Economics, psychology and blockchain systems

Blockchain platforms are economic systems. And just like any economy, a blockchain requires that its designers define monetary policy (inflation), fiscal policy (block size), taxation (fees), voting (governance/upgrades), and provide for the common defence (securing the network). Yet, unlike traditional economies, they offer the possibility of greater freedom and transparency because they avoid the problems of centralisation and concentration of power.

So the blockchain is great for academic economists, because it is a kind of living economic laboratory. Economists have plenty of tools for designing such systems. Does it end there? No, because the blockchain does not evolve randomly but by attempts at designing new, and better, models for money, ownership, control, trade, lending, licensing, and investment. In other words, many of the key innovations of the blockchain are economic innovations, and that means we need economists to help design them.

The problem with traditional economics is that it has two major assumptions, based on which the entire economic system is built. First, it assumes humans are rational and always and consistently optimise their utility (happiness, satisfaction). Second, economic theory assumes that on macro economic level there is or tends to be an equilibrium or balance which economics systems need to attain. In other words, we assume wisdom of the crowds and efficient market hypothesis. But what if neither is true, at least some times?

Humans are irrational by design. Just look at some of the decisions each of us make on a daily basis. We may vote for policies that go against our own economic interests. We make food selections that are at odds with our physical health. So there’s no clear, codeable logic in much of our behaviour.

Blockchain systems are, by design, difficult to change once deployed. Repairs and improvements to these systems are difficult. Protocols with billion-dollar valuations could disappear overnight. Things can get very acrimonious. Check the infamous Bitcoin block size debate. And one of the most difficult aspects for blockchain platform creators is accurately predicting people’s behaviour. That would be a relatively easy task if humans had a consistency, rational behaviour or an overarching logic in how they go about their lives.

Good news is that there is an entire field studying this – human irrationality and how to incentivise humans – very phenomenon, including Nobel laureates Daniel Kahneman and Amos Tversky and former Clinton advisor Cass Sunstein, who discovered that changing the default setting from “opt-in” to “opt-out” on things such as organ donation on a driver’s license and 401k contributions at work could dramatically improve uptake. This seemingly little change tapped on our Default Bias, enabling individuals to adjust their contribution levels (to retirement), but even the flummoxed novice who did nothing is at least socking some money away for retirement and taking advantage of company matching payments.

It turns out that we have a huge number of cognitive biases and knowing these and knowing how to go around these or nudge or incentivise us to act in desired ways is the key to understanding and predicting human behaviour accurately. One of most commonly-observed cognitive biases is loss aversion. Loss aversion derives from our innate motive to prefer avoiding losses rather than achieving similar gains. Kahneman and Tversy conducted an experiment asking people if they would accept a bet based on the flip of a coin. If the coin came up tails the person would lose $100, and if it came up heads, they would win $200. The results of the experiment showed that on average people needed to gain about twice (1.5x – 2.5x) as much as they were willing to lose in order to proceed forward with the bet (meaning the potential gain must have been at least twice as much as the potential loss). However, from traditional economic theory perspective, one’s risk appetite to losing or gaining $100 is the same.

The most tangible of incentives on blockchain platforms are digital tokens. Tokens usually represent currency, digital asset or some form of value in given blockchain system. Getting incentives right is fundamental to network growth, reflected in increased token adoption that yields positive network effects. Once this flywheel gets started, it serves as the ongoing funding mechanism for future development. Without it, the network cannot achieve self-sustainability. The value of the community and the token is what incentivises new members to join initially. If that value is off, new people don’t join and a death spiral begins. Once members are in, there needs to be a sustainable and growing value in the system to keep them using the tokens, participating in the community and helping the system grow. While token was the allure, the incentive system needs to account for conflicting interests of different types of users, system changes and perceived value and expectations from the system and, most importantly, it cannot necessarily based on the value of token itself. There are a few systems that help evaluate blockchain projects, including T3CG framework which is pretty solid.

Cryptoeconomics is hard as it requires expertise and mastery of mechanism design, contract theory, game theory, behavioral economics, public policy, macro-economics, and a solid understanding of decentralized technology in order to the design robust, sustainable and valuable blockchain economies. Hence is boils down to designing incentive systems based on known biases – default bias, endowment effect, bandwagon effect, etc – and other factors, including cultural values, public policies, system-specific goals.

I am very excited by potential of blockchain systems but also humbled by the realization that we have just scratched the surface on how to build optimal blockchain systems.

Creepy or cool? some AI breakthroughs and formula of life

You keep on hearing about AI is bad and once AGI is around, it will kill us off – paperclip maximization principle is a telling example? Check the below tidbits pushing the envelop.

Music

Historically, people line up to attend concerts of famous artists. Now, there is AI that generates pure gold jazz or what sounds like a mix of jazz and classic. Would you line up to hear these pieces? Would you still line up if you didn’t know whether it’s an algorithm or a human?

