Category Archives: Bitcoin

A Flash of Insights on Lightning Network

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I invented the Lightning Network.

Well, not really. But to the best of my knowledge, I was the first person to write a post describing something similar to how LN is conceived today.

I’m not saying this to take credit for its advent – it’s not like I really did anything. Others have invented the concept of micropayment channels on which my suggestion relied, and I only threw out some rough ideas; I didn’t present a full-fledged design, let alone wrote any code.

I’m saying this to emphasize the point that for some of us, that has always been the vision. One of the first burning questions I had when I was first introduced to Bitcoin was how the whole thing was supposed to scale. Concepts I’ve learned of since then – like SPV and pruning – helped, but I wasn’t completely satisfied. Ever since I heard about channels and thought about how they could be used in a network, that would become one of the first things I would reference whenever discussions of scalability came up.

The ability to use an on-chain transaction to anchor a channel, so that real bitcoins can be sent over it without having to bother the entire network or wait for confirmations for every payment – in such a way that the channel can always be closed unilaterally to recover the funds as normal bitcoins sitting in an address you control – is an idea so powerful that I can’t imagine how can anyone resist falling in love with it.

But the reason I am so excited about the development of LN is not that the vision I had is finally being brought to life.

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Lunch is being served

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I was at a conference yesterday. Estimates say that 1000 people attended. At 15:00 people have left the lecture halls and swarmed the lunch hall.

The rate at which food can be dispensed is finite, so people had to wait a long time in line to reach the coveted buffet. Those who decided to wait half an hour before going to eat (and struggle to find something to do in that time, seeing as everyone is eating), could get to the food without effort – but may have missed an opportunity to enjoy the entire variety the meal started with.

Likewise, when everyone is off the clock at the same time and drive home, they encounter traffic – but those who wait until 3 AM to hit the road, has the whole road to himself. This is the way of many aspects of life – if you try to do something at the same time many others are, you will run into overload.

Bitcoin is the conference, and lunch is being served. We are amidst a wave of interest in Bitcoin and its kin. This is not the first wave of its kind, but it is the biggest so far in absolute terms. Anyone who tries to go into the field at the same time as everyone else, sees that every system collapses under the load.

It begins with the Bitcoin network itself, where demand for transactions exceeds the available block space, and transaction fees go up.

Exchange services get hundreds of requests daily, and sometimes there are delays or missed messages.

Among the hosted wallets, those that are considered more reliable (such as Coinbase) are overloaded and struggle to handle support requests.

Other hosted wallets, which to begin with had been a scam, have decided that now is the time to pack their bags and vanish.

Public forums are overloaded, every thread is buried under many others within an hour, and there are more newbies asking questions than veterans who can answer them.

Physical community hubs are overloaded, and people who bother to arrive in person and consult, have to wait in line until an ambassador is free to assist them.

I, personally, am also overloaded with both messages and strategic activity, and one comes at the expense of the other.

When someone encounters a problem, it is hard to tell if she had unfortunately stumbled upon a scam, or whether it is a legitimate service that is experiencing load, or there is overload in the Bitcoin network, or that herself she erred in handling the wallet. And when she comes to ask and consult, she has trouble receiving answers.

Some people have lost money due to this whole mess.

Sad and doesn’t further a solution, but that is the situation today. For those who cannot accept that, I truly recommend to pass for the time being on buying Bitcoin (or Ether or ICO tokens or anything else). He can wait until the dust settles and things clear up, and one of two will happen – either the wave of interest will fade, and we go back to earlier demand levels which the systems can handle; or demand continues to grow, and over times the systems will upgrade to handle it – Segwit will be enabled, exchangers will hire more staff, and the community will muster more knowledgeable people who can support the newcomer.

If someone thinks that if he does not but bitcoins this very moment, he will miss the opportunity to get rich… Well, I can’t really tell him not to buy, and I do of course in favor of bitcoins being distributed among as many people as possible, and not concentrated in the hands of a few veterans. But he should know what he is going into, and not complain about anyone else but himself.

If you can’t take the heat, stay out of the kitchen.

And God said, “Let there be a split!” and there was a split.

