30 March 2014

About the nature of cryptocurrencies

A few days ago, Richard Gendal Brown published an interesting post describing Bitcoin as a land territory. There is some very good points in this article (importance of UTXO, ...) and it's great because like many things in Bitcoin, it invites you to think about the nature of money, cryptocurrencies... But I must confess that I feel a bit unconfortable with this metaphor, mainly because of its implications about the fungibility of bitcoins.

About fungibility
Fungibility is the property of a good or a commodity whose individual units are capable of mutual substitution. It's often said that cash is fungible, i.e. a 10$ bank note is interchangeable with another. Diamonds are not perfectly fungible because diamonds' varying cuts, colors, grades, and sizes make it difficult to find many diamonds with the same cut, color, grade, and size (more here).
One of Richard's axiom is that bitcoins are not perfectly fungible : they're more similar to diamonds (and others physical objects like lands) than to dollars. This is where I start to feel unconfortable with the metaphor of the land.

Bitcoin system is not about objects but about flows
Trying to figure what are the core concepts of Bitcoin, I noticed there's a common mistake made about the nature of bitcoins. We like to imagine bitcoins as objects (properties): it's in the name (bitCOINS), it's in the visual imaginary...

It's sometime the cause of "funny" situations like TSA looking for bitCOINS inside luggages. The problem is there's nothing in Bitcoin protocol like an object (property) which we could call a bitCOIN. Bitcoin protocol is all about flows.

Let's have a look at a bitcoin transaction. We have 3 inputs (i1=10btc, i2=5btc, i3=5btc) and 2 outputs (o1=10btc, o2=10btc). A bitcoin transaction acts like a multiplexer/demultiplexer plumbing fitting.

It's impossible to say if coins received by o1 come from i1 or i2 or i3. This information just does not exist in bitcoin protocol. The best we can say about this transaction is known as taint analysis and states that:
  • all outputs have received 50% of their flow (value) from i1, 25% from i2 and 25% from i3
  • all inputs have sent 50% of their flow to o1 and 50% to o2.
It's equivalent to consider bitcoins as a liquid flowing in tubes, not as objects. Larger tubes receive larger volumes of the flow.

Bitcoin as a system made of tubes and valves
I like to picture bitcoin as a complex system of tubes and valves. The liquid flowing through this system is what I call "trusted ownership".

Here's the full picture:
  • Coinbase transactions (bitcoins generated by miners) are the sources of the flows.
  • Transactions join tubes with different diameters (values of inputs/ouputs). Diameters of output tubes are defined by the person creating the transaction.
  • Outputs of transactions are valves. A valve can be opened if you know how to open it (you own the private key associated to an address,...).
  • The "thing" flowing in this system is not a kind of object (bitCOIN, satoshis,...) but is trusted ownership. Trusted ownership is not a object transmitted from one address to another. It's a continuous flow going from the sources to the latest UTXO.
  • If you "cut" the flow (basically what happens when a fork/reorg of the blockchain occurs with double spendings) the valves victim of double spending don't receive the flow anymore. The flow of trusted ownership going from the sources to these valves is broken and there's no more liquid reaching these valves : the coins have gone ! (TM MTGox)

Why the metaphor used is important ?
My take is that the metaphor used has a direct incidence about how we think about the cryptocurrencies systems and how they can be regulated (or not). IRS says bitcoin is property. IRS is not alone and it's often said that bitcoins are less fungible than cash. 

The problem is that technically speaking it's wrong. We consider that a bank note is interchangeable with another even if bank notes are physical objects with serial numbers. Thus, saying that bitcoins are less fungible than dollars is like saying that water is less liquid than pebbles. 

IRS can consider that bitcoins are properties but it's conceptually wrong and this mistake will be more and more problematic for them in the future. For now, transactions are most of the time issued by one person and that's why the metaphor of the land (or bitcoins considered as properties) seems ok. But nothing in Bitcoin protocol restricts the system to this scheme and mixers are a good example of a different scheme which breaks the metaphor of the property. 

According to the future decisions made by regulators Bitcoin could become a system of properties but it would be a distortion of the true nature of the protocol. As pointed out by Richard : "it is perhaps no surprise that the fungibility issue is so hot right now."

At last, a good news for Newsweeks
The metaphor of bitcoin as a system made of tubes and valves brings a goodie. It reveals the real identity of Satoshi Nakamoto. The mystery is over !

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