Hi,
In my last post I wrote about blockchain technology and the promise it holds. But to test the resilience of a new technology, we need to ask, can the rules be bent for the makers?
This one’s a bit long, so make sure you grab a cup of coffee to sip on,
A. Returns for the wealthy
1. Alternate coin returns
Alt coins refers to all crypto currencies other than Bitcoin. For example, Ether, Solana, Litecoin, Stellar, Cardano, Polkadot, Dogecoin etc.
These coins/tokens are listed on unregulated exchanges such as Coinbase which allows people to trade them. There are three major issues with this,
Firstly, Coinbase is not answerable to the public the way a stock exchange is. The due diligence prior to trading lies with the investor.
In the past this lack of regulations has caused problems. In 2019, QuadrigaCX believed to be Canada's largest cryptocurrency exchange, was declared bankrupt. The death of the founder of the exchange combined with mismanagement burned a hole through client’s wallets who are owed $190 million. The absence of an overseeing authority creates substantial risk for investors.
Secondly, Coinbase has its own venture fund which invests in tokens, in the initial funding period.
It then lists these tokens on its own platform as per its “process”. This creates a conflict of interest and an incentive to list the tokens to allow for an exit, at a profit.
Thirdly, listing leads to massive profits for early backers at the expense of retail investors.
As per fascinating research done by Fais Khan,
“Being listed for trading on Coinbase has been the holy grail of crypto - the equivalent of an IPO on Wall Street. And like an IPO, that seems to come up with a “pop” - Messari, a crypto research firm, documented in a report that the average Coinbase listing leads to a 91% gain in 5 days, on average. […]
Once a coin has been on Coinbase for a year, it appears to lag Bitcoin and Ethereum pretty soundly.”
This seems to stand out even more when you look at the investments made by a16z, one of the main venture capital firms in this space,
“A16z’s returns are much worse than Coinbase’s listings overall! This to me smells of insider selling. These should be the best coins there are, given a16z’s access, but instead 100% of those older than 12 months and 90% older than 6 months lag Ethereum.” […]
“My favorite angle is looking at when Coinbase and a16z invest together. This would seem to be the darlings of the industry (darlings of DeFi?), but in fact are the worst performers of any grouping!”
After an initial pop, over time venture capital backed tokens lag returns v/s Ethereum and Bitcoin. The people who have benefitted the most out of these pops are venture capitalists by sticking the coin to retail investors. It’s the opposite of conventional wisdom where you hold the asset for a long period of time to gain outsized returns. Here it is a game of who can I sell it too, quickly?
2. Decentralisation???
Decentralisation, meaning no one organisation has decision making power over the blockchain is a core tenet of crypto. But the Ethereum blockchain technology is slow and expensive (every transaction requires a fee which can range from $6-$150/transaction) to put data onto the chain.
Companies like Polygon have emerged to solve these problems.
Polygon is a unique company, it exists on top of the blockchain and validates the transaction outside it, leading to a lower gas fee. Polygon is vital to solving the issues faced by Ethereum blockchain.
Polygon’s ambition is to build the AWS of the web3, the next evolution of the web.
“Polygon, founded by three Indians on the Ethereum blockchain, raised $450 million in a round led by Sequoia Capital India. Nearly every investor of note in India participated in the round, including Tiger Global, Elevation Capital, Accel Partners, Steadview Capital, and Softbank Vision Fund II. After the round, the company was valued at a little over $13 billion.”- The Nutgraf
Polygon’s backers are accumulating power in web3, making it more centralised.
To take a cynical view of things,
The notion that the technology, code will work for the ordinary man and their interests is a myth.
The belief that the world will be fairer if the rules are enshrined in code, enforced by computers, and made extremely difficult to change sounds like a dream.1
The investors holding the power will always care for their bottom line.
Then how is this new technology any better than the current system? At least the current system is governed, protects people from fraudsters and has an option to seek legal recourse.
