Anonymous Transactions through Multisig Escrow

Hi Everyone,

After the flash crash last Monday on BTC-E which took the price as low as $309/BTC, prices rebounded to the $500/BTC range.  The flash crash was similar to the one that happened on bitfinex on the 14th (margin calls and stop losses cascading after large market sells).

Other news:
  • BitsharesX (bank and exchange DAC) climbs over 100% through the week:  This makes it the third largest crypto, only smaller than litecoin and bitcoin.  I was not able to find a good reason for this jump and I am still skeptical of its long-term viability (particularly the concept of market pegged assets:
  • Storj, a decentralized cloud storage system (i.e. distributed Dropbox), raises 910 BTC in crowdfunding:
  • Nxt asset nxttycoin rallied 150% over the past two weeks:  nxtty is an end-to-end encrypted mobile texting/communication app.
  • Crypti, and altcoin which rewards users for spending their coins at merchants, has been gaining traction recently:  From a cursory glance, it seems like the system is highly centralized in how it determines which accounts are merchants versus which accounts are consumers.
  • NYDFS extends the commenting period for virtual currency regulation:
  • Wedbush Securities publishes a new paper on bitcoin volatility:
  • Chain, a blockchain analytics company, raises a $9.5m investment round:
  • Coinbase acquires, another blockchain analytics company:  Blockchain analytics seems to be the hot thing recently.  Earlier in July, Tradeblock, yet another blockchain analytics company raised $2.8m:
I recently came across a PoW(scrypt)/PoS hybrid altcoin called supercoin.  Beside having lottery-like superblocks, they also have a anonymity mechanism based on multisig escrow.

The Sender elects a Mixer to serve is an anonymizing intermediary between him and the receiver.  To keep the Mixer honest, the sender also employs a Guarantor and a 2-of-3 multisig address.  The details are below:

I think this mechanism is interesting because it almost works.  By itself, the mechanism fails when Sender and Guarantor collude against Mixer.  This could be partially remedied by a reputation system since Mixer is allowed to reject Guarantors he doesn't trust.  The another problem is that the Guarantor knows both Sender and Receiver so there is some partial loss of anonymity there.  Finally, blockchain timing analysis could reveal a possible relationship between Sender and Receiver since Mixer is known to the network as one of many mixers (you could match up inbound txns to Mixer with outbound txns from Mixer).  All in all, it's a clever mechanism but I don't think it fully works yet.  At least the mechanism is more clever than most of the multisig escrow mechanisms involving customers and merchants posting collateral:

Kevin & Team Buttercoin
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Cascading Margin Calls and the Flash Crash

Hi Everyone,

This week markets have tumbled from $590/BTC to $500/BTC, seeing a low of $450/BTC.

Thursday at around 1am PST, bitfinex saw a flash crash taking the price to $450/BTC.  This flash crash was the result a series of very large market sell orders on bitfinex at around $525/BTC which further triggered cascading margin calls on the way down.  

Over 9000 BTC were sold in a matter of minutes, 650 BTC of those being liquidated leveraged long positions due to the cascade of margin calls.  While 650 BTC liquidated in margin calls is only about 7% of what was entirely sold, their presence is enough incentive for the initial dump.  In other words, given that you know that $5/BTC below the current price is a series of cascading margin calls worth about 650 BTC, how much would you be willing to sell ahead of it if you think there is a good chance for a slight drop in price or you had the long term intention to sell anyway?  And also, stop-losses on the way down would also cascade in the same way as liquidated margin positions.  Moreover, given that many traders have arbitrage algos running on multiple exchanges, stop-losses in non-bitfinex books could still end up impacting the bitfinex selloff once the arb bot would mirror some part of the foreign stop-loss sell as one leg of the arb. [Also, as a slight tangent, given that Ethereum will be liquidating some of their pre-sale bitcoins to pay back debts and use for development, getting in front of those coins is also worth some value.  4150 BTC will be withdrawn from the exodus address some of which will be used to pay off debts and prior expenses and establish development teams in Berlin and Amsterdam.  It is unclear how much of that 4150 BTC will be liquidated and how much will be kept in BTC].

Looking at bitfinex's swap market, active USD Swaps almost doubled between late May and early July.  This suggests that many traders entered into leveraged long positions somewhere between $560-$680.  Given the maintenance margin of bitfinex as 15%, margin calls should be spread between $476-$578.  While the slower selling pressure throughout the week above $525 did not trigger a cascading effect, the sharp sells around $525 did.

On the way down, bitfinex uses an algo to throttle the price (as an alternative to circuit breakers).  It works something like this: if an order would drop the price more than 10% in a minute, execute part of the order to take the price down 10%, then wait a few seconds, then execute another part of the order to take the price down 10% more, and wait a few seconds and repeat.  This is to give the market some breathing time to refill the bid wall before the large sell market order continues its way down the orderbook.

I suspect this also gives bitfinex some time to insert their margin call liquidation orders in front of individual chunks of the large market sell order.  If they are doing this, it would give added protection to swap underwriters since margin-called positions would be liquidated at higher prices and would also give traders who were forcibly closed by margin calls smaller loses due to a better price.  The person who loses out is the person executing the large market sell order which triggered the crash.

If bitfinex, instead, gives priority to the large market sell order over the margin call liquidation orders, then the large seller benefits from less slippage at the cost of the intermediate buyers on the way down who refill the bid walls during each "speed bump" (although there is less slippage, the overall price could be worse since market orders inserted between successively executed chunks of the initial order could depress the price more).

Bitfinex gives the second explanation for why they have this "price throttling".  They suggest that any market order of that size is likely to be manipulative since no rational person would prefer a worse execution price over breaking up the market order for a better price.  Therefore, they throttle it.

