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Opinion

My general opinions on things happening in the space, or opinions about different news articles

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Bitcoin Anonymity

Bitcoin Anonymity

When television media outlets discuss Bitcoin, and I use the term “discuss” loosely, it usually revolves around the same central points, depending on what the tone of the message they want to convey is. In the negative spectrum, it’s usually things like “it’s a ponzi“, or “only terrorists/money launderers/pornographers use it“, and to support their arguments (since terrorism is scary) they make claim that bitcoin is anonymous. Bitcoin anonymity is for the most part a farce; you can not have true anonymity in this space, at least not yet.

Why do people think Bitcoin is anonymous?

If you wish to make a payment or send bitcoins to another address you do not need their name or social security number. All you need is the public address, which is just a string of numbers or letters. This allows you to send value over the internet to anyone in the entire world at any time, day or night, and within 10 minutes the payment will arrive in their wallet. There’s nobody sitting in the middle of the transaction taking a percent or looking at what the payment was for to confirm that you’re allowed to pay them. It not only “just works”, but has been working non-stop 24 hours a day for the past 10 years.

Due to this reason of ease of use and lack of regulation by some central authority outside of the Bitcoin network (as the Bitcoin protocol is the authority) it’s an easy argument to just simply say “Bitcoin is anonymous”.

Why is Bitcoin not anonymous?

The government and central bank can control their own currency, and have full oversight on all of the banks in the entire network of banks. If you have US Dollars and want to purchase some bitcoins, you have two options. You can use an exchange that will take your dollars from your bank account digitally and give you bitcoins, or you can use an in-person transaction to buy bitcoins face-to-face from another person, much like if I give you $20 in person.

For the first option, KYC and AML are in play here. “Know your customer” and “Anti-Money Laundering” are utilized to make sure you’re “allowed” to use your US Dollars for the purchase of bitcoins. This means you must give up your social security number, driver’s license, and whatever else they deem necessary to make sure you’re not a bad guy. As soon as you do this, any transfer you make outside of the exchange to your own personal wallet of “anonymous” letters and numbers (the bitcoin address) there is a paper trail tying your personal identifiable information to this address. There are companies and government institutions dedicated to tracing and tracking payments in the blockchain. They can and do find criminals based on these on-ramp tracking methods. Bitcoin anonymity for option 1 is just simply not there.

For option 2, buying bitcoins in person, does offer some bitcoin anonymity. The drawbacks to in-person buying from others is usually you can’t use as much cash as you could from an exchange. There’s also the risk of being robbed. Finally, there’s the risk that the coins themselves were stolen and flagged by the government and now you’re being tracked. Even if you can get clean coins from someone else as soon as you move them to an exchange or somewhere else needing your KYC/AML information you are now a part of the tracked system.

Why is anonymity important?

I’m pretty sure this should be obvious to everyone as to why anonymity in any currency is important. As of right now in the United States, any time you use your credit card all of your purchases are tracked and in the open for anyone up the banking food chain to see what you’ve bought, where you bought it, and how much you paid for it. The only true anonymous exchange of value is when dealing with cash in hand with any individual or vendor.

The United States is only one country though. You probably don’t ever think “will the police come to my door if I buy this item”. Since Bitcoin is a world currency, and it works in any country, we have to be mindful that there’s world leaders in other countries that do not like their people buying certain books or donating money to political parties that might go against what their policies are. Anonymity is paramount for these individuals’ safety and security. Their leaders would mark them as domestic terrorists in their country for simply buying something they don’t agree with.

How to make your coins semi-anonymous

There is right now a way to make your coins semi-anonymous, but it takes some work. Until Bitcoin starts implementing more privacy features like Schnorr signatures and Bulletproofs, an individual can mask their coins with plausible deniability by using any of the following methods:

Lightning Network

The lightning network can be used to route coins with 100% privacy over a network in a peer-to-peer fashion that does not expose both the transaction amounts or the public addresses used. Theoretically you can create two nodes that you control, deposit coins on one node and withdraw them on the exit node you’ve created. In this manner the two addresses are not inter-connected, as the lightning network does not have any way to trace coins being routed on it helping you achieve bitcoin anonymity.

Local Bitcoins

Mentioned above, using a service like local bitcoins allows people to meet up face-to-face to buy and sell bitcoins. The two main disadvantages to this are the possibility of being robbed, and most people selling have a large mark up on the prices / don’t have a lot to sell for you. If you need around $2,000 worth of coins this is probably an ok choice.

Public Addresses

Never reuse a public address for receiving coins more than once. This makes blockchain forensics a piece of cake for companies looking to tie your identity to a bitcoin address. Every modern hardware wallet (and some software wallets) automatically create new addresses for you when looking to receive new coins. I highly suggest using this feature and not going against it.

Conclusion

As we just learned, bitcoin anonymity simply isn’t there yet. For any money to be sound money, fungibility is crucial for the success of the currency. You do have options though, and being mindful of what you’re doing will take you a long way in protecting your privacy when performing transactions.

