notify me so that I may give the appropriate credit.  I read a great deal and don’t know where ideas come from, weather inside or outside my head.

Bitcoin is not so much a currency as it is a network protocol where the number of packets that can be exchanged grows at some fixed rate to a defined maximum. There are rules for how the packets are exchanged on a peer to peer basis to ensure that packets aren’t duplicated or lost. This is the genius of Satoshi Nakamoto. This is what he created. In this context the lines with what Bitcoin can become are very blurry. As I understand there are portions of the original source code that leverage the network analogy. Continue reading