Personally, I don't buy that explanation.  Market manipulation is an ominous term which can mean anything from spreading false rumors to painting the tape to hunting for stop losses.  What some people call manipulation, others call good strategy.  In any case, "manipulation", real or not, is very difficult to pull off and usually the manipulator takes on exorbitant risk which results in huge losses if the market does not react how he wants it to react.  Regardless of which practices we term manipulation, there are good non-manipulative reasons for executing a large market sell in the face of cascading margin calls below you.

I think bitfinex is just looking out for its swap writers' solvencies and, thus, indirectly their own interests.  If there are full or partial defaults in bitfinex's swap market, people would be less willing to write them and those that do would require a higher premium.  This would make leverage more expensive and reduce margin trading volume altogether.

What this whole episode shows us is that the bitcoin markets are becoming more automated and more intricately interwoven.  Already fundamental news has stopped affecting the price and now we are starting to see flash crashes (much like the real world markets).  Maybe bots are getting progressively more tangled up with other bots and there will be more flash crashes to come.

Other news:
  • Bank of Canada came out with a paper which looks at arbitrage opportunities in the bitcoin markets and finds arbs no longer exist:
    • Unfortunately, the paper's methodology was questionable.  They use daily closing prices for their historic data which makes no sense since arbitrages don't last 24 hours barring special events like the China ban.
    • As a side note, if a market seems to have no arbs possible, it's because arbitrageurs are doing those arbs.  So tautologically, the lack of apparent arbs is evidence of the presence of arbs being done, so the question itself is rather pointless.  A better question would be, how fast do you have to be to capture the arbs from the other arbitrageurs?
  • Jed and Ripple strike a deal to avoid immediate selloff of Jed's $9bn XRP:
    • I wonder what Jed got out of that deal.  Maybe Ripple agreed not to sue Stellar.  Not that there is a strong basis to sue over open-sourced tech.
  • Viacoin unveils ClearingHouse, decentralized p2p trading on the blockchain:

Kevin & Team Buttercoin
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Bitcoin Price Bubbles and Socio-economic Feedback Cycles

Hi Everyone,

This week bitcoin traded between $575/BTC and $600/BTC, ending the week at $590/BTC.  Volatility continues to be low for many weeks in a row.

  • Gavin Andreson made a recent post on Bitcoin's scalability:  By using invertible bloom lookup tables, allows the decoupling of block size from block propagation time by allowing nodes to share only the block headers instead of the full block.  This erases the incentive for mining pools to include fewer transactions with the intent of propagating the block through the network faster because the block is smaller.  This would matter if two pools find a block at roughly the same time.
  • Monacoin crashes; BitcoinDark on the rise, Cloakcoin falls after a jump last week; Stellar starts trading on exchanges and has seen a rise in market cap albeit not much movement in price.
    • On a side note, the way Cloakcoin works is by having transactions which can be conditional on future states of the blockchain.  For example Bob creates a transaction (to be released 4 blocks from now) which sends coins to Mixing Node A which releases only if Mixing Node A sends some similar amount of coins to Joe in one of the next 4 blocks.  Combining this with one-use stealth addresses and two mixing steps, supposedly anonymity is achieved.  I'm not yet sure if this works or not.
  • There are rumors that AQR and DE Shaw are looking at bitcoin markets.
A Paper on bitcoin price bubbles and socio-economic feedback cycles was published week:  I found it very informative and it confirms some ideas I've had  about demand-side leading indicators to price movements like search volume and client downloads.  It was also very readable compared to some of that heavy crypto stuff and the results gave immediate real world insight.

Without getting too technical, it looks at the feedback loops between bitcoin price, bitcoin search volume (Google/Wikipedia), bitcoin word-of-mouth spreading (Facebook/Twitter), and bitcoin user adoption (client downloads/blockchain address analysis) by running a series of statistical/econometric tests.

The results are shown in this diagram:

  • Social Cycle: search volume goes up => word of mouth goes up => price goes up => search volume goes up
    • Hype begets hype (bubble behavior).
    • "Bitcoin's growing popularity leads to higher search volumes, which in turn result in increased social media activity on the topic of Bitcoin.  More interest encourages the purchase of bitcoins by individual users, driving the prices up, which eventually feeds back on search volumes."
    • This is mediated by the media reporting on price increases, which drives curiosity and greed, triggering their search activity.
  • Adoption Cycle: price goes up => search volume goes up => user adoption goes up => price goes up
    • Understanding begets adoption (organic growth).
    • "New bitcoin users download the client and join the transaction network after acquiring information about the technology.
    • "This growth in the user base translates into a price increase, as the number of bitcoins available for trade does not depend on demand, but rather grows linearly (more or less) with time."
  • Search-Price Dyad: negative external event happens => search volume goes up => price goes down
    • Negative news (e.g. goxings, bans, hacks) dissemination precedes market crashes.
    • Search activity responds faster to negative events than price drops.
    • People must figure out what's wrong before they can determine whether or not to sell.
    • 3 of the 4 largest price drops were preceded by the first, fourth, and eighth largest increases in Google search volume.
Other Findings
  • An increase of 10k client downloads leads an increase of $3.80 in price.
  • An increase of .01% in bitcoin tweets as a proportion of total tweets leads to an increase in price of $2.70.
  • Search levels experience sharp increases 2-4 days after price increases.
  • Word of mouth (through social media) increases 1-2 days after search volumes increase.
  • User growth (client downloads) also increases 1-2 days after search volumes increase.
  • There is little to no relationship between each of the variables beyond 4 days.
  • Bitcoin prices significantly deviated away from fundamental value (based on electricity costs during mining and mining efficiency) during the June 2011 bubble and the April 2013 bubble.
  • Price never dropped significantly below fundamental value.
    • This suggests the cost of producing bitcoins as a lower bound to their value.
    • This also suggests that at the current supply of bitcoins, the market always prefers them to the electricity used in their production.
  • Their model correctly identifies the sign of the 10 largest price increases and 9 of the 10 largest price drops.
***Technical Stuff***

Data is grabbed and bucketed into days.  Daily Google search volume was simulated out of weekly data and 3 months of the most recent daily data.  User adoption was, in one method, proxied by blockchain change address analysis and, in another method, by wallet client downloads.

