I will admit something first. Dogecoin is fun. Dogecoin makes you laugh out of sheer joy, despite yourself. Dogecoin sucks you down into a rabbit hole of memes, parodies, and all things not serious.
But is everything a joke? Obviously not. So, in that spirit – let’s get serious.
Bitcoin is an idea. A meme, if you will. Like how the original Doge meme is backed by a cute Shiba Inu dog, the Bitcoin meme is based on the idea of what money is. As we know, money is just a made up thing – a meme – which people ascribe value to. Money doesn’t have to be “backed by” anything. All you need is the collective belief of people in the meme of money. To take this comparison further, on the Doge side, the meme goes a bit deeper than just the dog. We have words like: “much”, “wow”, “so”, “amaze”, “many”, etc. that can enhance the context in which the Doge meme is being used. On the Bitcoin side, you have the mythical founder, dead simple cryptography, and a few other powerful ideas that go on to implement a glorified ledger of IOU’s. That ledger is considered legit because of the meme that Bitcoin is set in stone.
If Bitcoin itself is a meme, why not make a coin out of a literal meme? Enter Dogecoin.
Started off in 2013 as a joke, Dogecoin needed to work just like Bitcoin, but with a few tweaks. Why tweaks? Why not? It’s just a joke anyway. But sadly though, these weren’t “fun tweaks”. Like there is no Doge ASCII art in the transactions, or a “much wow” after every block of transactions. The tweaks were almost arbitrary technical departures from Bitcoin. Notably:
Proof of Work with the SCRYPT hashing algorithm in Dogecoin vs. SHA256 in Bitcoin.
Arbitrary rewards for block producers, but now changed to a fixed reward of 10000 Dogecoins per block (which are generated every minute).
Dogecoin works, in the sense that the jokes are funny, and if you choose to – you could use Dogecoin as money. If enough people choose to use it, it might very well thrive, not just survive. In 2021, enough people are buying it, holding it, talking about it, “meme-ing it”, and watching its value skyrocket in terms of USD. Because it’s funny, it’s an F.U to the traditional financial establishment, and perhaps even to the Bitcoin establishment (whatever that is).
But if everything about Dogecoin is warm and fuzzy, what gives?
Two things, specifically.
1. What makes a meme?
A meme implodes if what literally backs the meme fails to work. When I say “literal”, I mean the literal thing that backs the meme. Like in the case of Doge the meme, we want that Shiba Inu dog to have been real dog (and not secretly a stuffed toy), and the meanings of English words like “much” and “wow” to not change. In the case of Dogecoin, the literal technology that underpins the meme has to work. Let’s say Dogecoin can be double-spent because of the quirky way it is mined, or let’s say users cannot audit the global supply and the ownership of their Dogecoin because they cannot run a full node, or let’s say Dogecoin’s governing rules change tomorrow….for the lulz. In fact, those tweaks that Dogecoin did over Bitcoin can be argued to be quite unsound. These, and other technical artifacts can undermine the Dogecoin meme fundamentally.
Without being controversial, I can say that Dogecoin is orders of magnitude weaker than Bitcoin in these terms.
Why is that? That’s my second point
2. Stronger meme
Bitcoin’s meme is serious, to the point of almost being noble. This has inspired serious people. Some of these people have worked hard to make small technical improvements over the surprisingly good initial design, make the code robust against bugs, have a small footprint, and keep running forever. Some others have looked hard at the theoretical aspects of Bitcoin to see why it works, and have almost convinced themselves that it works because it has to work. Some others have meme-ed the idea that Bitcoin’s rules cannot change at all, and have fought long and hard wars of attrition to keep it as it is. There are entire industries built around Bitcoin’s mission, and words like “mission” get used quite often.
On the other side, we have Elon Musk and Joe Weisenthal of Bloomberg who have meme-ed about Dogecoin. And they have meme-ed well. Like Elon putting a Dogecoin on the literal moon (whatta great meme). Joe has even joked that Dogecoin is a purer incarnation of what a cryptocurrency should be, without all the added serious baggage of Bitcoin. I argue the opposite. The serious nature of the Bitcoin meme is what makes it work, by getting the virtuous cycle of seriousness begetting robustness begetting soundness.
