Tuesday, December 22, 2020

China Does Not Control Bitcoin


The County Election, George Caleb Bingham 1856

Let’s say there is a person who has never experienced or learned how a democratic process works. He could be a North Korean subject, or perhaps a time traveling Feudal era peasant. If we explain to this person what the American government looked like in 2017 -2019, when the Republican party took control of the executive and legislative branch (or 2008–2010 when Democrats took control), he may wrongly conclude that a single party controls the country, and that the American government is autocratic. This conclusion is of course wrong. In a functioning democratic process, a single party can take majority control but the people will vote them out if they don’t like how that party is governing.

This hypothetical person is making an observation regarding the configuration of a democratic government in a single slice of time, and makes the wrong conclusion because he does not understand the political process that created this configuration. A person who only understands tyranny will have a hard time comprehending a political process that is able to remove people in power through fair elections where each citizen has a singular vote.

Similarly, in the cryptocurrency community and in casual observers of Bitcoin, there are people who claim that Bitcoin is controlled by China because much of the current mining appears to be coming from China. While estimates are unreliable due to the anonymous nature of mining, industry insiders and studies places the percentage of mining from China to be at around 65%.

Referencing these estimates, Ripple CEO Brad Garlinghouse stated: “Bitcoin is really controlled by China. There are four miners in China that control over 50 percent of Bitcoin. How do we know that China won’t intervene?”. Garlinghouse is much like the confused North Korean subject who does not understand Democracy. As the CEO of Ripple, he only understands cryptocurrencies which are ruled through singular entities. Therefore, he has a hard time understanding that there is a systematic process in Bitcoin that allows for miners to be removed from power if they are deemed to be unworthy. Since he does not understand this process, he can merely describe the state of affairs in a single slice of time.

This willful ignorance is of course part of Ripple’s strategic effort to appeal to US based regulators. In response to the recent SEC lawsuit against them, Ripple responded by saying that this lawsuit will cede innovations in cryptocurrencies to China since “Bitcoin and Ethereum blockchains are highly susceptible to Chinese control because both are subject to simple majority rule, whereas the XRPL prevents comparable centralization.” The obvious subtext here is that Ripple is winking to the regulators saying: “Hey don’t sue us because we control XRP and if you take it easy on us, we’ll let you control it and not China”.

Although many like Garlinghouse are confused by it, Bitcoin’s systematic process of mining has been made clear from the beginning. Satoshi stated in his white paper that Bitcoin is a consensus mechanism of “one-CPU-one-vote”. Although we now have special machines custom built to perform mining (ASIC’s), the spirit of the statement remains the same. If you are willing to expend resources to mine, you are given votes proportional to the resource you’ve expended. One hash equals one vote.

Since Bitcoin does not know or care who is doing the mining, a singular entity is free to accumulate the majority of the hashrate of the Bitcoin network. But this is not a problem for Bitcoin, the same as how it is not a problem for Democracy if a political party gains majority control. At the inception of the Bitcoin network, Satoshi owned 100% of the hashrate for quite some time. There were also times in the past when a mining pool was verified to have more than 51% of the hashrate. The caveat to this is that if people do not vote out misbehaving or tyrannical entities, then Bitcoin cannot function. Democracy works in the same way through an informed and motivated electorate. Critics of Bitcoin are correct to say that China could in the future forcibly mobilize the miners in their country to 51% attack Bitcoin. But critics would be dead wrong if they believe that proponents of Bitcoin will do nothing in response.

While mining farms already operating outside of China will play a huge role to counter such attacks, individuals can make a difference simply by running ASIC’s from their homes. Right now, you can buy an Antminer S9 for about 30$ and run it with about a microwave’s worth of power consumption. With the current network hashrate of about 130 million TH/s, a single S9 (14 TH/s) buys you roughly 1 vote out of 10 million on the Bitcoin network (consider that a US citizenship buys you 1 vote out of 250 million). Such mining can be done by anyone in the world, and individual can expand their operation to as many ASIC’s as they are willing to spend money on. Furthermore, the availability of capable ASIC miners will increase in the future as newer generations of ASIC’s hit the physical limits of Moore’s law and their advantage against older ASIC’s become diminished.

