It’s 1993 again: (minus the walkman)

The TCP/IP protocol was formalized in 1983 and became the backbone of the internet. During the 1980’s, the applications were limited to simple transfers of information packets across government and educational institutions. Although the technology had promise, widespread adoption remained elusive.

It wasn’t until the invention of the Mosaic browser in 1993 that we started seeing wide adoption of the internet. Mosaic allowed a user friendly way for individuals to interact with the “World Wide Web”.

Mosaic was the critical tipping point that enabled mass scale adoption and use of TCP/IP enabled information transfers. Whether it was news (economist, wired), marketplace (pizza hut in Santa Cruz), information discovery (search engine) the Mosaic interface enabled it.

Similarly with the Bitcoin protocol, the application right now is limited to simple transfers of value i.e. individual X sends individual Y Bitcoin in exchange for a good and/or service.

In 1983, If everyone had believed the only significant use for the internet was to send simple messages across heavily endowed institutions, we’d be living in a very different world and I wouldn’t have had a chance to write this blog post.

The interesting use cases of value transfer which Bitcoin can service include smart contracts, supply chains and even healthcare. This does not include some of the other novel use cases around micro payments and future side chains that enable IoT coordination by allowing machines to write on an always accessible and globally readable database.

So, how do we get there? The true value of the Internet and Bitcoin is driven by powerful network effects, so it’s important to consider the unique growth challenges. Below, I attempt to identify those key factors in hopes of starting a discussion on Bitcoin technology adoption.

VC Funding:

From a funding perspective, total VC funding in Bitcoin related technologies for 2014 was ~$350M. We’re only halfway through 2015 and we have already seen $350M of venture funding pouring into Bitcoin startups. To put that into perspective, IoT saw ~$340M in venture funding in 2014.

Government Regulation:

Given that the primary use case (at least for now) deals with traditional value transfers and the Silk Road debacle is still a relatively recent occurrence, it’s important to consider the regulatory framework of Bitcoin.

We are seeing a wave of acceptance from institutions world wide. There are numerous examples I could mention, that could warrant an entire new blog post, but I’ll limit to a few key ones. The Chancellor of the Exchequer of the UK has indicated the country’s desire to become a hub for Bitcoin. NYFDC just released a framework for the regulation for Bitcoin. In one of the most implicit validations of Bitcoin, the US Government will be auctioning off ~$18M worth of Bitcoins that were seized from Silk Road. The US Government would never have sold $18M worth of cocaine that resulted from a criminal investigation.

Developer Adoption:

Needless to say, without builders building things nothing will materialize. There is a lot of significant interest in the developer community:

1-t9moBxhOMHudeRkwLPzeTgSource: https://medium.com/@kpcb_edge/our-focus-areas-block-chain-technology-f4681d843e9c

Despite the drops in the price of Bitcoin, the number of Bitcoin GitHub repositories continues to grow indicating significant interest in the developer community.

For the TCP/IP protocol, it was the release of the “HTML” language that allowed developers to create websites on a large scale. Bitcoin is already written in languages which developers are familiar with, but will new languages/frameworks emerge that will allow for more efficient development of software for applications that use decentralized value transfers? The HTML of Bitcoin?

User Adoption:

At the moment it seems like it’s only dramatic events that brings Bitcoin into the main stream. Whether it’s the Silk Road debacle or the recent Greek crisis, financial crisis seem to give Bitcoin good publicity.

As more applications are built on the Bitcoin and the narrative focuses on the story rather than the technology itself we could see Bitcoin entering daily lives of individuals.

For the internet, the story wasn’t “the TCP/IP protocol allows information to be accessed within seconds of delivery”, but rather “You can now access your daily news instantly”, that showed the true power of the internet.

As smart entrepreneurs figure out applications for Bitcoin and block chain related technologies the amount of users buying into the technology will scale. The number of internet users didn’t scale to 2.94 billion over night. It was years of infrastructure development and emergence of applications that slowly got almost half of the world’s population online.

There are a lot of positive head winds for Bitcoin and block chain related technologies. The sector is still relevantly young, is achieving widespread institutional acceptance and is filled with entrepreneurs building amazing products that could change our lives in ways we can’t even imagine yet.

So It almost does feel like it’s 1993 again, when all the infrastructure and regulatory environment was in place for the internet to thrive. Perhaps no one technology could ever have an impact on the scale of the Internet, but if there is one, Bitcoin could be a good contender.

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Is my money safe: There’s a FDIC for that.

One of the interesting discussions I’ve had regarding one of my early blog posts has been around bitcoin lending.

The invention of credit has had great implications for economic prosperity and progress. Arguably, the discovery of gold and similar minerals can be credited to have unleashed significant economic progress. It isn’t the intrinsic value of gold that created this value, but rather gold allowed a mechanism to measure credit.

The benefits of credit are widely apparent. A trader on the Silk Road could take a loan from a wealthy individual and use that to buy goods that he would later sell at a profit in a different country, paying back the creditor on his return.

Bitcoin, by design, is a deflationary currency i.e. it’s value increases by time since the amount of Bitcoin released into the network decreases by time and only 21 million bitcoins will be released.

This is in stark contrast to the money supplies issued by governments. There is no upper limit to the amount of dollars the US Fed can print. There used to be a time when all currency issued had to be backed by a certain amount of gold which did impose an upper limit. The gold system was discontinued to allow for expansion of credit to finance World War 2.

So the key question remains: Does Bitcoin lending occur, and if it does, what is the incentive to lend Bitcoin?

The main argument against the extension of credit via Bitcoin is that, by definition, the motive to lend money is to make a return (through interest). However, in the case of Bitcoin, you make a return by simply holding on to it (value increases steadily due to a deflationary network).

The counter argument becomes pretty simple. At the end of the day, if the return you realize through lending is greater than the return you realize through saving, as a rational investor, you would be inclined to lend Bitcoins. However, the ability to gauge the return you would get simply by holding the asset is wherein lies Bitcoin’s weakness.

The high volatility of Bitcoin makes it especially difficult for an investor to reliably “predict” the return they could expect by holding on to the asset.

Additionally, if you were to setup a Bitcoin lending network like a traditional bank, at any point in time you would have lent more Bitcoin then you have collected from depositors. This is the basic economics of how banks work. For each dollar that some one deposits at the bank, you lend out a multiple of that.

The reason that works is at any point in time, only a small percentage of depositors will ask to withdraw their money.

However, there is risk to that. If the amount of depositors looking to liquidate their assets does exceed the current assets the bank does own, the bank will be unable to fulfill its obligations and will “go under”. A typical “run on the bank”, and the reason why most banks fail.

This is a very important to issue to consider, and brings me to the original title of the post. The US Government ensures every bank deposit in the United States up to $250,000. That is to say, if you had deposits in a bank that went under, the US Government will reimburse you up to $250,000.

The US Dollar, backed by the full faith and credit of the United States Government has a clear advantage when it comes to extending credit.

So does Bitcoin lending occur? Yes – a lot of Bitcoin lending appears to be emanating from peer to peer lending networks where an investor could lend Bitcoin to individuals in economies where interest rates are exorbitantly high due to certain economic and political factors, but it remains to be seen whether it turns out to be a significant source of credit.

Below is an assurance from the US Government at my local Wells Fargo, assuring me my money is safe :).

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Byzantine Generals’ Problem: So what’s bitcoin?

I’ve had a great response to my first few posts and one of the questions/feedback I received most has been “Can you talk about what exactly bitcoin is?” So let’s take a step back and explore some of the philosophical and mathematical under pinnings that led to the bitcoin network.

The bitcoin network is widely credited to have solved the Byzantine Generals’ Problem, at least in practice, with certain assumptions.

That was a loaded phrase, so let’ explore in detail.

The Byzantine General’s Problem was first defined in 1982 by a group researchers out of SRI International. The research was in part funded by NASA and is a reflection of the impact the government has had in starting the internet revolution.

The scenario is defined as a group of Byzantine Generals with their troops camped around an enemy city. Communicating only by messenger, they must agree upon a battle plan. However, one or more of them might be traitors and might try to confuse others.

The Byzantine Generals’ Problem succinctly summarizes the issue with decentralized networks and why a centralized body (commercial banks/central banks/governments) has played a critical guarantor role in facilitating electronic transactions.

In our Byzantine Generals’ problem, the only way to ensure the messages are relayed accurately is for a centralized messenger dispatch system that ensures accurate messages are dispatched to all the generals.

To analogize this to an electronic financial system – the generals are merchants and individuals looking to make transactions, relaying messages is the finite money supply and the amount of money people possess (and thus can use for transactions) and the traitors are fraudsters that would take advantage by disseminating incorrect information. The incorrect information would be a fraudster looking to spend the same amount of money in multiple places (double spending).

Let’s say we develop an electronic financial system where a certain set of characters is generated for each unit of currency. Without a centralized authority certifying whether the unit of currency has been spent or not, a fraudster could send the same unit of currency to multiple individuals and hence spending the same “unit currency” in multiple places.

This is an important issue to consider since the existence of a centralized authority (banks) is what ultimately causes transaction costs to balloon (middle man taking cuts) and is why (to this day) international money transfers can take up to 5 days.

The bitcoin network solves this problem by storing each transaction on a public ledger known as the “block chain”. Every transaction that is made on the bitcoin network is recorded on to the block chain. If all the transactions are recorded on a block chain, what prevents somebody from tampering with it or spending the same bitcoin multiple times? The answer is in the decentralized manner in which bitcoin authenticates transactions.

Each time a block chain is created, a distributed network of nodes goes through a mathematical process to verify each of the transactions on the block chain. Each transaction on the block chain is related to the previous transaction. Whenever a node solves the mathematical problem to verify the transactions, it is rewarded with a certain amount of bitcoins. This reward is issued to encourage individuals to solve the mathematical problems to verify the transactions.

The nodes are setup by individuals looking to “mine” bitcoins by solving the mathematical problems. As long as the number of honest nodes is greater than fraudelent nodes, the authenticity of the system is maintained.

In essence, Bitcoin is an electronic currency that allows it to be used as a store of value without need of a centralized authority. The implications of this are significant especially as it relates to transaction costs and speed of transaction. It’s these technological properties that give it fascinating implications for use as a money supply and many other applications outside of currency yet to be explored.

For the more technically minded, here’s a link to the original research paper on the Byzantine Generals’ Problem. And here’s a White Paper from the founder of Bitcoin, Satoshi Nakamoto, whose identity is still unknown.

P.S.  I didn’t have any charts for this blog post but I thought it was interesting to find out I live 13 minutes from SRI International, where the research paper for the Byzantines Generals’ Problem was written.

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In Data we trust: not just a clever tag line

The term “In God We Trust” was first printed on paper currency in 1956 and first appeared on US coins in 1864. Although the phrase is widely accepted to be the official motto of the United States, a variation of the phrase (In Data we trust) can quite aptly describe the implications of the bitcoin network.

Before I delve deeper, let’s have a quick 101 on money supply. The total money supply in the economy has direct implications on inflationary and deflationary pressures in the economy. This is why the US Treasury can’t simply “print more money” to pay off its debts – a drastic increase in money supply would cause hyperinflation and has ruined a number of economies in history.

Interestingly, it’s not just irresponsible policy that can lead to hyperinflation. By the end of 1780, Continental Currency (the precursor to the US Dollar) lost a majority of its face value due to rampant counterfeiting by the British who used it as a tactic to weaken the revolutionaries of the “Thirteen Colonies”. This lead to the Coinage Act of 1792 which mandated a certain amount of gold and sliver in coins to prevent counterfeiting.

The total money supply in an economy is often referred to as M1. M1 refers to both money created by the central bank (the monetary base) and money created by commercial banks. The money created by commercial banks (fractional reserve banking) is the money created through lending and is a function of the monetary base and liquidity reserve requirements.

For example, the government might print $10,000 and circulates it to banks. Total M1 is now $10,000. At the same time, the government has a 1% mandatory liquidity reserve ratio for all banks. Which basically means for every $100 that a bank lends out, it only has to have $1 in reserves. So for each dollar created by the government, the banks can lend out $100. This is referred to as the Money Multiplier. So in our example, each $1 in the $10,000 can be lent out 100 times making the total M1 ($10,000 * $100) = $1,000,000.

Now, back to data. By design, the total amount of bitcoin created is strictly regulated and predictable through it’s algorithm. Below shows a chart of growth in bitcoin’s monetary base.

bitcoin-monetary-base

Source: http://www.dgcmagazine.com/bitcoin-money-supply-and-money-creation/

The monetary base of bitcoin is the money created through “mining” (mining is the process through which money is created in the bitcoin system – a process worthy of a seperate blog post).