To meme Dogecoin into a phenomenon stronger than Bitcoin, it has to come from many fronts. Textbooks have to written about it. Academic conferences dedicated to it should emerge. Universities should start teaching courses about it. CME has to create a futures market for it. Central Banks all over the world have to start aping it. Folks should be drilling holes into the Alps to create vaults that can store a piece of paper with a private key written on it. These and many more have to happen for a meme to emerge stronger. Also, critically, despite the memes, the thing has to not change, and keep its singular purpose.
Bitcoin, luckily, had many things go its way, which kick-started the virtuous cycle of meme-ing, and those memes attracting people who were good enough to improve the thing that underlies the memes. Dogecoin might get there as well, or might not.
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In 1996, a federal mint employee was eating bananas near where US dollar bills were being printed, and a Del Monte sticker on one of the bananas fell into the printing press and got under a transparent layer of a $20 bill. The Del Monte note was created. This particular $20 note is a collectible in some circles and has been auctioned many times before, and most recently for around $400,000. That the serial number of the note is printed over the Del Monte sticker makes this even cooler, and kind of unforgeable, and a fungible token became a non-fungible token.
What does it mean for something to be “fungible” anyway? As an example, dollars (or any money for that matter) are fungible. That is, a dollar is a dollar is a dollar. It doesn’t matter if it’s a note with serial number XYZ or ABC or a ledger entry in some bank’s database. If I give you a $10 bill to transfer an equivalent value, the actual printed bill is irrelevant. This was made much easier when we went from cash (physical transfer of value) to digital transfer of value, and we now transfer an abstract notion of $10 without having to bother with a physical vehicle to carry that value. Now that we have digital money like your bank deposits or Bitcoin – what is the equivalent of the Del Monte note? We will get to that question in a bit.
In the physical world, there are two primary requirements for an object to become a collectible.
It should be one-off, or a limited edition.
It should have some intrinsic appeal because of aesthetic reasons (a Picasso, a Ferrari 250 GTO) or quirky reasons (the Del Monte note).
The appeal of a collectible is driven by popular culture. That’s beyond the scope of this article. The limited edition nature is what I am interested in.
Limited Editions and Artificial Supply Caps
Most paintings appreciate in value after the painter has died. This makes that artist’s work provably limited edition. In rarer cases, the technology used to create the collectible in question is provably obsolete, or some raw materials have become extinct. Many times, if the creator is still active, they could implicitly make a promise that the collectible is limited edition. For example, the car company McLaren has implicitly promised us that they won’t make more of their iconic F1 supercar from the 1990’s. Or Ferrari with their 250 GTO from the 1960’s. Note that there is no technical reason that prevents them from making more of these cars. It’s just that if they break their word, the collectible nature of these cars will vanish.
On the other hand, Seiko and Casio G-Shock, the Japanese watchmakers, make many limited edition collections of watches every year. In the watch collectors’ community, it’s almost a joke when a new “limited edition” Seiko comes out. Sure, there will only be 50 of these specific watches with some specific quirk, but tomorrow, there will be another limited edition collection with some other quirk. Eventually, even among watch collectors it’s hard to know which of these is a true collectible, and which is not. But they are all limited edition, according to Seiko.
What about collectibles in the digital world, where anything can be copy-pasted? Making a limited edition of anything is quite hard. For the most part, digital money is the only thing that cannot be copy-pasted. Government controlled digital money does this by having a centralized database with a trusted party (commercial or central banks) and this trusted party is – er – trusted to not copy-paste. Bitcoin and related cryptocurrencies prevent copy-paste using cryptography, distributed computing, and game theory.
If you can make a unit of a digital money unique, by affixing a banana sticker on a it digitally, you get yourself a digital collectible, or a Non Fungible Token (or NFT).
Can we “affix a banana sticker” on a unit of digital money in your savings bank account?1 Bank account balances are not represented as cash-like notes with serial numbers. Every account has just a numerical balance, and that makes it quite hard to take a part of that balance, and affix a banana sticker on it. So, that’s out. What about the other money that we know about: Bitcoin? Bitcoin is cash-like, in the sense that each digital unit of Bitcoin (technically called a UTXO, or Unspent Transaction Output) has a unique serial number associated with it. But how do we affix a banana sticker on it? For better or worse, Bitcoin is a bit too focused on being a secure implementation of money, and makes affixing this banana sticker much harder, like that Del Monte note was a one-off with the US dollar, but most US dollar bills are unmarked and fungible. Bitcoin is out.