Fiction

Do you like Harry Potter? What about this Harry Potter? This algorithm learnt from the first few chapters of J.K.Rowling’s Harry Potter and created a novel of its own. Forget about J.K.Rowling, move on.

Film

TV series are great. Here is a script of Silicon Valley, generated by AI. Or a credibly-looking video from few dozen words (and some prior video training). Hollywood took heed.

Human behaviour

MIT researches created their AI system, which predicts human behaviour by approximating human “intuition” from myriads of data, and pitted it against human teams at data science competitions. The algorithm didn’t get the top score but it beat 615 of the 906 human teams competing. In two of the competitions, it created models that were 94% and 96% as accurate as the winning teams. Whereas the teams of humans required months to build their prediction algorithms, this algorithm trained 2-12 hours.

Cannibalism

Once virtual Adam and Eve (AI bots) were done with apples, they ate Stan, an innocent bystander (another AI bot) that happened to look like an apple.

Formula of life

OK, all the above are creepy, cool, scary, depending on your knowledge, interest and approach to life. But could these AI concepts eventually yield or create actual or natural life forms?

Even Artificial Life community acknowledges that the definition of “life” is contentious.

What Darwin’s theory talks about and what we believe is that there is clear difference between living organisms (in how they come to be and evolve) and everything else (from water vortexes to AI systems to coastal lines of England). Popular hypotheses credit a primordial soup, big bang and a colossal stroke of luck for creation of of life. Erwin Schrödinger framed life merely as physical processes in his treatise “What is Life?”.

But till now we had hard time explaining how (open) thermodynamic systems like our universe and even Earth evolved and how lifeforms evolved in them. We have answers for (close and weak open) ones. Till now.

According to Jeremy England from MIT given it a thermodynamic framing: it’s all about entropy (to create life, one has to decrease entropy). Carbon is not God. In his view, there is one essential difference between living things and inanimate chunks of carbon atoms: the former tend to be much better at capturing energy from their environment and dissipating that energy as heat. He has math formula, which indicates that when a group of atoms is driven by an external source of energy (like the sun) and surrounded by heat (like the ocean or atmosphere), it will often gradually restructure itself in order to dissipate increasingly more energy. This implies that under certain conditions, matter may acquire key physical attribute associated with life.

Now back to AI craze above. Imagine if we could introduce systems that artificially decrease entropy in AI systems as per Jeremy England’s prescriptions, near future could see a new Cambrian explosion of artificially constructed forms of life, which are….. songs, movies, fiction, ….. and perhaps new and better beings!

Here are more creepy/cool AI applications or here. Enjoy!

P.S. Ralph Merkle think of Bitcoin as life:

Bitcoin is the first example of a new form of life. It lives and breathes on the internet. It lives because it can pay people to keep it alive. It lives because it performs a useful service that people will pay it to perform. … It can’t be stopped. It can’t even be interrupted. If nuclear war destroyed half of our planet, it would continue to live, uncorrupted.

Two extremes in blockchain-sphere illustrate current state

How do you know how well an industry/technology/product/.. does?

One way to check is to find out the two contextual (from economic, technological, social, …other perspectives) extremes of that industry/technology/product/…

Let’s have a go at Bitcoin/blockchain.

If you go to Etherscan, click on top menu item Tokens and then View Tokens, and if you search for “fuck,” below is the screenshot from few days ago.

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This of course is just one extreme, negative one, illustrating at once absurdity, creativity and ambition one can find in crypto space. While some of those tokens are placeholders, some like FUCK Token have a website and give an impression of an upcoming product. The F-word derived tokens allude to Facebook and Ethereum. Unsurprising.

For a positive extreme, check out DeepRadiology, which employs both deep learning (Yan LeCun, father of deep learning, is their advisor) as well as blockchain to “applying the latest imaging analytic deep learning algorithm capability for all imaging modalities to optimize your facility service needs.“

Screen Shot 2018-04-14 at 2.12.29 PM.png

DeepRadiology uses AI to process myriads of data and blockchain to store and distribute it efficiently and effectively. Both time to process, for example, a CT scan and relevant costs are an order of magnitude less than the incumbents. Everyone wins.

And while Q1 2018 was bearish for all cryptocurrencies, whether rest of 2018 will be bearish or bullish is still a question. Either way, due to maturing crypto market, more educated/pragmatic crypto investors/enthusiasts and less easy-to-get crypto, the focus is now on technology itself, which is what’s needed, in long-term.

Lastly, for your education – and entertainment! – have a read of this list of 100 cryptocurrencies described in 4 words or less.

Bitcoin, ICOs, Mississippi Bubble and crypto future

Bitcoin bubble

Bitcoin has risen 10x in value so far in 2017, the largest gain of all asset classes, prompting sceptics to declare it a classic speculative bubble that could burst, like the dotcom boom and the US sub-prime housing crash that triggered the global financial crisis. Stocks in the dotcom crash were worth $2.9tn before collapsing in 2000, whereas the market cap of bitcoin currently (as of 03.12.2017) stands at $185bn, which could signal there is more room for the bubble to grow.