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Proof Of Keys Event

On January 3rd, 2019 there is supposed to be the first annual “Proof of Keys” event. For those that do not know what this is, the event is supposed to be a deadline for when users should have pulled all of their coins off of their exchanges and transferred them to their individual, private wallets. The purpose is to keep the exchanges honest about their solvency. While I personally think this is an admirable and honest attempt at exchange solvency, I do not believe this event will amount to anything other than individuals such as myself writing about it.

It’s important in my opinion to understand where this is all stemming from, so I’m going to reverse the clock to late 2013 when Bitcoin first rose to it’s all time high of around $1,000. Back then there was only one major exchange which offered Bitcoin buys and sells, and that website was mtgox. Mtgox (Pronounced Mount Gox) used to be a card game exchange for Magic: The Gathering (hence the name, mtgox) and pivoted to a Bitcoin exchange when Mark Karpeles purchased the site. The exchange was based out of Tokyo, Japan and there weren’t many laws revolving around Bitcoin so everything was pretty under the radar.

When the all time high hit and people began to withdraw their coins from MtGox it was discovered that there wasn’t enough coins to transfer out to everyone. A lot of people got burned, and out of that rose more legitimate exchanges like Coinbase. Everyone that’s traded Bitcoin since 2013 has always had the mantra of “not your keys, not your coin” so those individuals have always held their coins off of the exchanges in cold storage. However, and is always the case, every new wave of investors brings in new newbies and people that do not understand what 2013 veterans have been through.

The proof of keys event’s message is to weed out insolvent exchanges, but I think it’s really more about spreading the message of never leaving your coins on exchanges. If anything, that’s all that will come out of this event. There are 3 types of cryptocurrency investors:

  1. Long-term holders
  2. FOMOers
  3. Traders

Long-term holders

The vast majority of these individuals will always have their coins off of the exchanges to begin with. Unless their holdings don’t warrant purchasing a Trezor or Ledger (sub-1,000 USD investment) they will never have their coins on the exchange to begin with. The proof of keys event is not targeted towards them.

FOMOers

This group of people can be classified as those that purchased between the 10,000 and 20,000 range and just “forgot” about their purchase, completely writing it off as a loss. They just straight up do not give a hoot about the price anymore, nor do they read about crypto news or follow any Twitter celebrities about crypto. They are the sheep, the followers, and you will not hear or see them again until the next major bullrun. Every wave up generates a new flock of FOMOers, and the proof of keys event will not interest any of them.

Traders

Finally, this group of crypto holders will absolutely never pull their coins off of the exchange. It isn’t that they’re stupid; I think it’s the complete opposite. If you break the “Traders” group down you have sub-categories of traders. There’s arbitragers, speculators, day-traders, etc. Each of these have traders that are smart and traders that are dumb.

With all investing, even stocks, there’s a clear winner and a clear loser in a trade. It is a zero-sum game. You can not have two winners. The smart traders will realize that if they can get others to remove their coins from the exchange that will reduce liquidity and increase volatility which they can exploit. If they can get anyone to remove their coins if they’ve been actively trading before it’s a good thing for them. They’ll have more opportunities for arbitrage and/or being in a better spot for a winning trade as opposed to if their opponent was still in the game competing against them.

It makes sense for them to think they should pull their coins off of the exchange for the “Just in case” an exchange is insolvent, however it will be immediately realized that this is a mistake and they should keep their coins on the exchange to take advantage of the new opportunities that this “proof of keys event” would create for them. It makes all the more sense to keep them on a US based exchange like Bittrex or Coinbase since the laws and regulations here would mandate a stricter control of not having fractional bitcoin reserves further reducing the possible insolvency problem.

Conclusion

Ultimately I do not think the proof of keys event will amount to anything more than chatter on blogs and forums among those already deep into the crypto scene. While it’s certainly good to have the discussion about never keeping your coins on the exchange, the sad reality is that until we have a decentralized exchange or an exchange that allows atomic swaps of coins without the need for a central authority or custodian to hold our coins, the threat of insolvency will just have to be something that is a part of the game. Until then, stick to US based exchanges and only keep on exchanges what you can afford to lose.

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Lightning Network Effects On Exchanges

The lightning network is here, and it’s working. The number of lightning nodes and channels are increasing every day, with more software to support ease of use than ever before. As this network grows I have some predictions on the lightning network effects on exchanges.

High Frequency Trading

I predict that high frequency trading (HFT) will increase to a faster speed than is currently possible due to layer 1 speeds and will result in a tight bitcoin price reflected across all of the legitimate exchanges. Traders are always looking for an edge against their competitors, and this isn’t just limited to the cryptocurrency world.

…they are willing to go to extraordinary lengths to gain this speed advantage – including laying the shortest, and therefore straightest, possible fibre-optic cable between the Chicago exchange the New York exchange based in New Jersey, a distance of 827 miles.

