As Crypto Slumps, Goldman Sachs Aims for a Wall Street Built on Blockchain
Goldman and JPMorgan are already processing some trades using the technology behind cryptocurrency markets.
Tag: Blockchain
The Blockchain battlefront: Technology, business, and regulation
Comedian John Oliver quipped that cryptocurrency is “everything you don’t understand about money combined with everything you don’t understand about technology.” He missed another area of notorious confusion: the law. The great regulatory bureaucracy has awakened to the significance of blockchain-enabled technology, led by the SEC.
The government is certain that cryptocurrency must be regulated, but it is faced with a knotty question: What kind of asset is cryptocurrency? Security? Commodity? Currency? Something else? Meanwhile, technologists and entrepreneurs are creating new applications that affect the answer.
The new engine of innovation that the crypto markets looks a lot like the corporate stock shares we are familiar with, except with fewer intermediaries and less (you guessed it) regulation. Ventures can mint tokens that are representative of the underlying technology, thereby funding business activities with a mechanism directly tied to those activities. This drives innovation because innovators are free to embark on funding efforts without third party involvement, and the market is able to reward success and punish failure with minimal interference.
The resemblance to stocks has not gone unnoticed by the SEC. In fact, the capacity of cryptocurrency to act as an investment vehicle is the hinge upon which the future of the crypto industry will turn. Such vehicles are regulated as securities in federal law. So, we return to the nuanced question of what kind of asset are crypto currencies?
Currency, security, or commodity
The obvious answer is cryptocurrencies are currencies! It’s there in the name. BitCoin started the whole industry by proposing to create a digital currency to stand alongside fiat currencies as a medium of exchange. But cryptocurrencies have expanded far beyond this notion, and even in the case of a straight crypto coin like BitCoin, the asset doesn’t behave like currency.
The next bucket into which crypto assets might fall is commodities. Commodities are regulated by the Commodity Futures Trading Commission (CFTC). These include assets like gold, oil, and wheat—in general, a commodity is any asset that is an item of value, and the financial activity around it is based on the changing supply and demand for that item. Strangely, for a non-physical entity, BitCoin and its relatives share some characteristics with this asset class: Because blockchain transactions are permanent entries in the global ledger, they can be traded and valued something like a commodity.
The final traditional asset class to consider is securities. The Howey test (based on a case from the 1940s that established the SEC’s area of authority) is a standard test for determining whether something is a security. The three distinguishing characteristics of securities are:
A. The investment of money
B. Common enterprise
C. Reasonable expectation of profits derived from efforts of others
The first two characteristics are fairly easy to establish in the case of most digital assets. ‘C’ however is more difficult to determine, and this is where we return to the observation that crypto assets act a lot like shares, which is precisely what ‘C’ is driving at.
The universe of digital assets has a wide range of nuanced differences, bearing characteristics of all three asset classes—currency, commodity, and security—in varying helpings.
We can start to get an understanding of how the SEC is thinking about these questions by looking at what SEC chair Gary Gensler said about BitCoin being a different animal from the rest. He has said on a couple occasions that BitCoin, and only BitCoin, is a commodity.
This has been backed up with action. In May, the SEC doubled its crypto enforcement arm and renamed it to “Crypto Assets and Cyber Unit”. It opened a probe with Coinbase and has initiated an insider trading case that incorporates a securities charge, which would bring at least some crypto projects under the SEC’s jurisdiction.
These moves were criticized by CFTC commissioner Caroline Pham who said they were a “striking example of ‘regulation by enforcement,’” a critique that suggests both that the CFTC is interested in finding its footing in regulating the space and that clarity in the field is lacking.
Why classification matters
The general consensus is that by being classed as securities, the crypto industry will be more heavily regulated, but it also stand to grow more expansively as it matures. As a commodity, crypto would be less regulated, but also more limited in terms of growth.
Stepping back, it seems pretty clear that crypto-enabled digital assets are a new kind of thing, bearing characteristics of each asset category depending on the project. For example, some projects are explicitly invoking the stock fundraising model with “initial coin offerings” (ICO), the crypto equivalent of the traditional IPO. This is why the SEC has a spotlight on ICOs.
It is likely that we’ll start to see litmus tests that determine what camp crypto projects fall into, with securities demanding the most rigorous vetting. All of this will of course increase the overhead in running these projects, slowing innovation in the short term. In the long term, approval at the federal levels will bring greater adoption and more investment into the space.
In the middle term, we’ll see a convergence of traditional stock markets and crypto exchanges—something that is already happening. The FTX crypto exchange recently included stocks, while Webull, a more traditional exchange, includes crypto.
