Tag Archives: Bitcoin

Bitcoin Unlimited

On Bloomberg, Yuji Nakamura and Lulu Yilun Chen report about conflicting views in the Bitcoin community on how to address capacity limits in the blockchain.

Bitcoin Unlimited is essentially a software upgrade to the blockchain. Years ago, bitcoin’s early developers imposed a cap on the amount of data it could process. While that slowed down the network, it was seen as a necessary safety measure against potential attackers who could overload the system. Now, Unlimited supporters say the blockchain is robust enough that it doesn’t need any limit at all.

While most agree the blockchain is stronger, critics … say that removing the data cap is a risky move which will leave bitcoin vulnerable to governments and global banks. Without a limit, large organizations would use their resources to out-muscle smaller miners and effectively take control of the blockchain and bitcoin itself.

Money, Banking, and Dreams

In another excellent post on Moneyness, J P Koning likens the monetary system to the plot in the movie Inception, featuring

a dream piled on a dream piled on a dream piled on a dream.

Koning explains that

[l]ike Inception, our monetary system is a layer upon a layer upon a layer. Anyone who withdraws cash at an ATM is ‘kicking’ back into the underlying central bank layer from the banking layer; depositing cash is like sedating oneself back into the overlying banking layer.

Monetary history a story of how these layers have evolved over time. The original bottom layer was comprised of gold and silver coins. On top this base, banks erected the banknote layer; bits of paper which could be redeemed with gold coin. The next layer to develop was the deposit layer; non-tangible book entries that could be transferred by order from one person to another.

The foundation layer has changed over time:

One of the defining themes of modern monetary history has been the death of the original foundation layer; precious metals. … as central banks chased private banks from the banknote layer … and then gradually severed the banknote layer from the gold layer. By 1971, … [b]anknotes issued by the central bank had become the foundation layer. The trend towards a cashless world is a repeat of this script, except instead of the gold layer being slowly removed it is the banknote layer.

Fintech improves the efficiency of the layer arrangement and its connections. It also adds new layers: For instance, some payments made via mobile phone effectively transfer claims on deposits. And it may circumvent layers:

In U.K., the Bank of England is considering allowing fintech companies to bypass the banking layer by offering them direct access to the bottom-most central banking layer.

In contrast, a krypto currency like bitcoin establishes a new foundation layer, on which new layers may be built:

Even now there is talk of a new layer being developed on top of the original bitcoin foundation, the Lightning network. The idea here is that the majority of payments will occur in the Lightning layer with final settlement occurring some time later in the slower Bitcoin layer.

I fully agree with this characterization. In addition to the theme emphasized by Koning—adding layers—I would also stress the theme of untying higher-level layers from lower ones: Central bank money typically is no longer backed by gold; deposits typically are not fully backed by notes; and mobile phone credits may no longer be backed by deposits. The process of untying layers relies on social conventions and trust, and it is fragile. Important questions concern the cost of such fragility, and its necessity. Fragility is not necessary when the social cost of liquidity provision at the foundation layer is negligible.

Krypto Currencies and Privacy

On Wired, Andy Greenberger discusses Monero, Dash, and Zcash, krypto currencies that provide more privacy than bitcoin and its derivatives.

Unlike commercial services like PayPal, Bitcoin allows anyone to spend money online without providing identifying details. But if someone’s Bitcoin address is linked with their real identity, any transaction from that address is entirely visible on the public blockchain … Hiding those transactions requires taking extra steps, like routing bitcoins through “tumblers” that mix up coins with those of strangers—and occasionally steal them—or using techniques like “coinjoin,” built into some bitcoin wallet programs, that mix payments to make them harder to trace. “If I pay my rent in Bitcoin, it wouldn’t be that hard for the landlord to figure out how much money I earned if I don’t take extra precautions” …

Monero … implements a few features that Bitcoin still can’t offer. It uses a technique called “stealth addresses” to generate addresses for receiving Monero that are essentially encrypted; the recipient can retrieve the funds, but no one can link that stealth address to the owner. It employs a technique called “ring signatures,” which means every Monero spent is grouped with as many as a hundred other transactions, so that the spender’s address is mixed in with a group of strangers, and every subsequent movement of that money makes it exponentially more difficult to trace back to the source. And it uses something called “ring confidential transactions,” which hides the amount of every transaction.

Monero isn’t the first cryptocurrency designed to offer a financial privacy panacea: Dash, formerly known as Darkcoin, integrates the “coinjoin” technique that allows bitcoin users to mix their transactions with a few other spenders in what Todd calls a weaker form of anonymity than Monero offers. More recently, Zcash debuted with the strongest anonymity promises yet—it uses cryptographic tricks designed to make tracing a transaction not only unlikely, but mathematically impossible. Zcash has yet to be integrated into dark web markets, though, and still requires wielding the command line to use.

“Wer hat Angst vor Blockchain? (Who’s Afraid of the Blockchain?),” NZZ, 2016

NZZ, November 29, 2016. HTML, PDF. Longer version published on Ökonomenstimme, December 14, 2016. HTML.

Central banks are increasingly interested in employing blockchain technologies, and they should be.

  • The blockchain threatens the intermediation business.
  • Central banks encounter the blockchain in the form of new krypto currencies, and as the technology underlying new clearing and settlement systems.
  • Krypto currencies bear the risk of “dollarization,” but in the major currency areas this risk is still small.
  • New clearing and settlement systems benefit from central bank participation. But central banks benefit as well; those rejecting the new technology risk undermining the attractiveness of the home currency.


The Economist reports about a new digital currency platform, Zcash. The platform could handle more transactions than for example, Bitcoin. The open-source project backed by outside investors offers confidentiality:

Bitcoin obscures the identity of currency owners, but the “blockchain”, the ledger that keeps track of all the coins, is open and can be analysed to see the flows of funds. This is a serious barrier for banks: blockchains could reveal their trading strategies and information about their customers. Zcash, by contrast, shields transactions from prying eyes with a scheme based on “zero-knowledge proofs” (hence the “Z” in its name). These are cryptographic protocols proving that a statement (who owns coins, for instance) is true without revealing any other information (how many and where the money came from). And it is by selling this technology—called “zk-SNARK” (don’t ask)—to banks that Zcash, the company, wants to earn its keep.

“Central Banking and Bitcoin: Not yet a Threat,” VoxEU, 2016

VoxEU, October 19, 2016. HTML.

  • Central banks are increasingly interested in employing blockchain technologies.
  • The blockchain threatens the intermediation business.
  • Central banks encounter the blockchain in the form of new krypto currencies, and as the technology underlying new clearing and settlement systems.
  • Krypto currencies bear the risk of “dollarization,” but in the major currency areas this risk is still small.
  • New clearing and settlement systems benefit from central bank participation. But central banks benefit as well; those rejecting the new technology risk undermining the attractiveness of the home currency.
  • See the original blogpost.


In the FT, Philip Stafford reports about a digital currency initiative by the Bank of Canada and commercial banks. It

will involve issuing, transferring and settling central bank assets on a distributed ledger via a token named CAD-Coin.


The Bank of Canada said the experiment was a proof-of-concept and confined to interbank payment systems. … “None of our experiments are to develop central-bank issued e-money‎ for use by the general public.”

Blockchains in Banking (Commercial and Central)

The Economist reports about initiatives by commercial and central banks that aim at adopting the blockchain technology.

For commercial banks, distributed ledgers promise various advantages—but they also cause problems:

Instead of having to keep track of their assets in separate databases, as financial firms do now, they can share just one. Trades can be settled almost instantly, without the need for lots of intermediaries. As a result, less capital is tied up during a transaction, reducing risk. Such ledgers also make it easier to comply with anti-money-laundering and other regulations, since they provide a record of all past transactions (which is why regulators are so keen on them).

… Yet … [o]ne stumbling block is what geeks call “scalability”: today’s distributed ledgers cannot handle huge numbers of transactions. Another is confidentiality: encryption techniques that allow distributed ledgers to work while keeping trading patterns, say, private are only now being developed. … Such technical hurdles can be overcome only with a high degree of co-operation …

Meanwhile, central banks plan digital currencies built around the same technology.

Like bitcoin, these would be built around a database listing who owns what. Unlike bitcoin’s, though, these “distributed ledgers” would … be tightly controlled by the issuers of the currency.

The plans involve letting individuals and firms open accounts at the central bank …

Central banks … could save on printing costs if people held more bits and fewer banknotes. Digital currency would be tougher to forge, though a successful cyber-attack would be catastrophic. Digital central-bank money could even, in theory, replace cash. …

Better yet, whereas bundles of banknotes can be moved without trace, electronic payments cannot. … The technology first developed to free money from the grip of central bankers may soon be used to tighten their control.

Decentralization through the Blockchain?

The Economist reviews the blockchain technology underlying Bitcoin—“a way of making and preserving truths.”

It is the blockchain that replaces this trusted third party. A database that contains the payment history of every bitcoin in circulation, the blockchain provides proof of who owns what at any given juncture. This distributed ledger is replicated on thousands of computers—bitcoin’s “nodes”—around the world and is publicly available. But for all its openness it is also trustworthy and secure. This is guaranteed by the mixture of mathematical subtlety and computational brute force built into its “consensus mechanism”—the process by which the nodes agree on how to update the blockchain in the light of bitcoin transfers from one person to another.

One interesting aspect of the blockchain technology is that it provides incentives for “mining”, rendering it self-sustainable. The future may lie in blockchain applications beyond payments, for example in securities clearance, certification and the like.

Fintech Competition for Banks

In a series of articles, The Economist reports about technology companies that compete with traditional banks in areas ranging from lending to payments and wealth management.

The introductory article refers to AngelList and references reports by Goldman Sachs (The Future of Finance, copy posted here), BCG and Accenture. And it highlights two factors driving the structural change which I have also emphasized in a recent article: Technology and vanishing trust in banks. The other articles cover:

Updates—some more firms in the business: