#3 Scalability, tropical islands, auctions, and elephants in rooms
We cover some key concepts in crypto, such as scalability, airdrops or stablecoins, and one of the most relevant reputational issues for bitcoin (and this time it's not energy consumption).
Can we publish this now? Please?
After last week’s unexpected meltdown, we had to stop what we were doing to write about it. It seems like we can go back to normal business and publish our 4th newsletter which is, quite curiously, number 3.
Today we are approaching some relevant concepts that we think will help understand better some of crypto’s fundamentals, such as scalability and crypto’s approach to marketing; as well as recent news coming from companies both in the real world (Christies, eBay) and cryptoland (Kraken, Circle).
We won’t be speaking about crypto energy consumption (weird), but we still have time to address another stigma: bitcoin is for drug dealers.
BTW: we have already reached 1000 subscribers! Thanks to everybody. We would love to hear your opinions and questions. Find the different ways of contacting us, at the bottom of the mail.
Scalability
While most bystanders think CO2 emissions, criminal use, high volatility, or Elon’s opinion are some of the fundamental flaws in crypto, the truth is that for insiders, these are either water under the bridge or problems with a solution underway. For them, there are more pressing concerns. Ones that can really jeopardize the future of the ecosystem. Scalability is one of them.
Every blockchain has a limited ability to process transactions. Bitcoin’s blockchain, for example, writes a new block every ten minutes containing ~1MB of information with the details of the transactions. As bitcoin has grown in popularity, this capacity has been proven insufficient.
If the blockchain’s capacity does not grow proportionately to demand, the frictions of use become too big. You have to wait too much for your transactions to be approved, usage fees skyrocket, and all of this lifts a barrier to access the advantages of cryptocurrencies and blockchain-based applications. Crypto would never make it into a worldwide financial solution, and it could be bound to die of success, should this problem not be solved.
For newcomers to crypto, let us take a little break to share an explanation about how blockchains work and why this is important. There’s one metaphor that comes in handy. It takes place on a nice sunny tropical island, and it helps explain the technology, at least from this particular angle.
So we’re on that remote tropical island, hundreds of years ago. An island a few families scattered across a few villages within the island, peacefully coexisting. They usually trade goods between them, but as families get bigger and more families and villages appear, trade becomes more and more complex. To save time transporting goods from one point of the island to another, they build an immense hut in the middle of the island. They will take all the goods there, and instead of handing every item to each other, they will track who owns what through a ledger. The ledger says, for example, that family A has purchased 40 coconuts from family B in exchange for 10 pounds of fish, and family C has purchased a boat from family Din exchange for 400 coconuts (it’s not a very nice boat, tbh). By the end of the day, everyone will check the books, take home what the ledger says they bought, and let go of what the books say they sold.
Initially, that ledger is managed by a single person—a man who tracks transactions and writes them down in order. But over time, this man becomes corrupt. He starts messing with prices, accepting bribes, taking unfair commissions…
The islanders decide to act. There will be no central ledger anymore. Every family will have their own transaction book, handled by a ledger keeper from each who will act as a scribe. A stage is built in the middle of the hut, and every transaction is proclaimed out loud for all the scribes to write down. There’s not one single copy of the ledger, but as many as there are families, which makes bribing or tampering with records so costly it becomes virtually impossible to manipulate the market. By the end of the day, the villagers will compare all notes, and the information contained in the majority of them will be written down in one final book, which will determine who takes what home.
This solution decentralizes supervision, and therefore provides more security to the whole system, but it also makes it slower and less scalable. The more families involved in the process, the more scribes taking notes in their notebooks. More time writing down every transaction and more time, in the end, comparing the final notes.
Back in the real world, in current times, Vitalik Buterin coined the term “the blockchain trilemma” when describing the problem with scalability. It basically says the current state of affairs in crypto can only give you two of these three items: decentralization, security, and capacity. You want as many nodes (=ledger keepers in our island) as possible to guarantee the lack of a centralized, corruptible authority. Plus, an abundance of nodes makes messing with the system increasingly difficult. But also slower. Any tradeoff that makes things faster would require some concessions in terms of the degree of centralization or risk to security.
