Hash Power, Pt 1
I had been looking forward to Patrick O’Shaughnessy’s latest podcast about blockchains and cryptocurrencies for a while. With an abundance…
I had been looking forward to Patrick O’Shaughnessy’s latest podcast about blockchains and cryptocurrencies for a while. With an abundance of information on the subject and a fixed amount of time to absorb it, there’s a Red Queen effect dynamic where you’re fighting just to keep up. A futile quest, as I am learning more and more. This series of conversations with some of the brightest minds in the blockchain space puts things in perspective. It’s easy to get caught up in the minutia. That’s not to diminish the importance of the technical details, but sometimes it’s helpful to take a step back.
There were four takeaways that stood out:
Coordinating self-interested creatures is hard
Narratives have serious flywheel effects
Incentives are powerful
More power is accruing to individuals
Below are some of the notes and related takeaways I took in this series of conversations. Really looking forward for the next couple of episodes.
Irrefutable Proof of Ownership
Jeremiah Lowin — Head of Risk Management at a family office/ML expert
Blockchains are distributed, append-only databases that are hosted by tons of computers across the world. Whereas conventional databases and ledgers have been kept in house and simultaneously obtained by a third party, blockchains provide an alternate solution. Historically, databases have been operated on a central server owned by some entity. Blockchains remove the need for that centrally owned server because the “owners” are now the individual nodes on the network that contribute value to it in some fashion. Modifications and changes in ownership aren’t determined by a central entity, but rather by the participants in the network.
“I can own, and prove that I own a digital asset. Now maybe that becomes more interesting than just an MP3 file. Maybe that’s a key to my house as a digital asset on my phone. And sure, anyone can show up with the 1’s and 0’s that represent that key, but only I will be allowed into the house because I’m the one that the blockchain, the database shows is the owner of that key.” — JL
Organizing Self-Interested Individuals
Naval Ravikant —founder, CEO, angel investor, crypto investor
“Blockchains give us a new way to organize humans.” — Naval
Humans are inherently self-interested creatures, so the task of organizing them is an important one. This is partially done through creating incentive structures which compel individuals to unite around a certain goal. Effective incentive structures tend to stem from scenarios where each party derives material benefit and value in exchange for a good or service they provide.
So how do you organize a massive group of inherently self-interested individuals (Adam Smith’s words, not mine) who, despite what traditional economic theory assumes, are inclined to make irrational decisions influenced (explicitly or implicitly) by a laundry list of cognitive distortions and logical fallacies? Yuval Harari ascribes the persistence and survival of homo sapiens in part to their ability to tell stories. They can unify an otherwise self-interested group of individuals around something bigger than themselves.
“Harari in Sapiens laid out the interesting example of how human beings wiped out Neanderthals. You can only get a few hundred Neanderthals on a battlefield because those are the ones related by blood. But you can get thousands of humans on a battlefield because they imagine themselves as Christians or Americans or whatever. And those are just stories they’ve told each other. But the storytelling power that enables us to organize is really powerful. Like the United States is a story that we’re all Americans. The Ford Motor Company is a story. Capitalism is a story. Money is a story and even beyond just being a story, the best of these stories are actually networks. These are stories where we have rules of operation and cooperation. So for example we know what it means to be a US citizen. So we get certain rights, we have certain obligations, it’s a story that’s used to stitch together a certain network and that network is now the most powerful institution in the world.” — Naval
How do you organize this large group of people have come together around a common identity propelled through a story? Unification alone is insufficient. Organizing and coordinating are critical to get things done. Historically, there have been several mechanisms:
King or an emperor — someone in charge to punish those who “cheat”
Aristocracy or an elite in charge
Democracy — mob is in charge
Market — most recent solution. Open network organized based on merit. You have to actually contribute something to the network that’s valuable to get your way in.
“Blockchains bring market-based organization into all kinds of networks where it was not available before.” — Naval
Network Effects on Steroids
Patrick O’Shaughnessy
Bitcoin is an example of a network that appreciates in value as more people buy into in it. Patrick references George Soros’ concept of reflexivity, or a self-fulfilling prophecy. Acquiring customers is a massive challenge when trying to scale a business. Customer acquisition cost is often a disproportionately large component of a startup’s expenses. The hope is that the value generated from that customer throughout the life of her relationship with the company is greater than the initial cost of acquisition. Net Promoter Score is so valuable partially because if other people market a product based on their positive experience, the company doesn’t have to. In the case of Bitcoin, users and owners have every incentive to both expand the breadth of adoption and build the underlying network because value appreciates as the adoption grows.
