The Transaction Costs of Tokenizing Everything

I wonder if Al Gore ever looks down at us peons, crawling around the internet like eight-legged leeches:

I invented that. I took the initiative in creating the Internet. Now all these freeloaders are using MY internet protocol to drive billions of dollars worth of value. For FREE.

Damn, I should have done an ICO.

Even though Al Gore neglected to tokenize his internet protocol*, someone else came along with the next-best thing.

In 1999, a clever company called Enron invented something called a bandwidth contract.

The internet is just a bunch of routers and cables, sending and receiving data all day long. Most internet providers have peering agreements, where they carry each other’s traffic for free. Sharing is mutually beneficial, and their customers pay a fixed monthly rate regardless of use.

That’s all well and good when capacity is plentiful, but what happens if half the country wants to stream Sunday Night Football while I’m trying to sync my Bitcoin node? Whose data gets to go first?

Enron’s bandwidth contracts were designed to solve this potential queueing problem. By forcing internet users to bid for bandwidth by the minute, the free market would decide the optimal allocation of resources [1].

Sadly, Enron imploded before it could fully realize its bandwidth trading dream. Still, the idea of turning every network into a market was pretty hot in the dot-com days [2]. To see how things might have turned out, we can look at a company called Mojo Nation.

A MASSIVE AMOUNT OF STORAGE SITS UNUSED IN DATA CENTERS AND HARD DRIVES AROUND THE WORLD. Let your hard drive shit out money by fulfilling storage requests on the open market!

Such is the marketing pitch of services like Filecoin, Sia, Storj, MaidSafe, and all those other decentralized file storage tokens. Seventeen years ago, their founders were still in diapers when Mojo Nation launched to address the problem of Pareto-inefficient data storage.

Mojo Nation created a digital payment system to buy and sell computational resources. Participants could earn Mojo tokens by contributing things like disk space, bandwidth, CPU cycles. Those who wanted resources offered bids in outgoing requests. Mojo tokens relied on a centralized mint because blockchains weren’t around yet, but centralization was the least of its problems: Tokens were a huge distraction from what users really wanted to do, which was share files [3].

A bidding market is an awfully complicated thing. Take Bitcoin, for instance. Each block has a finite capacity, so participants submit transaction fees to incentivize miners to include their transactions. It’s a simple concept, but transaction fees are the most aggravating part of Bitcoin. There are people like Roger Ver who have been using Bitcoin since 2011 and STILL can’t figure out how transaction fees work.

I’m not trying to pick on Roger here; this is not a user-friendly experience. Those who want to tokenize all the protocols are effectively shoehorning the same shitty experience into every aspect of the internet. My mother can’t even update her Facebook picture without backup assist; how on earth will she manage five-dozen protocol tokens to navigate the web?

Many dot-com era platforms tried to create bandwidth exchanges, but none found willing participants. Enron and Blockbuster temporarily joined forces to create on-demand streaming video, in hopes that they could clog up so much bandwidth that internet providers would start a bandwidth bidding war. No such luck. As it turns out, bandwidth — and most computational resources — are simply too cheap to meter.

After Mojo Nation’s demise, a former employee stripped the token incentives out of the protocol and created a simple tit-for-tat filesharing system. The software client uploads files to peers that provide downloads [4]. Users can’t accumulate credits, and sometimes freeloaders go unpunished, but people don’t care about perfect resource allocation — they just want convenient file access. By 2004, BitTorrent was responsible for a quarter of all the traffic on the internet.

And everyone lived Pareto sub-Optimally ever after.

* Kidding. The Internet Protocol was created by Vint Cerf and Bob Kahn. The only thing Al Gore invented was global warming.

References:
1. Enron’s Bandwidth Trading patent, 2001.

2. Mark Miller and K. Eric Drexler. The Agoric Papers, 2000.

3. A conversation about Mojo Nation on Unenumerated, ca. 2007.

4. Bram Cohen. Incentives Build Robustness in BitTorrent, 2003.

5. Bryce Wilcox-O’Hearn, who now goes by Zooko, CEO of ZCash. Mojo Nation: Experiences Deploying a Large-Scale Emergent Network, IPTPS 2002.

6. Mojo Nation website from 2000.

If No One Spends Bitcoin, How Can It Have Value?

Medieval mint, engraving by Leonard Beck (1516).

It’s hard to imagine a world without penny candy and nickel newsreels, but for most of human history, petty transactions were a pain in the ass.

Prior to the Industrial Revolution, coinage was a labor-intensive process. Metal had to be melted, refined, hammered, and cut. Because it took just as much effort to hammer out a small coin as it did a big one, mintmasters were inclined to create only the largest denomination coins.

If it weren’t for taxation and church collections, the state would have had no reason to issue small denominations at all. To encourage the creation of small change, medieval states authorized seigniorage — mints reduced the relative quantity of silver in small denominations to offset production costs.

Production costs of coinage (brassage).

Debasement! Where legal tender laws are enforced, bad money drives out good. Creditors complained that debts were being repaid in shittier coins than what was lent out. In states without legal tender, the large-denomination coins became the unit of account, and smaller coins had a floating exchange rate depending on their level of debasement.

The more the small denominations were debased, the worse the exchange rate got. Seeing small denominations as a poor store of value, people melted them for the commodity silver, exacerbating the small-change shortage. Small coins provided liquidity, but the liquidity service was not valuable enough to counteract debasement.

The biggest transaction cost is trust.

The title question is backwards. Value does not come from the ability to spend; the ability to spend comes from value. The full-bodied large coins were more valuable than liquidity-providing small coins because the gold and silver content securely constrained their supply.