From the data they take first differences of each time series to guarantee stationarity (Augmented Dickey-Fuller test, KPSS test).

Next a vector autoregression of lag 1 (VAR(1)) is done and yields significant p-values thus passing the Granger causality test (Note: This is predictive causality, not "true" causality in the narrative sense, but it is good enough for trading strategies).

Pairwise correlation analysis was also done and while the results show interesting insights, more complex 3-cycle relationships are hidden so the authors prefer VAR(1).

Both normalized and non-normalized results of VAR(1) are given.

Impulse response functions are created to show the impact of 1 standard deviation shocks of each variable to the other variables.

The Bayesian Information Criterion achieves a minimum for the model with lag 4 (Note: This is a measure of the tradeoff between model complexity versus predictive power.  It penalizes having more variables more so than the Akaike Information Criterion does.  Given that AIC is arguably superior to BIC (, using 5 or 6 lags might make for a more comprehensive model.

Possible refinements to the model:
  • Use hourly buckets instead of daily buckets
  • Use VAR(4) or VAR(5) instead of VAR(1)
  • Model fundamental value based on changes in mining technology (GPU=>FPGA=>ASIC) instead of based on a constant energy efficiency value since later technologies are more efficient per kilowatt.
  • Add supply side modeling with hashing rate vs difficulty and the block reward halving point.
Kevin & Team Buttercoin
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Merchants Versus Consumers; Ethereum Pre-sale

Hi Everyone,

This week markets took a tumble from $600/BTC to $560/BTC before recovering to $595/BTC today.  There's been a lot of speculation why prices dropped so persistently earlier this week in spite of weeks of good news (with the exception of the BitLicense piece).  As I mentioned in my earlier posts, for the most part, bitcoin markets are no longer sensitive to fundamental news (with perhaps the exception of news at the level of Argentina's default (thought in this case there wasn't much of a reaction)).  Rather most people suspect that the recent price drop was based on the expectation of merchant adoption outpacing consumer adoption in the near term.  With Bitpay announcing free processing for all merchants, it's likely that the market expects incoming sell pressure from new merchant signups some weeks or months down the line thus depressing prices this week (insiders likely sold in front of the public announcement).  There is also a multiplier effect at work.  If the market expects the price to dip $5/BTC due to Bitpay's announcement, those who sell in front of the incoming merchants can drop the price multiple times that amount (say $40/BTC).  Also, there's another propagating effect since Coinbase and other competitors can be expected to follow suit and reduce fees for merchants thus magnifying the number of merchants entering the entire space.  Considering these effects in vacuum, the total drop should be an equilibrium price at which customers would be indifferent to spending the bitcoin to show support for new merchant acceptance and holding it because the BTC price has dropped too much for spending it to be desirable.  Ceteris paribus, and with some handwaving, the price drop can abstractly be thought of as the value of "good will" in the bitcoin community toward new merchants who accept bitcoin.  The more the price drops, the greater the "good will" which must be counteracted by lower price to reach equilibrium.  One argument against this interpretation is that for merchants to sell bitcoin through Bitpay, Coinbase, and other services, the bitcoin had to have been bought somewhere, sometime, by someone.  In fact, if customers immediately replace all bitcoins spent at merchants, the net effect will be zero instead of a drop.  Thus the actual selling pressure is the total bitcoins spent at merchants without buyer replacement minus the BTC collected by merchants and not liquidated into the market (i.e. some merchants choose to hold BTC instead of convert it to USD).  Taking this selling pressure and netting it against buying pressure from consumer adoption and we can get a prediction on short term price.  Of course much more goes into the market pricing mechanism than just merchant adoption versus consumer adoption but at least this is a short term signal to be considered with other signals on direction and magnitude.