Many a financiers and corporate stars think there is a bubble and a huge opportunity. One of the biggest bitcoin bulls on Wall Street, Mike Novogratz, thinks cryptocurrencies are in a massive bubble (but anticipates Bitcoin reaching $40,000 by end of 2018). Ironically (or not), he’s launching a $500 million fund, Galaxy Digital Assets Fund, to invest in them, signalling a growing acceptance of cryptocurrencies as legitimate investments. John McAfee has doubled down on his confidence in bitcoin by stating his belief it will be worth $1 million by the end of 2020.

Former Fed Chairman Alan Greenspan has said that “you have to really stretch your imagination to infer what the intrinsic value of bitcoin is,” calling the cryptocurrency a “bubble.” Even financial heavyweights such as CME, the world’s leading derivatives marketplace, is planning to tap into this gold rush by introducing bitcoin derivatives, which will let hedge funds into the market before end of 2017.

The practical applications for cryptocurrencies to facilitate legal commerce appear hampered by relatively expensive transaction fees and the skyrocketing energy costs associated with mining at this juncture. On this note, Nobel Prize-winning economist Joseph Stiglitz thinks that bitcoin “ought to be outlawed” because it doesn’t serve any socially useful function and yet consumes enormous resources.

Bitcoin mania has many parallels with Mississippi Bubble

Bitcoin’s boom has gone further than famous market manias of the past like the tulip craze or the South Sea Bubble, and has lasted longer than the dancing epidemic that struck 16th-century France, or recent dot.com bubble in 2000. Like many others events such South Sea Bubble, ultimately, it was a scheme. No (real economy) trade would reasonably take place but the company’s stock kept rising on promotion and the hope of investors.

In my view, a more illustrative example, with many parallels for Bitcoin, is Mississippi Bubble, which started in 1716. Not only was the Mississippi Bubble bigger than the South Sea Bubble, but it was more speculative and more successful. It completely wiped out the French government’s debt obligations at the expense of those who fell under the sway of John Law’s economic innovations.

Its origins track back to 1684 when Compagnie du Mississippi (Mississippi Company) was chartered. In August 1717, Scottish businessman/economist John Law acquired a controlling interest in the then-derelict Mississippi Company and renamed it the Compagnie d’Occident. The company’s initial goal was to trade and do business with the French colonies in North America, which included most of the Mississippi River drainage basin, and the French colony of Louisiana. Law was granted a 25-year monopoly by the French government on trade with the West Indies and North America. In 1719, the company acquired many French trading companies and combined these into the Compagnie Perpetuelle des Indes (CPdI). In 1720, it acquired the Banque Royale, which had been founded by John Law himself as the Banque Generale (forerunner of France’s first central bank) in 1716.

Law then created speculative interest in CPdI. Reports were skillfully spread as to gold and silver mines discovered in these lands. Law exaggerated the wealth of Louisiana with an effective marketing scheme, which led to wild speculation on the shares of the company in 1719. Law had promised to Louis XV that he would extinguish the public debt. To keep his word he required that shares in CPdI should be paid for one-fourth in coin and three-fourths in billets d’Etat (public securities), which rapidly rose in value on account of fake demand which was created for them. The speculation was further fed by the huge increase in the money supply (by printing more money to meet the growing demand) introduced by Law (as he was also Controller General of Finances, equivalent to Finance Minister, of France) in order to ‘stimulate’ the economy.

CPdI’s shares traded around 300 at the end of 1718, but rose rapidly in 1719, increasing to 1000 by July 1719 and broke 10,000 in November 1719, an increase of over 3,000% in less than one year. CPdI shares stayed at the 9000 level until May 1720 when they fell to around 5000. By the spring of 1720, more than 2 billion livres of banknotes had been issued, a near doubling of the money supply in less than a year. By then, Law’s system had exploded – the stock-market bubble burst, confidence in banknotes evaporated and the French currency collapsed. The company sought bankruptcy protection in 1721. It was reorganised and open for business in 1722. However, in late 1720, Law was forced into exile and died in 1729. At its height, the capitalisation of CPdI was greater than either the GDP of France or all French government debt.

Why did Law fail? He was over-ambitious and over-hasty (like this Bitcoin pioneer?). He believed that France suffered from a dearth of money and incumbent financial system (Bitcoin enthusiasts claim it will revolutionize economies and countries like India are ideal for it) and that an increase in its supply would boost economic activity (Bitcoin aims to implement a variant of Milton Friedman’s k-percent rule: proposal to fix the annual growth rate of the money supply to a fixed rate of growth). He believed that printing and distributing more money would lower interest rates, enrich traders, and offer more employment to people. His conceptual flaw was his belief that money and financial assets were freely interchangeable – and that he could set the price of stocks and bonds in terms of money.