There are plenty of cheap solutions for illiquidity. When small coins were scarce, retailers and craftsmen issued lead and copper tokens as a substitute for change. The tokens had no commodity value, but customers accepted them because they trusted their local businesses.

Foreign trade doesn’t have the benefit of localized trust, so merchants must rely on a scarce and unforgeable intermediate commodity. The Group 11 elements (Copper, Silver, Gold) have been universally employed as coinage metals thanks to the eons-old neutron star collisions that created a limited supply. Their shared electron configurations make them pliable and corrosion resistant. Atomic weight corresponds to the required energy input and hence, unforgeable value.

There’s no cheap substitute for securely constrained scarcity, especially since humans are so good at making scarce things abundant. Domesticated livestock, designer knockoffs, genetically engineered plants. Even labgrown diamonds are nearly indistinguishable from the real thing. We try to mimic scarcity with patents and licensing and zoning regulations, but these are all expensive solutions. Fiat money pretends to be scarce, and that costs us $600 billion a year.

People are trying to make Bitcoin knockoffs. After all, it’s human nature to want to make a scarce thing abundant. If they succeed, then Bitcoin has no value. But if Bitcoin has no value, how can anyone spend it?

See Also:
1. Nick Szabo, Unforgeable Costliness, 2004.
2. Thomas J. Sargent & François R. Velde. The Big Problem of Small Change, 2002.

Happy Indigenous Peoples’ Day!

They changed Columbus Day to Indigenous Peoples’ Day over here. To celebrate, here is the 1657 deed in which Native Americans sold Manhattan to the Dutch for beads. The signatories drew a picture of themselves at the bottom.

We, the undersigned natives of North America, hereditary owners of Staten Island, Sackis of Tappaan, Taghkoppeauw of Tappaan, Temeren of Gweghkongh, Mattenou of Hespatingh, Waerhinnis Couwee of Hespatingh, Weertsjan of Hackingsack, Kekinghamme of Hackinchsack, Wewetackenne of Hackinghsack, Neckthaa of Hackinghsack, Minquasackyn of Hweghkongh, Terincks of Hweghkongh, Mikanis of Gweghkongh, Mintames Seevio of Gweghkongh, Acchipior of Hweghkongh, certify and declare for ourselves and our descendants in presence and with the knowledge of the underwritten witnesses, to have sold and conveyed as a free hereditable property now and forever without any further claims to be made by us or our descendants to Lubbertus van Dincklaecken, attorney for his right honorable Henrick van der Capellen tho Rijssel, the whole of Staten Island, by us called Eghquaons, for the goods hereafter specified, to be brought from Holland and delivered to us, the owners.

10 boxes of shirts; 10 ells of red checked cloth; 30 pounds of powder; 30 pairs of Faroese stockings; 2 pieces of duffel; some awls; 10 muskets; 30 kettles, large and small; 25 adzes; 10 bars of lead; 50 axes, large and small; some knives.

We further promise that if any other Indians or nations should commit insolence, molestation or force against the inhabitants of Staten Island at any time, we shall assist in preventing and resisting them.

In witness whereof we the owners have signed this with the witnesses in due form of law on the land of Waerhinnis Couwee at the Hespatingh near Hachinghsack in New Netherland the 10th of July 1657.

Source: New York State Archives

Map of New York, by a Dutch mapmaker c. 1635. Rotate it counterclockwise. NY used to have a lot of beavers and turkeys!

Stick Another Fork in Bitcoin

Here we go again. Come the Ides of November, some subset of Bitcoin nodes will switch to an incompatible protocol that doubles the block size while retaining the compacted data structure of segregated witness, also known as segwit. (Back in August, a BitcoinCash fork was created for bigger blocks without segwit).

The upside of a decentralized currency is that no one can ever agree on anything, making it difficult to engage in shenanigans like open market operations and debt monetization. The downside of a decentralized currency is that no one can ever agree on anything.

If everyone collectively decides to change the rules, it’s consensus. If a subset of the population decides to change the rules, that’s collusion. Every user has a different threat model, and hence a different threshold for what constitutes consensus.

If your chief concern is the ability to spend money overseas, then the only consensus that matters is between yourself and the person you wish to pay. Your threat model is customs and border control, which can be thwarted using concealed private keys. Actually, you don’t even need private keys when fleeing the country. Just take your Coinbase password. Or a Visa debit card.

If you also worry about things like consensus rules and the monetary policy that governs your block chain, then you need the help of full nodes. Your threat model is miner collusion. As long as full nodes perform block validation, Bitcoin miners can control all the hashpower in China and still have no ability to change the rules of the network – full nodes will drop invalid blocks.

If you don’t trust yourself to secure a private key, then your threat model is your own unreliable self. You probably have an account with Coinbase, BitGo, Bitfinex, or some other service. The nodes run by exchanges and wallet providers are economically important, because many people rely on them to participate in the network.

But maybe you don’t trust the economically important nodes either.

Maybe Goldman Sachs gets into the business of trading Bitcoin. Maybe they go long on Bitcoin credit default swaps, get in over their heads, their counterparty goes bust, and now they want a bailout. Maybe Lloyd Blankfein is buddies with the CEOs of Coinbase, BitPay, and all those other economically important nodes. Maybe the CEOs and miners gather for a secret meeting in New York, and agree to hard fork a bailout.

If your threat model is everyone but yourself, and you would rather adhere to consensus rules than follow the economic herd, then you need your own full node.

(And if you would rather follow the economic majority regardless of preconceived rules, then go back to the US dollar.)