This post addresses none of the valid criticisms in comments on your recent posts, especially challenges to the accuracy of your assessment of counterparty risk. These were all different ways of saying, “Your posts do not contain enough information to allow me to determine the likelihood that you are a genius versus a crank.”
You can’t just keep invoking Scott Alexander’s Bitcoin regrets. Those opportunities are gone.
This post, in which you instead conclude that “haters gonna hate,” does not advance your cause. I am just irritated that you keep posting without seeming to absorb the community’s epistemic values.
Which epistemic values? I am posting these trades in public (not always on lesswrong itself but in adjacent spaces which are easy enough to check if needed). If they blow up I will suffer the reputational consequences. The inverse should occur if they work out well. Do you want to bet on whether FTX.com losses a substantial amount of user funds in the next year? What odds do you give?
The opportunities don’t seem gone to me. Though I doubt we see anything as good as 2011 bitcoin. Many rationalists bought Solana around January 7th when it unlocks. I posted about this on the EA investing group in early January (before the unlock). It is up more than 10x. That’s not 250x but it’s something. The arbitrage opportunities I discuss are live right now.
You claim there are these huge counterparty risks but you have no presented any data substantiating your claims. I would estimate the expected loss rate in decentralized finance is probably between 1.6%-2.75% yearly. This is based on actual empirical data. The loss on a centralized is dramatically lower. Probably a tenth of that. Exchanges do not commonly lose user funds. They have been safe for many years. You should be more concerned with getting hacked than with counterparty risk from a Cefi exchange. As I said before the risks would have to be quite large not just present to compensate for the returns. I see no evidence that they are.
I believe scholarship is one of the twelve virtues. Please teach me this value. Please show me some kind of credible analysis that counterparty risks are extremely high (as in 10%+ a year)? Many people I know will be very interested if you can. I will share your findings with many interested parties.
FTX is bankrupt,with at least an$8 billion hole on their balance sheet. Customer funds gone, many people lost 6 and even 7 figure balances.
So… what were those odds on “FTX.com losses a substantial amount of user funds” again?
The more info that comes out, the more it looks like the entire thing was fraudulent from the beginning. They even have a software back-door that allows them to transfer funds without alerting auditors, which it looks like they used many times with FTX customer deposits.
Additionally...
Celsius: bankrupt.
BlockFi: bankrupt.
Voyager: bankrupt.
3 arrows capital: bankrupt.
Terra Luna: worthless.
Genesis: likely bankrupt.
Digital currency group: ???
Obviously this is hindsight, but you should STRONGLY update, because it looks like the counter-party risks were well over 10%. In fact, many were even calling SBF and FTX fraudulent well before it came to light and blew up, but people didn’t really listen.
We all need to strongly update on this. I know I have.
I’d also encourage you to consider what happens if/when the SEC decides to finally label every “crypto” except Bitcoin a security, and force them to file S1 disclosures. This process will likely be greatly accelerated by the FTX debacle. I suspect MANY of these “projects” will completely fall out of favor, being out competed by better securities like Google and Apple. Their current price merely reflects their regulatory arbitrage, which will end.
Why do you expect Bitcoin to be excepted from being labelled a security along with the rest? (Apologies if the answer is obvious to those who know more about the subject than me, am just genuinely curious)
No, it’s not obvious; it’s a perfectly legitimate question. Here’s the Howie test, the criteria established by the Supreme Court for security classification:
An investment of money
In a common enterprise
A reasonable expectation of profit
Derived from the efforts of others
Bitcoin’s biggest difference from other Crypto securities are #2 and #4. Bitcoin is common, but it’s not exactly an “enterprise.” There’s no organization or group working on it in an attempt to increase it’s value, the way, for example, the Ethereum foundation attempts to increase the economic value of ETH. There are the core devs, but the authority they have to actually change the software is much, much lower, requiring massive agreement across the board from miners and nodes.
And for #4, while it is the miners efforts that create security for the network, it’s not as direct as the members of other crypto projects actively working, for profit, on the software. The profit comes from Bitcoin’s increasing network of users who decide to store their economic value in it, not because it’s becoming a more and more useful piece of software as people improve it (like, say, what happens in a traditional equity like google or microsoft).