Law’s aim was to replace gold and silver with a paper currency (just like how Bitcoiners want to democratise/replace fiat money and eliminate banks). This plan was forced upon the French public – Law decreed that all large financial transactions were to be conducted in banknotes. The holding of bullion was declared illegal – even jewelry was confiscated. He recommended setting up a national bank (Banque Generale in 1716), which could issue notes to buy up the government’s debt, and thus bring about a decline in the interest rate.

During both South Sea and Mississippi bubbles, speculation was rampant and all manner of initial stock offerings were being floated, including:

For settling the island of Blanco and Sal Tartagus
For the importation of Flanders Lace
For trading in hair
For breeding horses

Some of these made sense, but lot more were absurd.

Economic value and price fluctuations of Bitcoin

Bitcoin is similar to other currencies and commodities such as gold, oil, potatoes or even tulips in that its intrinsic value is difficult – if not impossible – to separate from its price.

A currency has three main functions: store of value; means of exchange; and unit of account. Bitcoin’s volatility, seen when it fell 20% within minutes on November 29th 2017 before rebounding, makes it both a nerve-racking store of value and a poor means of exchange. A currency is also a unit of account for debt. As an example, if you had financed your house with a Bitcoin mortgage, in 2017 your debt would have risen 10x. Your salary, paid in dollars, etc. would not have kept pace. Put another way, had Bitcoin been widely used, 2016 might have been massively deflationary.

But why has the price risen so fast? One justification for the existence of Bitcoin is that central banks, via quantitative easing (QE), are debasing fiat money and laying the path to hyperinflation. But this seems a very odd moment for that view to gain adherents. Inflation remains low and the Fed is pushing up interest rates and unwinding QE.

A more likely explanation is that as new and easier ways to trade in Bitcoin become available, more investors are willing to take the plunge. As the supply of Bitcoin is limited by design, that drives up the price.

There are governments standing behind currencies and reliable currency markets for exchange. And with commodities, investors have something to hold at the end of the transaction. Bitcoin is more speculative because it’s digital ephemera. That isn’t true for all investments. Stockholders are entitled to a share of a company’s assets, earnings and dividends, the value of which can be estimated independent of the stock’s price. The same can be said about a bond’s payments of principal and interest.

This distinction between price and value is what allowed many observers to warn that internet stocks were absurdly priced in the late 1990s, or that mortgage bonds weren’t as safe as investors assumed during the housing bubble. A similar warning about Bitcoin isn’t possible.

What about Initial Coin Offerings (ICOs)? An ICO (in almost all jurisdictions so far) is an unregulated means, bypassing traditional fund raising methods, of raising capital for a new venture. Afraid of missing out on the next big thing, people are willing to hand their money over no matter how thin the premise, very much like in case of South Sea or Mississippi Bubbles. They have close resemblance to penny stock trading, with pump-n-dump schemes, thin disclosures and hot money pouring in and out of stocks.

ICOs, while an alternative financing scheme for startups, aren’t so far sustainable for business. Despite the fact that more than 200 ICOs have raised more than $3 billion so far in 2017, only 1 in 10 tokens is use after the ICO. And a killer app for most popular public blockchain platform Ethereum, which sees increasing number of ICOs? First ecosystem (game to trade kittens) has been launched and almost crashed Ethereum network. This game alone consumes 15% of Ethereum traffic and even than it’s hard to play due to its slowness (thanks Markus for this info bite!).

So overall, Bitcoin (and other crypto currencies) exist only for the benefit of those that buy-n-hold and use them while creating an explicit economic program of counter-economics. In other words, Bitcoin is not as much about money but power.

How it all may end (or begin)

The South Sea Bubble ended when the English government enacted laws to stop the excessive offerings. Mississippi Bubble ended when French currency collapsed, French government bought back (and ultimately wrote off debt via QE) all CPdI’s shares and cast out instigators. The unregulated markets became regulated.

From legal perspective, most likely the same thing will happen to cryptocurrencies and ICOs. China temporarily banned cryptocurrency exchanges till regulations can be introduced. Singapore, Malaysia, and other governments have plans to introduce regulations by end of 2017 or early 2018. Disregard, ignorance, or flaunting of regulatory and other government-imposed rules be mortal for startups and big businesses alike.

From technology perspective, a number of factors, including hard forks, ledger and wallet hacking and its sheer limitations related to scaling, energy consumption, security might bring it down. Also many misconceptions about blockchain/Bitcoin such as claims of a blockchain being everlasting, indestructible, miners providing security, and anonymity being a universally good thing are either exaggerated, not always or patently not true at all.

From business perspective, startups and companies raising money via ICO can be subject to fraud – Goldman Sachs’ CEO claims Bitcoin is a suitable means for conducting fraud, and thus subject to money laundering, counter-terrorist and other relevant government legislation. From investors perspective, shorting seems to be the most sure-fire way of investing profitably in cryptocurrencies.

