Socratic Seminar 17

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Geopolitics

• US government announces seizure of 50676.17 bitcoin that was stolen from Silk Road

  • James Zhong pled guilty to committing wire fraud in September 2012 when he unlawfully obtained over 50000 Bitcoin from the Silk Road dark web internet marketplace.
  • On November 9, 2021, pursuant to a judicially authorized premises search warrant of ZHONG’s Gainesville, Georgia, house, law enforcement seized approximately 50,676.17851897 Bitcoin, then valued at over $3.36 billion.
  • This seizure was then the largest cryptocurrency seizure in the history of the U.S. Department of Justice and today remains the Department’s second largest financial seizure ever.
  • Specifically, law enforcement located 50,491.06251844 bitcoin of the approximately 53,500 Bitcoin Crime Proceeds
    • (a) in an underground floor safe; and
    • (b) on a single-board computer that was submerged under blankets in a popcorn tin stored in a bathroom closet.
  • In addition, law enforcement recovered
    • $661,900 in cash
    • 25 Casascius coins (physical bitcoin) with an approximate value of 174 bitcoin
    • 11.1160005300044 additional bitcoin
    • Four one-ounce silver-colored bars
    • Three one-ounce gold-colored bars
    • Four 10-ounce silver-colored bars
    • One gold-colored coin.
  • Around March 2022, Zhong began voluntarily surrendering more bitcoin to the Government
    • In total, ZHONG voluntarily surrendered 1,004.14621836 additional bitcoin.

• El Salvador presents bill to Congress that paves way for bitcoin-backed volcano bonds

  • On November 17, El Salvador’s Minister of the Economy submitted a digital assets issuance bill to the country’s legislative assembly, paving the way for the launch of its bitcoin-backed “volcano” bonds.
  • A year ago, El Salvador announced plans to issue $1 billion in bonds on the Liquid Network, a federated Bitcoin sidechain, with the proceedings of the bonds being split between
    • A $500 million direct allocation to bitcoin
    • An investment of the same amount in building out energy and bitcoin mining infrastructure in the region
  • Bitfinex is set to be granted a license in order to be able to process and list the bond issuance in El Salvador.
  • The bonds will pay a 6.5% yield and enable fast-tracked citizenship for investors.
  • The government will share half the additional gains with investors as a Bitcoin Dividend once the original $500 million has been monetized.
    • These dividends will be dispersed annually using Blockstream's asset management platform.
  • The act of submitting the bill kickstarts the first major milestone before the bonds can see the light of day.
    • The next is getting it approved, which is expected to happen before Christmas, a source close to President Nayib Bukele told Bitcoin Magazine.

Market/Adoption

• FTX collapse and contagion

  • Deep dive into Sam Bankman-fried (SBF) and the FTX / Alameda fraud
    • Great video summarizing this history of FTX and the timeline of the collapse
  • FTX Collapse And Humility Of Bitcoin (Obsidian Link)
  • The FTX Fiasco and the Fallout to Come (Obsidian Link)
  • FTX's downfall and crypto's Bitcoin betrayal (Obsidian Link)
  • FTX was a crypto exchange founded in 2019 by Sam Bankman-fried (SBF)
    • It experienced massive growth since its founding to become the third largest crypto exchange in the world
  • Sam also founded a crypto hedge fund called Alameda Research
  • FTX gives Alameda priority orderflow, allowing its sister hedge fund to front-run other traders - basically a perpetual money machine for Alameda by earning a few basis points off all that trading volume
  • Alameda's leaked balance sheet showed that a large chunk of their assets were in FTX's own exchange token FTT
    • $5.8 billion of the $14.6 billion reported
  • FTT is an exchange token that FTX issued
    • It gave various benefits on the exchange to holders, like reduced trading fees
    • FTX and Alameda have always held the majority of the tokens with only a small amount actually circulating on the free market
      • Alameda's holdings represented 2-3x FTT's entire circulating supply
  • Here's how the FTX / Alameda collusion worked:
    1. FTX creates FTT out of thin air
    2. Alameda buys or premines FTT at super low price
    3. FTX pumps FTT via wash trading, token burns, and other scammy methods
    4. Alameda posts FTT back to FTX as collateral, borrowing "real" assets from FTX's customer deposits
  • The scheme collapsed when CZ from competitor exchange Binance tweeted that he was going to sell all of Binance's FTT holdings - worth more than $500 million
  • The sell pressure against FTT cratered its price, which took FTX and Alameda out with it (as 2 of the largest token holders)
  • FTX paused all withdrawals the next day and have since filed for bankruptcy
  • Alameda and FTX had financial ties to all sorts of other entities in the space who are now being affected by the collapse and deleveraging
  • The resulting contagion has rippled into other parts of the industry:
    • BlockFi files for bankruptcy as FTX contagion spreads
      • Back in June, we mentioned that FTX was bailing out BlockFi with a $250m line of credit
      • That later morphed into a $400 million credit facility and gave FTX the ability to acquire BlockFi
      • BlockFi's solvency was put into question after FTX collapsed
      • BlockFi had already paused withdrawals a couple weeks ago
      • BlockFi officially filed for bankruptcy earlier today
      • BlockFi has $1-10 billion in liabilities but only ~$250 million cash on hand
      • Not looking good for client funds that were on the platform
    • Gemini Earn and Genesis Global Capital halt withdrawals/redemptions amid Genesis solvency concerns
      • Genesis Trading services a large portion of the institutional investor base in the bitcoin and broader crypto markets.
        • For lending, trading, hedging, exchange yields, etc., Genesis Trading was the brokerage to facilitate a lot of that activity.
      • Genesis held a short client call to announce the suspension of redemptions, withdrawals and new loan originations.
      • With exposure to FTX and Alameda Research, the company now needs another liquidity injection after having nearly $175 million locked in a trading account with FTX.
      • Parent company Digital Currency Group (DCG, the parent company of Grayscale), injected $140 million into the business to keep operations running smoothly.
        • Genesis is still scrambling to find more capital (around $1 billion?)
      • Gemini Earn had to halt withdrawals as a result of the solvency concerns with Genesis - they stopped paying out yield to Gemini's clients
  • Stay humble. Stack sats. Practice self-custody.
    • The best way to avoid this kind of contagion risk is to withdraw bitcoin from exchanges to keys you control
    • You don't actually own any bitcoin that you give to a third party to hold on to
    • Irresponsible leverage is being cleared from the system as each bad actor files for bankruptcy - this is ultimately a good thing, even if it's difficult for those who might have lost funds
    • These events might cause short-term price volatility for bitcoin, but the protocol itself is entirely unaffected - we keep mining blocks
    • This is why it's so important to hold your own keys

• Bitcoin Policy Institute releases new report on Proof of Reserves (Obsidian Link)

  • The Bitcoin Policy Institute (BPI), a non-profit dedicated to furthering governmental Bitcoin adoption, has released a new report discussing proof-of-reserves (PoR) in the bitcoin and cryptocurrency ecosystem following the FTX collapse
  • BPI’s report argues that the adoption of PoR will
    • Provide information on counterparty risk
    • Reduce the chance of systemic default contagion
    • Improve user trust in their custodial relationships
  • BPI continues to explain that recent systemic failures in the industry have attracted the eyes of lawmakers, as was seen with the fall of FTX when the CFTC and SEC both announced they were investigating the company.
  • Because a lack of transparency has fueled the downfall of many companies over the course of this past year, BPI suggests that the only logical path forward is for the industry to adopt a PoR-based approach.
  • As of November 9, eight exchanges have reportedly followed Binance in announcing their intentions towards increased transparency in the ecosystem.
  • David Zell, co-founder of BPI, also commented on the dynamic shift of the industry. “FTX’s bankruptcy should remind all of us that the only way to hold digital assets without counterparty risk is to custody them yourself,” said Zell. “But when customers deposit their assets with a third party, firms need to be as transparent as possible about the state of those funds. Solutions like proof of reserves can play a major role toward that end.”

