What is it worth?

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What’s new?

Interesting Engineering reported that the CEO of Turkish cryptocurrency exchange Thodex fled to Thailand with $2 billion of crypto assets, leaving 400,000 users of the exchange in the lurch.

What does it mean?

Blockchain is a computer technology that prevents changes from being made to a series of records; the most important features of blockchain are distributed storage and a type of internal consistency (one block of data is related numerically to the previous block, hence “block chain”). If someone wanted to change a record in a blockchain, they would have to change the record in many, many locations, and would have to change many, many records in order to maintain the internal consistency of the records. Blockchain thus can prevent certain types of fraud, that is, fraud in which records are altered. Blockchain creates unalterable accounting records. Blockchain is currently used for cryptocurrencies such as Bitcoin, that is, currencies created and maintained as computer records.

Most implementations of blockchain rely on proof of work to establish and maintain the records. When a new record is added, blockchain sites perform long and complicated calculations (following the internal consistency rules) to add the record; the first site to present proof of the completion of that work, called mining, is rewarded with additional cryptocurrency.

Blockchain protects against only certain types of fraud, that is, fraud involving the changing of accounting records. Blockchain will not prevent many other types of fraud. In fact, the whole area of cryptocurrency has a great deal of fraud; an Internet search on the words “blockchain fraud” or “blockchain scam” will turn up many examples.

Consider, as an example, an area of fraud I was concerned with for my 40 years as a professor of engineering: cheating by students. Blockchain could protect against recorded grades being changed fraudulently, a type of fraud that does occur. I am aware of several such cases that were detected and there are probably others that went undetected. But cheating by students takes many other forms, none of which would be prevented or detected by blockchain, for example, someone copying another’s work on homework or during a test.

Blockchain is also touted as useful for verifying someone’s identity and for establishing trust in business dealings with unknown partners, but I suspect that the actual usefulness is more limited than the hype and that other computer technologies can accomplish such goals. The mathematics of computational complexity, which I discussed two weeks ago in this blog post, underlie all these technologies for computer security.

What does it mean for you?

Blockchain, as with many new technologies is the subject of much hype, some of which is misleading and even incorrect. For example, this article at Forbes says:  “Were the expensive free-range eggs we purchased really created at a free-range farm?  Was the gold ring I bought online really made with 24K gold? Companies can combat fraud with blockchain by verifying the legitimacy of every part of the supply chain process, helping both the buyer and manufacturer. You’ll never have to question that organic produce and those free-range eggs.”

I disagree. Nothing in blockchain can prevent someone from, at any point in the supply chain, substituting eggs from caged chickens for eggs from free-range chickens, just as nothing in blockchain can prevent a student from looking over the shoulder of another student during a test.

Blockchain does have important uses. The immutable nature of blockchain records is an important feature in maintaining security. But most hacking episodes involve stealing private records, not altering such records.

I am not addressing here the huge amount of electricity required for the proof of work aspect of blockchain (see, for example, “Bitcoin consumes ‘more electricity than Argentina’”) because, I am told by my local blockchain expert, other methods of blockchain do not rely on proof of work. I am also not addressing the independence of blockchain from regulations or governments (as part of crypto anarchism, for example), which others cite as an attractive feature; one upshot is that your recourse in the case of fraud and scam are limited. And, whatever you do, don’t lose your password; if you do, you lose your assets.

Where can you learn more?

This 2018 article “Blockchain is not a silver bullet for fraud prevention” is still very useful. Here is another article cautioning about the hype. This December 2020 article in Finance Magnates blames the lack of a killer application outside of cryptocurrencies for the failure of blockchain to achieve its promises. This December 2019 article uses a Gartner diagram of the phases of hype to speculate that blockchain will be useful five to ten years from now. This piece in TechBeacon lays out in detail some of the pitfalls of blockchain.

Some argue that blockchain eliminates the need to rely on trust  in business transactions, but this article by noted cryptographer Bruce Schneir points out that trust is always needed. He asks “Would you rather trust a human legal system or the details of some computer code you don’t have the expertise to audit?” He includes this image tweeted by Internet pioneer Vinton Cerf:

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One thought on “What is it worth?”

  1. A few thoughts:

    Cryptocurrency is about trusted peer-to-peer transfer of digital currency. The idea is that a central, trusted authority (i.e. a federal reserve bank or credit card company) is not needed. Blockchain makes that possible. Blockchain is just the means to that end. There are other ways to do it (e.g. hashgraph).

    Blockchain also makes other things possible, like trusted recording of property deeds–a big problem in some South American countries. This use of blockchain does not need to be linked to currency.

    Blockchain has some serious drawbacks. It is susceptible to the 51% attack: if a majority of nodes in the system are co-opted by an attacker, they can add and verify false entries in the ledger. This is what happened to Bitcoin SV early in its history, and very few exchanges will buy or sell Bitcoin SV to this day.

    Contrary to public perception, the blockchain ledger is not private. All transactions are preserved and are always public. (Monero attempted to build privacy into its blockchain, with partial success.)

    Bitcoin uses the SHA-256 algorithm for hashing. The original intent was that anyone could run a bitcoin node and do mining with idle CPU cycles (i.e. a screen saver or program running in the background). The difficulty of mining a block is variable–it can be made easy or very, very difficult. Satoshi never envisioned warehouses full of ASIC miners consuming megawatts of electricity, mining blocks with unnecessarily high difficulty settings. Mining was to be done by the “little guy” at home, and thus the currency was to be much more widely distributed.

    It was also expected to take many decades to mine all possible coins. Over 19M coins have been mined, of ~23M possible coins. Other cryptos have tens of billions of tokens circulating.

    Bitcoin’s greatest advantage is that its supply is strictly limited, but demand keeps growing. I have watched Bitcoin grow from $3/coin to $30, to $300, to $3000, to $30,000 and up. That’s four orders-of-magnitude, in spite of inflation (i.e. creation of new bitcoin). There is over $1T invested in Bitcoin, and now institutional investors are taking interest. In the coming years, I expect it to exceed $300,000/coin. As we approach the 23M coin limit, the price will go even higher. It’s supply and demand.

    Tax law is another problem. The government doesn’t like Bitcoin. The IRS considers it a commodity. You pay capital gains tax on bitcoin when you sell it. (The SEC has sued Ripple, claiming that it’s a security. It’s an interesting case because the Ripple network was invented by one organization as a way transfer money between banks, and they decided to sell XRP to the public to raise capital.)

    The intent was that cryptos would be used as currencies. Supply and demand, as well as tax law are discouraging this. Many investors today hold them as commodities. But historically, that was also the case with gold and silver–they serve as a store-of-value AND currency.

    Someday soon, I think we will have a cryptocurrency based on something other than blockchain. It will have none of the technical drawbacks, will not be considered a commodity, and will be widely used as a an actual currency.

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