The main thing… Who exactly would be required to register Bitcoin with the SEC? Who would file the S1 disclosure with Bitcoin? Who would the SEC sue if “Bitcoin” was an unregistered security? There was no IPO (well, ICO I guess). There’s no foundation. There are no stakeholders; since Bitcoin is PoW.
This is specifically about Bitcoin, and does not apply to other coins that don’t have a fixed supply, or those that use a different consensus mechanism.
For anyone who stumbles across this comment in the future, the argument is basically that there is no market mechanism to ensure transaction fees stay high enough to maintain block security. The argument hinges on the assumption that miners need to be rewarded at least 1% of daily transaction volumes for them to be willing to spend money on the ASICs needed to mine blocks.
You can collateralize Bitcoin, and that is really where Bitcoin’s future lies, its collateral to recapitalize the financial system. The dynamics of QE operate like an auto-immune disease, its making collateral harder to come by, debt instruments become MORE expensive, because the Fed is effectively bidding up the price. However, this creates a new paradigm where all assets are higher in value than where they should be, if we’re operating in a normal interest rate environment (by normal, one that doesn’t have massive Central Bank interference to effectively fix the market rates). This is why we have such a monopolized economy as well, it makes borrowing costs cheaper for those with the best ability to access credit. Thus, all assets become too expensive. This leads to extreme inequality because few people under 40 can afford to have normal things people want, and leads to this extractive economy we operate in. This also becomes impossible to reverse too because the Fed raising the interest rate leads to a market crash (as they found out in 2018, nearly collapsing the entire stock market).
You need a way to unwind this dynamic because like an auto-immune disease, you’re attacking healthy cells (small businesses, who can’t access credit, or get priced out of competing against would-be monopolists, as well as zombie corporations who just exist in perpetuity rolling over their debt, 20% of US corporations on the stock market are now zombified).
So, Bitcoin operates within the monetary reality of the world today, whereas so many other cryptos are trying to design something new, innovative or fantastical, none of them are obviously better for this absolute contorted situation we find ourselves in. It can become the new version of collateral, so that the Fed can release the pressure valve of perpetual QE, and allow them to unwind without mass bankruptcy of the US economy. However, this is another conundrum, because Bitcoin’s deflationary attributes also make for a more appealing settlement layer than what its actually competing against, which is the Fed. This is ultimately what many technologists misunderstand, Bitcoin is more like a first order layer of money, to clear transactions at the highest level. It’s more comparable to Fedwire or other various Federal Reserve settlement layers.
Yeah this is worrisome for me as well. It also appears that human beings are more objectively rational with their money under slight inflationary pressure, because that slight pressure offsets the irrational loss aversion we all have hard wired into our brains.
It seems like Bitcoin with a small, permanent, inflation rate would function much better as a long term, stable, secure, monetary system than this deflationary one we have. The inflation is paid out to the miners, as a fee for maintaining the network security, rather than to autocrat grifters like it is now. It’s a perfect economic give and take.
The current system is very awkward. I’m holding Bitcoin, but I’m not paying the miners to secure it in any way. I should be paying a small amount of that wealth to the people securing it, because I’m benefiting from its security.
It’s difficult, because 80-90% of Bitcoiners are religious zealots, rather than Bayesian. It’s a new religion, and it certainly has a lot of good things going for it, so it’d be a shame if the zealotry dooms it in the end.
If you’re holding Bitcoin because you believe you can sell it to someone else for the same or more in the future, then I suppose that’s reasonable. It still has another 10-20x before it surpasses the total value of all gold, so perhaps there’s still some alpha to be had.
But if you’re holding Bitcoin because you belive it will actually function as a medium of exchange in the long run, I would re-consider your position. None of the stakeholders developing Bitcoin mining clients have any incentive to increase the functionality of the L1 layer. Most of the funding for such development comes from L2 payment networks like Lightning. They have every incentive to keep the Bitcoin protocol slow and unsuitable for payments (after all, their product is supposed to be the thing that solves that problem).