Technology

• LND v0.15.4-beta: hotfix release to fix another critical chain sync bug

  • Marty's Bent Issue #1278: Another LND-btcd bug emerges (Obsidian Link)
  • Second critical bug in less than a month causing LND nodes to fall out of sync with the blockchain
  • Bug intentionally triggered by the same developer that caused last month's LN bug (Burak)
  • Specifically targeted LND nodes - OP_RETURN message said "you'll run cln. and you'll be happy."
  • Lots of debate on whether publicly exploiting the bug was the ethical choice (Obsidian Link)
    • Should Burak have responsibly disclosed the bug to Lightning Labs?
      • Probably, but there's some nuance
      • There actually was a disclosure already - AJ Towns reported the bug through GitHub on October 11, two days after the original bug was triggered by Burak’s 998-of-999 multisig transaction.
        • LND had already quietly patched the bug and expected to include the fix in a future release
        • This “silent patch” methodology is a common tactic for critical vulnerabilities in order to protect those who are slow to upgrade (if you’re loud about the critical fix, an attacker might become aware of the exploit and target non-upgraded nodes)
      • You could argue that there was a strong and immediate risk of this new bug being discovered and exploited by a bad actor
        • This second bug was literally right above the one from last month in the codebase, so anyone reviewing last month's bug could have easily noticed this one too.
        • AJ also reported the bug on Github and left a public post about it up for 10 hours before being deleted - basically leaving instructions for a bad actor to see and exploit
    • Burak's actions may have actually limited the potential damage of this exploit
      • If a malicious actor had found the bug before a well-intended developer, they could have tactically opened new channels to vulnerable nodes, routed the entire contents of those channels back to themselves and then exploited the bug to drain the full channel balance back on-chain
        • Because of the way this was exploited in practice, users only had to worry about their existing channel partners stealing their funds - ironically protecting them from being intentionally attacked
  • Key takeaways
    • Critical codebases (like LN node infrastructure) need to prioritize auditing for security bugs over integrating new features
    • Bitcoin and Lightning code maintainers need to increase communication and collaboration to detect and mitigate these issues early on, strengthening the ecosystem overall.
      • This same bug was actually already patched in the Rust Bitcoin implementation but no one noticed
    • Protocols that depend on observing on-chain activity should delegate as much of that functionality as possible to Bitcoin Core itself (where there are the strongest safety and reliability guarantees), rather than leveraging in-house code or less-audited third parties.

