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Bitcoin and blockchain demystified: basics and challenges

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Bitcoin, blockchain, Ethereum, gas, …

A new breed of snake oil purveyors are peddling “blockchain” as the magic sauce that will power all the world’s financial transactions and unlock the great decentralised database in the sky. But what exactly are bitcoin and blockchain?

Bitcoin is a system for electronic transactions that don’t rely on a centralised or trusted third-party (bank or financial institution). Its creation was motivated by the fact that digital currency made of digital signatures, while providing strong ownership control, was viable but incomplete solution unable to prevent double-spending. Bitcoin’s proposed solution was a peer-to-peer network using proof-of-work (system to deter network attacks) to record a public history of transactions that is computationally impractical for an attacker to change if honest nodes control a majority of CPU power. The network is unstructured, and its nodes work with little coordination and don’t need to be identified. Truth/consensus is achieved by CPU voting, i.e network CPUs express their acceptance of valid blocks (of transactions) by working on extending them and rejecting invalid blocks by refusing to work on them.

Satoshi Nakamoto’s seminal paper “Bitcoin: A Peer-To-Peer Electronic Cash System” has references to a “proof-of-work chain”,“coin as a chain,” “chain of ownership”, but no “blockchain” or “block chain” ever make an appearance in it.

Blockchain (which powers Bitcoin, Ethereum and other such systems) is a way for one Internet user to transfer a unique piece of digital asset (Bitcoins, Ether or other crypto assets) to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows the transfer has taken place, and nobody can challenge the legitimacy of the transfer. Blockchains are essentially distributed ledgers and have three main characteristics: a) decentralisation, b) immutability and c) availability of some sort of digital assets/token in the network.

While decentralisation consensus mechanisms offer critical benefits, such as fault tolerance, a strong guarantee of security, political neutrality, and authenticity, they come at the cost of scalability. The number of transactions the blockchain can process can never exceed that of a single node that is participating in the network. In fact, blockchain actually gets weaker as more nodes are added to its network because of the inter-node latency that logarithmically increases with every additional node.

All public blockchain consensus protocols make the tradeoff between low transaction throughput and high-degree of centralisation. As the size of the blockchain grows, the requirements for storage, bandwidth, and computing power required to fully participating in the network increases. At some point, it becomes unwieldy enough that it’s only feasible for a few nodes to process a block — that might lead to the risk of centralisation.

Currently, the blockchain (and with it, Bitcoin, Ethereum and others) challenges are:

  1. Since every node is not allowed to validate every transaction, we need nodes to have a statistical and economic means to ensure that other blocks (which they are not personally validating) are secure.
  2. Scalability is one of the main challenges. Bitcoin, despite having a theoretical limit of 4,000 transactions per second (TPS) currently has a hard cap of about 7 transactions per second for small transactions and 3 per second for more complex transactions. An Ethereum node’s maximum theoretical transaction processing capacity is over 1,000 TPS but processes between 5-15 TPS. Unfortunately, this is not the actual throughput due to Ethereum’s “gas limit, which is currently around 6.7 million gas on average for each block. Gas is the computation cost within Ethereum, which users pay in order to issue transactions or perform other actions. A higher gas limit means that more actions could be performed per-block. In order to scale, the blockchain protocols must figure out a mechanism to limit the number of participating nodes needed to validate each transaction, without losing the network’s trust that each transaction is valid.
  3. There must be a way to guarantee data availability, i.e. even if a block looks valid from the perspective of a node not directly validating that block, making the data for that block unavailable leads to a situation where no other validator in the network can validate transactions or produce new blocks, and we end up stuck in the current state (reasons a node is offline include malicious attack and power loss).
  4. Transactions need to be processed by different nodes in parallel in order to achieve scalability (one solution is similar to database sharding, which is distribution and parallel processing of data). However, blockchain’s transitioning state has several non-parallelizable (serial) parts, so we’re faced with some restrictions on how we can transition state on the blockchain while balancing both parallelizability and utility.
  5. End-users and organisations (such as banks) have hard time or don’t want to use blockchain. To do even a simple Bitcoin transaction requires a prior and stringent KYC check just to sign up on one of many crypto trading or exchange platforms.  “The Rare Pepe Game is built on a blockchain with virtual goods and characters and more,” explains Fred Wilson of USV. “And it shows how clunky this stuff is for the average person to use.”
  6. There is lot of hype, around blockchain which sets wrong expectations, misleads investments and causes lots of mistakes. Bloomberg reports that Nasdaq is seeking to show progress using the much-hyped blockchain. The Washington Post lists Bitcoin and the blockchain as one of six inventions of magnitude we haven’t seen since the printing press.  Bank of America is allegedly trying to load up on “blockchain” patents. Also, due to its volatility, uncertain status (can it be considered a legal tender such as normal fiat money or is it security, etc?),  there is much instability of holding crypto assets.
  7. Contrary to common belief, disintermediating financial institutions, so the reasoning goes, multiple parties can conduct transactions seamlessly, without paying a commission. However, according to one research, cost savings might be dubious as moving cash equity markets to a blockchain infrastructure would drive a significant increase of the overall transaction cost. Trading on a blockchain system would also be slower (at least in foreseeable future) than traders would tolerate, and mistakes might be irreversible, potentially bringing huge losses.
  8. To drive massive adoption which will induce further technological advancement, a killer app on blockchain or Ethereum would be a must. Despite much invested resources and efforts globally, So far there doesn’t seem to be one, but there arguably is potential in few areas such as digital gold, payments and tokenization.
  9. Blockchain’s immutability might pose a problem for specific types of data. The EU ‘right to be forgotten requires the complete removal of information, which might be impossible on blockchain. There are other privacy-related concerns that people might want to remove or forgotten such as previous insolvency, negative rankings, and other personal details that need to change.