What if we had Bitcoin-like platforms where affixing banana stickers on non-copy-paste-able digital tokens is easy. These are NFT platforms built on Ethereum.
A bit of history here: Ethereum, being a more ambitious platform than Bitcoin, wanted to allow general purpose computation on a decentralized system with no central operator (the opposite of say, Google Cloud or Amazon Web Services). General purpose computation is all fine and dandy, but most users wanted coins equivalent to Bitcoin, but with more fine-grained control on how the actual units were minted and transferred. Note that Bitcoin itself has these minting and transfer rules, but they are all set in stone. Ethereum’s underlying currency: Ether, also has such rules, and for the most part, they are also hard to change. But if a single user wanted to create their own such coin platform, with their own minting and transfer rules, they could create such a platform on Ethereum. This platform standard was called ERC-20, and all the ICO’s you heard about from 2017-2018 were ERC-20 coin platforms with specific mint and transfer rules created by specific teams. To give another analogy, every ERC-20 token-platform is like a bank. Users of a specific ERC-20 token-platform have their own account in this bank with fungible ERC-20 tokens in these accounts, and can transfer these tokens from their account to someone else’s account. This entire ERC-20 bank, along with other such banks, are all built on Ethereum. There are 1000’s of popular ERC-20 token-platforms on Ethereum, with each of them having many users.
One such platform is Cryptopunks, which is an ERC-20 token platform created by a company with 2 engineers. Cryptopunks added one new feature to each of its erstwhile fungible tokens. Each token is associated with a unique 24×24 pixel art image representing various human like faces, which added – er – personality, to each token. It turned out that these tokens were now not fungible at all – some of these tokens have cooler personalities and are valued higher. Thus was born the ERC-721 standard, which allowed token-platforms to add a unique personality to each token that the platform mints. The ERC-721 standard is also popularly known as the NFT standard. Any token-platform that conforms to this standard allows creation/transfer/showcase of tokens with personalities – and sometimes, the personality is as random as a random string of 32 characters. The digital fingerprint of an image file can be 32 characters, and if you add such a fingerprint to a token – this token now has art associated with it. You could add digital fingerprints of music files to a token. Cryptokitties is another famous NFT platform on Ethereum – where each token represents a kitten, with kitten like features – all digital, of course. Note here that the token is associated with the token platform, which is in turn associated with the meta-platform on which the token-platform is built. Could the same 32 character fingerprint of some art be associated with a token from another NFT-platform? Yes, it can be.
Price is what someone is willing to pay
After all that background, the main question is – are NFT’s valuable? From the earlier analogy, we could ask ourselves – are watches valuable? There are more watches coming out every year – and Seiko makes many limited edition collections every year – is a particular Seiko watch from a particular limited edition collection worth $69 million? You have surely heard of the Paul Newman Daytona Rolex. As we said earlier, it’s hard to understand the popular culture that makes something a collectible. But, what’s definitely understandable is – what makes a digital artifact a limited edition. The NFT standard says nothing about NFT’s being limited edition. It just says that there should be a way to create NFT’s, transfer ownership, and show their uniqueness. So, we have to trust the NFT platform that it will somehow enforce the limited edition nature of these tokens. In Ethereum, the computer code (also called a smart contract) that controls any deployed NFT-platform cannot be changed after it’s been deployed. This gives us some notion of trust: we can inspect the deployed code, and check for ourselves tokens minted by this smart contract are truly limited edition. Does that give us true limited edition now? Not quite – there are two major caveats.
Deployed smart contracts can be modified in the future, if there are backdoors or hooks, in the code. Proving their non-existence is quite hard. Foundation App, a popular NFT-platform, is just one public backdoor. The contract can be changed unilaterally by that organization in the future.
An organization which deploys the V1 version of the NFT-platform could deploy a V2 version tomorrow, and a V3 version next year. If the organization puts enough marketing around these new versions of the same platform, users move. Case in question – Uniswap, the popular DeFi exchange contract is now in its V3 version.
In contrast, Bitcoin was deployed just once, and cannot be changed. And the code is open and has been pored over by normal users, bounty hunters, cryptographers, butt-hurt software engineers, and other experts over the last 11 years and it’s almost certain that there is no backdoor. A backdoor could be built in the future, but it will be very hard, and very visible. An NFT, on the other hand is a single token created by one among many NFT-platforms, on top of one among many meta-platforms like Ethereum. To put that in context, there are around 10,000 NFT-platforms on just Ethereum right now. If we leave Ethereum, we get other blockchain platforms, which are ostensibly decentralized across the world – and NFT-platforms are being built on them. NBA TopShot NFT-platform is on the Flow blockchain meta-platform. I have no idea how Flow works.
To give a concrete example, let’s take the NFT that captured the popular media’s limited imagination. Beeple’s $69 million “EVERYDAYS: THE FIRST 5000 DAYS”. The painting itself is 300+ MB, and like most NFT’s is not actually stored on the blockchain, but somewhere else on the internet. It’s not that easy to find, but I will save you the trouble by pointing to a link the works (for now).
Here’s how it was done:
A SHA256 hash of the actual image file – its digital fingerprint – was computed.
The fingerprint was then affixed to a token minted by a smart contract that lives on the Ethereum blockchain. This smart contract is actually called “MakersTokenV2” (no, I am not making this up).
The token was then transferred to the buyer’s Ethereum wallet. The buyer apparently paid the equivalent money in Ether to Beeple through Christie’s, the auction house.
Ironically, this transaction itself cannot be traced on the Ethereum blockchain. We really don’t know for sure if the money was truly transferred or not. Assuming the transaction happened, the buyer now owns the right to transfer the token on the MakersTokenV2 smart contract on Ethereum to someone else.
A grand total of 10 people might have inspected the MakersTokenV2 code. We know not what we know not.
There is this other idea that poor artists, ripped-off musicians, multi-billion dollar sports-organizations like the NBA could associate their content with an NFT platform and get better remunerated for it. Each piece of content goes on a specific token from a specific NFT-platform, and committed fans will buy them. What I fail to see is how an NFT-platform is different than a private art-gallery or a record label, or a pay-per-view sports channel. They can all channel money to the artist, and they can enforce copy-paste protection through law. If a piece of art is fingerprinted and attached to another token on a competing NFT-platform, and this token is then sold – what happens? The artist or the NFT-platform representing the artist will sue the other platform or buyer. Or some such.
So, are NFT’s a fad? Yes.
Is every Bitcoin an NFT? Technically, yes. But every Bitcoin is worth the same value as every other Bitcoin.
Is every USD bill with a unique serial number an NFT? Technically, also yes. But every dollar bill is worth the same value as every other dollar bill. The Del Monte note though, is the kind of NFT that is in vogue now for being an NFT. That’s the fad part.
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The nature of Bitcoin is such that once version 0.1 was released, the core design was set in stone for the rest of its lifetime – Satoshi Nakamoto, creator of Bitcoin
This goes against the more well understood motto of technology startups: “move fast and break things.” Unlike a startup, or even a big company, Bitcoin doesn’t move fast, or break things. Of course, I am not talking about its price as measured in USD or INR. I am talking about the entire Bitcoin system, or Bitcoin, the protocol. Bitcoin is stagnant, ossified, set-in-stone, resistant-to-change, and any number of such synonyms you can look up in a thesaurus. There are a few obvious questions that come out of this:
Why is ossification preferred over, say, innovation?
How do you achieve ossification in software?
Does it matter?
If you sit back and think, the answers to these questions are not obvious. Let’s address them.
It seems obvious that innovation is good, innovation is right, and innovation works. Maybe it even captures the essence of the evolutionary spirit. So, why does Bitcoin not want to innovate? The answer lies in layers. By layers, I mean – in layers of abstraction. In any system, the base layer has to be set in stone for the layers above it to work. Think of civil engineering: it works because the laws of physics are set in stone. The value of the gravitational constant doesn’t change over time, thankfully, just because nature wants to innovate.
Having an “innovative” base layer comes at a high cost to systems being built above it. Bitcoin was designed as a base layer for the world’s financial system. We can argue that that’s a stupidly ambitious goal, and is most likely not going to happen. That might very well be. Given the goal (stupid as it might be), innovation goes against Bitcoin’s purpose. An unchanging base layer of money allows innovation in layers above because a predictable foundation is a good foundation. Change-resistance tells its users that their initial trust in the system will not have to be recalibrated every now and then. A user’s understanding of Bitcoin doesn’t have to be updated after every recession. Money should be independent of booms and busts in the real economy.