During the dot-com craze, Warren Buffett was asked why he didn’t invest in technology. He famously answered that he didn’t understand tech stocks. But what he meant was that no one understood them, and he was right. Why else would anyone buy the NASDAQ 100 Index when its P/E ratio was more than 500x – a laughably low earnings yield of 0.2% – which is where it traded at the height of the bubble in March 2000.

It’s a social or anthropological phenomenon that’s reminiscent of how different tribes and cultures view the concept of money, from whale’s teeth to abstract social debts. How many other markets have spawned conceptual art about the slaying of a “bearwhale“

Still, the overall excitement around Bitcoin shows that it has tapped into a speculative urge, one that isn’t looking to be reassured by dividends, business plans, cash flows, or use cases. Highlighting a big, round number like $10,000 only speaks to our emotional reaction to big, round numbers. But it doesn’t explain away the risk of this one day falling to the biggest, roundest number of all – zero.

Survival of blockchain and Ethereum vs. alternatives

As outlined in my previous post, blockchain faces number of fundamental – technological, cultural, and business – issues before it becomes mainstream. However, potential of blockchain, especially if it were coupled with AI, cannot be ignored. The potent combination of blockchain and AI can revolutionise healthcare, science, government, autonomous driving, financial services, and a number of key industries.

Discussions continue about blockchain’s ability to lift people out of poverty through mobile transactions, improve accounting for tourism in second-world countries, and make governance transparent with electronic voting. But, just like the complementary – and equally hyped – technologies of AI, IoT, and big data, blockchain technology is emerging and yet unproven at scale. Additional, socio-political as well as economic roadblocks remain to blockchain’s widespread adoption and application:

1. Disparity of computer power and electricity distribution

Bitcoin transactions on blockchain require “half the energy consumption of Ireland”. This surge of electricity use is simply impossible in developing countries where the resource is scarce and expensive. Even if richer countries assist and invest in poorer ones, the UN is concerned that elite, external ownership of critical infrastructure may lead to a digital form of neo-colonialism.

2. No mainstream trust for blockchain

Bitcoin inspired the explosive attention on blockchain, but there isn’t currently much trust in the technology – as it’s relatively new, unproven and has technical problems and limitations – outside of digital currencies. With technologies still in their infancy, blockchain companies are slow to deliver on promises. This turtle pace does not satisfy investors seeking quick ROI. Perhaps the largest, challenge to blockchain adoption is the massive transformation in architectural, regulatory, and business management practices required to deploy the technology at scale. Even if such large-scale changes are pulled off, society may experience a culture shock from switching to decentralised, automated systems after a history of only centralised ones.

3. Misleading and misguided ‘investments’

Like the Internet, blockchain technology is most powerful when everyone is on the same network. The Internet grew in fits and starts, but was ultimately driven by the killer app of email. While Bitcoin and digital currencies are the “killer app” of blockchain, we’ve already seen aggressive investments in derivative cryptocurrencies peter out.

Many technologies also call themselves “blockchain” to capitalise on hype and capture investment, but are not actual blockchain implementations. But, even legitimate blockchain technologies suffer from the challenge of timing, often launching in a premature ecosystem unable to support adoption and growth.

4. Cybersecurity risks and flaws

The operational risks of cybersecurity threats to blockchain technology make early adopters hesitate to engage. Additionally, bugs in the technology are challenging to detect, yet caused outsized damage. Getting the code right is critical, but this requires time and talent.

While relatively more known Bitcoin’s PoW-based blockchain systems and Ethereum see limelight and PR, there are number of alternative blockchain protocols and approaches, which are scalable and solve many of fundamental challenges the incumbents face.

PoW and Ethereum alternatives

Disclaimer: I neither condone, engage nor promote any of the below alternatives but simply provide information as found on websites, articles and social media of relevant entities and therefore not responsible whether the information thus provided is accurate and realistic.

1. BitShares, SteemIt (based on Steem) and EOS white papers which are all based on Delegated Proof of Stake (DPOS). DPOS enables BitShares to process 180k transactions per second, which is more than 5x NASDAQ transactions/s. Steem and Bitshares process more transactions/day than the top 20 blockchains combined.

In DPOS, each 2 seconds – Bitcoin’s PoW generates a new block each 10 minutes – a new block is created, through witnesses (stakeholders can elect any number of witnesses to generate blocks – currently 21 in Steem and 25 in BitShares). DPOS is using pipelining to increase scalability. Those 20 witnesses generate their own block in a specified order, that holds for a few rounds (hence the pipelining), after the order is changed. DPOS confirms transactions with 99.9% certainty in an average of just 1.5 seconds while degrading in a graceful, detectable manner that is trivial to recover from. It is easy to increase the scalability of this schema, by introducing additional witnesses either by increasing the pipeline length or using sharding to allow to generate in a deterministic/verifiable way few blocks during the same epoch.

