This is Something Interesting, an independent, ad-free roundup of interesting Bitcoin and economics news along with my commentary and perspective. If someone forwarded you this newsletter, you can get it for yourself by clicking here.
In this issue:
A fork? In my blockchain?! It’s more common than you think. (reader submitted)
What should a central banker do about Bitcoin? (reader submitted)
A double spend attack has been spotted in the wild
What does a fork in a cryptocurrency mean?
“On your piece on Ethereum you left out the fact that misbehaving devs can be forked away, which I think is one of the most interesting dynamics in crypto. What do you think?” - LB
You are 100% right I did omit that whole topic - I had to trim a lot of things to stay under the GMail truncation limit! Let’s talk about forks.
The point of a blockchain is for everyone on the network to agree about the state of the network - in Bitcoin’s case the goal is for everyone to agree about how many bitcoins there are and who has them. Disagreements can still sometimes happen in this process - they are known as forks because everyone agrees on the history but after the disagreement the chain "forks" into two (or more) directions.
Most of the time this happens by accident because of a bug and it is embarrassing but tends to resolve itself pretty quickly because everyone has an incentive to install the fix as quickly as possible. At times though these agreements are more philosophical in nature and can’t necessarily be patched over with a security fix. In that case the community may splinter and the fork may become permanent.
The result is kind of like a religious schism combined with a reverse corporate merger: everyone who held a stake in the network before the split inherits a stake in both of the diverging networks and afterwards you can transact on either network independently. There are no rules governing how the market will value the new tokens after the split - it may introduce value (because of new behavior) or it may destroy value (because smaller networks make the tokens less useful as money).
This has actually happened in Bitcoin’s history more often than you might think:
The reason you don’t hear more about these Bitcoin knock-offs is they’re basically worthless. Forking the Bitcoin network is a bit like declaring that you are starting a new internet. There is nothing really stopping you from doing it but unless you convince everyone else to join you it won’t amount to anything. That’s why it is possible to "fire the devs" with a fork - the story goes like this:
Greedy devs introduces update that pays them infinity tokens
Greedy devs bribes some nodes so they install the greedy update
Honest nodes refuse to update, so the network forks into token-greedy and token-honest
People would rather hold a money that didn’t pay infinity tokens to the devs so they sell their token-greedy and use it to buy token-honest.
The price of token-honest goes up, the price of token-greedy goes down, eventually to zero "firing" the greedy devs
The most famous and significant fork in Bitcoin was a (failed) attempt to do just that. In 2017 the Bitcoin community was torn by a heated debate about whether to raise the block size limit. Businesses favored the increase (because it lowered of sending Bitcoin payments) and developers opposed it (because it increased the cost of running a Bitcoin node). Eventually a group of like-minded individuals implemented a version of Bitcoin with larger blocks and released it under the name Bitcoin Cash.
The market ultimately decided it valued decentralization more:
There was a similarly controversial fork in Ethereum when they decided to rollback the DAO hack. Those in the community who felt that code should be law split off and formed Ethereum Classic (ETC) which was basically Ethereum but without that rollback - effectively firing the devs for their attempts to intervene in the DAO. Here, too, the market ultimately sided with the dev team:
It’s hard for forks to be successful, really. First you need to convince a large subset of the network to take a material financial chance on your network. Then you have to convince that community to stay together, even though the main thing they have in common as a community is a willingness to fork. Often times those groups end up splintering up into smaller groups with every disagreement, which is essentially what ended up happening to Bitcoin Cash. It’s a tight needle to thread.
So as a theoretical threat to keep devs in line it’s there but it is something of a nuclear option - it could easily fail or backfire. It’s works best for super unambiguous misbehavior like granting yourself infinite tokens. What this market-driven logic is really good for is making the developers useless as a point of control. Governments can demand whatever backdoors they want and the developers can just explain how it is out of their control. Sorry, boss! Take it up with the market. ¯\_(ツ)_/¯
Central Banks, Bitcoin and You
“Suppose Bitcoin succeeds and becomes the next global reserve currency. What does that mean for central banks? What should Christine Lagarde do about Bitcoin?” - IS
Well I know it sounds dumb but if you think Bitcoin is eventually going to succeed the first and most obvious thing you should do is buy bitcoin. Central banks hold gold, US Treasuries and other assets for the same reasons that households do - they want to preserve and expand their purchasing power. If a central bank sincerely believes that Bitcoin is going to become a global reserve asset, they should start buying Bitcoin ASAP before the market catches on and prices rise. From the perspective of a central bank Bitcoin is just another kind of gold.