On the flip side, change-resistance resists all changes, good and bad. This is a philosophical preference, and reasonable sides have disagreed about this. Ethereum, the second most popular cryptocurrency, has argued that good changes are worth the cost, and is going ahead with radical changes to its base layer as we speak. And has done sweeping changes in the past.
Software is just text interpreted by a computer to perform some actions. How do you design a software system that cannot be changed easily? This goes into the weeds of decentralized distributed peer-to-peer systems, and a bit of the mechanics of how Bitcoin works.
Bitcoin, the system, is made of tens of thousands of computers that run a specific piece of software. Each computer runs its own local copy of the software and maintains its own local copy of the so-called “coin-ownership database.” Satoshi released the first version of this software after 2 years of working on it (or so he/she claimed). This software’s source code is open, and anyone can modify it, or run it as it is. Many groups of people have modified this software as per their own vision. Each group has their own version of the software, which they hope users will run.
The key thing to understand is that users decide what version of the software they want to run. All these users’ software together makes up the Bitcoin network. These users are not in a central database somewhere, with phone numbers or email addresses on which they can be contacted and asked to upgrade their software. They are not in a single country or jurisdiction where they can be coerced to upgrade their software, or else. They are spread all over the world in a loosely coordinated arrangement, interacting only through their already installed software. These could have been installed anytime over the last 11 years, and getting them all to agree on what software to run – is a coordination problem of mammoth proportions. Software that runs by itself on a device, while talking to a central server is reasonably easy to upgrade (like a gaming app on a phone). Software that only talks to peers will need other peers to also upgrade and follow the upgraded protocol for things to work. This kind of “protocol upgrade” is much harder to coordinate and enact. Cases in point: (a) the move from IPV4 addresses to IPV6 addresses on the Internet. (b) the disastrous set of upgrades from SSL 1.0->2.0->3.0->TLS 1.0->1.1->1.2->1.3 (SSL and TLS protocols enable the “S” in HTTPS).
The Bitcoin network agrees on a shared coin-ownership database despite every user running their own version of the software. If one user’s coin-ownership database differed from another user, Bitcoin would cease to work. So, how does it work then? This is where the idea of distributed consensus through proof of work comes in. Bitcoin nodes (each computer running the Bitcoin software is abstractly called a “node”) that also validate transactions and assign coin-ownership to users are called mining nodes, and these nodes have to burn enough electrical power to qualify every 10 minutes to propose valid transactions (a “block” of transactions) that the rest of the network accepts. The network rejects this block if it contains invalid transactions. What is valid/invalid was written in software by Satoshi in the first version of Bitcoin, and changing that requires the collective software upgrade that we encountered earlier. Additionally, this notion of what constitutes burnt electrical power is universal in nature, and all nodes can agree on this without relying on any trusted third party. This is the reason Bitcoin burns more power than your friendly neighboring country – to trustlessly determine who owns what through the universal physics of electricity.
But let’s say that some mining node decides to make a block with a transaction that allocates itself some additional money. An invalid transaction, so to speak. Let’s say this mining node can convince half the nodes in the network to change their software and accept that this block is valid. This half would accept this invalid block as valid and update their local copy of the coin-ownership database. The rest of the network would reject this block, and would have a different coin-ownership database. We have what is called a hard fork.
Bitcoin has had many hard forks in its history – almost all of them by design. And none of them with a 50-50 split; all of them were lopsided splits. A few people wanted to change the rules of the game over the years, got a few more people to agree with them, and decided to have different versions of the coin-ownership database. Think of how, before the partition of India in 1947 – there was one Rupee, and a database of who owns how many rupees. This database was, of course, not maintained on a computer – but through ownership of bearer notes. After partition, there were two versions of the Rupee, with two databases of who owns what. Each Bitcoin hard-fork can be thought of as a similar partition of a currency with separate coin-ownership databases going their own way after partition. The fork with the largest set of miners, users, economic value, and other intangible metrics takes the moniker of “Bitcoin.” Others call themselves “Bitcoin Cash,” “Bitcoin Cash SV,”, “Bitcoin Cash ABC” and so forth.