The ongoing battle
Perhaps the most central battle in the larger war is that between the SEC and Ripple. Ripple created the XRP coin, designed for blockchain-based payments. The SEC and Ripple have been locked in an epic legal struggle since December of 0221, when the SEC sued Ripple for raising over a $1 billion via sales of their token, alleging it is an unregistered security.
It’s such a precedent-setting battle on unknown terrain, that hitherto unconsidered issues are arising. For example, on July 30, 2022 a third party entered the fray claiming cryptographic keys should be redacted from the proceedings, similar to how bank accounts are handled.
The SEC action put a big dent in XRP value and caused it to be delisted from US exchanges like Coinbase. It also sent a shiver through the entire industry. The truth is both sides have a point: The streamlined fundraising, married closely to the actual technological medium hold astonishing promise for innovation, but it has great potential for abuse.
A even-handed approach that avoids forcing crypto assets into existing categories and frameworks is required. Not only do we want to avoid throwing a wet blanket on the entrepreneurial promise, but blockchains are decentralized global networks, and we don’t want to force them into the shadows but welcome them into the fold in a way that preserves their unique characteristics and gives adequate protection to investors and users.
One size does not fit all in software projects. A small open-source project looking to fund itself should not be treated with the same instrument as a big enterprise effort. Hopefully, in addition to a suitable blending of categories, a sensible scaling of laws can be devised, to allow for the space to innovate with agility that is so essential to software projects of all kinds.
Blockchain, Regulation
Blockchain breakthroughs: A tech revolution told in whitepapers
Blockchain is one of the great blindsides in the history of technology. Major trends around cloud technology, virtualization, and mobile you could see coming, but a novel distributed computing model based on public key cryptography? That came almost completely out of the blue.
When the Nakamoto whitepaper dropped in 2008 it unceremoniously set off a ferment of innovation that continues growing to this day. It wasn’t entirely unexpected if you were watching the digital currency scene—at the time an even nerdier backwater of the already highly nerdy cryptography frontier. The paper itself gives a tip of the hat to several prior artists like Adam Back’s HashCash whitepaper.
In that view, Bitcoin looks like a sensible progression. However, even as a natural outcome of compounding creativity the Bitcoin paper is extraordinary.
The proof of work (PoW) solution to the double-spend problem is non-obvious even knowing the prior art. And that idea led to an unpredictable result: the possibility of decentralized, permissionless virtual machines.
The first shoots in this spreading revolution were issued by Vitalin Biturik in the Ethereum whitepaper. The basic idea of leveraging blockchain to build Turing machines was introduced there. Once you have established the viability of a permissionless, compute-enabled network, you get what you might expect: a horde of smart computer scientists and engineers leaping into the space to find new ways of taking advantage of and improving upon the possibilities.
In short, we have seen an outpouring of genius. Obviously there have been some blind alleys and questionable characters at work. None of that discredited the real groundbreaking work that has been and is being done in the space. After the Ethereum virtual machine’s introduction, several promising avenues of progress have been proposed and implemented. Here’s a look at some of the most prominent.
Ethereum and the virtual machine
If Bitcoin is the root from which the web3 tree has grown, Ethereum is the trunk from which the branches have spread. Ethereum took the conceptual step of saying with a system in hand for verifying transactions are valid, maybe we can build a virtual machine. There are devils in the detail here—implementing such a system is a substantial challenge—but not only is it possible, it also opens up applications with unique characteristics.
In general, these applications are known as dApps, or distributed applications. dApps are comprised of smart contracts that run on-chain and the traditional web apps that interface with them.
The concept of a smart contract is perhaps the best concept to use as a lens in understanding Ethereum’s basic innovation. Smart contracts are so called because they represent a contract on the network—they specify what are valid and binding contracts for the participants. (Participants are cryptographically bound to these contracts via their private keys). In a sense, the blockchain structure enables code to describe a variety of verifiable agreements between people and systems.
Smart contracts are “smart” because they are autonomous. This is the characteristic that really distinguishes them from conventional applications: no intervention by outside entities is necessary for their action.
With a generally available network that can enforce contracts, in which participants can join in a permissionless way, many traditional business models are potentially vulnerable to disruption. As this article describes in detail, finance is potentially just the tip of the iceberg. Also inherent in Ethereum basic design is the possibility of decentralized governance, or DAO (distributed autonomous organizations).
Many practical realities must be overcome in realizing the promise of blockchain, and many of the innovations in subsequent projects are targeted at doing just that.
Peercoin and proof of stake
The consensus mechanism is the means by which nodes in the network come to agreement on what are valid transactions. Bitcoin originated PoW consensus, which uses the cryptographically demonstrable work done in mining certain values. This works but suffers from being energy intensive and acts as a performance bottleneck. The Peercoin whitepaper introduced an alternative mechanism known as proof of stake (PoS).
The wealth of projects that have since been built using the PoS model is a wonderful testament to its efficacy, but perhaps the greatest testament is Ethereum itself moving to a PoS model with Ethereum 2. Proof of stake opens up possibilities by streamlining the overall operations of blockchain networks.
Proof of stake works by ensuring validator nodes are vested in the network. In general, that means establishing that validators hold a certain amount of the crypto token used by the platform to denote value. At the very highest level, you can say proof of stake works by creating an incentive for nodes to behave correctly. Compromising the network by means of a Byzantine network attack, like a Sybil attack or a 51% attack, will devalue the very coins held by the malicious nodes. This increases the cost of attacks and is a disincentive. It’s simpler and more lucrative to simply participate in good faith.
PoS eliminates the high energy cost on validator nodes. It also reduces the minimum time required by nodes to process transactions. That is because the nature of PoW is doing difficult computations, something that depends upon time and electricity.
PoS is not without drawbacks. Nevertheless, it represents a real innovation and opened up not just new implementations, but also caused people to begin thinking creatively about proof of consensus and other fundamentals in “layer 1” technology.
Solana and proof of history
Another breakthrough in blockchain thought is Solana’s proof of history (PoH) mechanism. It’s whitepaper describes a system wherein a verifiable delay function (VDF) is applied to the network, enabling validator nodes to largely ignore the question of transaction ordering.
A verifiable delay function is one that, similar to a mining function, establishes that it has run by executing a cryptographic function. This function outputs a hash that then proves it has run and a certain amount of time has elapsed. This is like a cryptographic clock.
By devising an architecture that allows validators to share a single VDF server, the entire Solana network boasts radically faster block verification times. It’s important to note that PoH by itself is a performance optimization, not a validation mechanism. It must be combined with a consensus mechanism. In Solana’s case, its token (SOL) adopts PoS.
Avalanche and validation neighborhoods
The Avalanche whitepaper introduces an ingenious approach to consensus. It proposes that nodes can agree upon valid transactions by sampling a small set of the network. You can think of this as validation proceeding against a ‘flash’ subnet. As the paper says, “Each node polls a […] randomly chosen set of neighbors, and switches its proposal if a supermajority supports a different value.”
This simple-seeming idea is well suited to the conditions of a distributed network. It obtains lower overhead for nodes because they don’t have to refer to the entire network to be assured they have a valid copy of the blockchain state. At the same time, the interconnected operation of all the different validator neighborhoods means the overall network state always moves towards valid consensus.
Avalanche’s whitepaper is also notable for explicit and clear statements of two other principles that have gained traction. The first is the idea of creating a “network of networks” wherein the underlying network enables a variety of networks that can operate independently or when desired interdependently via the chain’s token (AVAX). The example given in the paper is of one subnetwork that handles gold contracts and another that handles real estate. The two operate independently unless someone wants to buy real estate using their gold, at which point AVAX becomes the medium of exchange.
The second idea Avalanche puts forth well is self-governance. In short, it has built in its protocol the ability of nodes to alter the parameters of its operation. In particular, the member nodes have the ability to control staking timeframes, fee amounts, and minting rates.
Internet computer and partial synchrony
The internet computer project is founded on a whitepaper that introduces a new mechanism for obtaining beneficial characteristics from both conventional and blockchain networks, thereby “obtaining the efficiency of a permissioned protocol while offering many of the benefits of a decentralized PoS protocol.”
This is done by considering the overall network as a collection of somewhat independent subnets. Each subnet operates in terms of liveness as a permissioned network dependent upon a centralized PKI (public key infrastructure). However, the context of these networks is run by a DAO. That is, the protocol, network topology and PKI are all in the control of the decentralized network.
This enables efficiency of transaction processing without sacrificing safeness. This is called partial synchrony in the paper, the idea being that each subnet operates for a defined period as a synchronous network. This allows the subnets to rapidly proceed. The subnets then participate in asynchronous collaboration to confirm the validity of the progress. This operates on the explicit assumption that less than ⅓ of the network may be participating in a Byzantine style attack—a common threshold in distributed computing. The overall asynchronous network is then tuned to preserve safety and resilience in harmony with the subnets being tuned to maximize throughput.
Ongoing innovation
While we’ve covered a lot of ground here, there are other intriguing whitepapers, and more being proposed. It’s a fascinating space to watch, with some daring and mind-expanding thinking going on.
Blockchain, Emerging Technology
6 things that prevent Blockchain from ruling the world
The blockchain is the technology behind Bitcoin (and other cryptocurrencies) which is currently dominating the headlines, due to its meteoric rise over the past month, and the equally massive plunge it has taken this week. Bitcoin is nothing but volatile.