A more interesting question to ask ourselves is what should we do if we think Bitcoin might become a global reserve currency but it isn’t a sure thing. If we buy Bitcoin in that case we are hedging against the possibility that Bitcoin succeeds but we are also making it more likely. Some nations should be more receptive to Bitcoin displacing the dollar than others. Poor nations or nations like Cuba or Iran that have limited access to the global banking system are probably pretty open to disrupting the hegemony of the dollar. Institutions like the International Monetary Fund (IMF) and the US Govt. probably not so much. They should still buy some just in case, but they want to be very careful about not buying so much as to help build momentum.
If you’re the US Government and you definitely don’t want Bitcoin to displace USD as the world’s global currency there are a handful of things you could do. You can outlaw using Bitcoin, which would certainly hurt the price in the short term. It’s a high stakes wager though because if you fail to kill the network that ends up being a powerful advertisement for its resilience. Instead you may want to just regulate it so that it is inconvenient to use outside of the existing banking structure, or tax it heavily to discourage use without fully outlawing it.
You may also want to just print your currency into oblivion while it still has purchasing power and use that newly created money to buy Bitcoin before anyone else can. That doesn’t necessarily mean giving up on fiat currency - consider the possibility that Bitcoin replaces gold for central banks but does not end up being widely owned by ordinary citizens, perhaps because it is too expensive to transact in.
Central banks might choose to issue digital currencies of their own (CBDCs) so they can offer digital cash and programmable money in their preferred denominations without giving up the surveillance and control of the traditional banking system. A "Fedcoin" might fill the need for a digital bearer asset while still allowing the government to print more as desired. You could even implement taxation or financial regulations directly into the Fedcoin blockchain so that compliance was inescapable.
To be clear, I don’t think any of the central banks are doing any of those things right now. They are slow moving, cautious organizations helmed by people steeped in experience and hence a kind of inertia of perspective. The current leaders of the financial world are still working their way through the outdated belief that the primary purpose of Bitcoin is money laundering (It’s actually saving). They haven’t even started to acknowledge the more serious threat it poses to their monetary policies.
Doublespend spotted in the wild
When miners are trying to find new blocks to add to the blockchain they are doing so probabilistically and sometimes two miners find (different) new blocks at the same time. When that happens miners choose one of the two blocks to build off of and whichever block is found next then "orphans" the block it wasn’t built on. The whole process is called a re-org and it happens naturally every 2-3 weeks or so. A two block re-org is rarer but still happens perhaps once a year. As far as I know a three block re-org has never happened.
When a re-org happens the transactions in the orphan block stop being confirmed and the transactions in the longer chain become universally accepted. That is why bitcoin transactions aren’t ever totally final but always probabilistically final. The more confirmations they have the less likely it is that a longer chain will be discovered - and it is always possible that longer chain will have invalidated our transaction and spent that bitcoin elsewhere. When that happens it is called a "double-spend attack" because the attacker tricked the recipient into thinking they were getting paid but then snatched the payment back. It’s like a modern digital take on the old coin-on-a-string vending machine hack.
Anyway there was a double spend today in the wild for a staggering $21:
I personally doubt this was an actual attack, since the minimum hashpower cost for such an attack would be around $100k or so. Not a very efficient criminal. But that didn’t stop some pearl wringing publications from writing panicky articles about how Bitcoin was broken and it could just as easily have been a $21 million attack. I mean … technically? But if you are accepting a $21M payment on just one confirmation that’s really more on you. It’s like saying cars aren’t safe because you could drive drunk and without a seatbelt. Don’t do that?
Anyway, the market did not like it at all and Bitcoin crashed down to ~$31,000 at time of writing. Once again this movement was led by Coinbase where a roughly $100 premium turned into a roughly -$164 negative premium as Coinbase holders dumped aggressively:
The coins that are moving off of exchanges continue to move into addresses that belong to longer term holders. In fact the accumulation by long term holders right now is the largest we’ve seen in years:
Other things happening now:
Blackrock (the largest investment fun in the world) has officially granted permission for two of its funds to begin investing in cash-settled Bitcoin futures. They won’t be holding Bitcoin directly but the signal this sends is huge. The career-risk for financial advisors suggesting Bitcoin has plummeted:
Observe! The most terrifying chart in the market:
Presented without comment: