This stuff is old. I was quite young and dumb when I wrote this.
In search of the perfect cryptocurrency design
Cryptocurrencies might not be such a hot topic any more, but this has
been in my head for a while and I have finally collected the patience to
write it down.
With the rise of the Bitcoin network, decentralized cryptocurrencies
became more widely known. A great excitement about not having to rely on
central authorities providing the money and controlling the flow of it
was among small but growing groups of hackers and tinkerers,
libertarians and activists. No one would have to put up with the evil
banks any more. At first, the great mass of the people remained skeptic,
with many calling this Bitcoin thing a pyramid-, a pump-and-dump scheme.
The public who looked at bitcoin rather as an investment opportunity or
storage of value was merely convinced by asseverations of network safety
or anonymity.
It did not help either that Bitcoin sparked multitudes of alternative
cryptocurrencies, “altcoins”, most of them just slightly modified forks.
What twitter bootstrap seemed to be for websites, the Bitcoin protocol
was for altcoins. In fact, many bitcoin-related sites, such as the
troubled bitcoin-central.net, seem to have been hastily build using
exactly that software.
Freedom of choice on a diverse market of cryptocurrencies can be a great
thing, but most altcoins could now really be called pyramid schemes.
Looking at the sheer numbers of those different altcoin protocols,
one might not be compelled to believe that every one of them was
developed for the good of humanity.
Consensus was that the first investors would receive too much reward
simply for believing in the currency, and the early miners would earn a
fortune simply by turning their small contribution to network stability
in the beginning into vast amounts of money in the times when the
currency’s value would show exponential growth. Bitcoin had been
designed to make the early adopters rich, while making the late birds
buying into it pay for their hesitation. It was almost like investing
into a small silicon valley startup in 1998; with substantial increases
of shareholder value.
Yet despite its critical (to me) problems and many voicing their
skepticism broadly, Bitcoin seems to miraculously have come into wide
circulation, and even in times of worldwide trouble, its value has
stayed relatively stable. It has demonstrated that a cryptocurrency can
be bootstrapped and grow far beyond the point of gaining critical mass.
To my knowledge, none of the more popular forks did solve a problem that
most people did not seem to care for much: The problem of unfair
distribution. It was not even fixed in freicoin, whose developers
claimed they developed it with good intentions. Even the ppcoin
protocol, which is very advanced in design and code, does not adequately
address the distribution problem.
So, how can cryptocurrencies be fixed? Do they even need to be?
Here are my thoughts on this.
Some aspects to keep in mind when designing a cryptocurrency:
- distribution of the currency and the clients
- security & integrity of the network
- anonymity and decentralization
- compliance with the law
- accessibility/usability
- public image and representation
- resource preservation
Problems and worries:
Bitcoin
- A “kill switch”, as described by Loper OS
- In the near future, mining - the rewards consisting of ever
decreasing bitcoin quantities and the costs rising rapidly - will
not be profitable any more.
This means that malicious entities would have far less competition
in the mining process. Single home users with affordable equipment
will become increasingly insignificant, while ASIC producers would
get pressured into exclusive contracts with big organizations, maybe
even governments.
While some possible 51% situations in the past seem to have been
harmless, mining in the future would not be a matter of profits, but
rather a matter of control,
so the focus would greatly shift towards unprofitable investments
that nonprofits are too poor for and only entities with malicious
intent could afford to make, destabilizing and possibly shutting
down the entire system.
- Confirmations taking too long
- Dedicated hardware, high power consumption, miners generate data
clutter that is not usable outside the network, e.g. for scientific
purposes
- Till early April 2013, Bitcoin had been in a constantly high
deflation. This discourages investments and encourages hoarding
of coins. Since a short steep inflation around May 2013 ended, the
deflation has continued and not stopped as of writing this article.
freicoin
- Unpopular with many people because of the built-in demurrage
- Not truly decentralized since about 80% of the mined coins go to a
foundation
ppcoin
- 1% inflation per year is not enough to compensate for the advantage
the early miners gained
- Sunny King as a Benevolent Dictator for Life of the project, and he
seems to have shifted his focus unto primecoin
Cryptocurrencies in general
- Legal issues:
- Money laundering
- Tax evasion
- Smuggling and black markets
- (Secret) messages stored in the blockchain, for example the
recent chipo discussion or the wikileaks cables
- The system being gamed(no mistakes software-side):
- Manipulation of exchange prices
- Investors utilizing ddos attacks for quick profits in a matter
of days
- Manipulation of trade volume and price by traders trading with
themselves
- Early adopters trying to create the impression that the currency
is in circulation while in fact they just move it across their
accounts
- Not knowing how much of the currency is abandoned (sleeper
problem)
- The blockchain being spammed with micro-transactions
- Bugs in the code not being publicly disclosed and used for personal
gain / untrustworthy developers
- The amount of peers does not equal the amount of actual users.
therefore, it is difficult to enforce democratic processes, since
one could just fire up some hundred VMs to gain voting power. I am
interested in how future conflicts about transaction fees will
evolve.
- The blockchain getting too big, making it nearly impossible to use
heavy clients for users that are not well endowed
- A fundamental mistake in planning is almost impossible to fix in a
running system. Even as a developer, you do not have the power to
get rid of the ghosts you called.
- Transaction fees getting too high
- Possibly significant fluctuations in value, since it is not
controlled by a central authority
- Misunderstandings and false expectations
- The system being too complex to use, let alone fully understand to
most users
Ideas on how to solve some of the aforementioned problems:
Decentralized
Merging of coins
As the coins are split into smaller fragments, the blockchain gets
bigger. To address this issue, clients merge all fragments of a wallet
together, creating a coin that is worth the sum of the small ones
altogether. The old fragments of coins are “molten” and made worthless;
the new coin(with the value of the sum of fragments) is treated like a
newly minted one; the changes are distributed into the network as a
patch. The network still knows where the coin came from, since the
fragments that are put into the coin are part of the blockchain, but it
does not transmit a new transaction as a sum of tiny blobs in masses of
a few satoshis, but rather as one big blob. In order for this to
succeed, the client has to invalidate the old fragments, while at the
same time proving to the network that his new minted coin is valid. I am
not sure how to integrate such a behavior into the network’s hash chain
mechanism.
The predefined way
In this model, the distribution of coins is controlled both in time and
in volume. At first, only very small amounts are paid to the miners,
thus keeping the total circulation of the cryptocurrency in an
assessable amount. This way, the currency can prosper sustainable growth
and spread of the currency. Parallel to the advancement of time, the
rewards paid to miners rise (linear growth). This way, the early
adopters can help spread the currency but the profit is limited. The
rewards would rise for about half a year, then stagnate, and after a
year, halve every x discovery blocks.
The ever increasing inflation way
Mining stays rewarding. The rewards of the miners are not ever changed,
guaranteeing a steady influx of new coins, while simultaneously creating
inflation.
Artificial scarcity
Coins lose their value over time, becoming worthless compared to freshly
mined coins. This idea is already implemented in freicoin, but not
satisfactory(to me) since the demurrage fee is too low in the early
phase, not compensating for high demand and little supply. A fixed
demurrage rate or a fixed inflation like in ppcoin is not optimal, the
inflation should follow a predefined curve: first a high inflation rate;
after about a year it is lowered.
Involving centralization
The donation way
This is a specifically weak idea, but it may be worth thinking about. In
order to obtain money/coins/credits/… in the cryptocurrency’s
“system”, one must donate “real” money outside the system to a
charitable organization or one that defends hacker ethics, as chosen by
the network. The transactions’ values are then converted into a stable
currency (maybe the Yen or something similar) and the user receives the
converted amount in in-system-currency. The exchange rates would have to
be set static. This idea defies the whole purpose of decentralized
currencies, but could eventually be implemented in a decentralized way,
relying on votes of relayers to verify organizations and absolute
transparency of transactions.
The ripple way
Opencoin, the company behind the ripple system, has taken another
approach at cryptocurrencies. Its IOU system goes back to the roots of
money, when it was publicly recognized as a proof of being owed goods,
whereas now money has become more abstract, being used as value storage.
The ripple system relies on users repaying their debt in the real world
via a predefined currency. The only way for users to convert their
issues of debt into real goods, as it seems to me, is to use a gateway.
The dynamic way
By binding the cryptocurrency to real world value (or the median of a
variety of currencies on earth), the currency would be very stable, and
investors would have little incentive to gamble on the system, while
people who do not trust the banking systems would have an opportunity to
deposit their savings into a stable environment. This system would be
extremely vulnerable to manipulation of the data input on values of
currency. It would need trusted sources of data, and trusted platforms
are not such a good idea.
Freezing before launch
To prevent early adopters and developers from gaining profits in the
non-competitive environment that is the early phase of the launch of the
cryptocurrency, the source code is released a significant time before
the network launches and the genesis block is mined.
Earlier I mentioned that the current cryptocurrencies may not need
fixing. Bitcoin has succeed as a payments system; enough people accept
it as a valid currency to trade with others. While this is a great
accomplishment, there should be viable alternatives, preferably without
kill switches. So far, a fair distribution model that fulfills the needs
of both active (miners & exchanges) and passive (client users who view
the system as a payments system) network participants seems out of reach
to me.
At least designing a nearly perfect cryptocurrency is something we
should strive for.
Sadly, my knowledge on this topic is fairly limited and I have not yet
fully read and understood most design papers; the ideas proposed and
addressed by me all have major flaws. It might be more interesting to
spend some time on reading and understanding the articles linked in the
“recommended reading” section.
Design papers
Recommended reading
How the Bitcoin protocol actually
works -
an excellent explanation
Bitcoin, or How to Hammer in Nails with a
Microscope
Shitcoin: a Modest Proposal
Proof of Stake
Proof of Work
Tragedy of the
commons
Bitcoin Fees
Hawala
Bitcoin is a 21st century
Hawala
Bitcoin Is Fundamentally
Flawed
BitCon: Don’t
License: CC-BY-SA (just link back to this page)