2. IOTA (originally designed to be financial system for IoT) is a new blockless distributed ledger which is scalable, lightweight and fee-less. It’s based on DAG, and its performance INCREASES the bigger the networks gets.

3. Ardor solves the common (to all blockchains) bloat problem, relying on an innovative parent/child chain architecture and pruning of the child chain transactions. It shares some similarities with plasma.io, based on NXT blockchain technology and already running on testnet.

4. LTCP uses State Channels by stripping 90% of the transaction data from the blockchain. LTCP combined with RSK’s Lumino network or Ethereum’s Raiden network can serve 1 billion users in both retail and online payments.

5. Stellar runs off of Stellar Consensus Protocol (SCP) and is scalable, robust, got a distributed exchange and is easy to use. SCP implements “Federated Byzantine Agreement,” a new approach to achieving consensus in a real-world network that includes faulty “Byzantine” nodes with technical errors or malicious intent. To tolerate Byzantine failures, SCP is designed not to require unanimous consent from the complete set of nodes for the system to reach agreement, and to tolerate nodes that lie or send incorrect messages. In the SCP, individual nodes decide which other participants they trust for information, and partially validate transactions based on individual “quorum slices.” The systemwide quorums for valid transactions result from the individual quorum decisions by individual nodes.

6. A thin client is a program which connects to the Bitcoin network but which doesn’t fully validate transactions or blocks, i.e it’s a client to the full nodes on the network. Most thin clients use the Simplified Payment Verification (SPV) method to verify that confirmed transactions are part of a block. To do this, they connect to a full node on the blockchain network and send it a filter (Bloom filter) that will match any transactions affecting the client’s wallet. When a new block is created, the client requests a special lightweight version of that block: Merkle block, which includes a block header, a relatively small number of hashes, a list of one-bit flags, and a transaction count. Using this information—often less than 1 KB of data—the client can build a partial Merkle tree to the block header. If the hash of the root node of the partial Merkle tree equals the hash of Merkle root in the block header, the SPV client has cryptographic proof that the transaction was included in that block. If that block then gets 6 confirmations at the current network difficulty, then the client has extremely strong proof that the transaction was valid and is accepted by the entire network.

The only major downside of the SPV method is that full nodes can simply not tell the thin clients about transactions, making it look like the client hasn’t received bitcoins or that a transaction the client broadcast earlier hasn’t confirmed.

7. Mimir proposes a network of Proof of Authority micro-channels for using in generating a trustless, auditable, and secure bridge between Ethereum and the Internet. This system aims to establish Proof of Authority for individual validators via a Proof-of-Stake contract registry located on Ethereum itself . This Proof-of-Stake contract takes stake in the form of Mimir B2i Tokens. These tokens serve as collateral that may be repossessed in the event of malicious actions. In exchange for serving requests against the Ethereum blockchain, validators get paid in Ether.

8. Ripple’s XRP ledger already handles 1,500 transactions/second on-chain, which keeps on being improved (was 1,000 transactions/sec at the beginning of 2017).

9. QTUM, a hybrid blockchain platform whose technology combines a fork of bitcoin core, an Account Abstraction Layer allowing for multiple Virtual Machines including the Ethereum Virtual Machine (EVM) and Proof-of-Stake consensus aimed at tackling industry use cases.

10. Blocko, which has enterprise and consumer grade layers and has already successfully piloted/launched products (dApps) with/for Korea Exchange, LotteCard and Huyndai.

11. Algorand uses “cryptographic sortition” to select players to create and verify blocks. It scales on demand and is more secure and faster than traditional PoW and PoS systems. While most PoS systems rely on some type of randomness, algorand is different in that you self-select by running the lottery on your own computer (not on cloud or public chain). The lottery is based on information in the previous block, while the selection is automatic (involving no message exchange) and completely random. Thanks David Deputy for pointing out this platform!!!

12. NEO, also called “Ethereum of China,” is a non-profit community-based blockchain project that utilizes blockchain technology and digital identity to digitize assets, to automate the management of digital assets using smart contracts, and to realize a “smart economy” with a distributed network.

Bitcoin and blockchain demystified: basics and challenges

Bitcoin, blockchain, Ethereum, gas, …

A new breed of snake oil purveyors are peddling “blockchain” as the magic sauce that will power all the world’s financial transactions and unlock the great decentralised database in the sky. But what exactly are bitcoin and blockchain?

Bitcoin is a system for electronic transactions that don’t rely on a centralised or trusted third-party (bank or financial institution). Its creation was motivated by the fact that digital currency made of digital signatures, while providing strong ownership control, was viable but incomplete solution unable to prevent double-spending. Bitcoin’s proposed solution was a peer-to-peer network using proof-of-work (in order to deter network attacks) to record a public history of transactions that is computationally impractical for an attacker to change if honest nodes control a majority of CPU power. The network is unstructured, and its nodes work with little coordination and don’t need to be identified. Truth (i.e. consensus on longest chain) is achieved by CPU voting, i.e network CPUs express their acceptance of valid blocks (of transactions) by working on extending them and rejecting invalid blocks by refusing to work on them.

