Venezuela’s “Petro” cryptocurrency proposal needs improvement

I was supposed to have a nice day today. I finished a final exam and was looking forward to meditating all evening about how nice it is living in America again, and how much I relish American-as-apple-pie customs like pick-up trucks, groundhogs, and bourbon.

When suddenly, as I sat at my kitchen table enjoying aforementioned bourbon, this popped into my feed:

Mother of God.

This reminds me of Estonia’s Estcoin proposal – which I will charitably describe as “preliminary” – published last week.

But the Petro is worse.

1) It is entirely unclear what is being proposed

Like Tether, we’re being told the Petro is

“Backed by a barrel of oil,”

…but we aren’t told what “backed” actually means or how that barrel of oil is intended to capitalize into the value of the Petro-token. Is this a promise by the Venezuelan government to pay a holder of a given Petro the proceeds from a given barrel of oil at a future date?

Is it a proportional revenue share? Is it equity in PDVSA?

We’re not sure, and buyers of the Petro should make damn sure they get sure before outlaying a huge amount of BTC on Petros in the near future.

What I am sure of is that substantially more structuring work is needed here. If any big international law firms want some consulting help in preparing your pitch, hit me up.

2) The “Petro” doesn’t need mining

Although the Venezuelan government seems to think it does. From the press release:

“Every single Petro will be backed by a barrel of oil,” Maduro said, promising to provide cryptocurrency mining throughout the country. “We will set up a special team of cryptocurrency specialists so they will be engaged in mining in all states and municipalities of our country.”

This is absurd. Thinking the Petro blockchain should be mined is a technical mistake as elementary as it is inexcusable.

Cryptocurrency mining is a game-theoretic exercise designed to keep transaction validators in a proof-of-work cryptocurrency system with no central issuer honest by granting rewards for honest transaction processing (i.e. coins) and by imposing costs on participants for dishonest transaction processing (wasted electricity).

Where an issuer can be identified (say, a sovereign) and the thing being bought and sold comes with legal rights (say, dividends from oil production), you obviate the need for mining as you vest control of the system in one person: here, it’s the issuer. (Cf. with finance where you might want to vest that power in an agent or trustee.)

This is how, e.g., the Tether cryptocurrency operates, or (preferably) any of the numerous blockchain clients incubated by the Hyperledger Project. Or other, proof-of-stake systems like Tendermint which allow you to tailor consensus to a high degree of specificity when used in conjunction with a private implementation such as Hyperledger Burrow.

If you’re a country, the kind of system you want to run is a permissioned system where you control the validators, not an open system that can be hijacked by a bunch of anonymous electricity thieves in China  (miners).

The benefit to your users is the transparency and the automation, not the money-printing function which is associated with cryptocurrencies like Bitcoin, Litecoin et al.

3) There are better solutions here

Per the RT report:

The new cryptocurrency was announced by Maduro at the beginning of December as a way “to innovate toward new forms of international finance for the economic and social development of the country.”

Technology has its limits.

Cryptocurrency and blockchain tech is a tool which puts power in the hands of the individual citizen by removing the need to go through intermediaries or third-party data controllers to verify that a transaction has or has not been processed correctly.

If you’re serious about launching a cryptocurrency, or about extracting value from the country’s vast oil reserves, you should also get serious about enacting liberal free-market economic and democratic reforms that will help your country and your people benefit to the most significant degree from the platform.

What is required to get the greatest returns from this technology investment, then, is not just technology but also a healthy dose of libertarianism. In addition to cryptocurrency, Mr. Maduro, I recommend you check out Ludwig von Mises’ Economic Calculation in the Socialist Commonwealth or The Wealth of Nations. Or the Adam Smith Institute’s handy blog.

That’s all for now.


How high transaction fees threaten cryptocurrency institutions’ solvency

I guess you really can have too much of a good thing, even in Bitcoin:

If the above is right, it constitutes a major own-goal by companies that should really should have known better.

Estonia’s “Estcoin” is a Nakamoto Scheme

Today we learn that Estonia’s Estcoin is still charging full speed ahead, despite the fact that European Central Bank supremo Mario Draghi more or less shot down the idea back in September:

From the Estcoin announcement blog post by project lead Kaspar Korjus:

Much of the criticism of estcoin was based on the fact that Estonia simply can’t start its own cryptocurrency even if it wanted to. Estonia’s only currency is the euro and this is an essential feature of our EU membership, which we are proud to have. No one here is interested in changing that.