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A year ago, I’ve written How I learned to stop worrying and love the fork, espousing my view that a split of Bitcoin into two networks is possible, and might even be good under the right circumstances and with proper preparations.

Half a year ago, I’ve followed up with I disapprove of Bitcoin splitting, but I’ll defend to the death its right to do it, which elaborated a bit and aimed to refute some misinformation.

I’ve been meaning to write another followup to address some questions that have been raised…

And then Ethereum Classic happened.

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I disapprove of Bitcoin splitting, but I’ll defend to the death its right to do it

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In a slideshow published by Brian Armstrong, CEO of Coinbase, he promotes the view that Bitcoin is currently undergoing a winner-takes-all elections, and that variety in Bitcoin protocols is akin to variety in web browsers.

I find this incorrect, misleading and destructive.

Unlike physical currencies, governed by the laws of nature, and centralized currencies, governed by the whims of their issuers, it’s not at all obvious what ultimately governs a decentralized digital currency such as Bitcoin. There’s the protocol and the code, of course, but those are mutable and thus adhere to a higher authority.

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How I learned to stop worrying and love the fork

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It’s hot in Israel in August, but not nearly as hot as the global debate surrounding the release of Bitcoin-XT and the contentious hard fork that would ensue if enough people adopt it. It seems that both proponents and opponents of Bitcoin-XT dread the possibility of the network splitting in two, and focus on making sure everyone switches to their side to prevent this from happening. Contrary to this post’s title, I don’t actually like the prospect of a fork; but I do claim that having two networks coexist side-by-side is a real possibility, that it is not the end of the world, and that we should spend more energy on preparing for this contingency.

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What is real? And what is virtual?

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The word “virtual” has several meanings. But the most obvious meaning people think of is “not real”. The uninformed often call Bitcoin a “virtual currency”, and contrast it with “real currency” such as the US dollar.

This is of course nonsensical. You could make stronger arguments for Bitcoin being real than for the US dollar. This is why Bitcoin should be more correctly referred to as a “digital currency”, emphasizing the fact that its existence consists in bits of digital information; or as a “cryptographic currency”, emphasizing that its operation is based on cryptography.

Similarly, the defining feature of the US dollar and its kin is that their issuing and usage is mandated by governments (regardless of whether an external body such as the Federal Reserve is charged with doing the actual issuing), and thus should be referred to as “government currency”. Alternatively, the terms “traditional currency” and “legacy currency” are slightly broader and emphasize that this is the kind of currency we have used so far. The term “fiat currency” is sometimes used to mean government currency, but personally I am not fond of that, as the literal meaning of the term is too broad.

A deeper understanding of the phrase “virtual currency” can be achieved only by contrasting it with something which is truly a virtual currency, such as World of Warcraft Gold. In the WoW game, virtual warriors are paying virtual gold to buy virtual swords with which to slay virtual dragons (or something like that. I’ve never actually played WoW).

None of this is real. Dragons of the kind featured in WoW have never existed in our physical universe. The WoW Gold does not correspond to any actual Au atoms. These are things that exist only in the virtual, simulated world.

The virtual dragons are encoded as bits, manifested as electrical and magnetic signals on computing devices somewhere. The bits are very real – they are configurations of actual electrons in our universe. But they are bits, not dragons.

Within the virtual world, the WoW gold is the ubiquitous currency used by the population, it is actual metal the people go out and mine, and it is not controlled by anyone. As such, the WoW gold is a virtual, physical, decentralized currency.

But just as the virtual dragons double as real bits, the WoW gold doubles as a real, digital, centralized currency.

The owners of this currency are the real players with user accounts that possess WoW Gold. And it has real value – real people offer real money (such as USD) to get WoW Gold, because they prefer to spend their real time playing WoW and slaying virtual dragons than farming virtual gold. And there are real sweatshops in China where real people work in real terrible conditions to play the game, earn WoW Gold, and sell it to aforementioned real players.

Of course, as a real digital currency, WoW Gold is centralized and is thus barely usable. It is completely controlled by Blizzard, hence is inefficient, and tricky to use because, AFAIK, its exchange for things of real value is an EULA violation. So WoW Gold is a bad real currency, whose saving grace is the extra semantics placed on it by the controlling company – which is entitlement to in-game virtual currency.