Speculators and bigger institutions will be the first ones to pioneer this. The very first crypto exchange to implement this will cause the others to implement it too due to demand from their customers. The real winners will be the traders that can either get direct channels to the different exchanges with enough liquidity to perform their transfers near instantly, or the developers that can calculate the cheapest and shortest channel hops between nodes to get to the proper exchange.

Since the liquidity will be increased between all of the exchanges and arbitrage will create razor-thin advantages for the speculators, we will end up seeing the price of bitcoin stabilize between all of the exchanges that implement lightning deposits and withdrawals.

Altcoin Markets Will Disappear

Altcoin markets as they’re known today will not exist in their current form once lightning is implemented on exchanges. They will exist solely as coin swaps on the exchange with no way to “pull” the altcoins off via lightning as that is a bitcoin based solution as of this writing.

The adoption of this idea will be really slow at first, as the profit made from each buy/sell is currently very high on exchanges and that’s not something they’ll want to let go of. Once one exchange does it however, it’ll be like a domino effect causing the vig to drop to near zero, and we’ll see another tight gap between the different exchange’s prices.

Custodial Service Centralization

The less technical savvy traders, which would be the ones that aren’t into bitcoin for it’s technology and most likely the majority of traders, will not be running their own bitcoin node and lightning node to hold their coins. They are going to rely on the exchanges to act as custodians of their coins. This isn’t really that different from today’s implementation since traders are leaving their coins on exchanges anyway to buy or sell,¬† but it has some interesting possible effects.

hackers had raided that Mt. Gox exchange and stole 744,408 bitcoins belonging to Mt. Gox customers, as well as an additional 100,000  bitcoins belonging to the company, resulting in the exchange being declared to be insolvent
https://blockonomi.com/mt-gox-hack/

The first effect is an obvious one, and that is if the private keys aren’t in your possession then the coins aren’t technically yours. Traders burned by exchanges in the past that have stolen their customer’s coins learned their lesson and became savvy enough to hold onto their own coins, but the implementation of lightning on exchanges now really does allow for you to pull the coins off of the exchange and hold them yourself. The fee to move them will be almost 0 and transfers out instantly. There’s no excuses anymore not to keep coins off of exchanges.

This leads into the second effect which is more of a byproduct, and that is a kind of self-audit of the exchange’s holdings of the coin. Currently there’s no real way of knowing how many coins an exchange holds and whether or not the volume you see on an exchange is due to fake coins / IOUs for coins that they really don’t have. Using lightning will ensure true liquidity increases and will keep exchanges honest of their coin holdings since customers can pull them off at any point in time.

The lightning network effects on exchanges won’t truly be known until it happens, but I feel the above are absolute possibilities.

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The Bitcoin Cash Stress Test

If you like to follow crypto news you may have heard about the Bitcoin Cash stress test. On September 1st, 2018 the community over at /r/btc performed a test of their network by broadcasting thousands upon thousands of transactions with the intent of showing the robustness of their network, hoping to prove to the world that their Bitcoin is the real Bitcoin. To me this was just a dog and pony show with no real testing going on.

Stress testing involves attempting to determine the robustness of the system by testing beyond the normal means of operation. Stress testing isn’t limited to network testing, and is used in the software development world to see how and when a piece of software breaks by meandering away from a happy path of usability. What the bitcoin cash stress test actually aimed to do was perform load testing of their network by seeing how big their blocks could get without toppling over their system.

Load testing generally refers to the practice of modeling the expected usage of a software program by simulating multiple users accessing the program concurrently. As such, this testing is most relevant for multi-user systems.

This was not a real test for a couple of reasons. The first, and in my opinion, main reason this doesn’t prove their system is any more robust than Bitcoin’s system is Bitcoin Cash’s source was a clone of Bitcoin’s. The main change made to Bitcoin Cash’s code was changing the block size limit from 1 mb to 32 mb (or in the future, more). The only people they’re fooling are amateur readers or people that don’t understand the history between the two coins.

The second big and most glaringly obvious reason I see this as a PR stunt attempt is you’re only really testing the http protocol’s ability to deliver big blocks to the nodes in the network. To be honest it isn’t really a test of the http protocol either, since the blocks being made were no bigger than, on average, 3 mb. You can see exactly how big these blocks were if you scroll back to September 1st.

The short duration of the test along with the inconsistency of the block sizes do not make for a good test. In fact, there is a coin out there today that ran into this kind of load testing not because they were testing their coin but because the network was actually creating large blocks. It was Ethereum. The CryptoKitties dapp was helping to create large blocks consistently over a longer period of time causing pileups in nodes that had slower internet connections.

The inability to download blocks over a long period of time is a problem. A one-day load test will not be enough to see what the real ramifications will be of having bigger blocks. The result down the road will be more centralization of nodes which will contribute to lower security of the network overall. The Bitcoin Cash stress test was nothing more than a PR stunt.