Satoshi Nakamoto’s seminal paper “Bitcoin: A Peer-To-Peer Electronic Cash System” has references to a “proof-of-work chain”,“coin as a chain,” “chain of ownership”, but no “blockchain” or “block chain” ever make an appearance in it.

Blockchain (which powers Bitcoin, Ethereum and other such systems) is a way for one Internet user to transfer a unique piece of digital asset (Bitcoins, Ether or other crypto assets) to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows the transfer has taken place, and nobody can challenge the legitimacy of the transfer. Blockchains are essentially distributed ledgers and have three main characteristics: a) decentralisation, b) immutability and c) availability of some sort of digital assets/token in the network.

While decentralisation consensus mechanisms offer critical benefits, such as fault tolerance, a guarantee of security (by design), political neutrality, they come at the cost of scalability. The number of transactions the blockchain can process can never exceed that of a single node that is participating in the network. In fact, blockchain actually gets weaker (only for transacting) as more nodes are added to its network because of the inter-node latency that logarithmically increases with every additional node.

All public blockchain consensus protocols make the tradeoff between low transaction throughput and high-degree of centralisation. As the size of the blockchain grows, the requirements for storage, bandwidth, and computing power required to fully participating in the network increases. At some point, it becomes unwieldy enough that it’s only feasible for a few nodes to process a block — that might lead to the risk of centralisation.

Currently, the blockchain (and with it, Bitcoin, Ethereum and others) challenges are:

Since every node is not allowed to validate every transaction, we need nodes to have a statistical and economic means to ensure that other blocks (which they are not personally validating) are secure.
Scalability is one of the main challenges. Bitcoin, despite having a theoretical limit of 4,000 transactions per second (TPS) currently has a hard cap of about 7 transactions per second for small transactions and 3 per second for more complex transactions. An Ethereum node’s maximum theoretical transaction processing capacity is over 1,000 TPS but processes between 5-15 TPS. Unfortunately, this is not the actual throughput due to Ethereum’s “gas limit”, which is currently around 6.7 million gas on average for each block. Gas is the computation cost within Ethereum, which users pay in order to issue transactions or perform other actions. A higher gas limit means that more actions could be performed per-block. In order to scale, the blockchain protocols must figure out a mechanism to limit the number of participating nodes needed to validate each transaction, without losing the network’s trust that each transaction is valid.
There must be a way to guarantee data availability, i.e. even if a block looks valid from the perspective of a node not directly validating that block, making the data for that block unavailable leads to a situation where no other validator in the network can validate transactions or produce new blocks, and we end up stuck in the current state (reasons a node is offline include malicious attack and power loss).
Transactions need to be processed by different nodes in parallel in order to achieve scalability (one solution is similar to database sharding, which is distribution and parallel processing of data). However, blockchain’s transitioning state has several non-parallelizable (serial) parts, so we’re faced with some restrictions on how we can transition state on the blockchain while balancing both parallelizability and utility.
End-users and organisations (such as banks) have hard time or don’t want to use blockchain (despite many having used or using distributed ledgers). To do a simple Bitcoin transaction requires a prior (quite a few exceptions) KYC check just to sign up on one of many crypto trading or exchange platforms. “The Rare Pepe Game is built on a blockchain with virtual goods and characters and more,” explains Fred Wilson of USV. “And it shows how clunky this stuff is for the average person to use.”
There is lot of hype, around blockchain which sets wrong expectations, misleads investments and causes lots of mistakes. Bloomberg reports that Nasdaq is seeking to show progress using the much-hyped blockchain. The Washington Post lists Bitcoin and the blockchain as one of six inventions of magnitude we haven’t seen since the printing press. Bank of America is allegedly trying to load up on “blockchain” patents. Also, due to its volatility, uncertain status (can it be considered a legal tender such as normal fiat money or is it security, etc?), there is much instability of holding crypto assets.
Contrary to common belief, disintermediating financial institutions, so the reasoning goes, multiple parties can conduct transactions seamlessly, without paying a commission. However, according to one research, cost savings might be dubious as moving cash equity markets to a blockchain infrastructure would drive a significant increase of the overall transaction cost. Trading on a blockchain system would also be slower (at least in foreseeable future) than traders would tolerate, and mistakes might be irreversible, potentially bringing huge losses.
To drive massive adoption which will induce further technological advancement, a killer app on blockchain or Ethereum would be a must. Despite much invested resources and efforts globally, So far there doesn’t seem to be one, but there arguably is potential in few areas such as digital gold, payments and tokenization.
Blockchain’s immutability might pose a problem for specific types of data. The EU ‘right to be forgotten’ requires the complete removal of information, which might be impossible on blockchain. There are other privacy-related concerns that people might want to remove or forgotten such as previous insolvency, negative rankings, and other personal details that need to change.