Since WoW Gold and its kin double as both digital currency and virtual currency, it is easy to see why people would get confused. But the contrast with Bitcoin becomes clear: It is digital, but it is not virtual. There is no virtual world in which Bitcoin is the currency. Rather, it is a currency used in our real world to pay for real products and services. It is digital and still fledgling, to be sure – but unlike WoW Gold, which is centralized and thus a bad currency, Bitcoin is decentralized and has all it takes to become a ubiquitous currency.

When in doubt, we should remember – that which vanishes is virtual, that which remains is real.

Multi-PPS: Dissolving mining pool centralization

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The Bitcoinsphere is abuzz with news of the GHash.io mining pool exceeding 50% of the Bitcoin network hashrate, which is of course in contrast with Bitcoin’s decentralized vision.

While it is indeed worrisome, I personally believe it is not something to panic about, as the underlying causes are solvable and we should not see such a phenomenon recur going forward.

The current centralization is the result of two distinct causes. One is the concentration of mining within a few large mining farms, often controlled by those who manufacture mining ASIC chips. These either take the mining risk themselves or forward it by offering mining contracts to the public. This is made possible by the economies of scale in building machines and operating them that large entities enjoy. This is indeed a problem, however, I believe this will be alleviated somewhat as SHA-256 computation becomes more of a commodity, as I claimed in ASIC will not Centralize Bitcoin Mining.

The second cause is that even individual miners who operate their own machine independently, use these machines in conjunction with large mining pools. The reason is, that with all classical mining pool reward methods, the larger a pool is, the better performance it can offer its miners in terms of the tradeoff between variance, fees and maturity time. A large pool will be more lucrative and hence attract more miners and become even larger, with the ultimate limit being consolidation within one pool.

Fortunately, I believe the latter cause is easily solvable. All it takes is using a reward framework that does not lead to “the rich get richer” effect. P2pool is often cited as a possible such framework, but while it has its merits, I do not believe it has what it takes to offer a sustainable solution, mostly due to the difficulty of small miners to use it.

Starting with p2pool as a basis, thinking what can be done with it and following it to its logical conclusion, I arrived at Multi-PPS, which I wrote about a year ago. Its basic premise is that miners should mine in multiple pools simultaneously, in proportion to each pool’s strength. Using this framework has two important features:

  1. The miner enjoys performance that is equivalent to that of a pool with a combined size of all pools he uses together.
  2. The stable equilibrium is not consolidation in one pool, but rather, maintaining a distribution between many pools according to the merits of each.

Of course, implementing this is nontrivial, and there are some technical performance issues to consider; however, the numbers do look promising, and the effort in implementing it is small relative to the potential gain. More details are available in the linked post.

Because this is such a hotly debated topic now and this proposed solution receives too little attention for my taste, I have decided to choose it as the topic for my technical talk in the upcoming Inside Bitcoin Tel Aviv Conference at the end of July.

Mtgox post mortem

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(I’m assuming the rumors of Mtgox’s demise are not exaggerated, though it’s too early to tell).

It can currently be expected that whoever had money stored in Mtgox, will not see it again.

I am truly sorry for all those who have lost their money this way, certainly if this is a significant amount or even the entirety of their bitcoins.

But I also believe that people should take responsibility for their decisions and not expect too much sympathy if they make mistakes that cause them harm. I, too, have done nonsensical things which cost me a lot of money, and I try not to blame for them anything or anyone but myself.

Holding a significant amount of bitcoins on Mtgox was a mistake. Not just any mistake, but an antithesis to a core idea of Bitcoin. Bitcoin is about being decentralized and not having to trust anyone else to use. So what is the point with trusting all of your money with someone else?

There is a simple rule for trust – weigh what the other side has to gain from embezzlement, and what he has to lose. Anyone holding quantities of money for many people has a very strong incentive to get up and run, even if he has a successful business. 4 years in the market is really not enough time to build a reputation and trust that will justify deposits in the amounts Mtgox had.

And it’s not like Mtgox had a clear track record in these years. They’ve had lots of hacks and a variety of problems, and for almost a year it’s been nearly impossible to withdraw USD and there have been talks about insolvency.