Many have warned of a Malthusian catastrophe impending over crypto: you can only grow to a certain extent before the whole system collapses. But technology always has some answers, and one of them, or more probably a combination of several, will probably help kick the problem away. Let’s take a quick tour through some possible solutions.
Increasing block capacity. It’s the easiest solution: it immediately creates more space, but what will happen when the current block size becomes too small again? Besides, bigger blocks require better hardware to run a node, hurting decentralization. It is a short-sighted solution that can’t be repeated many times because it would bring back the problem.
Optimizing the blockchain. Bitcoin was already able to trim down the information that entered every block, moving some non-necessary info outside blocks (SegWit, Segregated Witness). Something like allowing ledger keepers in our island to write down only the initials of the names instead of the full names of people involved in transactions. Nevertheless, this looks more like basic maintenance and good table manners. Scalability needs more of a shove.
L2, or second-level solutions. Every Bitcoin or Ethereum transaction pays the same fees, regardless of whether it is a $5 coffee in BTC or a $100 million transaction between wallets on Ethereum. One possible improvement could involve layering blockchains: a slightly less decentralized blockchain that sacrifices a bit of decentralization for very cheap transactions, and the main blockchain would only be used, for example, for daily summaries, limiting the number of operations. This is the approach chosen by Bitcoin’s Lightning Network or Ethereum’s rollups.
A blockchain of blockchains. Instead of having the main blockchain and several sidechains, we can have a mesh of different blockchains with a protocol that connects them to send messages and transactions. It’s a technologically challenging solution, really difficult to implement, but it improves capacity by several magnitude orders. This is the approach followed by Ethereum 2.0 and shards, Polkadot and parachains, and Cosmos and zones.
The implications of scalability are huge, and they can prevent crypto from becoming a global solution. But Malthus was wrong about humans, so maybe there’s hope for crypto.
Can we go back to the island?
⬡ Six Angles
We select six topics to illustrate the very different angles crypto can be approached from. We could choose dozens, but six is the atomic number of carbon… and otherwise we'd be writing for ages.
1. Marketing | Airdrops
Some could say crypto has reinvented the wheel when its startups take an old marketing technique and give it a fancy name. They wouldn’t be one hundred percent wrong. Airdrops are crypto’s couponing system. Change the flyer with a discount for a token and the mailbox where the flyer slides for a cryptographic wallet, and that’s what airdrops are. They consist of depositing units of a cryptocurrency in people’s wallets. Giving away coins, in other words. Sometimes without permission or knowledge from the recipient, sometimes in exchange for social media actions or working email. Still very similar to coupons.
But there’s one important thing about airdrops that makes them different: crypto really relies on network effects. Every user that owns a coin is adding value to the whole of the project by legitimizing it. If they speak about it, use it (maybe in governance systems), exchange it (though not just selling to get rid of them)…they are helping build a legitimacy that is the cement that holds the building blocks of a crypto startup together.
Sometimes people cheat with airdropping by giving coins away to “celebrities,” whose wallet addresses are well known, as a way of making it look like support for the project. This comes to prove airdrops are coupons with mojo.
2. Reputation | Bitcoin’s illicit use
Last week, Nic Carter, crypto ambassador, data nerd, and philosopher, went on live TV to fight one of bitcoin’s longest-standing criticisms: its use for illicit purposes.
Bitcoin’s reputation as a tool for criminals is well-rooted. Some very relevant public financial figures, including Biden’s Treasury Secretary Janet Yellen or Central Bank President Christine Lagarde, have openly shared their reservations, feeding a narrative that dates since the beginnings of the currency. And with the Silk Road (a black market with bitcoin as the only currency) or the Wannacry ransomware attacks (that accepted payment only in bitcoin) providing two of the most popular use cases in the eyes of Main Street consumers, we can understand why.