To conclude, I think Ethereum is furthers along compared to PoW-based public blockchains. Ethereum is still orders of magnitude off (250x off being able to run a 10m user app and 25,000x off being able to run Facebook on chain) from being able to support applications with millions of users. If current efforts are well executed, Ethereum could be ready for a 1–10m user app by the end of 2018.

However, there are less-known alternative models that are much more scalable. Once scalability issues are solved, everything will become tokenized and connected by blockchain.

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apple and judiciary of cool

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It was perceivable that “to Google” became a verb synonymous with “to search;” but it might’ve been difficult to forecast a judiciary ruling on the concept of coolness.

This happened unsurprisingly in a judgment involving Apple, which brought the case alleging Samsung’s Galaxy Tab 10 infringed its iPad design. British Judge Birss disagreed saying Apple’s designs weren’t being infringed because Samsung’s product was not as “cool” as the iPad.

This can be watershed in jurisprudence.

Originally, in a 1997 article, Gladwell wrote about the group of people he called coolhunters who scoured American cities to find out what cool kids thought about sneakers.

Written by Hayk

July 14, 2012 at 8:45 pm

Posted in business, innovation, technology

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peter’s laws

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  1. If anything can go wrong, fix it!
  2. When given a choice – take both!
  3. Multiple projects lead to multiple successes.
  4. Start at the top and work your way up.
  5. Do it by the book…but be the author!
  6. When forced to compromise, ask for more.
  7. If you can’t beat them, join them, and then beat them.
  8. If it’s worth doing, it’s got to be done right now.
  9. If you can’t win, change the rules.
  10. If you can’t change the rules, ignore them.
  11. When faced without a challenge, make one.
  12. “No” simply means begin again at the next highest level.
  13. Don’t walk when you can run.
  14. Bureaucracy is a challenge to be conquered with a righteous attitude, an intolerance for stupidity, and bulldozer when necessary.
  15. When in doubt: THINK!
  16. Patience is a virtue but persistence to the point of success is a blessing.
  17. The squeaky wheel gets replaced.
  18. The faster you move, the slower time passes, the longer you live.

Admittedly, 160 words.

Written by Hayk

October 31, 2011 at 5:18 pm

Posted in business, politics

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hedge funds and twitter – glimpses of future?

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Since creation of the first hedge fund in 1949, 10.000 funds and $2 trillion past, there is a change under way.

Derwent Capital, with its initial $39 million, is Europe’s first “social media-based hedge fund” founded on findings of this paper, which asserts that Twitter can:

predict daily moves in the Dow Jones … change in emotions expressed online would be followed between two and six days later by a move in the index… predict its movements with 87.6% accuracy.

Still small compared to standard ones, the fund analyzes thousands of tweets for words “happy,” “sad,” “angry,” etc. to determine public sentiment/mood.

Written by Hayk

September 30, 2011 at 6:50 am

best buy micro-innovation and fidel castro

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One manager of a Best Buy store, who resembles Fidel Castro, leveraged this “asset” turning his store into the best performer. How? Revolutionary mode (called his store “La Revolucion,” posted “Declaracion de Revolucion” in the break room, made store supervisors wear army fatigues,…) and encouragement to whistle when employees do good things.

In Cuba, considered “Internet enemy” by Freedom House, Internet has only 14% penetration,  served much like rationned food.

In 2010, Castro admitted he admired Internet and WikiLeaks’ influence on American government and agreed to have a Cuba-Jamaica-Venezuela fiber-optic line, increasing its connectivity 3000 times, but not for ordinary citizens.

Written by Hayk

September 21, 2011 at 8:46 am

what breeds ideas and innovations

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Where good ideas come from claims innovation originates in seven realms:

  1. Adjacent possibilities.Use existing components. Gutenberg used wine press for his printing press.
  2. Liquid networks. 21st-century cities and the Internet make it possible for informal networks to form, enabling idea cross-pollination/inventions.
  3. Slow hunch. It takes years for a hunch to evolve into an invention.
  4. Serendipity. LSDTeflonViagra.
  5. (Unplanned/unexpected) errors. de Forest‘s development of audion diode/triode resulted from erroneous thinking.
  6. ExaptionVacuum tubes were developed for long-distance telephone/radio transmission and later used in computers.
  7. Platforms. Development of TRANSIT, a precursor of GPS by Applied Physics Laboratory.

Written by Hayk

September 11, 2011 at 8:51 am

what physics can teach about marketing

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TED talk by Dan Cobley

Summary:

  1. a=F/m  (Anderson launched Accenture; Hoover is more than vacuum cleaner; why P&G keeps separate brands).
  2. Δx Δh ≥ 1/2 (McDonalds sells millions, while mothers talk about healthy life to their kids).
  3. You cannot prove a hypothesis through observation, you can only disprove it (scientific method) – BP spent millions building environment-friendly image and than one accident ruined it all; Toyota perceived as reliable and one big recall changed that image; Tiger Woods.
  4. Increasing entropy (2nd law of thermodynamics) – your brand is more and more  dispersed; you can’t fight it; embrace it.

Written by Hayk

September 9, 2011 at 7:12 am