If one does not have access to facilities or the power required to mine, they can fund friendly miners with Bitcoin. This can be done by either utilizing Bitcoin transaction fees, or by directly sending a transaction to the miner. By simply initiating transactions that would get accepted on the friendly chain (but not the chain of the 51% attacker), Bitcoin users can fund and incentivize friendly miners to counter the 51% attack.

I would also not underestimate the Bitcoin miners in China. Many of them will refuse to comply if China orders them to work against Bitcoin, as the destruction of Bitcoin also means that their livelihood is destroyed. The competitive nature of mining guarantees that miners are mostly people who believe in the long term value of Bitcoin. Profit seeking miners who intend to convert their gains into fiat will generally get pushed out by the believers who are willing to take short term fiat losses. Mustafa Yilham, VP at a large Chinese Bitcoin mining firm, states that “from our experience in China, most large scale miners are very firm believers in Bitcoin”.

In summary, China does not control Bitcoin. They are merely voting participants in the global Bitcoin network, the same as everybody else. The beauty of the Bitcoin network is that it does not discriminate against anyone from participating in the formation of consensus. If you take this aspect away, you end up with XRP, or whatever abomination of a currency that Facebook is creating. Does China have a chance to maliciously control Bitcoin? Yes they certainly do. I think it would be irresponsible to say that China didn’t have a chance. Such predictions can create complacency, much like how incorrect polling numbers can create complacency in the electorate. But I’m certainly not betting on that to happen. And like many others, I will be vigilant and ready to make sure that never happens because that is how Bitcoin truly works.

Monday, December 21, 2020

The Biggest Short : On the Impending Bitcoin Bull Market

As I write this, Bitcoin just ripped through 19,000 $ and hit all time highs. As a holder of Bitcoin, part of me is euphoric, the other part of me is a bit melancholy. If this bull market is going to play out, this would be my third bull/bear cycle in Bitcoin, and this feeling of melancholy is a bit new for me.

Every Bitcoin bull market has a story. During my first in 2013, I was just in amazement that this Bitcoin thing existed at all. I really didn’t know much about it other than that it was this magic internet money. The 2013 cycle was a story about the rise and fall of the Mt. Gox Bitcoin exchange, which I nearly lost money on while trying to arbitrage it. At my second bull market in 2017, the story was the rise of blockchain and distributed software. I felt validated that I was right about the potential of Bitcoin. I was also stupefied by the number of altcoins and Initial coin offerings (ICO’s) that Bitcoin managed to catapult into the stratosphere, some of them which I’ve helped develop.

This incoming bull market feels different, because the story isn’t about Bitcoin, blockchain, or cryptocurrencies at all. The story is not about some niche things that only a bunch of nerds care about, where I could join in and make some money. The story is one that affects everyone in the world, and we are living it as we speak. As Bitcoin rockets upwards, COVID is raging around the world, governments have failed to contain it and destroyed their economies, central banks have unleashed the printing press, institutions are failing, and people are suffering.

There’s a scene in the movie Big Short where the two young traders from Brownfield fund are dancing and celebrating the deal of their lifetime. They just managed to short the CDO’s which will shortly blow up in the bank’s faces in the 2008 financial crisis. The veteran trader who helps them out, played by Brad Pitt, angrily tells them to stop dancing. He tells them this:

“Do you have any idea what you just did? You just bet against the American Economy. Which means, if we’re right, people lose homes, people lose jobs. people lose retirement savings, people lose pensions.”

Like the young traders in the movie, I didn’t really understand or comprehend the gravitas of what I was buying in my first two bull cycles. It was just magic internet money. But now I do, and the story of this bull market makes it clear. If you are buying Bitcoin, you are going short. Most shorts are of no consequence. If you are right, maybe a company goes bankrupt or the price of an financial instrument drops by a few percentage points. But if you are making a “Big Short”, you are betting against a foundational economic reality. If you are right, the pain will be so real and prevalent that it will affect you even though you are theoretically on the other side of the trade.