Perhaps in a few years there will be a service reliable enough for the simple individual to trust with their money (preferably with a multisig arrangement or suchlike). But for now we are all early adopters and we should make the effort to learn how to store our bitcoins securely. It’s not trivial but not rocket science, and there are guides such as my previous post about paper wallets. Even with some basic methods you can reach a high level of surety. We hear all the time about people losing money they trusted with someone else, but despite all the talk of hackers we rarely hear of people whose own wallets were hacked. One can also divide his funds between different places (one of which could have been Mtgox) so that if anything happens one would not remain with nothing.

Back to the subject at hand. There are two problems with holding bitcoins on Mtgox. One is that an Mtgox wallet is not really designed for everyday use, so whoever has his money there is in fact stating that he has no interest in using Bitcoin but sees it purely as a speculative investment. This is not a problem in itself – it is legitimate to believe in Bitcoin and to want to profit from this belief. But part of this belief should be a belief in using Bitcoin in the way it was designed. And putting all of your bitcoins with someone without sufficient reputation and without layers of cryptographic or regulatory protection is not the way Bitcoin was meant to be used. So in essence, whoever has put his money with Mtgox is looking to profit from a belief but is not really acting on this belief. (Either that, or he doesn’t really believe in Bitcoin and simply wants to ride a trend, which is worse.)

For a long time people proficient with Bitcoin have been recommending not to hold funds in shared wallets such as Mtgox. I point that out not for gloating or a childish “told you so”, but simply to clarify that this is not hindsight, putting money in Mtgox is problematic and one could have known it was problematic. This must be taken in consideration to understand that the problem is not with Bitcoin, and to learn from it how to be more careful in the future.

I should clarify that exchanges are necessary, but this is what they are, exchanges. People who want to invest in Bitcoin, should buy and get them out of the exchange. People who want to day trade, should weight the profits of trading against the risks of holding money there.

The summary of the Mtgox issue is that (probably) an exchange that has been struggling for a long time is shutting down, and people who acted against the spirit of Bitcoin lost from it. The implications for Bitcoin are not major, beyond a self-fulfilling prophecy – people think this has implications for Bitcoin, and that itself harms Bitcoin.

I hope we all learn something from this story, and that despite the pain we will not stop believing in Bitcoin. It is not the currency which has failed us, it is us who have failed the currency.

How to create a reasonably secure Bitcoin paper wallet

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tl;dr: If you don’t want the explanations, just follow the bolded instructions.

Some of us want to store a sizable amount of bitcoins as a long-term investment or savings. We need a way to store our keys (the pieces of data that give us, and only us, access to our coins) that will be safe from both loss and theft; but we do not care about them being easily usable on a daily basis. A great way to do this is paper wallets – storing our keys on printed pieces of paper.

Following this tutorial will allow you to create your very own paper wallet.

1. Go to https://raw.github.com/pointbiz/bitaddress.org/master/bitaddress.org.html. This is essentially a program that allows you to create keys (and corresponding Bitcoin addresses) in an easily printable form. Ignore the text you see when visiting the page.

2. In your browser’s menu, choose “Save page as” to save this file somewhere on your computer. All browsers have an option to do this, even if differently named. if you can’t find it try simply pressing Ctrl+S.

3. Disconnect your computer from the internet. This is very important. Your secure, offline paper wallet will be of no use if the generated keys are sent to an attacker by malicious software through an internet connection.

4. Open the file bitaddress.org.html you saved earlier (by double-clicking it). You’re not going to get your keys from the website’s server – rather, the page you’ve downloaded contains the program needed to generate the keys locally on your computer, using your browser. For this, it is best to download a copy of the page. Preferably, you should disable any addons running on your browser, for example, by running in incognito mode.

5. Go to the “Bulk Wallet” tab. The site contains many different options for generating paper wallets, but I find this one to be the best. It’s no-nonsense and allows you to print many addresses at once.

6. Choose the number of addresses you wish to print (e.g., 50), fill it in “Rows to generate”, and click “Generate”. Use as many as you can fit in a printed page in big enough letters to be easily readable.