To conclude, I think Ethereum is furthers along compared to PoW-based public blockchains. Ethereum is still orders of magnitude off (250x off being able to run a 10m user app and 25,000x off being able to run Facebook on chain) from being able to support applications with millions of users. If current efforts are well executed, Ethereum could be ready for a 1–10m user app by the end of 2018.

However, there are less-known alternative models that are much more scalable. Once scalability issues are solved, everything will become tokenized and connected by blockchain.

Blockchain + AI = ?

What happens when two major technological trends see an synergy or overlap in usage or co-development?

We have blockchain’s promise of near-frictionless value exchange and AI’s ability to conduct analysis of massive amounts of data. The joining of the two could mark the beginning of an entirely new paradigm. We can maximize security while remaining immutable by employing AI agents that govern the chain. With more companies and institutions adopting blockchain-based solutions, and more complex, potentially critical data stored in distributed ledgers, there’s a growing need for sophisticated analysis methods, which AI technology can provide.

The combination of AI and blockchain is fueling the onset of the “Fourth Industrial Revolution“ by reinventing economics and information exchange.

1. Precision medicine

Google DeepMind is developing an “auditing system for healthcare data”. Blockchain will enable the system to remain secure and shareable, while AI will allow medical staff to obtain analytics on medical predictions drawn from patient profiles.

2. Wealth and investment management

State Street is issuing blockchain-based indices. Data is stored and made secure using blockchain and analyzed using AI. It reports that 64% of wealth and asset managers polled expected their firms to adopt blockchain in the next five years. Further, 49% of firms said they expect to employ AI. As of 01.2017, State Street had 10 blockchain POC’s in the works.

3. Smart urbanity

To supply the energy, distributed blockchain technology is implemented for transparent and cost-effective transactions between producers and consumers, while machine learning algorithms can even hone in on transactions to estimate pricing. Green-friendly AI and blockchain help reduce energy waste and optimize energy trade. For example, an AI system governing a building can oversee energy use by counting in factors like the presence and number of residents, seasons, and traffic information.

4. Legal diamonds

IBM Watson is developing Everledger using blockchain technology to tackle fraud in the diamond industry, and deploying cognitive analytics to heavily “cross-check” regulations, records, supply-chain, and IoT data in the blockchain environment.

5. More efficient science

The “file-drawer problem“ in academia is when researchers don’t publish “non-result” experiments. Duplicate experiments and a lack of knowledge follow, trampling scientific discourse. To resolve this, experimental data can be stored in a publicly accessible blockchain. Data analytics could also help identifying elements like how many times the same experiment has happened or what the probable outcome of a certain experiment is.

There are forecasts that AI will play a big role in science once “smart contracts” transacted by blockchain require smarter “nodes” that function in a semi-autonomous way. Smart contracts (essentially, pieces of software) simulate, enforce and manage contractual agreements and can have wide-ranging applications when academics embrace the blockchain for knowledge transfer and development.

6. IP rights management

Digitalization has introduced complicated digital rights to IP management, and when AI learns the rules of the game, it can identify actors who break IP laws. As for IP contract management, for music (and other content) industry, blockchain enables immediate payment methods to artists and authors. One artist recently suggested the blockchain could help musicians simplify creative collaboration and making money. Ujo Music is making use of the Ethereum blockchain platform for song distribution.

7. Computational finance

Smart contracts could take center stage where transparent information is crucial for trust in financial services. Financial transactions may no longer rely on a human “clearing agent” as they automatized, performing better and faster. But since confidence in transactions remains dependent on people, AI can help monitor human emotions and predict the most optimal trading environment. Thus, “algotrading” can be powered by algorithms that trade based on investment patterns correlated with emotions.

8. Data and IoT management

Organizations are increasingly looking to adopt blockchain technologies for alternative data storage. And with heaps of data distributed across blockchain ledgers, the need for data analytics with AI is growing. IBM Watson merged blockchain with AI via the Watson IoT group. In this, an artificially intelligent blockchain lets joint parties collectively agree on the state of the device and make decisions on what to do based on language coded into a smart contract. Using blockchain tech, artificially intelligent software solutions are implemented autonomously. Risk management and self-diagnosis are other use cases being explored.

9. Blockchain-As-A-Service software

Microsoft is integrating “BaaS modules” (based on the public Ethereum) in its Azure that users can create test environments for. Blockchains are cheaper to create and test, and in Azure they come with reusable templates and artifacts.

10. Governance 3.0

Blockchain and AI could contribute to the development of direct democracy. They can transfer big hordes of data globally, tracing e-voting procedures and displaying them publicly so that citizens can engage in real-time. Democracy Earth Foundation aspires to “hack democracy“ by advocating open-source software, peer-to-peer networks, and smart contracts. The organization also aims to fight fake identities and reclaim individual accountability in the political sphere. IPDB is a planetary-scale blockchain database built on BigchainDB. It’s a ready-to-use public network with a focus on strong governance.