But according to a recent report by Chainanlysis, a blockchain analysis company that provides investigation to improve compliance and crime-fighting on the blockchain, the dollar is more used for illicit purposes both in absolute and relative terms.
According to an excerpt from Chainalysis’ 2021 report, in 2019, criminal activity represented 2.1% of all cryptocurrency transaction volume (roughly $21.4 billion worth of transfers). In 2020, the criminal share of all cryptocurrency activity fell to just 0.34% ($10.0 billion in transaction volume).
According to the UN, it is estimated that between 2% and 5% of global GDP ($1.6 to $4 trillion) annually is connected with money laundering and illicit activity. This means that criminal activity using cryptocurrency transactions is much smaller than fiat currency and its use is going down year by year.
From the Forbes’ article “The False Narrative of Bitcoin’s Role in Illicit Activity”
Whether you want to believe the words of Nic Carter, Chainalysis, or other advocates for bitcoin’s innocence, some arguments can’t be contested.
In the words of Carter, “any monetary system is going to be used for crime,” and nobody requested a ban on dollars “because Pablo Escobar hid heaps of them in his basement.” Blaming bitcoin for illicit use sounds like killing the messenger as much as it would call for a ban on bank transfers because they help money laundering.
Plus, bitcoin is traceable. In the words of former CIA Director Michael Morell, “the blockchain ledger on which Bitcoin transactions are recorded is an underutilized forensic tool. “ Morell has recently become a public spokesperson for bitcoin, at the request of the Crypto Council for Innovation, a lobby created by some of crypto’s biggest fish Coinbase, Fidelity Square, and Digital Assets. The Council requested analysis to the former CIA head (“the terms of the engagement were that I would “call it as I see it,” with objectivity and transparency,” he claims in the preface), where he concluded that the transparency of the bitcoin blockchain is a greatly underexploited asset against illicit activity. And one that provides even more tools for crime-fighting than the available ones for other traditional payment systems.
Whether you want to believe the data provided by Chainalysis or not, these two fundamental aspects about cryptocurrencies should make everyone request more depth from bitcoin’s critics when claiming its nefarious use.
3. Auctions | eBay & Christies
“Any form of collecting is about the convergence of passion, interest, and opportunity.” Where do you think this quote comes from? It is either from eBay’s blog or Christie’s webpage.
Both auctioneers have made it to the timelines of crypto Twitter recently. In such nefarious times for crypto as the last month, eBay and Christies provide some light rays, offering more examples of mainstream adoption.
The case of Christie’s is not new. The biggest auction house in the world sold 9 Cryptopunks, belonging to the Larva Labs founders’ own collection for just under $17M. Maybe the oddest part is that Cryptopunks were sold alongside a skull painting by Basquiat, sold for $93M.
This is not the first time Christie’s enters the realm of crypto art. Just a few months ago, Christie’s sold Beeple’s digital artwork for a whopping $69M.
Beeple made history – and Christie’s made history by proxy – by selling a work that exists only digitally, a JPEG that can be freely accessed and stored by anybody with an internet connection and some spare megabytes of memory. (Forbes).
And this is not the last case. Christie’s is on an NFT streak. Just two days after the Cryptopunk’s auction, model Emily Ratajkowski sold the ownership of an Instagram picture of her for $140k. And a few weeks later, they sold some pieces of digital art unearthed from floppy disks belonging to Andy Warhol for over $3M. It seems appropriate that Warhol is the artist who inaugurated this peculiar fusion between the old and the new.
The case of eBay is slightly different. The ecommerce site recently announced it would start allowing the sale of NFTs on their platform, although within some limits. Only certain trusted sellers, and only using their traditional forms of payment, although the company admits to being exploring the possibilities of accepting cryptocurrencies.
In both cases, though, there seems to be a perfect fit. NFTs do have a place in the adult world.