7. Connect a printer with a USB cable. Of course you will need a printer for this. It’s safest to disconnect the computer entirely from any network, so this leaves USB for the connection. (I’m assuming you’re not using a parallel port for this…)

8. Click the page’s “Print” button to print several copies of a paper with the keys and corresponding addresses.

9. Create a file with the Bitcoin addresses (the shorter strings starting with “1”).

10. Make sure you have not saved the private keys (the longer strings starting with “5”, “K” or “L”) anywhere on the computer.

11. Clear your browser cache. This will decrease the chance that your browser keeps the keys. Instructions on how to do this on various browsers is available at http://www.wikihow.com/Clear-Your-Browser%27s-Cache.

12. Reset the computer. This will prevent malware from sending keys it has stored in the computer’s memory.

13. Reconnect the computer to the internet. It is safe to do so now with any trace of the keys erased.

14. Store the paper copies in multiple secure locations – a safe in your house, a relative, a safety deposit box, etc. Keep in mind that if a thief that understands Bitcoin gets his hand on one of the copies, the coins are gone. If all of the papers are lost or damaged to the point of illegibility, the coins are gone.

15. Send the bitcoins you’re saving to addresses in your paper wallet. You could send all of them to one address, but there are several advantages not to store too much on a single address. Split the coins however you see fit. You can always add more coins to any of the addresses. You can save most of the addresses you printed for future use. Keep in mind – once you send from an address, it is no longer secure and you will need to store your funds in the other addresses.

16. Eventually, you’ll want to actually use the funds stored on the paper wallet. That’s a problem for future you, but it is still useful to try this out so you know you can. Most clients have a feature for “importing” a private key – including Bitcoin-QT, blockchain.info and some hosted wallets. Try this option in your client of choice. The most secure method is to import the key into an offline wallet – for example, using Armory. This is fairly complicated now, but hopefully by the time you want to do it, the software and hardware to make it easier will exist.

Extra credit: As the title implies, this procedure will allow you to create a reasonably secure paper wallet. I’ve avoided some cautionary measures that I deemed would deter most users – perfect is the enemy of the good. If you do, however, want a more secure wallet, here are some more things you could do:

1. Make sure bitaddress.org is what it should be. In theory, the website from which you download the generation software could be hacked and replaced with malicious content. A simple way to protect against this is to search the web for mentions of “bitaddress was hacked”. A harder one is to compare the webpage’s SHA1 hash against the digitally signed hash.

2. Use a Linux live CD. Linux is less vulnerable to malware than Windows. This is true regardless of whether the reason is Linux being inherently more secure or hackers not bothering writing malware for it. If you don’t already use Linux, you don’t even have to install it – you can run it directly from the installation disc. For example, you can use Ubuntu for this – burn an Ubuntu live CD, and follow the procedure after booting from it.

3. Use a multi-factor system, such as multisig, SSSS or key encryption. You can encrypt your keys before printing them, so that stealing the paper will be useless without the password. However, a password strong enough to offer meaningful protection will be too hard to remember – you’d probably want to write it down; so this is really a primitive version of SSSS. Shamir’s Secret Sharing Scheme allows you to split the keys into n pieces, so that m pieces are required to recover the key. You can place the pieces in different places knowing that several pieces will need to be stolen to compromise the coins. The security of this, however, still relies on the computer in which the key is generated and split and on which it is combined and used. Using a multi-signature address is more secure, but also more complicated.

4. Don’t trust your printer – printers have memory which, combined with malicious firmware, could send their copies to an attacker once connected to the network. I don’t think this is a very serious risk, and I don’t know of countermeasures other than forgoing the printer and hand-writing the keys.

Additional tips:

1. Not all fonts are created equal. In some it is difficult to tell capital letters from small ones, which may create problems when you try to import the keys. Choose a clear font.

2. Consider laminating the papers, or using similar measures to protect them from damage.

3. bitaddress.org also allows creating QR codes for the keys. This is more space-consuming, but allows easier import.

Disclaimer: Use at your own risk! Even with the best security practices there can be failures; and these suggestions aim to balance security with accessibility rather than maximize security. I offer absolutely no warranty or guarantee and will take absolutely no responsibility if this guide leads, either directly or indirectly, to loss of coins or any other harm.

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.