News this week:
  • Stellar, a Ripple clone with more transparent and equitable initial distribution and built-in 1% inflation started by Jed McCaleb, founder of MtGox and Ripple, launches:  They also have a partnership with Stripe which can serve as a strong foundational gateway.  I found this slightly funny: a github commit where Jed is replacing all instances of the string "ripple" with "stellar":  It should be fine, of course, since the Ripple protocol is open source.  Ripple XRP tanks 10% on Stellar announcement.
  • Mircea Popescu of MPEX fame offers to sell an ethereum future (5000 ETH per 1 BTC) deliverable March 15, 2015 on #bitcoin-assets:
  • In March, one of the Bitcoin contributers, Peter Todd, wrote a piece on treechains ( which is basically a more elaborate version of sidechains.  It tries to solve the problem with sidechains (2-way) where reorganizations of the blockchain can lead to undesirable situations which may result in inflation and the danger of sidechains being merge-mined with too much hashing power and 51% attacked.  Most of the other core developers like Gavin, Jeff, and Greg are not fans of the treechain idea (though they do like sidechains).  This week Peter Todd joined the Viacoin team as Chief Scientist to work on treechains causing the altcoin to spike 70% on the announcement.  As with all pie-in-the-sky ideas, this will either be really good or really bad.
  • Argentina defaults on interest payments to bold holders.
Regarding the Ethereum pre-sale, I have a slight suspicion that it might be over-bought.  The Ethereum team did such a good job promoting it that a good deal of people think it's a good idea.  That's not to say it's not a good idea, just that investments that are understated and "more hidden" often return more than investments which everyone is aware of and watching.  It's also analogous to the idea that when your oldest relatives are asking you how to buy bitcoin, the bitcoin price is probably peaking on a hype bubble and it's time to sell.  Also, personally, I would never have invested into bitcoin had I not carefully done my research and thoroughly read the Satoshi white paper.  With Ethereum, I doubt that most people buying have read the white paper (, yellow paper (, or genesis sale terms (  In the terms of agreement Section 19.9, it says "Purchaser understands, that while the Ethereum Team will make reasonable efforts to complete the Ethereum software, it is possible that an official completed version of the Ethereum Platform may not be released and there may never be an operational Ethereum Platform".  This is a real possibility.  Also, I'm not sure if the claims on ETH bought in the presale can be traded before the actual genesis distribution.  Not being about to trade out of ETH in the scenario where things are going badly is liquidity risk.  And then there's the question why one of the founders Charles Hoskinson (also a founder of Bitshares) is no longer with them?  So that is why I have very mixed opinions about Ethereum.  But all that being said, I will likely still buy a couple BTC worth of ETH.  For me buying ETH is a bet that Vitalik, Gavin and the rest of the team know what they are doing and will be able to execute.  Even if the project is 90% fated to fail, the scale and the scope of the project is so grand that the net expectation could still be positive.  Finally, given that you want to buy, there is a tradeoff between buying now for a discount and buying later at a higher price.  Right now you get 2000 ETH/BTC and in three days the price changes to 1970 ETH/BTC.  You lose out on 1.5% by waiting.  Alternatively, you can think about it as paying 1.5% for a few days more worth of information.  Just a thought.

Kevin & Team Buttercoin
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Smart Contracts

Hi Everyone,

This week markets have been dropping from $630/BTC to $595/BTC.  A sharp selloff on Thursday was subsequently followed by two smaller selloffs.

In the news this week:
  • Ethereum launches their presale where you can buy 2000 Ether per BTC:  Price goes up in 10 days.
  • BitsharesX, a cryptocurrency developed to be used with DACs (Decentralized Autonomous Corporations), starts trading on select altcoin exchanges (bter and BTC38):  It is currently the 8th largest crypto with a market cap of $18m.
  • Ripple introduces their smart contract project, Codius:
Given the news this week, let's talk about smart contracts.  A smart contract is essentially a computer program which mediates between two (or multiple) parties based on predetermined encoded rules.  It essentially replaces the function of lawyers and courts for dispute mediation.  It is also often self-enforcing.  The simplest example of a smart contract would be a vending machine.  You put money into the vending machine with the understanding that a Coke will come out.  The vending machine functions as a smart contract between you and the owner.

So what about Ethereum?  Ethereum is a protocol on which smart contracts can be designed and executed.  These smart contracts also have the property of not requiring trust between the parties mediated by the contract (e.g. if a contract specifies the rules where I can hold your data for you and you pay me for it (decentralized Dropbox style), then so long as I can produce proof-of-storing-your-data to the contract machine, I will get paid even if neither of us trust each other or even know each other).  However, there are certain types of contract which require external information which requires trust of some type of oracle (e.g. if I bet you through a contract that the BTCUSD price is going to go up, the contract machine must serve also as an oracle to figure out what the price of BTCUSD actually is).  Trust is therefore required in the process by which the oracle decides on the state of the outside world.  For example, if the oracle checks the BTCUSD price through Bitstamp's and Btc-e's APIs, as party to the contract you have to trust that Bitstamp and BTC-e's API's are working properly, the oracle has the right certs for Bitstamp and BTC-e, and that there are proper failover procedures for when Bitstamp and BTC-e's APIs are formatted differently from before, temporarily down, or completely defunct.  Also how does the oracle handle bad/glitched data (e.g. Bitstamp shows $0/BTC because of some bug)?  Where oracles are involved, the situation can get messy.  Still in today's world, there are many companies and services we choose to trust for deciding on the state of things like our bank serving as an oracle on the amount of money we have in our account.  If Ethereum works out, there will likely be many contracts essentially doing the same thing, competing with each other for business.  There will likely be two opposite effects. First, an oracle with high trust would be more valuable than an oracle with low trust or a short history of correctly deciding on states of the world.  Over time, those contracts (which require oracles) with strong network effects will tend towards natural monopolies as the highest trust oracle squeezes out its clones.  The second effect is that newer and better (seen as more fair) oracles will be created to mediate the same conceptual contract.  If the newer and fairer oracles are significantly better than the older oracles, they will gain market share.  If the newer and fairer oracles are only marginally better than the older one(s), then the network effect dominates and the older oracle(s) stays a monopoly (oligopoly).  But who knows how things play out.  Ethereum is a highly speculative play at a new and more decentralized world.