For that reason, along with the general lack of interest in innovation within the Bitcoin community, I would be extremely surprised if Bitcoin ever became a scalable payment solution.
I’m not really sure I understand your objection. If the L2 improvements are well funded, then the underlying asset would still be at the center of a future payment network.
L2 is the innovation. The idea behind the protocol is that innovation happens on top of L1, because that’s a far less risky way to innovate.
There’s certainly a question of whether L2 built on top of L1 can actually scale enough to succeed, but that doesn’t seem to be what you’re saying. Everyone invested in the Bitcoin space has an incentive to increase the functionality of Bitcoin as a whole. I’m not understanding the issue with L1 staying constant.
I think Bitcoin’s network security is unstable in the long run due to the over-reliance on money printing to subsidize it. The existing validators have strong incentives to resist moving away from proof of work due to sunk costs in ASICs. There also just seems to be a lot of misunderstanding about the lack of advantages of proof of work compared to proof of stake or other consensus mechanisms.
So unless the incentive to attack the Bitcoin network exponentially decrease over time, the fundamental protocol must be changed at some point. And maybe Bitcoin survives that anyways. I don’t really know.
As for L2 scaling, last time I checked the lightning network had something like 650 transactions completed in its entire history. I really have no idea why that number is so low, but to me it indicates the product just isn’t very good. Can it be improved?
Maybe. But with Bitcoin’s transaction rate it would take like 1.5 years for everyone in the US to do one single transaction transferring money from Bitcoin to the lightning network. I just don’t see how that scales unless you basically NEVER write to the Bitcoin blockchain.
I mean maybe that can work? It’s not like people own shares of stock at the depository trust. Intermediaries work well elsewhere in the economy. But why would I want to use the lightning network? Literally the only potential upside I can think of is exposure to Bitcoin prices.
My overall impression is just that there are a dozen obvious things you could do if you wanted Bitcoin to be used as money and basically none of them are being done, so Bitcoin stakeholders must not care that much about facilitating exchange via Bitcoin. And I don’t see any reason why that will change.
I agree that the block subsidy is a large economic driver of mining right now. I don’t understand why Bitcoiners seem so convinced there will be a smooth transition from block subsidy to voluntary fee as the halvings continue. Is there literally any evidence that the fee market will work? Isn’t it pure conjecture? I’d really like an answer on that one.
As for L2 scaling, yeah I don’t believe LN in it’s current form is all that usable. Lots of smart people believe its getting there, though, so without doing object level analysis for myself I tend to think L2 will ultimately succeed. Again, though, I haven’t seen a high quality back and forth about this between two smart, well informed, people, which is definitely concerning.
The one major disagreement we have is that “proof-of-work has no advantages over proof-of-stake.” These two consensus mechanisms are entirely different. Proof-of-work requires staking a resource that is external to the network. This is critical, as it means that, were the network to fork, you can only stake your energy on one of the two new chains. In contrast, under proof-of-stake, your stake is duplicated in a fork.
This is critical, as it means that, were the network to fork, you can only stake your energy on one of the two new chains. In contrast, under proof-of-stake, your stake is duplicated in a fork.
I honestly never really thought about this before but I suppose it’s worth considering. Maybe it’s easier for a community to split after some controversial decision with proof of stake?
Proof of work is not really immune to it though. When the DAO hack happened on Ethereum, the chain split into Ethereum and Ethereum Classic even though the network used proof of work at the time.
Validators will continue to stake on any chain so long as it’s profitable. I don’t really see how proof of stake vs work changes that.
You mention the EA investing group. Where is that? A cursory search didn’t seem to bring anything up. Also, more generally speaking, what would be your top few recommendations of places to keep up with the latest rationalist investment advice?
This post addresses none of the valid criticisms in comments on your recent posts, especially challenges to the accuracy of your assessment of counterparty risk. These were all different ways of saying, “Your posts do not contain enough information to allow me to determine the likelihood that you are a genius versus a crank.”