Chris Dixon of Andreessen Horowitz recently said that in his experience, “99% of networks fail in the bootstrap phase.” The implicit incentive structures within blockchains provide a potential solution to that problem.
Permissionless Innovation & Tracking Scarcity
Naval Ravikant
“A society gives you money for giving society what it wants. Blockchains give you coins for giving the network what it wants.”
Blockchain protocols are self-organizing and permissionless.
“What blockchains allow us to do is build scarce protocols and keep track of scarcity. Now when you’re keeping track of scarcity, you need some way to say, OK, this bandwidth now belongs to that person. This file storage now belongs to that machine. Any blockchain, because it’s essentially allocating scarce resources, needs to have a token to keep track of these scarce resources. There are a few marginal use cases where you can use a blockchain without a token. But almost always it makes sense to use a token. It’s almost built into the definition.” — Naval
Individual Sovereignty
Naval
“The history of the human race is that we’ve managed to create more and more, but it’s been harder and harder to hold on to.”
“Every human now has trillions of transistors working for them across the world. Doing all kinds of intellectually menial tasks that they wouldn’t want to do. So the trend of the Internet, the trend of computing, has been democratization of power, of intellectual power. It’s democratization of creating and holding onto wealth.” — Naval
We have historically relied on institutions to protect what we make and what we own. Laws, social contracts, and punishment imposed by an entity larger than you have been integral parts of maintaining ownership. Blockchains put the power in the hands of the individual and remove the need for a trusted third party, be it a government, organization, union, etc to enforce rules to protect people’s rights and possessions. This is empowerment of the individual also provides another benefit that Nick Szabo has espoused for years: “trusted third parties are security holes.” By removing them, it minimizes the risk of potential security issues. The risk is diversified across thousands (or more) nodes within a given network.
“Blockchains are part of the opposite trend. Blockchains make it possible for humans to trade, communicate, and hold onto wealth by themselves. So now you have a model where you can create something and hold onto it without having a sovereign or a lord or someone with a bigger weapon or gun protect it.” — Naval
Programmable Incentive Structures
Fred Ehrsam — ex-FX trader, founder of Coinbase
“The entire world we’re living in can be described through incentive structures. That’s why blockchains are so interesting because they allow you to explicitly program incentive structures into these self-contained universes.”
“One of the reasons humans have sort of taken over the Earth I suppose is we’ve been able to coordinate ourselves better and on a great scale than anything else that we’re aware of.” — FE
Creation of the Joint-Stock Corporation, which allowed a bunch of investors to mutually go in on this new amorphous kind of organism, a company, and do really big things
Governments are another way of sort of coordinating human behavior
Massive tech companies like Google and Facebook coordinate behavior
“Blockchain-based protocols are the next logical step. They provide the proper incentives for everyone to spread them like viruses. The minute I own a BTC or ETH, my incentive is now to make sure that thing is successful in the universe and spread it.”
Consensus Mechanisms
Charlie Noyes — Pantera Capital
Miners would be forced to do a lot of time consuming and costly computational work. The global network agrees or reaches “consensus” every ~10 minutes on the “state” of the ledger. Who owns what amount of bitcoins as a result of the recent transactions? This method for reaching consensus on the ledger, or proof of work, was bitcoins way of removing the need for a central authority. Think of a hash like a fingerprint. If a fingerprint uniquely identifies a human being. A hash uniquely identifies a piece of data. SHA-256 is the hashing mechanism used in bitcoin. Miners are all looking for this nonce, this random magic number that when it’s included in the block, will result in a hash that has the number of leading zeros required for it to meet a pre-determined difficulty level.
“BTC provides digital scarcity. The miners are the realization of that digital scarcity. So mining is extending the chain. Creating new blocks and letting new transactions happen on the network.”
“The question is just how is it possible without any central authority to control the distribution of these bitcoins? how is it possible to enforce scarcity of them in a decentralized way? What bitcoin says is that in order to do this, you have the make the problem hard. You have to make it difficult and bitcoin is really in many ways the first platform to do this correctly.”
Fundamentally, what these miners are doing is they’re flipping billions of quarters per second and trying to get a certain number of heads. You can’t guess what the outputs going to be given an input. And you can’t go backwards from the output to the input. we call it a one-way function in that you just have to calculate it to know. — CN
“And (mining)gets computationally harder and harder as there’s more and more hash power. And hash power I just think of as server power, CPU power that’s dedicated to doing this in this global network. The reason why anyone does this and the reason there are miners to begin with is that if you’re the miner that is the first to calculate the nonce, you send it out, you find the missing piece in this new block header that’s going to hash and add this block to the chain. You’re compensated in BTC.” — Patrick
Ethereum & Smart Contracts
Charlie Noyes
“Bitcoin is become, more or less, a simple store of digital value. In another sense, blockchains more broadly speaking, including examples like Ethereum, FileCoin, and others represent a leap forward in our ability to coordinate globally by creating little markets with their own tokens. And their own ways of earning and spending these tokens, almost like a fairground.” — Patrick
Ethereum’s fundamental difference from bitcoin is instead of being purely a network for transaction value, it’s a network for contracting value.