Bitshares, on the other hand, wants to do away with oracles for outside world state verification. It was born out of the idea, can we have a USDBTC, gold, oil, exchange without touching fiat/gold/oil.  They believe that a bitAsset like USDBTS will be pegged to the real USDBTS rate based on behavioral confirmation of traders even without the virtual asset being redeemable for the real one (i.e. bitAsset USDBTS cannot be redeemed for real USD).  The logic is very circular but I can't say for sure that it won't work.  After all, most gold ETFs cannot be redeemed for gold.  But all things considered, I'm leaning toward this not working correctly.  On a side note, Bitshares uses Delegated Proof of Stake for it's consensus mechanism.  Everyone uses their stake to vote for delegates who they entrust their staking rights to.  These delegates then have staking power equal to the total stake delegated to them and use it to decide which transactions to include in the next block and which transactions are legitimate if there are double-spend conflicts. Individuals can, at anytime, choose a different delegate to represent them.  I'm not sure this solves the Nothing-at-Stake problem (might make it worse).  Bitshares also uses TITAN (Transfer Invisibly To Any Name) which is basically just stealth addresses bound to a naming registrar (e.g. you can send to Bob instead of 13w5sdkdgs42sSk4EsfdeE).

Kevin & Team Buttercoin
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Competition in the Bitcoin Space and the Future

Hi Everyone,

This week markets dropped slightly from about $635/BTC to $630/BTC.  Intermittent swings brought us as low as $615/BTC and as high as $640/BTC.  Volatility this week has been notably low given the number of pieces of exciting news.  This may suggest that regulatory news and industry news (short of goxings) no longer has a strong effect on price.  Macro news like the ECB taking the deposit rate negative a month ago may still have an effect:

News this week:
  • New York's Department of Financial Services have released proposed "BitLicense" regulations.  Marco Santori gives his take on them:  Regulations look strict; they may push innovation overseas if not amended and if other states follow New York's lead.
  • GHash.IO commits to capping its hashrate at 40% of the network total hashrate:  Given their trackrecord, some believe this to be an empty promise:
  • TradeBlock (formerly The Genesis Block), a Y Combinator blockchain analytics company, raises $2.8m from Andreesen, Barry Silbert and a few others:
  • Shopify, already using Bitpay for merchant services, also integrates with Coinbase giving merchants a choice between the two:
  • Circle releases its wallet to positive reviews giving Coinbase direct competition:
  • Elliptic Vault raises $2m giving Xapo direct competition:  From what I can see so far, Xapo is cheaper and has a higher coverage limit through their captive insurance company.
Competition between bitcoin companies is heating up this week.  This is, of course, healthy for the ecosystem as it drives prices (fees) down and generates value to the consumer. It's also bad news for the incumbent but, in the bigger picture, competition is inevitable in spaces where profit margins are high and barriers to entry are low.  These companies were likely expecting competition sooner or later.

Here is one way it could play out in the next few years.  As bitcoin enjoys higher and higher prices due to adoption, speculation, and shifting sentiment and bitcoin companies pull in serious profits, more startups will enter the space to get a piece of the action and a bubble forms and then pops.  Final market share breakdown for each segment of the bitcoin space (wallet, exchange, merchant services, etc.) will likely follow some power law distribution where most of the profits are captured by the top few companies and very little remains for the rest.  For every Google, there are a couple of AltaVistas.  As each segment of the bitcoin space becomes saturated, mergers and acquisitions will likely follow between the players who survive giving the merged conglomerates better price-setting power and better economies of scale (on the costs side).  All the while, the investors and VCs which back the right metaphorical horses get paid off handsomely.  Among those investors, some deliberately picked horses they thought were strong while others sprayed their money around giving them a diversified basket of seedling companies.

Yet that whole narrative is an old narrative applied to a new situation.  If cryptocurrency truly is a phenomenon on the same plane as the internet revolution of the 1990's and 2000's, it's possible that the narrative itself changes.  In other words, just as no one could have predicted how the internet would play out in 1993, maybe no one can predict how this whole cryptocurrency phenomenon will play out.  It's possible that entirely unexpected industries will be morphed by blockchain technology and the best innovations and products will be created by disenfranchised hackers and cryptographers, not investor-backed companies.

The first scenario likely plays out if the applications layer of bitcoin holds most of the value as opposed to the second scenario playing out if most of the value is in the technical developments in blockchain technology and cryptocurrency lateral to bitcoin.  In the first case, capital is quite useful for consumer product development and improving time-to-market.  In the other case, capital is not as useful for generating technical innovations and finding novel uses for fringe tech.  Is bitcoin English to some future Esperanto or is bitcoin AltaVista to some future Google?  Personally, I lean toward the first scenario playing out but I would not be surprised either way.

Kevin & Team Buttercoin
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Making Money in the Markets

Hi Everyone,

This week markets fell from about $645/BTC to $612/BTC.  This likely suggests that the market thinks Tim Draper overpaid for his 30k BTC.  Bitcoin warnings out of Italy and bitcoin regulation out of Argentina could also have dropped the price a few ticks.

In other news:
  • Litecoin botnet Lecpetex was taken down by Facebook and Greek local authorities:
  • Gox will auction off and give proceeds to creditors:
  • Next version of Bitcoin Core will have floating fees depending on your inputs' coin-age and average transaction confirmation time on the network:
  • BitXBay, an Ebay-esque decentralized and anonymous marketplace was released this week:  They use collateral multisig escrow payments to keep parties honest.  I'm not convinced that this incentive system actually works.
  • 3.5 BTC puzzle with 32 page solution solved:
  • Grooveshark and XHamster now accept bitcoin.
Making Money in the Markets

First, let's ask ourselves how hard is it to win money in the markets?  Assuming that the market is a zero-sum game (i.e. someone must hold a losing position for someone else to win; zero-sum in money but positive-sum in utility since not all participants enter the market for profit only (e.g. buy weather futures to mitigate crop failure risk)), it seems that by being a better predictor of an asset's future market value than half of the players in the market, you will win.  But that isn't actually the case.  Even in this simplified model, you would need to be better than half the capital, not half the people.  Since capital tends to centralize toward the better players (i.e. the winners) in this sort of game, you likely need to be better than 90%-95% of the other players.  Adding on frictional costs like broker fees and exchange fees makes the game negative-sum and ups the threshold to beat. So when is it possible for you, as one person, to be right where many people are wrong?

In the super-short term, profits are divided according to the power law (i.e. 1st takes most, 2nd takes some, 3rd takes crumbs, etc.) to those firms with the best and fastest technology.  Strategies are often simple although the computer hardware and routing/communication technology is very sophisticated.  Speed is valued above all else.

In the short-medium term, in the absence of private and material information, you will likely lose in your analysis of public information to the teams of Math/Stats/Physics PhD's, veteran traders, and other experts at top hedge funds and prop shops.  On top of that, you are also competing against people who actually do have insider information so you will be left picking up crumbs at best and losing at worst.

In the long term, a singular powerful insight not obvious to most people can net you a huge payday.  This is where having a better mental representation of the world can make one person right where hundreds/thousands of people are wrong.  Being able to predict the subprime mortgage crisis would compensate you for thousands/millions of missed short and medium term opportunities.  At this frequency level, being perceptive and meta-reflective matters more than anything since the market, itself, is highly reflexive.  Primary effects cause secondary effects which cause tertiary effects.  All parts of the market system update to new states simultaneously with complex feedback loops and general interconnectedness.

What about market efficiency?  How efficient is the market?  The wisdom of crowds is a phenomenon whereby the aggregate opinion of a large population tends toward the truth even if most members of the population are uninformed.  For example, if a group of people in a room are shown a jar with some number of marbles in it and told to guess the number, the average guess of the group is usually very close to the actual number of marbles in the jar.  Does price discovery in the market follow this same process?  No, while some market participants are trying to guess the intrinsic value of the investment asset, others are trying to guess, at a meta-level, what that aggregate guess will be.  In this way price discovery is more reflexive than the discovery process of the number of marbles in a jar.  Another difference between the marbles example and the markets is that with guessing the number of marbles in the jar, there is no real emotional investment into whether there are 42 marbles versus 47 marbles but with the markets real money is at stake so greed and fear play in integral role in players' behaviors and the determination of price.  This also adds to stronger market reflexivity.

Consider a second experiment (Keynesian beauty contest) where a group of people are told to pick a number between 0 and 100 such that it is 2/3rds of the average guess of the group.  A person might think about choosing 66 and before realizing that should everyone else guess 66, he should guess 44.  But if everyone else guesses 44, he should guess two-thirds of that and so on.  Under perfect rationality on the part of all players, the optimal guess converges to 0.  However, in actual experiments where this game is played out, the winning value is often somewhere between 10 and 25.  Taking this further, we can think of this winning value as a quantification of the meta-rationality of a group.  Without a functional form, we can make ordinal comparisons by saying a group which has a winning value of 10 is more meta-rational than a group which has a winning value of 20 but we cannot compare absolute distance in any way (group-10 is more meta-rational than group-20 by the same amount that group-20 is more meta-rational than group-10).  Nevertheless, it should suffice as a tool to think about market efficiency.  Any market comprised of a population which does not yield a winning value of 0 in this experiment cannot be considered an perfectly efficient market.  How inefficient a particular market is can be quantified by how far it's population would deviate from 0 in it's winning guess should they be subject to this experiment.

The market is filled with a diverse set of players, some more meta-reflective or meta-rational than others.  Predicting the future price of an asset, then, can simply be thought of as an exercise in being slightly more meta-rational than 50% of the capital (95% of the players) in that asset (game).

Kevin & Team Buttercoin
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Auctions, Bidding Syndicates, and Bidding Strategies

Hi Everyone,

This past week opened at $600/BTC before jumping to $640/BTC-$660/BTC before ending at $634/BTC.  Much of the early action from $600/BTC to $640/BTC was likely due to US Marshal auction insiders buying up to at least their bid, possibly a little more based on their expectation of the winning bidder's bid conditional on their own information set (their bid price and the fact that they didn't win).  The market seems to agree that the winning bid is somewhere between $640/BTC and $660/BTC.  On a side note, it's interesting that the US Marshal sent the 30k BTC to the winner (Tim Draper) with no network fee (coin age likely helped speed up the inclusion of this transaction into a block).

Had an interesting thought the other day on why syndicates (e.g. SecondMarket's syndicate) don't win auctions like the US Marshal bitcoin auction.  One common reason a person might join a syndicate instead of become a bidder himself (herself) is that he might not have the capital or desire to buy a full 3k BTC block.  In either case, his slippage from buying through the market would be significantly smaller than slippage incurred by someone buying a full 3k BTC through the market.  Therefore, his "soft" upper bound on what he is willing to bid is much lower than a full-block bidder's upper bound.  So long as there are enough real bidders (and assuming some bell-esque distribution of willingnesses to pay), there will likely be at least one bidder who is willing to bid above the syndicate's highest bidder's upper bound (as proxied by slippage) which means the syndicate will not win.  By the same reasoning, it makes sense that one bidder swept all the blocks since, if his intention was to buy 30k BTC, his market slippage would have been the greatest compared to bidders who wanted fewer than 30k BTC and thus his upper bound on willingness to pay would be the greatest.  Conditional on a person being the highest bidder of this group (those who want all $30k BTC) he is very likely to be the highest bidder overall as well (once again assuming some bell-shaped distribution of willingnesses to pay).

Another interesting thing to consider is the bidding strategy for the syndicate.  At the lower limit, the syndicate will take the top bids which total a quantity of 30k BTC and do a weighted-average to get the syndicate's bid price and then bid on all blocks at that price (assuming the syndicate does not purposely bid below this to net itself some profits on a win).  If the syndicate wins, almost everyone (besides the bottom bidders) gets what they bid for and everyone is happy.  At the upper limit, the syndicate will take the top bids which total a quantity of 3k BTC and do a weighted-average to get the syndicate's bid price and then bid on one block at that price.  If the syndicate wins, only the top bidders get what they bid for and everyone else gets cash returned.  There are also intermediate strategies involving bidding on 2-9 blocks but considering the edge cases reveal the some insight.  In the first case of taking the grand average of all bids summing up to a quantity of 30k BTC, there are reflexive effects.  Those syndicate members who bid less also pay less and thus free-ride on the higher bidders' willingnesses to pay.  So optimum bidding strategy for syndicate members involves shading bids down because the marginal effect of an individual's lower bid on his own profits is positive and stronger than the marginal effect his lower bid has on reducing the average syndicate bid and subsequently the probability the syndicate actually wins.  In other words, if you are a syndicate member, your maximum payoff is achieved when you bid the lowest possible bid that still puts you in the the top 30k BTC bidded for (so you still qualify).  This essentially turns into a multi-player Prisoner Dilemma situation, the end result being an aggregate syndicate bid which is much too low to have a reasonable chance to win the auction.  Strategy effectiveness increases monotonically as the syndicate's bidding strategy moves toward securing fewer and fewer blocks.  In the limit case of the syndicate bidding on one block, their chance of success is highest as both the average price bidded by qualified members is naturally higher and due to less moral hazard of qualified members shading down their bids (though there is still some of this so long as it takes more than one syndicate member to clear one 3k BTC block).  Also it's worth noting that higher homogeneity in syndicate members' willingnesses to pay implies lower moral hazard since the low-bidding free-riders extract less value from the high-bidding members.

Finally, it's worth noting that a syndicate benefits directly from the flow information it receives from its bidders.  First, if we ignore all bids under market value (there's some ambiguity here on what market value means e.g. market value before the start of the auction or market value right before the end of the auction or somewhere in between), the syndicate gains information on how many coins are demanded above market price and at which specific prices.  Going further, the syndicate also knows at what times it's members bidded what price and how that compared to market price at that exact time.  In the event of losing the auction, the syndicate can estimate how much unsatisfied demand exists in the market from its own members which gives a lower bound on unsatisfied demand in the entire market.  Second, the syndicate can buy on the market up to it's own final aggregate bid and gain positive expected value.  If they win, they get coins at cheaper than their bid.  If they lose, they get coins at cheaper than the winner.

To conclude, bidding syndicates make the most sense where the average price of the auctioned asset on the market decreases with respect to quantity bidded for (similar to many commodities e.g. a 100 kilos of wheat will be cheaper per kilo than 10 kilos of wheat).  This is true for angel syndicates as well where it is less hassle for a startup to deal with a syndicate than its individual members so it can offer a better deal to the syndicate.  There and in normal commodity markets there are direct synergies and efficiency gains of a syndicate banding together to get a cheaper price.  In the case of the US Marshal bitcoin auction, the opposite is true where the average price of the auctioned asset on the market increases with respect to quantity bidded for due to the way slippage works (e.g. 100 bitcoins will be more expensive per bitcoin than 10 bitcoins).  This combined with inherent moral hazard between low-bidding members and high-bidding members makes it very unlikely for a syndicate to win this type of auction.

Other news this week:
Kevin & Team Buttercoin
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Bitcoin Markets React to US Marshal Auction Close; Lighthouse

Hi Everyone,

This week markets traded between $555/BTC and $605/BTC.  The US Marshal Bitcoin Auction just ended a few hours ago.  At the close of the auction the markets jumped from $584/BTC to $598/BTC.  This likely indicates that a bidder in the auction also bought up all the coins in the market below his bid at around $598/BTC.  If a bidder wins, he or she also would likely be willing to buy up coins for cheaper than what he paid in the auction.  If a bidder does not win, that means someone won with a higher bid also implying that he should buy up all cheaper coins on the market anyway.

This also suggests that the auctioned coins sold for above market price (considering $584/BTC the market price and those auction coins selling for at least $598/BTC) in a the immediate sense of "market price".  Ultimately, if markets are somewhat efficient, the market itself should have an expectation for what price the auction closes based on the available information it can gather (e.g. leaked list of bidders).  Given that bitcoin was trading at $630/BTC before the auction announcement, we can also say that the auction likely settled at under market price in that sense if we assume that the confounded GHash 50% effect was less than $32 in downward movement).

Also from the charts you can see someone selling coins at $590/BTC for 6 hours starting 8 hours before the close of the auction up until 2 hours before the close.  Likely that person (possibly a bidder in the auction) believed the auction would not close above $590/BTC and thus sold coins at that level in the face of upward pressure.  Then the price takes a dip to $575/BTC before shooting up.  This suggests that about 1 hour before the close of the auction, the highest bid was at least $575/BTC.

Of course this is all speculation.  A more comprehensive analysis would require looking into the tick data of exchanges and drawing more informed inferences from that.