Buying Bitcoin is a short against the foundation of the world’s economic system. It is simply impossible to be 100% on the other side of this trade because you exist in it. It’d be like trying to short the Titanic while you are on the Titanic. As Bitcoin rises, so will global inequality and social unrest. Currencies will fail and financial systems will crumble. People will lose homes, jobs, savings, pensions, and their lives. At the same time, governments will tighten their financial controls, increase censorship, and violently try to prop up their failing regimes.

Up until about 2017, I used to believe that Bitcoin was mostly only useful in failed countries with hyperinflation like Venezuela, and that people like myself who live in first world countries didn’t really need it. I thought of Bitcoin as a short against these regimes, and these regimes only. However, as I learned more about economics and how central banks worked, I realized that this wasn’t the case. In 2020 much of what I learned in theory is being played out in reality.

There are really two stories to this bull market. The first story is one of historic unemployment borne by the lower class. You can see this clearly in the chart below where the unemployment rate for low wage workers have exploded, while high wage workers are nearly back to previous levels.

This story is also that of people waiting in long lines at the food bank, and of people looting. Of small businesses getting crushed. It’s also a story of people looking for answers to their economic woes in the wrong places. The left seeks out Marxism, and the right seeks out Fascism like it’s the 1920's.

The second story is that of ballooning asset prices, despite the cratering of economic activity caused by a global pandemic. The Federal Reserve has increased its balance sheet by more than 3 trillion dollars by going on a massive buying spree for bonds, corporate debt, and mortgage backed securities. Stock prices is at all time highs relative to GDP and the Dow just hit 30k for the first time ever. The real estate market is booming. Absurd business operations have received millions in federal loans. The beneficiary of all this is of course the upper class, who owns most of such assets. The people that should have the largest safety nets in an economic crisis, are getting the most “aid”, if you can even call it that.

The mainstream media and politicians have described the current situation in the US as a K- Shaped recovery. Austrian economists describe this as the Cantillon effect, a process where those closest to the money spigot gain the most benefit from all the money being printed. Both of these descriptions are very polite ways to describe the systematic pillaging and redistribution of wealth to the upper class. As one Twitter user describes it, “K-shaped recovery” is a phrase assholes use with a straight face instead of “I got mine, suckers.”

The most insidious part of this story is that the average person getting screwed has no idea what is happening to them. They can instinctively feel that they are getting a bad deal, but they don’t know who or what is screwing them over. The right will blame immigrants, china, and liberals. The left will blame racists, rich people, and conservatives. Watching this play out is like playing the popular multiplayer game “Among Us” where you try to identify the imposter (or “sus”) among your space ship crew. You know exactly who the imposter is because you watched him kill your crewmates, but the other surviving crewmates don’t believe you.

Image for post
Fed is very sus

Being right is not enough. Bitcoin can go to a billion dollars and you can still lose. And in this bull market, the stakes have been raised. It’s no longer about insignificant bullshit like Mt. Gox, blockchain technology, or ICO’s that has no relevance to the rest of the world. This bull market is about the ungodly amount of money that has been stolen and injected into the world economy that is trickling its way into Bitcoin. People are finding it impossible to go long on a market that has been rigged by the central banks and the ruling class. Even big name macro investors in traditional finance like Stanley Druckenmiller and Paul Tudor Jones agree with this sentiment on a logical level. For many who have held onto their Bitcoin for a long time, they agree on a moral level.

If you are a Bitcoin holders now, congratulate yourself for being here. But before getting too giddy, we have to remember the story of this bull market. Bitcoin is no longer some niche thing in its own little world. The world of Bitcoin is colliding and merging with the real world as we speak. In this Bitcoin bull market, and in many more cycles to come, the story will be about failed economic systems all over the world meeting its inevitable demise. The pain is coming regardless of whether you hold Bitcoin or not. I’m going to be humble and ready, but I’m not in the mood for much dancing.