The quote at the beginning, by the way, is from eBay. Jordan Sweetnam, SVP, wrote it in eBay’s blog.
4. IPOs | Kraken and Circle
When Coinbase finally crossed the street and joined the mainstream financial market through their IPO, we all wondered who could be the next. Two candidates are taking clear steps: they are Kraken and Circle.
Kraken is one of crypto’s historical exchanges. You can call a company founded in 2011 historical only when their reason to exist, in this case, bitcoin, only predates them by two years. It has been one of the most relevant accelerators of crypto adoption in its ten years of life. Companies such as Kraken or Coinbase are what banks invented in and for crypto look like.
Kraken’s IPO has been on the radar for a while now. The recent price drop cast a certain shadow of doubt over it. The possible regulatory interventions that partly caused the dip sparked some rumors of Kraken considering leaving the US. But the company is showing commitment with its IPO, which will likely happen in 2022, with a valuation currently estimated at $4BN. Dan Held, director of Growth Marketing ad Kraken, claimed recently that “everything seems to still be on track for a direct listing sometime in 2022”.
Circle is another company taking steps towards the mainstream market. Circle is a payment and treasury infrastructure that is bringing the power of stablecoins to the public. Circle recently raised $440M in a movement that is being interpreted as preceding a SPAC deal. SPAC (Special Purpose Acquisition Companies) are corporate vehicles for public finance. Companies with no operations formed to raise capital. Circle’s SPAC, incidentally, is said to have a target valuation of $4BN.
Meet the $4BN crypto team.
5. One chart | Stablecoins
In our “meltdown special edition” of crypto digest, we mentioned that, while the price of assets (BTC, ETH, you name it) was taking a gigantic blow, there were objective reasons for optimism. We can still not be certain about what will happen shortly. Still, it looks like the recent earthquake had a psychological explanation: there were good reasons for the fear, indeed, with the regulatory omens, but the foundations of the crypto ecosystem looked strong enough to take the punches. The April 2021 crisis never looked like it was the death of the crypto economy. Some on-chain metrics provided a look through the smoke and ashes and allowed for a colder analysis.
We mentioned, for example, NVT price and ratio (an estimation of bitcoin’s value based on the activity on the blockchain and not the price displayed in payment platforms). There are other possible KPIs, such as active bitcoin or Ethereum wallets, which could be the equivalent of the number of opened bank accounts. Today we will be looking at stablecoins in circulation.
Stablecoins deserves a post for itself-they will soon have it; here’s our promise -. They are one of the most important ramps into crypto and an asset that has become an engine for the system. Stablecoins are cryptocurrencies whose value is tied to an outside asset, such as USD or EUR. They take the benefits of crypto (transaction speed, decentralization…) and take away the volatility, making them a currency great for usage, more than investment.
During the last dip, the number of stablecoins did not diminish. Many investors exchanged crypto assets for stablecoins but did not convert those stablecoins into euros or dollars. The money did not leave the system. It just stood on the sidewalk, waiting to come back on the road.
6. Analysis | What now?
We should probably address the elephant in the room and give our opinion on where we are standing now and what will happen next. Here’s our take, with a disclaimer: we don’t know what is going to happen. If someone pretends to know… don’t trust them.
It seems like the big earthquake is over. Prices are slowly recovering, and we can see signals of long-term holders buying again.
There is no news (no news = good news) from China or other regulatory bodies. The FUD might still be there, but now it’s more like a hangover. Some Chinese farmers are moving their activity elsewhere, to places such as Kazakhstan, or selling their hardware. But the panic is gone.
Is crypto warming up to get out on the field again? We can’t tell, nobody can, but we do believe.
Last week we reached +1000 subscribers in our newsletter (remember, we have a Spanish version too, “suscríbanse”). Now that we are starting to build a community, we would like to write about your areas of interest or concern. So if there is any topic you want us to adress, write us at info@carbono.com, or reach out to @carbono_com, @raulmarcosl or @mrubio on Twitter.