You can’t just keep invoking Scott Alexander’s Bitcoin regrets. Those opportunities are gone.
This post, in which you instead conclude that “haters gonna hate,” does not advance your cause. I am just irritated that you keep posting without seeming to absorb the community’s epistemic values.
Which epistemic values? I am posting these trades in public (not always on lesswrong itself but in adjacent spaces which are easy enough to check if needed). If they blow up I will suffer the reputational consequences. The inverse should occur if they work out well. Do you want to bet on whether FTX.com losses a substantial amount of user funds in the next year? What odds do you give?
The opportunities don’t seem gone to me. Though I doubt we see anything as good as 2011 bitcoin. Many rationalists bought Solana around January 7th when it unlocks. I posted about this on the EA investing group in early January (before the unlock). It is up more than 10x. That’s not 250x but it’s something. The arbitrage opportunities I discuss are live right now.
You claim there are these huge counterparty risks but you have no presented any data substantiating your claims. I would estimate the expected loss rate in decentralized finance is probably between 1.6%-2.75% yearly. This is based on actual empirical data. The loss on a centralized is dramatically lower. Probably a tenth of that. Exchanges do not commonly lose user funds. They have been safe for many years. You should be more concerned with getting hacked than with counterparty risk from a Cefi exchange. As I said before the risks would have to be quite large not just present to compensate for the returns. I see no evidence that they are.
I believe scholarship is one of the twelve virtues. Please teach me this value. Please show me some kind of credible analysis that counterparty risks are extremely high (as in 10%+ a year)? Many people I know will be very interested if you can. I will share your findings with many interested parties.
So update as of November 23rd, 2022…
FTX is bankrupt, with at least an $8 billion hole on their balance sheet. Customer funds gone, many people lost 6 and even 7 figure balances.
So… what were those odds on “FTX.com losses a substantial amount of user funds” again?
The more info that comes out, the more it looks like the entire thing was fraudulent from the beginning. They even have a software back-door that allows them to transfer funds without alerting auditors, which it looks like they used many times with FTX customer deposits.
Additionally...
Celsius: bankrupt.
BlockFi: bankrupt.
Voyager: bankrupt.
3 arrows capital: bankrupt.
Terra Luna: worthless.
Genesis: likely bankrupt.
Digital currency group: ???
Obviously this is hindsight, but you should STRONGLY update, because it looks like the counter-party risks were well over 10%. In fact, many were even calling SBF and FTX fraudulent well before it came to light and blew up, but people didn’t really listen.
We all need to strongly update on this. I know I have.
I’d also encourage you to consider what happens if/when the SEC decides to finally label every “crypto” except Bitcoin a security, and force them to file S1 disclosures. This process will likely be greatly accelerated by the FTX debacle. I suspect MANY of these “projects” will completely fall out of favor, being out competed by better securities like Google and Apple. Their current price merely reflects their regulatory arbitrage, which will end.
Why do you expect Bitcoin to be excepted from being labelled a security along with the rest?
(Apologies if the answer is obvious to those who know more about the subject than me, am just genuinely curious)
No, it’s not obvious; it’s a perfectly legitimate question. Here’s the Howie test, the criteria established by the Supreme Court for security classification:
An investment of money
In a common enterprise
A reasonable expectation of profit
Derived from the efforts of others
Bitcoin’s biggest difference from other Crypto securities are #2 and #4. Bitcoin is common, but it’s not exactly an “enterprise.” There’s no organization or group working on it in an attempt to increase it’s value, the way, for example, the Ethereum foundation attempts to increase the economic value of ETH. There are the core devs, but the authority they have to actually change the software is much, much lower, requiring massive agreement across the board from miners and nodes.
And for #4, while it is the miners efforts that create security for the network, it’s not as direct as the members of other crypto projects actively working, for profit, on the software. The profit comes from Bitcoin’s increasing network of users who decide to store their economic value in it, not because it’s becoming a more and more useful piece of software as people improve it (like, say, what happens in a traditional equity like google or microsoft).
Even still, it’s certainly murky.