3. NFT’s as a vehicle to provide returns for whales?
Non fungible tokens (NFT’s) are a way to prove ownership of digital art and collectibles. NFTs can be photography, art, music, video file, tweets, memes, practically anything.
“Non-fungible” means that it’s unique.
For example, a Rs.10 note is fungible — one note can be exchanged for another Rs.10 note, and you’ll have the same value. A family heirloom, however, is non-fungible.
Anil Dash was one of the early pioneers in this space. Here are excerpts from his article,
“One major challenge is that the blockchain has, at present, approximately zero uses for the typical consumer. Theoretical uses abound, but no ordinary person is choosing a blockchain-based technology over its traditional counterpart. More than a decade after blockchains first caught tech geeks’ eye, not a single smartphone app that you use with friends or co-workers relies on that technology. By contrast, when the web was the same age that bitcoin is today, it had half a billion users around the world.”[…]
“Billions of dollars are now invested in cryptocurrencies, and the people who have made those bets can’t cash in their chips anywhere. They can’t buy real estate with cryptocurrency. They can’t buy yachts with it. So the only rich-person hobby they can partake in with their cryptowealth is buying art. And in this art market, no one is obligated to have any taste or judgment about art itself. If NFT prices suddenly plunge, these investors will try buying polo horses or Davos tickets with cryptocurrencies instead. Think of a kid who’s spent the day playing Skee-Ball and now has a whole lot of tickets to spend. Every toy looks enticing. NFTs have become just such a plaything.”
Real world utility as a medium of exchange is still a challenge, despite all the claims that it’s being adopted widely.
The lack of widespread real-world utility can be seen around us.
There is a barbershop next to my house which has a sticker stating Bitcoin accepted here. I casually asked him if anyone has paid in Bitcoin, he said it’s just to show that we offer this but in reality, no one has paid in Bitcoin. The fees to process the transaction combined with the volatility of the currency makes it risky for businesses to use.
So then, what do you do with crypto, speculate? NFT’s can be viewed as an exit option by crypto wealthy (whales). Buy NFT’s by selling Ether, hold them with the aspiration that NFT’s price will jump and if it does exit at a profit.
Widespread adoption of crypto as a medium of exchange might reduce this but currently speculation in NFTs is rampant.
B. Structural flaws in blockchain technology
1. A system which can be used to oppress women
Another core pillar of crypto is trust.
Trust in the system, eliminating the need for an overseeing authority. But malicious actors can use features such as anonymity and immutability (storing data forever) to hurt a section of people – mostly women.
Here are excerpts from an article by Molly White, a software engineer and creator of Web3 Is Going Just Great
The problems with storing data forever,
“It is a nightmare when you think about its implications for user-created data, particularly when considered through the lens of abuse and harassment. If someone stores revenge porn or child sexual abuse material on a blockchain, it is there forever and cannot be removed. Individual platforms built on the blockchain can choose not to display it, but the data is still there and can be accessed by anyone, either directly or by just choosing to use a different platform built on the same chain.” […]
“Imagine if the cringy posts by a twelve-year-old were guaranteed to be available in perpetuity as soon as they were saved. Or if the ill-conceived, drunken ramblings of a person who had few too many were there forever, not deleteable the following day.”
The problems with anonymity,
Unlike traditional banking, connecting one’s real-life identity to a wallet address is purely optional. One person can have multiple addresses,
“When I receive a harassing message on the social networks I use, it tends to be pretty straightforward to just block the user. Most social networks introduce barriers to creating armies of new harassment accounts to cycle through when one is blocked, typically requiring email or phone verification, and using this data along with device data to propagate any bans to new accounts created with the same details.
With blockchains, the ability to easily create new addresses is a feature and intended use of the technology.”
It’s the 21st century, no system should proudly display its features which are truly bugs and which can be used to harass women online.
2. Theft, security, privacy, punishable offences
Theft -
Theft is unnervingly common in crypto marketplaces. From bugs implanted in smart contracts to phishing attacks to misusing voting power, users have faced it all.