That’s why we have always referred to estcoin as a proposed ‘crypto token’.

Actually, you’re still calling it “Estcoin.” You know, “coin.” As in currency. But I digress.

Kill it with fire, Mario

Lest we forget what the European Central Bank said about the Estcoin proposal back in October, I will repeat it here:

“No member state can introduce its own currency; the currency of the euro zone is the euro.”

So if it’s not a legal, national currency, what is Estcoin? Estonia says

“Governments do need to consider the disruptive impact of how crypto tokens can be used as currency because they provide a more efficient means for exchanging value globally. However, crypto tokens have far more significance than their use as a currency and don’t necessarily fall into that category.

“From Estonia’s perspective, estcoins were proposed as a way to raise money and support for the development of our digital nation from more people around the world. We would also want to structure the tokens so that they help build our e-resident community and incentivise our own key objective, which is to increase the number of companies started in Estonia through e-Residency.”

Ok, I get it. So Estcoin isn’t a currency, it’s a share or some kind of fund unit in a proposed national investment platform?

Not quite, per Estonia’s e-residency folks:

“What problem does estcoin solve for people who hold estcoins? This is another key and commonly repeated criticism of the proposal that estcoin is ‘a solution looking for a problem’. Since the proposal was published, I’ve been repeatedly asking audiences if they would be interested in purchasing estcoins and the response is a resounding yes, even if they are not always sure why yet.”

So Estcoin is

  • Something we are expected to buy,
  • That is called a “coin” but isn’t a currency,
  • That isn’t a share or other contractual investment,
  • That other people will also want to buy because it goes up in value,
  • Even though no one, including the Estonian E-Residency team, can say what the financial product being created will actually do or how it will work.

There is only one name for such a messy hodgepodge of unclear promises bundled together in something that isn’t a contract of any kind but is nonetheless intended to be an investment.

Estcoin is a state-sponsored Nakamoto Scheme. Sensible people with solid financial services experience in the Estonian government –  or, as a last resort, the EU institutions – can’t intervene and get some grown-ups in the room quickly enough.


This marmot disapproves of Estcoin

Stablecoins are doomed to fail

A brief history of the stablecoin

Those of you who have been following this blog for awhile may recall my deep and enduring disdain for the “stablecoin” concept, that is, the idea that it is possible for “crypto-economic” magic and game theory to ensure that a cryptocurrency can be reliably pegged to the value of some real asset without requiring a bankruptcy-remote contractual mechanism to ensure convertibility of the crypto-asset into the real deal (something mainstream finance already does extremely efficiently).

The first of these “stablecoin” follies was the Bitshares project, back in 2014, which claimed that blockchain alchemy could create a stablecoin called BitUSD which was pegged to the dollar and indeed pegged to any other asset (gold, silver, marmots) which users of the system chose to create. I wrote at the time that the Bitshares “USD peg” system was doomed to fail, and sure enough, 100 hours after launch the thing fell flat on its face.

I had thought that would be the end of it, either because the wider community learned from this project’s mistakes, or that some government agents would take notice of the fact that people were running around selling “shares” unconnected to a prospectus or actual shares.

None of that happened. So it was not the end.

In the intervening period, the “blockchain without Bitcoin” craze came and went and then, in early 2017, Ethereum (another scheme crafted by the hands of men) shot “to the moon,” with the coins – originally valued at something like $0.30 – shooting up to $450 a pop and a $30 billion market cap. The herd took notice and ICOs began to proliferate at an alarming rate.

By the time the SEC piped up, on 25 July, the gold rush was already well underway.

The promise of overnight riches was irresistible to both startups and their venture backers alike, legal consequences be damned, and soon afterwards startups everywhere, like untrained dogs, began leaving proverbial messes all over the field of financial regulation the world over.

In October, a scheme called Basecoin claimed to have re-discovered the philosopher’s stone of finance. As with Bitshares, the scheme creates a cryptocurrency instrument that is collateralized by itself and depends on an environment of ever-rising cryptocurrency prices and never-ending cryptocurrency collateral. I wrote about it. It’s a really bad idea.

Now we stumble upon MakerDAO. I paid very little notice to MakerDAO so wasn’t going to say anything about it, but then they decided to tell a journalist that “Preston hasn’t said anything about our project because our project is amazing.”

That made marmot angry. You wouldn’t like marmot when he’s angry.

