Bitcoin and the Blockchain
My attempt to simplify my thoughts regarding the current state (2015, Q2) of bitcoin and the blockchain so that anyone and everyone can understand.
After almost a year of trading bitcoin’s price decline, 2015 has provided the bitcoin community with some positive changes in the reception of bitcoin. The media still remains obsessed with bitcoin’s price volatility while skeptical of its legitimacy. However, the underlying technology for bitcoin, which is known as ‘the blockchain,’ is being portrayed under a much different light. In 2014 alone, VC interest in bitcoin’s infrastructure amounted to almost $350 million (USD) in investments. We are only in the middle of Q2 for 2015 and $300 million has been invested so far in bitcoin related ventures, bringing the total amount invested in bitcoin (without regarding bitcoin’s market cap) to over three quarters of a billion dollars (1). Despite this surge in investment capital and wall street interest, bitcoin’s price has continued to decline since its peak price of over $1200 per bitcoin on Mt. Gox. Today bitcoin is trading in the mid-$200 range. Everyone worrying over the day to day volatility of bitcoin prices fails to take into account the growth period required for over $700 million in investments to take root and starting producing results. Salim Ismail from Singularity University, provides us with a fairly concise summary of how exponential growth comes about (2)…
Exponential Growth takes about 40 years to start, but then catches everyone by surprise, mostly the industry experts. Initially people are very excited about the changes new technology can bring, and then as this doesn’t immediately change the world, people are disappointed and go back to the normal way of being. From there the technology or change gradually builds momentum in the background to being its exponential growth…
The disappointment phase usually stems from the lack of immediate success. For majority of the bitcoin community, price is strongly tied to the success of bitcoin. Due to the continuous stream of investment capital and highly skilled talent pool moving into bitcoin space there seems to be an exciting development or announcement every day. I view one of the most noteworthy events so far as the announcement of NASDAQ’s blockchain project. Most importantly, Michael Casey of the WSJ was able to confirm that the project would be on “THE [bitcoin] blockchain. It’s a colored coin implementation…” (3) The blockchain’s potential to function as a ledger for smart contracts has been known and discussed for quite some time. However, NASDAQ finally making the first move in utilizing the blockchain serves as a pivotal moment in bitcoin’s history.
On May 11, NASDAQ officially announced that it has plans to “leverage blockchain technology as part of an enterprise-wide initiative. Nasdaq will initially leverage the Open Assets Protocol, a colored coin innovation built upon the blockchain…”(4) Simply put, colored coins allow users to tie specific contracts to bitcoins, with each bitcoin or fraction of a bitcoin also being unique. How would NASDAQ make use of colored coins? This simple example should help clear things up…
Company A has is part of NASDAQ’s pilot project.
Ownership of the shares for Company A is documented onto the blockchain.
X amount of bitcoins are then ‘colored’ to represent the corresponding shares for Company A.
– This will most likely be done through a protocol similar to Counterparty (XCP)
Ownership of those colored bitcoins would also represent legal ownership of the shares for Company A.
Afterwards, all transactions pertaining to the shares for Company A can be processed through blocks without need for an intermediary between two peers. Keep in mind that this project relies on bitcoin’s blockchain and therefore is subject to both bitcoin’s strength and weaknesses. This upcoming project along with its pending success has several implications for bitcoin’s value and security.
Bitcoin’s blockchain network is secured through a process called mining. Mining requires users to dedicate computational resources (hash power) towards solving a cryptographic hashing function (SHA256D). The more hash that is dedicated towards mining, the more complex the function becomes. Bitcoin rewards provide users with the incentive to mine and help secure the network. If the value of each bitcoin increases, it is only natural that more and more users will dedicate ever increasing amounts of hash power towards mining. Higher hash rates leads to improved security since attempts to compromise or attack the network will be more costly. Furthermore any compromise to the network can be detected by peers and mitigated, ultimately being at cost to the attacker due to market dynamics.
Since genesis, bitcoin’s overall hash rate has been steadily increasing despite bitcoin’s price decline since almost two years ago.5 Not only is hash rate increasing, mining equipment is becoming more sophisticated, rendering previous mining models more obsolete (refer to Moore’s Law). Increasing number of users who participate in mining bitcoin are faced with the dilemma of mining for a loss since electricity costs have to be accounted for and eventually stop mining or continue to do hoping that bitcoin will increase in time. We are coming to a point where either the hash rate or bitcoin price will have to give.
How does NASDAQ’s project relate to bitcoin’s price or hash rate?
Company A — Z’s shares are documented and secured on blockchain.
Collectively Company A — Z’s shares amount to $1 billion dollars (USD)
If bitcoin’s value falls to $50/ BTC, the entire market cap of bitcoin (around 14 million bitcoins in current circulation) amounts to $700 million dollars. Continued price decline will result in decreased hash rates especially as bitcoin hits new lows.
Securing $1 billion worth of assets on a network that is only worth $700 million does not make sense.
A network with relatively low value is more susceptible to compromise and attacks and would not make a good use case for securing important documentation and contracts.
If there is a security flaw, the project will not succeed. If the project proves successful and more companies are allocated to the blockchain ledger, the bitcoin network would be responsible for securing even larger amounts of value, resulting in security to be of even more utmost importance.
Currently, the largest security exposure in the bitcoin sector is for average users. As bitcoin infrastructure continues to develop, the security risk for day to day users will slowly become smaller and the focus will shift completely to the overall network. Considering recent events and the pending success of NASDAQ’s project, bitcoin’s future looks optimistic including the price. However, there are various other factors that may also play a role in bitcoin’s future such as block size changes, regulation, etc. which will perhaps be explored at another time…
Ref.
1) http://www.coindesk.com/bitcoin-venture-capital/
2) http://www.evolutionpartners.com.au/exponential-growth-vs-linear-thinking-in-management-teams.html
3) https://twitter.com/mikejcasey/status/597545262345682945
Will be doing a follow-up post so re-uploading my previous post on medium for reference.