In our original M1 equation, we had two relative unknowns i.e. we didn’t know how much money the central bank will create and we didn’t know how much money banks will lend out.

Bitcoin at least solves the first part of the equation – we know exactly how much bitcoin is going to be created in the next 100 years.

Why is this important? Risk & uncertainty are kryptonite for commerce. In growing and developing economies the risk of the central bank exercising irresponsible monetary policy and printing money is high which significantly increases a merchant’s risk of conducting business in the local market.

If a global merchant conducts business in a developing economy through bitcoin, the exchange rate and currency risk are completely mitigated. Additionally, most traditional banks charge higher fees for foreign transactions to act as an “insurance policy” against the risks outlined above. Bitcoin doesn’t need to charge these exorbitant transaction fees.

There are also implications for developed economies. The Fed holds 8 regularly scheduled meetings each year where each word is analyzed by the Bloombergs and CNBCs of the world looking for hints for changes in monetary policy. The decisions which the Fed makes has far reaching implications on borrowing rates, financial models and inflation. If some of the decisions the Fed makes were known in advance, some uncertainty would be moved out of the system. As an example, the monetary base is one of the factors which are affected by the Fed.

So, what does this mean? Is the Fed going to go away? No. Even if the whole world transitioned to bitcoin we would still need a regulatory authority to manage issues such as fractional reserve banking (second part of the M1 equation mentioned above). Bitcoin does not have a way to regulate irresponsible lending. But perhaps, that might be the next breakthrough in the bitcoin network?

So, in Data we trust to provide a steady predictable monetary base to conduct commerce creating marketplaces and use cases previously thought impossible with centralized constructs of monetary policy. Data has replaced trust in certain instances. Previously we “trusted” the US Government to exercise responsible monetary policy. Now, it’s Data that ensures responsible monetary policy.

P.S. If you’re curious, below is a chart showing the growth in M1 in the US from the Board of Governors of the Federal Reserve System.

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Marketplaces: Are they just a big bang?

Physics and Economics were my favorite subjects in high school. What fascinated me was that both disciplines study complex systems put in place by nature and/or man.

Both have a strong empirical component (Macro economics/Quantum Physics) and a strong deterministic component (Micro economics/Classical Physics).

No wonder most Physics PhDs end up as traders on Wall Street. Or more recently, Data Scientists at Facebook.

Being a poster child capitalist, I wanted to explore using concepts defined in physics to better understand marketplace phenomena.

During the inception of marketplaces, there are a lot of unknowns. How many buyers are going to show up? How many sellers are going to show up? What goods will be sold? What’s going to be the starting bid?

The answers to these questions during the early stages will ultimately decide the characteristics and long term fate of the marketplace.

That’s exactly what happened during the big bang. The basic chemical DNA of the cosmos that was created during the first few moments decided the elements necessary for life to exist and governed the behaviors of species for the consequent eons (and still does).

Ok, so what? Being an early participant during the inception of a marketplace can you give significant power towards influencing the ultimate natural state of the marketplace.

For example, the bitcoin marketplace was officially “created” when the first transaction was completed in February 2010. Although the behavior of the bitcoin marketplace is largely determined by an algorithm, at the initial asking price of $0.01 per BTC you could buy a huge chunk of bitcoin and ultimately own a large piece of the marketplace.

Yes, hind sight is always 20/20 – but if you understood at the time a new marketplace was forming, you could’ve capitalized on the opportunity.

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Do you even Data, bro

After thinking about it for a while now, I’ve finally decided to start a blog. I’ll post my thesis on marketplaces, hypotheses on human behavior and general thoughts on the future.

In an era of “Data Science”, it’s easy to lose sight of simple answers to powerful questions.

To start, let’s look at a simple chart from Google’s Ngram viewer. The below chart shows the percentage occurrence of the word data in Google’s corpus of books since 1800 with a smoothing of 3 years. Trends are more apparent if you deploy a moving average – this allows to “smooth” anomalies such as seasonal variations. So in this case each data point is actually an average of the last three years.

The Y-axis shows of all the unigrams in Google Books sample, the unigram (data in this case) was used Y % of the time.

Now, why is this chart important? The use of data in the common lexicon skyrocketed in the 1900s. We also started seeing unprecedented productivity gains starting in the 1900s. The use of data allows us to make intelligent calculated decisions to set us up for success.

Of course, we must not forget : correlation doesn’t imply causation.

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