There is also a softer notion of partition called the “soft-fork”, which is a bit more technical and nuanced. Soft-forks do change the notion of what Bitcoin means, but affecting these soft-forks over the entire network takes many years of coordination, and can only be done for the least controversial changes. And there is no guarantee that they might ever see the light of the day. The last successful Bitcoin soft-fork (fork-name: SegWit) was in 2017 and the forking/upgrade process left such a scar on the system that the next fork/upgrade (fork-name: Taproot) though code-complete, and almost entirely uncontroversial, might take years to roll out – if at all.
If they are so hard, how does Ethereum pull off forks? These are some of my reasons (ranked in order of how controversial they could be):
Ethereum’s BDFL is well known in real life, very active, and has strong opinions on how Ethereum should evolve. His word commands respect in the community, and is able to affect change. Bitcoin’s creator disappeared in 2010, and has not been heard of since.
Ethereum’s nodes are comparatively harder to run, and are thus run by fewer people – who can coordinate upgrades more easily. Bitcoin nodes have a lighter CPU, memory, and network footprint, and can be run by more people.
Ethereum’s users want newer features and are willing to upgrade more easily. Bitcoin users are more resistant to change.
I claim that Bitcoin’s resistance to change is one of its biggest value propositions, and gives us a form of money whose monetary policy, rules of the game, and general contract with the outside world are almost set in stone. You can buy bitcoin, bury the private key, come back to it in 50 years, and it will still be valid, and perhaps, more valuable.
A 17-year old boy looks at bitcoin and sees the possibility of creating a world computer that can run an alternate universe. His name: Vitaly Dmitriyevich “Vitalik” Buterin.
Vitalik dropped out of school in 2014 when he was awarded with a grant of $100,000 from the Thiel Fellowship to work on Ethereum full-time.
To understand Ethereum, one needs to first understand massively multiplayer online role-playing games (MMORPGs.)
Games, Networks and Virtual Universes
Parents have been yelling at their kids since the days of Atari’s Pac-Man about spending too much time in front of the screen.
It will melt your brain! Why don’t you go out and play like normal kids!
Over the last four decades, games got progressively realistic, immersive, networked, multiplayer, and pervasive. People started spending more on games, gaming rigs, and consoles. Video game makers moved away from a one-time, hit-based production system to creating virtual spaces where gamers can write their own story. The metaverse was born.
The metaverse is to game makers that SAAS is to enterprise software. Once a metaverse crosses a tipping point, network effects kick in and revenue explodes. Some gamers, the whales of the metaverse, spend an obscene amount of real money buying virtual goods. Everything is for sale – avatars, dresses, weapons, skills – inside the metaverse.
Globally, recent estimates for annual virtual-goods revenues have totaled over $52 billion.
Gaming evolved into a sub-culture onto itself.
Metaverses have a big problem: they can implode if they get boring.
Back in 2003, Linden Lab launched Second Life – an online virtual world. By 2013, it had about one million regular users. Users, or residents, as they are called, can login using client software and create virtual representations of themselves, called avatars, and are able to interact with places, objects and other avatars. They can explore the world (known as the grid), meet other residents, socialize, participate in both individual and group activities, build, create, shop, and trade virtual property and services with one another.
The platform principally features 3D-based user-generated content. Second Life also has its own virtual currency, the Linden Dollar, which is exchangeable with real world currency (wikipedia.)
At the peak of its hype-cycle in 2006, American Apparel had a virtual store and even IBM had set up a “property.”
And then it died.
While media articles on its failure focus on buggy software, missing the switch to mobile, etc, the biggest reason was that it was owned by a company (centralized decision making,) that had to host and pay for the servers themselves (centralized scaling,) and there could be only one Second Life.
Ethereum is a platform on which another Second Life can be created on a distributed network not owned by a single corporation.
In a nutshell, the Ethereum platform allows programmers to write code that runs on a distributed network. To incentivize miners to run the code, they are paid in Ether (ETH.)
The code is called a smart-contract and to run it, you need to supply it with ETH. The code will do the work and consume the Ether. Both the code, and the ledger keeping track of ownership of the Ethers, are on a blockchain.
Technically, the code runs on many computers across the world, computing and storing data locally, but networking globally, to create a distributed ledger which is sometimes also called “a blockchain”.
With these basic building blocks, one can construct self-contained virtual worlds with virtual goods, etc.