• Full replace-by-fee (RBF) debate

  • Bitcoin Core 24.0 release candidate includes controversial mempoolfullrbf configuration option
  • Pros and cons of merging full RBF into Bitcoin Core
  • The RBF debate is a matter of incentives and individual choice (Obsidian Link)
  • John Carvalho's argument against changing the default RBF behavior in Bitcoin Core
  • Very nuanced discussion with a lot of intermingled/overlapping arguments
  • Background context
    • What is a node's mempool?
      • The mempool (memory pool) is a smaller database of unconfirmed or pending transactions which every node keeps.
      • After you broadcast a transaction, the bitcoin node you're connected to adds the transaction to its own mempool and then notifies its peers to let them know about the transaction too - those connected nodes then add the transaction to their own local copy of the mempool and share the info with their peers
      • Nodes share mempool data by relaying signed transactions to each other, but there is no single mempool and few if any nodes keep the entire mempool.
      • Mempool data dynamically propagates through the bitcoin network in that way, where each node maintains a slightly different snapshot of pending transactions waiting to get picked up by a miner
      • As miners are hashing for the next block, they pull transactions from their view of the mempool to include in that block.
      • The specific transactions they choose usually depend on the fee attached to them - miners generally prioritize higher fee transactions
      • When a transaction is finally confirmed by being included in a mined block, it is removed from the mempool and that update propagates through the network of node peers
      • A related term is a "0-confirmation transaction", which is just a transaction that is known about (because nodes can see it in their mempool), but it hasn't yet been included into a block
        • These unconfirmed transactions haven't yet settled on chain and aren't considered final or immutable - they are at greater risk of being double spent (meaning those UTXOs could get included in a different transaction, invalidating the original payment)
    • What is replace-by-fee (RBF)?
      • Bitcoin already allows opt-in RBF - transactions can be individually flagged as RBF-capable in order to allow the sender to replace an unconfirmed transaction with another similar transaction which pays a higher fee.
      • RBF only works while the transaction is in the mempool.
      • This mechanism exists to allow users to respond if the network becomes congested and fees rise unexpectedly. If a user sends a transaction with a low fee, and finds that it is taking too long to confirm, the user can raise the fee they pay to confirm their transaction faster.
    • What is this feature specifically?
      • Full RBF is a different kind of mempool policy that a bitcoin node can follow - rather than only allowing transactions to be replaced if they explicitly opted in to RBF, full RBF nodes would allow any transaction to be replaceable by default
      • However, this specific Bitcoin Core update does not actually enable full RBF
      • It only adds a configuration parameter that can be used to enable it on an individual basis
    • Why is it controversial?
      • If enough users enable full RBF, 0-confirmation transactions are no longer a viable tool that a bitcoin merchant can use when trying to offer a fluid UX to customers
        • This is because RBF-able transactions always have the potential to be replaced, so receiving merchants are forced to wait for a full confirmation before they can consider a payment settled
      • A subset of Bitcoin Core developers think RBF should be the default behavior anyway and have gotten defensive to criticisms from other industry participants who disagree - at least according to John Carvalho
      • A lot of people weren't aware of this change until it was already about to be merged into the Bitcoin Core release candidate, so it caused a lot of commotion quickly
        • Not enough time to adequately debate the pros and cons or for affected services to prepare
      • Now that it's part of the release candidate, it takes even more effort to remove the change - new PR, PR review, more room for potential bugs by adding another change this late in the review process
      • Primary arguments in favor
        • RBF gives users more control
          • Can respond more dynamically to fee market
          • Enables users to update/cancel unconfirmed transactions
          • This change only adds a configuration option that users can manually enable if they want full RBF on by default
            • They still have to change the config file on their node to turn it on
        • RBF is inevitable anyway
          • It's already possible if users opt-in for specific transactions
          • As the fee market becomes more congested in the future, users will probably be incentivized to adopt RBF by default - eventually there will be a tipping point where most people have it on
        • 0-confirmation transactions are not safe
          • 0-conf transactions are not "real" bitcoin - it's not official until it's confirmed at least once, and preferably more than that
      • Primary arguments against
        • Doing nothing keeps everyone happy
          • Users that want RBF can already enable it on a per-transaction basis
          • Services that want to leverage 0-conf transactions can still do so by hedging risk appropriately
        • Adding this configuration option hastens the inevitability of RBF adoption
          • RBF may be inevitable, but under typical circumstances, it might not be widely used for years
            • Currently, very few transactions actually signal RBF-capability
          • In the meantime, the UX that 0-conf transactions can enable provides more value to end users than the occasional person wanting to RBF a transaction
            • Always having to wait for a full confirmation before responding to the client causes a bad UX for some merchants/services - no instant Lightning channel funding, easy online purchases with on-chain funds, bitcoin ATMs, etc.
            • For example, the benefit of a service being able to instantly onboard someone to the Lightning Network with 0-confirmation funding transactions might be worth not encouraging unnecessary RBF usage in the near future

• Cash App now allows sending and receiving bitcoin payments via Lightning (Obsidian Link)

  • Cash App users can send and receive payments in BTC via the Lightning Network.
    • Previously, users could only send Lightning payments but not receive them
  • Cash App has an active user base of 47 million, over six-times larger than the population of El Salvador
  • Ideally, you should withdraw from Cash App often, but custodial Lightning wallets can be useful for handling small amounts without having to manage your own liquidity
  • After the most recent update, CashApp now also supports unified QR codes
    • These are QR codes that encode BIP21 Payment URIs - a scheme for creating a "payment link"
    • That payment link can be used to embed multiple payment methods in a single QR code
    • Individual wallets can automatically choose which payment method to use based on the context - the user doesn't have to be aware of it when scanning a QR code

• Trezor enables KYC-free P2P bitcoin trading via Hodl Hodl integration

  • Hodl Hodl leverages multisig to enable P2P transactions between buyers and sellers without needing to take custody of funds
    • The buyer, the seller, and Hodl Hodl each hold one key, and 2 signatures are required to move the bitcoin
    • Hodl Hodl's key acts as an arbiter in the event of a dispute
  • The Hodl Hodl integration is included in the Trezor Suite software, so Trezor users can now easily buy bitcoin P2P within Trezor's native software and the funds are deposited directly to cold storage
  • Services like this can help eliminate custodial/exchange risk that occurs when you buy bitcoin through more traditional means

• Synonym launches Bitkit mobile wallet to showcase Slashtag technology (Obsidian Link)