Blockchain tech, on the other hand, is a transparent, distributed digital ledger, that is inherently secure. It has the promise to revolutionize many diverse sectors, including musical digital rights management, secure digital voting, storage of healthcare records, and digital ‘smart’ legal contracts – to name but a few applications. The blockchain is frequently referred to as a disruptive invention, even compared to the very invention of the internet itself.
While blockchain technology offers many advantages, including a high level of security against fraud, and potentially cost-effective transactions, it may not become a storming success and sweep the world off its feet as soon as you might think. As with most fresh technological innovations, it faces an uphill battle towards adoption.
Here are some of the current obstacles that are ‘blocking the blockchain’, as it were.
1. Energy wastage
Bitcoin and cryptocurrency mining are highly dependent on GPUs and ASIC miners for profitability. Anyone who has built a computer is aware that GPUs require a robust power supply to function, with a greater amount of power on tap being ideal for stability.
Also note that the security of the Bitcoin blockchain is obviously critical, and must mean that any effort to defraud the system isn’t worth the while, as that effort would be better directed at simply mining the next Bitcoin, as this would be more profitable.
Now, as of December 6, 2017, the energy consumption of Bitcoin mining reached 32.36 Terawatt-hours per year, which is a ridiculous amount of power, and is actually higher than the energy usage of 159 individual countries according to one estimate.
With all this in mind, maintaining data in a blockchain – and keeping it intact and free of fraud – is an inherently energy-inefficient process. In the current era of 6W processors for laptops, deep sleep states for electronics, and solar panels, all aimed at greater energy efficiency and independence, the high energy consumption of blockchain technology and virtual currency mining flies in the face of this.
2. Data woes
Generally speaking, the internet is fairly efficient when it comes to the transmission of data. The user requests information, and the server transmits back the piece of data requested with only a small amount of additional data required to get it there.
However, the blockchain, in order for it to be preserved, as well as to prevent hacking, needs multiple copies distributed across many nodes. And the blockchain then requires a large amount of storage – for example, Bitcoin’s blockchain was nearly 150GB in size as of last month, and it’s getting bigger all the time.
Furthermore, transmitting so much data for the blockchain each time also consumes additional electricity, making the blockchain quite inefficient. In a time where efforts are being made to compress video further to decrease the data required for a download, blockchain’s bulkiness makes little sense.
3. Time for adoption
While blockchain technology may ultimately work for some sectors, its wider adoption may be a sluggish process, particularly when it comes to industries which are notably set in their ways.
Some sectors – like legal and healthcare – have only just started to move away from paper records, and in some cases still maintain them as backups. They are unlikely to jump to a cutting-edge solution such as the blockchain overnight.
The technology will need to clearly demonstrate advantages and gain a proven track record before this happens, and that could potentially take decades. After all, remember that stock markets held onto their old ticker tapes in the 1970s, after using them from 1867, and the last telegram in the world was sent in 2013.
4. Centralized may be a good thing
Bitcoin was developed to be a decentralized cryptocurrency that allows for peer-to-peer transactions. However, this can be a disadvantage, such as when governments cannot track funds easily, and risk losing on the tax side of the equation (which may, potentially, mean that the average taxpayer ends up paying more). It also makes things more challenging when users experience fraud, and recovering funds can be difficult.
5. Slow transactions with cryptocurrency
Some tout Bitcoin as the future of currency, and the promise is that peer-to-peer transactions can happen in a fast and cost-efficient manner that can compete with traditional credit cards.
However, Bitcoin transactions are painfully slow, with transactions occurring at the glacial pace (at least in the world of finance) of multiple hours for each transaction in some cases. One of the current reasons for this bottleneck is that each transaction has to be confirmed by six miners.
Obviously enough, this process needs to be sped up significantly for Bitcoin to realistically become a true rival to established methods of buying goods.
6. Private problems
Many of the advantages of the blockchain come from its public use – anyone can download the entire blockchain, and mine for additional currency, which democratizes this process.
It also keeps it immune from hackers – with such a large legitimate group dedicated to mining, any fraud attempts would effectively have to ‘out-mine’ the miners, a process that would take a colossal amount of computing power for a popular cryptocurrency. This type of blockchain is known as a public blockchain.
So what about a private blockchain? Well, the same blockchain tech can be applied as a storage medium, and if a company doesn’t want anyone to download the entire blockchain – and no one is going to mine it – then this is kept as a private blockchain. It is also held in a handful of private nodes, rather than distributed across thousands of public nodes as is the case for a public blockchain.
With a private blockchain, while it is more carefully controlled, and far less likely to be hijacked or hacked, it also flies in the face of the whole fundamental idea of this technology – losing the advantages of transparency and wider distribution that make the blockchain tech intriguing in the first place.
Article published on TechRadar