CryptoKitties was the first mainstream use case for Ethereum’s blockchain. It operates as a non-fungible token (NFT), unique to each CryptoKitty. Each CryptoKitty is unique and owned by the user, validated through the blockchain, and its value can appreciate or depreciate based on the market. These virtual kittens (tokens)are also traded on crypto exchanges.
What is fascinating is not just the technology but the storytelling that made it real. The kittens are unique, supply-constrained, have traits (some of which are rare) that can be passed on through breeding, etc. There is an ecosystem of tastemakers and specialists around it that keep the story alive. And consumers willing to part with real money for virtual kittens.
DeFi – Decentralized Finance
Imagine a global, open alternative to every financial service you use today — savings, loans, trading, insurance, and more — accessible to anyone in the world with a smartphone and internet connection.
There are DeFi dapps that allow you to create stablecoins (cryptocurrency whose value is pegged to the US dollar), lend out money and earn interest on your crypto, take out a loan, exchange one asset for another, go long or short assets, and implement automated, advanced investment strategies.
This is a nightmare for regulators like SEBI and the RBI who are tasked to protect consumers. Who are you going to sue and who are you going to jail when there is no “owner” as in the real world?
For better or for worse…
Ethereum is the biggest crypto-currency after Bitcoin. There is a large ecosystem around the infrastructure breathing life into this alternate parallel virtual universe. It is here, it exists, and it is growing.
Some think that the current economic and political order is an accident of history. What if we had the opportunity to evolve an alternative? What would it look like? Don’t we owe it to ourselves to find out?
We leave you, dear reader, with these thoughts and a recording of our fascinating conversation with someone who is working on a PhD in crypto-currencies and who also happens to be a dear friend of mine. Enjoy!
When faced with a cash-crunch, whether due to wars or natural calamities, the first instinct of governments since time immemorial has been to debase their currency.
Take the Roman empire, for example. The major silver coin used during the first 220 years of the empire was the denarius. During the first days of the Empire, these coins were of high purity, holding about 4.5 grams of pure silver.
However, with a finite supply of silver and gold entering the empire, Roman spending was limited by the amount of denarii that could be minted.
This made financing the pet-projects of emperors challenging. How was the newest war, thermae, palace, or circus to be paid for?
Roman officials found a way to work around this. By decreasing the purity of their coinage, they were able to make more “silver” coins with the same face value. With more coins in circulation, the government could spend more. And so, the content of silver dropped over the years.
By the time of Marcus Aurelius, the denarius was only about 75% silver. Caracalla tried a different method of debasement. He introduced the “double denarius”, which was worth 2x the denarius in face value. However, it had only the weight of 1.5 denarii. By the time of Gallienus, the coins had barely 5% silver. Each coin was a bronze core with a thin coating of silver. The shine quickly wore off to reveal the poor quality underneath.
By 265 AD, when there was only 0.5% silver left in a denarius, prices skyrocketed 1,000% across the Roman Empire.
Traditionally, citizens of a country have limited options to escape a government hell bent on debasing their own currency. They could buy gold, but the government can find ways to restrict how much gold one could own. For instance, the US restricted gold ownership for over 40 years claiming that “hoarding” of gold was stalling economic growth and worsened the depression. In some left-leaning countries, people default to using the US Dollar as a store of value. But often, like in the case of Argentina in 2001, the government can freeze bank accounts and restrict withdrawal of hard currency. One could try to accumulate hard assets, like land, for example. However, real-estate is not portable and can always be sized by the government, like India in the 1950’s and South Africa in the mid-2000’s.
Each of these traditional assets have trade-offs.
Gold: cannot be used for electronic payments. But everybody knows its price and is a trusted store of value.
US Dollar: centralized clearing either through SWIFT or ACH means the US Government can shut you off at any time. But it is a widely accepted medium of exchange (world trade is denominated in it.)
Hard assets: not portable, one-of-a-kind, tough to value and transact with a high liquidity premium. But is known to hold its value through inflationary environments.
Bitcoin was designed to overcome most of these problems.
Bitcoin is meant to be a decentralized, fixed-supply, infinitely divisible, digital currency.
Decentralized: there is no central ledger or clearing-house for bitcoin transactions. All bitcoin transactions are written on a blockchain. To win the right to write to the blockchain, miners compete and if they win, are awarded bitcoins. Anyone can become a miner, so transactions are settled by a distributed network of miners that does not require a central authority.