Scary marmot

On MakerDAO

Having taken fifteen minutes to review the MakerDAO paper, the Dai system is at its core a very simple cryptocurrency-collateralised derivative contract, with a lot of intermediate steps to confuse its buyers of the facts that (a) that contract is massively overcollateralized in the underlying cryptocurrency (which is Ethereum by default) and (b) in the event of an Ethereum black swan event the value of the underlying collateral, and therefore the value of the stablecoin, will also be wiped out.

Speaking generally, the system requires someone who wishes to obtain $100 worth of Dai to post, say, $150 Ethers’ worth of collateral. This, of course, is insane, because it would be easier for the user to simply go to Coinbase and sell his Ether for actual dollars, and he’d have $50 worth of Eth left over to go spend on other things.

The system also assumes that overcollateralising will protect the value of the Dai. Not so; it simply increases a Dai holder’s exposure to the price of the underlying Ether. If Ether gets wiped out, the Dai collateral will be worthless, so the user will have lost $150 in an effort to create $100.

Screen Shot 2017-12-18 at 7.04.13 PM.png
They admit this as well, but nobody, including the dev team, seems to care

Put differently, this system makes zero sense and is broken to the core: it only works if the price of Ether goes up. Cognizant that the conventional wisdom is that the Ethereum “World Computer’s” price will always go up, and it has done nothing but go up for the last 18 months, I can see how this might make sense to the MakerDAO team.

Unfortunately for them, history shows that this investment thesis has been wrong 100% of the time, and Ethereum is as user-friendly and scalable as an angry rhinoceros experiencing heroin withdrawal.

Long story short

Crypto-collateralized stablecoins are the perpetual motion machines of modern finance.

I don’t blame the developers building these things; stablecoins are just a stupid meme invented by guys like Vlad and Vitalik back in the heady, schelling-point-heavy days of Ethereum Proof-of-Concept 3 et seq. that nobody in the community possessed the requisite experience or gravitas to refute.

I refute it now. It’s a terrible goddamned idea.

A stablecoin that is collateralized by itself is a complex and fragile Nakamoto Scheme doomed to fail.

A stablecoin that is collateralized by real assets and structured correctly is not a stablecoin, but a unit trust.

That’s all for now.

Postscript, 11 December 2017

I rest my case.

Screen Shot 2017-12-11 at 4.01.34 PM.png


No, the U.S. Senate isn’t banning Bitcoin

A lot of folks have been panicking since an article in BTCmanager described some proposed new legislation working its way through the U.S. Senate using the words “criminal” and “bitcoin” in the same sentence.

This immediately launched thousands of screaming cryptocurrency enthusiasts, now armed with the mistaken impression that Bitcoin is about to be criminalized in the U.S., into the stratosphere.

Later in the day, I stumbled across this article by @Beautyon_, “Senate Bill 1241 is a Threat to America,” on Twitter:

What the hell is this all really about, you ask?

In a line, the US Senate is moving a bill to move digital currency transactions clearly within the usual KYC/AML reporting frameworks already in place. Presumably this is being done to both bring digital currency regulation clearly in line with all other forms of money transfer business, and add another arrow into the quiver of prosecutors looking to take down the sophisticated criminal enterprises which use digital currency to stay out of sight and frustrate attempts to build cases.

@Beautyon_ argues that this attempted legislation is “unconstitutional and bad for America” on First Amendment (freedom of speech etc.) and Fourth Amendment (freedom from unreasonable searches and seizures, etc.) grounds.

Statist shills, making laws n’ stuff

Although eloquently written, it strikes me that this argument is… how shall I say it? Completely wrong.

Subject to the usual caveat that I’m an English lawyer and not yet US-qualified, three points:

This is not “Bitcoin Criminalization” or a “Bitcoin Ban.”

 Senate Bill 1241 puts cryptocurrency business on a level footing with existing money transmitting business by dropping cryptocurrencies into the already-existing reporting framework for monetary transactions. The main thing to look out for, on my quick reading, is that it reclassifies cryptocurrency exchanges and anyone “issu(ing), redeem(ing) or cash(ing)” cryptocurrency as a “financial institution” under the existing law. They will therefore be required to, among other things, (a) keep records, (b) conduct enhanced due diligence designed to detect money laundering, and (c) not permit structuring of transactions to evade reporting if the law passes.

Unless I’m reading this incorrectly, Bitcoin would remain perfectly legal. Merely holding a balance would not trigger a reporting obligation. Failing to report certain kinds of Bitcoin transactions is what becomes a crime.