Gary Gensler has stated Bitcoin alone is a commodity a few times: https://www.coindesk.com/layer2/2022/06/28/secs-gensler-reiterates-bitcoin-alone-is-a-commodity-is-he-right/
The main thing… Who exactly would be required to register Bitcoin with the SEC? Who would file the S1 disclosure with Bitcoin? Who would the SEC sue if “Bitcoin” was an unregistered security? There was no IPO (well, ICO I guess). There’s no foundation. There are no stakeholders; since Bitcoin is PoW.
I know I’m kind of late to the party here, but here is the best argument against the future value of Bitcoin I’ve yet read
This is specifically about Bitcoin, and does not apply to other coins that don’t have a fixed supply, or those that use a different consensus mechanism.
For anyone who stumbles across this comment in the future, the argument is basically that there is no market mechanism to ensure transaction fees stay high enough to maintain block security. The argument hinges on the assumption that miners need to be rewarded at least 1% of daily transaction volumes for them to be willing to spend money on the ASICs needed to mine blocks.
You can collateralize Bitcoin, and that is really where Bitcoin’s future lies, its collateral to recapitalize the financial system. The dynamics of QE operate like an auto-immune disease, its making collateral harder to come by, debt instruments become MORE expensive, because the Fed is effectively bidding up the price. However, this creates a new paradigm where all assets are higher in value than where they should be, if we’re operating in a normal interest rate environment (by normal, one that doesn’t have massive Central Bank interference to effectively fix the market rates). This is why we have such a monopolized economy as well, it makes borrowing costs cheaper for those with the best ability to access credit. Thus, all assets become too expensive. This leads to extreme inequality because few people under 40 can afford to have normal things people want, and leads to this extractive economy we operate in. This also becomes impossible to reverse too because the Fed raising the interest rate leads to a market crash (as they found out in 2018, nearly collapsing the entire stock market).
You need a way to unwind this dynamic because like an auto-immune disease, you’re attacking healthy cells (small businesses, who can’t access credit, or get priced out of competing against would-be monopolists, as well as zombie corporations who just exist in perpetuity rolling over their debt, 20% of US corporations on the stock market are now zombified).
So, Bitcoin operates within the monetary reality of the world today, whereas so many other cryptos are trying to design something new, innovative or fantastical, none of them are obviously better for this absolute contorted situation we find ourselves in. It can become the new version of collateral, so that the Fed can release the pressure valve of perpetual QE, and allow them to unwind without mass bankruptcy of the US economy. However, this is another conundrum, because Bitcoin’s deflationary attributes also make for a more appealing settlement layer than what its actually competing against, which is the Fed. This is ultimately what many technologists misunderstand, Bitcoin is more like a first order layer of money, to clear transactions at the highest level. It’s more comparable to Fedwire or other various Federal Reserve settlement layers.
Yeah this is worrisome for me as well. It also appears that human beings are more objectively rational with their money under slight inflationary pressure, because that slight pressure offsets the irrational loss aversion we all have hard wired into our brains.
It seems like Bitcoin with a small, permanent, inflation rate would function much better as a long term, stable, secure, monetary system than this deflationary one we have. The inflation is paid out to the miners, as a fee for maintaining the network security, rather than to autocrat grifters like it is now. It’s a perfect economic give and take.
The current system is very awkward. I’m holding Bitcoin, but I’m not paying the miners to secure it in any way. I should be paying a small amount of that wealth to the people securing it, because I’m benefiting from its security.
It’s difficult, because 80-90% of Bitcoiners are religious zealots, rather than Bayesian. It’s a new religion, and it certainly has a lot of good things going for it, so it’d be a shame if the zealotry dooms it in the end.
If you’re holding Bitcoin because you believe you can sell it to someone else for the same or more in the future, then I suppose that’s reasonable. It still has another 10-20x before it surpasses the total value of all gold, so perhaps there’s still some alpha to be had.