Fixed-supply: there can be only 21 million bitcoins in total. This makes it impossible to be debased like regular currencies.
Infinitely divisible: bitcoin’s smallest unit is called a “satoshi.” It represents one hundred millionth of a bitcoin, or 0.00000001 BTC ($0.00035 USD, at current price.)
Digital: you access your bitcoins through a unique 34-character key. There is no other identifier tying you to your bitcoins. You can use many such keys to send, accept, and store your bitcoins anywhere in the world.
A shared illusion
As far as I can tell, money is a shared illusion. We have a lot of beliefs in various systems, whether it’s the universe or government or organized religion, that serve more of an existential function to give us a sense that there is some order in the world. A big part of money’s function is the ability to help us measure things in an understandable way. – Adam Waytz, Kellogg School of Management
Money is whatever a group of people can agree on that is
a store of value
a medium of exchange
a unit of account
It is not necessary to use a government-issued currency (fiat) to achieve these ends. However, since taxes can only be paid in fiat and the government can use violence to extract the taxes owed, it is often convenient to keep using it.
It is no wonder that even though the technical pieces of bitcoin have been around since the mid 90’s, it took the shock of the 2008 Global Financial Crisis to breathe life into it. With widespread panic, bank runs, countries at the brink of default, and evaporating faith in the global financial system, the time was ripe for an alternative to emerge.
An elegant solution to a well defined problem… with trade-offs
From a technical point of view, bitcoin does what it says on the tin. And the code that drives all of it is public. There are no surprises. But every solution has tradeoffs. Bitcoin’s biggest trade-off is that settling transactions is extremely slow and expensive.
There is no hard limit to how long bitcoin transactions can take to be confirmed. It can take anywhere between 10 minutes and over a day. The two biggest influences on the confirmation time are the amount of transaction fees and the activity on the network. This is not something that can be used for micro-payments, like buying a cup of coffee. But this is only one part of the problem.
New bitcoins enter circulation as block rewards, produced by miners who use expensive electronic equipment to earn or mine them. Every 210,000 blocks, or roughly every four years, the total number of bitcoin that miners can potentially win is halved. But the consequence of this dropping block reward is that eventually, it will dwindle to nothing.
In a few decades when the reward gets too small, the transaction fee will become the main compensation for nodes. I’m sure that in 20 years there will either be very large transaction volume or no volume. – Nakamoto
When you learn that the total annual energy consumption of the Bitcoin network is comparable to the power consumption of Chile, you’ll immediately understand why this is a problem.
This makes #2 of what makes something money questionable in the context of bitcoin. If you can’t use something to transact for everyday needs, is it really money?
Volatility kills accountants
The volatility of Bitcoin is roughly three times higher than that of most country currencies. Compared to a currency pair like USDCAD or USDEUR, which barely breaches 2% (10-Day) volatility even during the Great Financial Crisis, Bitcoin at its lowest volatility is lucky to be below 2%. And this is true even if you compare it with other least-developed country currencies.
The problem with this kind of volatility is that if you own bitcoin denominated assets, what is it worth? This makes the #3 reason of using something as money questionable in the context of bitcoin.
Bitcoin is more like art, less like money
Picasso’s Les femmes d’Alger was sold for $179.4 million in May 2015.
What makes a piece of art valuable? It just sits there and does nothing. So, like bitcoin, it obviously has no intrinsic value. And, like bitcoin, supply is usually capped because the artist is usually long gone. Also, like bitcoin, there is an ecosystem around art comprising of auction houses, galleries and museums that promote a shared myth.
The #2 and #3 use-cases of money is barely met by bitcoin. But bitcoin fits nicely into the art metaphor. With two big differences.
Art, unlike bitcoin, is not divisible. This means that the price of a piece of art is capped by how much someone is willing and able to pay for it. Bitcoin has no such constraint. If someone with $10 buys a fraction of bitcoin for $50,000, then that price gets printed.
Bitcoin is completely digital. Bitcoin represents digital scarcity, which, before Bitcoin, had almost no solutions. Before bitcoin, only things in the real-world were not “copy-pasteable.”
This makes bitcoin an infinitely divisible digital collectible.
We leave you, dear reader, with these thoughts and a recording of our fascinating conversation with someone who is working on a PhD in crypto-currencies and who also happens to be a dear friend of mine. Enjoy!