Other News:
  • In the altcoin world, Monero has been crashing from a high this week of $5.37 to $2.52, over a 50% drop.  The end of last week saw Darkcoin being dumped for Monero and this week we are seeing Monero crashing and Vericoin rising from $.07/VRC to over $.18/VRC.  
  • Vericoin is a PoS coin whose main innovation is network-dependent-stake interest which increases the interest paid to stakers as the amount of staked coins in the networks increases.  This gives a snowballing incentive for stakers to stake their coins thus improving the security of the network.  you can read about here:  It also has a suite of consumer and merchant-friendly wallet features (e.g. VeriSend, VeriBit, VeriSMS).  Although incentivized staking is a nice feature, I don't see it as a big innovation.  I see the real challenge in PoS is that there is incentive for all users to stake their coins in all branches of the blockchain and incentivized staking does not solve this issue.  Ultimately, I don't personally care for this altcoin.
  • Tax haven country Jersey wants to be bitcoin island:
  • Swarm, a bitcoin crowdfunder, launches and raises 1200 BTC in funding in just 18 hours:  Swarm intends to be a crowdfunding platform where startups can raise capital from the crowd in bitcoin for equity.
Speaking of crowdfunding platforms, Mike Hearn, a bitcoin core developer, is working on a project called Lighthouse which is decentralized crowdfunding built on top of the bitcoin protocol using assurance contracts (  Anyone can create their own funding campaign directly on the blockchain and interested parties can fund the campaign in bitcoin.  Backers have the option of changing their mind and getting their bitcoins back so long as the campaign goal isn't hit yet.  Basically, it aims to be a cheaper, decentralized version of Kickstarter with take-backs.  On the other side of the valley, there's an app called Yo.

Kevin & Team Buttercoin
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Mining centralization; US Marshal leaks bidder list; Monero

Hi Everyone,

This week traded between $540/BTC and $615/BTC before ending the week at $593/BTC.  Volatility was highest in the beginning of the week and settled down thereafter.

Interesting bits from the week:
  • Ghash.IO continued to hover between 45% and 50% of the network hashrate before coming down sharply to 36% where it sits today:
  • US Marshal leaks list of potential bidders for it's bitcoin auction:
  • Japan announces that it will not regulate bitcoin:
  • Monero has been on the rise.  I mentioned Monero and ring signatures in one of my previous posts (5/30/2014) and, since then, it has quadrupled in value.  Currently it is the 13th largest cryptocoin by market cap:
  • An article by Tuur Demeester drew parallels between the invention of bitcoin to the invention of petroleum as an energy source:  I thoroughly enjoyed the parallels.
Concerns about a 51% GHash.IO continued this week as some in the bitcoin community had suspicions that much of the hashing power coming from "unknown" mining operations actually belonged to GHash and that GHash was simply splitting their hashing to appear smaller.  This is no longer believed to be the case as two mystery addresses unrelated to GHash.IO were found to represent about 8% of the network and were originally counted as belonging to the "unknown" group.

There was also suspicion in the past that GHash sent fake miners to infiltrate other pools to show partial work while withholding full solutions to reduce honest member payouts.  See block withholding attack:  This type of attack would cause the attacked pool to seem "unlucky" and might ultimately drive members to convert to a pool which is not being attacked.  This could be a minor contributing factor to how GHash has been gaining members (the major factor would be the 0 fees).

In any case, given the whole 51% scare, many have come up with possible solutions to the centralization of mining power we are seeing with GHash:
  • P2P mining enabled by an auxiliary blockchain:  P2Pool does this, has been active for a while, and is gaining traction.
  • Lamport Signatures:
  • Not using Lamport Signatures:  Incorporates a secret which allows pool members to steal the block from the pool thus making pools which don't trust its members impossible.
  • Fawke Signatures:
  • Two-Phase PoW: One phase is outsourcable and the other is not thus creating an equilibrium size for mining pools (i.e. the equilibrium is set to the point when the efficiency losses of a pool due to the nonoutsourcable phase of PoW is equal to the gains in utility to members from reducing the variance of their payouts).
  • Nonoutsourcable Scratch-Off Puzzles: ???
  • Multi-PPS:  Individual miners mine blocks where the coinbase transaction is split between multiple mining pools and each pool pays the individual per share of partial work proportionally based on the proportional split of the coinbase transaction.
It's rather amazing that not 1 week after the 51% scare, the bitcoin community has come up with several possible solutions to mining centralization.  It furthers my confidence that no challenge bitcoin encounters will be insurmountable.

I also recently read a piece by Vitalik Buterin which took a very thorough but concise look at mining centralization:  I highly recommend it.

The US Marshal email leak was quite interesting.  First, from the list we can see players like DRW Trading (top-tier prop shop), Matrix Capital (Tiger Cub) (on a side note, Pantera Capital is also a Tiger Cub)), and BNP's stat arb desk taking a serious interest in bitcoin.  Tiger Cubs and other hedge funds, bank trading desks, and prop shops are all coming to bitcoin?  I wouldn't be surprised if Jane Street and GETCO are also positioning themselves for a Jump into bitcoin.  Looks to be a huge year in the making.

There has also been speculation whether the auction coins will trade above or below market price.  It all depends on the propensity of the bidders to have directional opinion.  Folks like the stat arb desk and Binary Financial are probably only looking for a deal they can quickly flip for profit so they will likely underbid the market.  Coinbase is also unlikely to buy at a premium since they usually keep their books balanced.  For SecondMarket's syndicate, they will likely aggregate the bids they receive from their syndicate members and pass them on as block bids to the auction (capturing any differential in the process) so their bidding prices will likely vary per 3k BTC block and depend on their members' propensities to buy.  For DRW and Matrix, it's hard to say. They could see this as an opportunity to get into bitcoin for a directional play, giving up less slippage than market would charge them.  If this is true, it is possible that the auction closes at above market rates.  I am more inclined to believe that Matrix will take a serious long position here rather than DRW or any of the others.  Since most of the big players are well-capitalized enough to buy all blocks being auctioned, it is hard to say how the auction will play out and whether most people will come away empty-handed.

Kevin & Team Buttercoin
Bitcoin Trading Made Easy | 

Buttercoin currently in Private Beta, if you'd like access right now apply here.