Monthly Archives: November 2013

Naive views of financial markets

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When I was a child, I did not really understand stock markets.

Sure enough, I knew that every corporation had stock; I knew that the stock price could go up and down; I knew you could buy stocks and profit or lose accordingly. But I thought these were all just numbers going up and down randomly. I did not know what caused these changes, or indeed, that they were caused by anything at all.

I recall one day when my father referred to the CEO of some company as being successful, seeing that he managed to bring the company’s stock price up. I was confused. Stock prices just behave randomly, right? How is the price going up any indication of that person’s performance?

As I grew up, I have learned that the goal of a corporation is to generate profit; I’ve learned that the company shares these profits with shareholders in the form of dividends; that people are willing to pay for the stock in order to enjoy these dividends, either directly or indirectly. The greater the profit potential of a company, the higher the price people will be willing to pay for its stock. If the stock price goes up, it is because the company is doing something right, and by extension, so do the people in it.

It surprises and saddens me that these days, “professional” economists hold the same naive views about financial markets that I did as a child, at least as far as their criticism of Bitcoin goes. They talk about how the exchange rate of Bitcoin goes up and down wildly without representing anything; how it is stupid to buy bitcoins; how people who want to gamble are better off in the casino or the stock market.

What they fail to mention is that Bitcoin is the world’s first decentralized digital currency. It is like the money we know, only better (in about a dozen ways). In the same way that companies generate profit, currencies facilitate commerce. The better the currency is at its job, the more it will be in demand, and the higher the price people will be willing to pay for it. And Bitcoin has what it takes to be great at its job.

For sure, there is a lot of uncertainty and speculation. If you look at the price of any traded asset, Bitcoin included, in a short enough time scale, it will be indistinguishable from Brownian motion. The short-term fluctuations are noise. But the long-term upward trend from 0 to the $700 range is the signal. It means that Bitcoin is getting better and better at its job, thanks to the brilliance and hard work of its inventor and supporters.

Bitcoin is not about the price going up, that is just a natural side effect of doing well what it is about. People who profited from it are, for the most part, not people who gambled and won – but people who had the foresight to see something big is happening, spent the time to learn what this is, understood what Bitcoin is about, believed that it would be successful, and were right. In so doing, they helped Bitcoin become what it is today, and for that they are fairly rewarded.

So to all the investment advisors that hold the financial worldview of a 10 year old, my message is – please, grow up.

Hashrate amplification attacks

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A lot of people asked me about the recent paper by Ittay Eyal and Emin Gun Sirer, titled Majority is not Enough: Bitcoin Mining is Vulnerable.

In this paper they describe a hashrate amplification attack – a way to find a greater percentage of the total valid blocks in the network than an attacker’s portion of the hashrate would indicate, potentially leading to dire consequences.

I really wish I had the time right now to examine this paper thoroughly. It’s a topic that interests me, I want to be up to date on Bitcoin research, and I’d be able to comment much more intelligently if I did. Unfortunately, as is often the case with me, I am wholly occupied right now with previous commitments and barely have a minute to spare.

But precisely because of this, I want to save some time by writing down a single response I can direct people to. And I believe I have enough understanding of the issue to say this:

  1. The basic idea of the attack is not new; it can be traced at least 3 years back. Nobody seemed to panic about it back then, and no reason we should start now. I did not participate in the original discussion but have read it with interest, and mentioned it whenever the topic came up. I had half a mind to conduct a more thorough research of it myself, but could never allocate the time.
  2. They’re not the only ones to perform a detailed analysis of the attack. Over the past few months, a young Israeli researcher called Lear Bahack has independently studied the same issues. As it happened, one day before Eyal’s and Sirer’s paper was published, I sat down with Lear to discuss his results. My impression is that his research is more detailed, accurate, and thought out. He unfortunately was beat to publishing the results, but we will soon see him write about his innovations.
  3. According to Lear, the attack is not nearly as easy to carry out as Eyal and Sirer would have us believe, in particular due to unrealistic assumptions about the network topology and the operation of mining pools. There is no real danger in the near future.
  4. He also suggested a protocol change that could remove this vulnerability, which we should hear about soon.
  5. The paper title and the way they write about it elsewhere is alarmist and self-centered. They give the impression they feel they’re the first ever to find a vulnerability with Bitcoin, and try to sow panic with talks about how Bitcoin is broken. I’ll take their word for them honestly being motivated by the desire to get the potential attack thwarted before any damage is done (EDIT: I did until I saw this), but it certainly looks like they’re just after the publicity, maybe even seeking profit from price manipulation.
    It’s not the first time we see alarmist headlines inspired by academic papers. It happened with the transaction graph work of Adi Shamir et al., and with the red balloons work of Aviv Zohar et al. But in those cases the researcher gave a neutral description and the media blew it out of all proportion. It is unfortunate that in this case, the sensationalism comes from the researchers themselves.

All this notwithstanding, we should thank Ittay Eyal and Emin Gun Sirer for their work on this interesting and potentially important topic. Stay tuned for further developments.

Updates:

Lear has published a sample of his results in this forum post, and also put up his paper (work in progress) at http://arxiv.org/pdf/1312.7013.pdf.