ICOs
Charlie Noyes
On Ethereum, you can create sub-currencies. Meaning you can write a contract that says:
This is a token
There are a billion of these tokens (for example)
It will have the functions “send, receive, create, etc.”
“So I send the smart contract 1 Ether. Internally, on the blockchain, it calculates and it says “I’ve received one Ether, take a million of these tokens, if they’re are any left, and send them to Charlie.” So then Charlie receives these tokens, and on that contract, it’s sort of like a sub-ledger. You can think of it like a triple accounting entry notebook where it says, “Charlie.Eth now owns all of these tokens.” And all of the operations are handled within the smart contract itself. It’s really like bootstrapping a blockchain. You don’t really need a new blockchain to issue these new tokens. You can bootstrap it off of Ethereum.” — CN
Fat Protocols & Separation of Power
Naval
“Normally the protocols are free and the apps create the chokepoints and they capture all the value that’s created up top. The HTP developers don’t make any money. Google, Uber, FB founders get fabulously wealthy.”
“In the new model, the protocols actually have a lot more power. Why? The protocols have more power because they hold state, identity, scarcity. So they actually track what the scarce asset is, they can actually hold the user data so if the user switches an application up top, the Blockchain itself can have the identity data and user data, or it can point to the user data and have a hash to it. In a way the data is open. So the data is open, identity is opened and scarcity is tracked at the protocol layer. The value goes into the protocol.”
US Government Currently
Executive branch — carries out the orders
Legislative branch — writes the orders
Judicial branch — adjudicates disputes
Blockchains Governance Experiment
Executive branch — miners execute by throwing computing power to carry out what the code says
Legislative branch — developers create the law, which is the code itself
Judicial branch — users adjudicate disputes
“The way the users adjudicate is that they’re free to leave. It’s open borders. There’s no exit or entry. You can go into the next coin. You can vote with your feet. You can vote with your money. So what you end up with is the market-based governance system that has a legislative, executive, ad judiciary where the users are free to come and go and it creates a model of governance that is far more flexible, permissionless, scalable, and in some weird sense of the word fair, than anything else invented to date by the human species.”
The only merit I have is the force of my ideas combined with voting with dollars and work, in bitcoin’s case by mining, or by writing code. I have to contribute something valuable to the system to have a say, but even then, nobody is going to have the entire “say.” — Naval
Corporate Applications
Peter Jubber — Head of Strategy & Planning at Fidelity
“We saw pretty quickly that the involvement of intermediaries could quickly be eliminated were you to believe something like [blockchains] could come to scale.” — Peter Jubber
This was a fascinating look at a large corporation who has taken a serious look at the potential implications of blockchains on their entire business. The lens Peter and company took resembles Jerry Neumann’s approach towards “predicting” the future. It’s not about “knowing” what will happen. Instead, it’s about asking if there is some state of the world in the future where blockchains and cryptocurrencies might play a role in financial services (and beyond).
“We said “lets look at what happens if you believe these trends to play out over this time frame [10 years].” It’s not at all about prediction. It’s about understanding and provoking, you don’t have to be right.”
“I think large incumbent players, and that would include us by the way, should feel fairly threatened by what this could represent in the future. So for the financial system that’s in place, that’s an issue. So every incumbent should be spending time and money on this topic to understand it, at least to understand the threat, but I think there’s just a massive opportunity.” — Peter Jubber
Jokes & Toys
Olaf Carlson-Wee — Founder/CEO at Polychain Capital
“That idea that the money lives on the internet is the breakthrough. So now you have the same open source, open access, architecture you say on the internet for communication, now we have it for finance. And so this means that you can build banking products, loan products, derivatives, all sorts of crazy financial systems all using smart contracts, which again is sort of this code that lives inside a blockchain.”
“Just like the early Internet looked like a joke or a toy, I think cryptocurrency to the average person like a joke or a toy. People were struggling to find the Internet useful until ’94 or ’95, but then five years later the Internet was an integral part of daily life. It happens very slowly until it doesn’t.”
Morgan Housel has written about the evolution of views on a technology’s perceived usefulness (or lack thereof) and scalability. Relevant takeaway — many things that ultimately change the world are initially viewed as “toys.”