This will remove much of the edge cryptocurrencies currently enjoy in the form of regulatory arbitrage. It will make operating a cryptocurrency exchange a far more labor-intensive and tedious proposition. That said, the existing framework is presumptively constitutional so it should be well within the province of Congress to extend it in this way.

The First Amendment is irrelevant

…although I recommend reading Beaut’s argument anyway from the standpoint of working through a well-written a priori logical argument.

This Senate bill is an amendment to an existing federal law which seems to have ample constitutional justification under the Commerce Clause.

Beaut argues that software, being plaintext, attracts First Amendment protection as “speech” and therefore cannot be regulated.

He points us to the example of the encryption program PGP, which the U.S. government had banned from export in binary form (which it was able to do as any encryption program larger than 40 bytes was classified as a “munition”). The PGP team instead published the source code as a plaintext document in a book, which attracted 1st Amendment protection, and shipped the book abroad; recipients abroad then recompiled it and could use PGP themselves.

This argument does not work for the current situation with Bitcoin as nothing in the proposed amendment suggests that the publication of Bitcoin software is regulated in any way, shape or form, nor that people will be restrained from publishing on the Bitcoin network in any way they choose (unless that use is in furtherance of a crime).

A Bitcoin transaction is capable of being a monetary transaction. If it meets certain threshold criteria (size and whether it forms part of a series of transactions) it ought to be reportable. And that is indeed what the new Senate bill says. Not that the system can’t be used, but simply that transactions on it of substantial value by persons engaging in certain types of business will need to be reported. 

The fact that Bitcoin or any other software is, at the end of the day, just a bunch of text constituting executables, as with PGP, doesn’t exempt these programs from the entirely constitutional regime that governs money transfer when these programs are used to facilitate money transfer.

Beautyon’s thinking about the First Amendment ignores/eviscerates the Congressional power granted by the Commerce Clause, which applies to business conducted with software. If the First Amendment overrode the Commerce Clause, 1A could be used as a bludgeon to exempt all online transactions from legal oversight, as anything online is necessarily software-driven (and therefore text-driven). For this reason the probability of the courts adopting that position is zero.

The 4th Amendment isn’t relevant either…

…because the blockchain is a public file, readable by all.

Beaut argues that if Bitcoin is subject to a disclosure regulation, so is all software; thus, he says, the Fourth Amendment to the US Constitution is under threat by the proposed amendment, because e-mail is also software and if they mandate disclosure of your Bitcoin without a warrant, they can also mandate disclosure of your e-mail without a warrant.

This is, to put it lightly, a stretch. The 4A states the right of the people to be free from unreasonable searches and seizures of their “persons, houses, papers and effects” and prevents the fruits of any such unlawful search or seizure from being introduced against that person in court.

I struggle to see how a write permission on a publicly-available blockchain balance is a “paper or effect.” Public keys are pure information. When we have possession of one, we can learn a great deal without needing to also know the associated private key; we know, for example, the transaction inputs and outputs associated with a given address. The Senate bill asks us to put a name to that already-public information if and only if we engage in the specified regulated activity.

Even if this information were an effect, the last time I looked, Bitcoin was 100% publicly readable by anyone, anywhere, at any time. This means, as far as my understanding of the Fourth Amendment goes, one does not really have a reasonable expectation of privacy on the blockchain any more than one has a reasonable expectation of privacy in a pile of garbage you leave out on a street corner. Thus a 4A violation is difficult to make out. (Admittedly the Monero/ZCash situation, where information that would be public on Bitcoin is encrypted, is a little different, but not much – so I’ll leave that aside for today.)

Chill out

In most cases, then, telling the government which bit of the blockchain is yours, whilst annoying, does not act as a prior restraint on speech, does not implicate a privacy concern protected by the Fourth Amendment, does not materially change an already-constitutional regulatory framework and therefore does not undermine the foundations of the Republic.

Which is not to say that crypto-systems don’t implicate speech and privacy issues from time to time. They can and they do. They just don’t here.

Anyway. It’s a Sunday night, so I’m signing off. My tip to the Bitcoin community would be to chill out and don’t embarrass yourself by sounding off some total nonsense to your Congressman about how their “Bitcoin Ban is unconstitutional under the Fourth Amendment.”

If you are really that concerned, you’ll want to chat with a US-qualified public law lawyer or financial regulatory lawyer first.