On 19th February 2022, 32 NFT’s worth $3 million were stolen via a phishing e-mail. OpenSea the platform, couldn’t prevent the NFTs from being transferred off its marketplace. Furthermore, there are very few ways to remedy a breach or insure against losses.
Security-
Traditional finance has its flaws. But due to its long existence the scale and depth of attacks has reduced, or customers are aware of the problems and are therefore mindful. But in crypto…
In 2016, hackers stole 119,754 bitcoins from a cryptocurrency exchange called Bitfinex. The hackers breached the exchanges systems and sent the bitcoin to a digital wallet under their control. ~25,000 of those stolen bitcoin were laundered via a complicated money laundering process that ended with some of the stolen funds being cashed out through bitcoin ATMs and used to purchase gold, non-fungible tokens (NFTs) and Walmart gift cards.
The remainder of the stolen funds were recovered and valued at over $3.6 billion at the time of seizure 5 years later.
Privacy -
You need wallets to store coins, tokens or NFT’s, think of it like a demat account for shares. Companies such as MetaMask or Coinbase provide soft wallets wherein you can trade crypto with ease. But with convenience comes issues,
In December 2021, a privacy vulnerability was found with the popular wallet MetaMask, where a malicious actor can easily create an NFT and airdrop it to a victim to obtain their IP address and thus potentially their location.
Offenses/Crimes-
A report by the United Nations states, North Korean missile program received funding through stolen crypto. In 2021, the cyberattacks could have netted as much as $400m worth of digital assets.
The list of problems can go on and on. But as per a report by Chainanalysis,
Despite the increase in crime, illicit transactions accounted for only 0.15% of total volume as crypto trading volume grew to $15.8 trillion in 2021, up 567% from 2020 totals.
In fact, criminal activity as a percentage of cryptocurrency transaction (0.15%) was by far the lowest percentage over the past five years.
Adoption of crypto far outpaced illicit transactions in the space.
C. Energy Consumption
As per The New Yorker,
“Bitcoin-mining operations worldwide now use energy at the rate of nearly a hundred and twenty terawatt-hours per year. This is about the annual domestic electricity consumption of the entire nation of Sweden.
According to the Web site Digiconomist, a single bitcoin transaction uses the same amount of power that the average American household consumes in a month, and is responsible for roughly a million times more carbon emissions than a single Visa transaction.”
Crypto enthusiasts believe that by upping the ante of electricity consumption it is pushing the world to find sources of renewable electricity.
That may not be true. Let’s examine this through a simplified example,
If 1 BTC requires $10/hour and takes 10 hours, the cost of producing that 1 BTC for the miner is $100.
If the next day, the price of electricity drops to $1 the miners cost drops to $10. Miners rush to capitalize on this by increasing mining capacity to make use of the cheaper electricity. However, this works only for a while as increased capacity leads to harder problems which take longer to solve driving the production cost up.
This is inevitable as the mining companies are all profit seeking companies who want to maximize their gains. Hence, they will all compete to get assets at a cheaper price as well as work to preserve the price of the coins they already have mined.
This entire situation is complicated further by bitcoin’s inbuilt protocol which reduces the rate of mining by half every so often. Meaning you need more and more energy to produce the same number of bitcoins.
Phew I know that was a lot.. If you read the whole thing then Congratulations! I know I have given you a lot of food for thought, so please comment and let me know what you think.
For me personally, I hold Ether and Solana and will continue investing in them little by little, as I believe in blockchain technology. This is due to it’s potential to remove incentives that corrupt the system. Smart contracts are a great example.
Imagine a world where, by providing automatic execution we can help farmers in India and not people like Sharad Pawar and Lalu Prasad Yadav who bend the system for their gain.
The currencies are volatile but that’s a bug of human nature to speculate. I don’t believe that it will replace finance and banking but innovations in blockchain tech will be applied to the traditional system which will positively affect the common men and women.