But if you’re holding Bitcoin because you belive it will actually function as a medium of exchange in the long run, I would re-consider your position. None of the stakeholders developing Bitcoin mining clients have any incentive to increase the functionality of the L1 layer. Most of the funding for such development comes from L2 payment networks like Lightning. They have every incentive to keep the Bitcoin protocol slow and unsuitable for payments (after all, their product is supposed to be the thing that solves that problem).
For that reason, along with the general lack of interest in innovation within the Bitcoin community, I would be extremely surprised if Bitcoin ever became a scalable payment solution.
I’m not really sure I understand your objection. If the L2 improvements are well funded, then the underlying asset would still be at the center of a future payment network.
L2 is the innovation. The idea behind the protocol is that innovation happens on top of L1, because that’s a far less risky way to innovate.
There’s certainly a question of whether L2 built on top of L1 can actually scale enough to succeed, but that doesn’t seem to be what you’re saying. Everyone invested in the Bitcoin space has an incentive to increase the functionality of Bitcoin as a whole. I’m not understanding the issue with L1 staying constant.
Sorry, I didn’t really explain myself clearly.
I think Bitcoin’s network security is unstable in the long run due to the over-reliance on money printing to subsidize it. The existing validators have strong incentives to resist moving away from proof of work due to sunk costs in ASICs. There also just seems to be a lot of misunderstanding about the lack of advantages of proof of work compared to proof of stake or other consensus mechanisms.
So unless the incentive to attack the Bitcoin network exponentially decrease over time, the fundamental protocol must be changed at some point. And maybe Bitcoin survives that anyways. I don’t really know.
As for L2 scaling, last time I checked the lightning network had something like 650 transactions completed in its entire history. I really have no idea why that number is so low, but to me it indicates the product just isn’t very good. Can it be improved?
Maybe. But with Bitcoin’s transaction rate it would take like 1.5 years for everyone in the US to do one single transaction transferring money from Bitcoin to the lightning network. I just don’t see how that scales unless you basically NEVER write to the Bitcoin blockchain.
I mean maybe that can work? It’s not like people own shares of stock at the depository trust. Intermediaries work well elsewhere in the economy. But why would I want to use the lightning network? Literally the only potential upside I can think of is exposure to Bitcoin prices.
My overall impression is just that there are a dozen obvious things you could do if you wanted Bitcoin to be used as money and basically none of them are being done, so Bitcoin stakeholders must not care that much about facilitating exchange via Bitcoin. And I don’t see any reason why that will change.
I agree that the block subsidy is a large economic driver of mining right now. I don’t understand why Bitcoiners seem so convinced there will be a smooth transition from block subsidy to voluntary fee as the halvings continue. Is there literally any evidence that the fee market will work? Isn’t it pure conjecture? I’d really like an answer on that one.
As for L2 scaling, yeah I don’t believe LN in it’s current form is all that usable. Lots of smart people believe its getting there, though, so without doing object level analysis for myself I tend to think L2 will ultimately succeed. Again, though, I haven’t seen a high quality back and forth about this between two smart, well informed, people, which is definitely concerning.
The one major disagreement we have is that “proof-of-work has no advantages over proof-of-stake.” These two consensus mechanisms are entirely different. Proof-of-work requires staking a resource that is external to the network. This is critical, as it means that, were the network to fork, you can only stake your energy on one of the two new chains. In contrast, under proof-of-stake, your stake is duplicated in a fork.
I honestly never really thought about this before but I suppose it’s worth considering. Maybe it’s easier for a community to split after some controversial decision with proof of stake?
Proof of work is not really immune to it though. When the DAO hack happened on Ethereum, the chain split into Ethereum and Ethereum Classic even though the network used proof of work at the time.
Validators will continue to stake on any chain so long as it’s profitable. I don’t really see how proof of stake vs work changes that.
You mention the EA investing group. Where is that? A cursory search didn’t seem to bring anything up. Also, more generally speaking, what would be your top few recommendations of places to keep up with the latest rationalist investment advice?
There are several groups now because people wanted to keep some topics seperated. Sadly I don’t think any of them are open to the public.
I have no idea if this is the answer, but there’s a cluster if investing discussion on the EA side around mission hedging. That may be relevant.