  • The wallet boasts many features:
    • Portable social profiles
    • Dynamic payable contacts
    • Interoperable data feeds
    • Passwordless web accounts
    • Slashtags
  • A slashtag is a cryptographic keypair derived from the same seed as your Bitcoin wallet. Anyone can publish data using networked “drives” that are identified by keys the user controls, enabling a censorship-resistant peer-to-peer web.
  • Slashtags enables users to take control of their data.
    • The protocol does not require a blockchain, includes uncensorable social profiles, automatically-updated contacts, contact payment preferences, passwordless authentication, and more.
  • Slashtags leverage the same Holepunch technology as Keet
  • Bitkit is still in beta, and Lightning functionality is currently limited for US users (regulatory hurdle)
  • Non-US users can purchase Lightning liquidity on-demand without manually managing channels via Synonym's Blocktank service

• Perth Heat baseball fans can now ‘boost’ players with bitcoin over the Lightning Network

  • Named #sats4stats, the new collaboration with IBEX allows fans to send Lightning micropayments to individual players during games
  • Similar to "boosting" podcast creators with Podcasting 2.0-enabled apps
  • “Each player will have a Lightning QR code linked to their profile for instant boost from any lightning wallet in the world
    • #Sats4stats will allow fans to send sats directly as the action unfolds at the ballpark or via live broadcast feed.
    • Fans will be able to send messages to their favorite players and retweet their ‘boosts’,” per the statement.
    • In a future where this feature is more heavily used, a substantial portion of a player's income could come directly from fans instead of being dependent on various organizations
  • Australian baseball team Perth Heat last year became the first sports team worldwide to begin operating on a Bitcoin Standard.
    • Since then, the club has already begun paying players and staff in bitcoin and recently activated all concession stands with the ability to pay in bitcoin.

Mining

• Margin Squeeze - How bitcoin mining revenues evaporated over the past months
  • Marty's Bent Issue #1275: Miners are in a world of hurt (Obsidian Link)
  • Pain in the mining world continues as hashrate continues to climb over the last several months
    • It has been dropping a bit in November as unprofitable miners have been forced to shut off
  • Bitcoin miners have never produced less bitcoin per unit of hashrate
    • A miner's daily bitcoin compensation for a unit of hashrate is called the bitcoin-denominated hashprice
    • 1 EH/s now produces about half as much bitcoin per day as it did one year ago
      • Only miners who have more than doubled their hashrate over the past year earn the same amount of bitcoin as they did in October/November of last year
    • The bitcoin-denominated hashprice will likely keep trending downwards as the difficulty keeps growing due to more hashrate coming online
    • On a longer timescale, in spring of 2024, the block subsidy halves again from 6.25 BTC to 3.125 BTC, which will lead to a massive drop in the bitcoin-denominated hashprice
    • Because of the falling bitcoin-denominated hashprice, miners who want to keep their bitcoin production on par with previous years will have to rapidly grow hashrate
  • Bitcoin miners have never made less dollar per unit of hashrate
    • Not only have one unit of hashrate never generated less bitcoin than now, but the value of this bitcoin has also evaporated.
    • During the golden days of bitcoin mining in October 2021, the average bitcoin price was $59k, and we're now sitting around $16-17k, which is a decline of ~75%
    • Since then, the lethal combination bitcoin becoming more difficult to mine per unit of hash and the massive drop in price per coin have caused dollar-denominated hashprice to plummet by over 80% since its all-time high.
    • Some hashrate derivatives products are gaining popularity on the market to help enterprise miners hedge their revenues over time, but this market is brutal for even the most effectively hedged miners
  • Only energy-efficient machines powered by low-priced energy are cash flow positive
    • The Luxor report includes a chart about 2/3 of the way down that compares breakeven hashprices for various machines at different power costs
    • Machines that can access cheap/wasted energy are still doing okay
    • The problem is that getting access to such cheap electricity is very difficult during the current energy crisis, which has led to surging energy prices all over the globe
  • Takeaways
    • Hard to say if we've reached maximum pain for miners, but it seems like more is to come
    • Some large miners used easy money financing from a year ago when interest rates were more favorable to purchase a lot of hardware that's just now coming online
      • Even if it's unprofitable to plug in, they might anyway because of the massive sunk cost (time, money, & resources)
      • Could turn into a situation where miners are churning water to see who folds first

Optional Topics

• Bitcoin White Paper Day was on 10/31
  • Anniversary of when Satoshi released the whitepaper to a cryptography mailing list on October 31, 2008
• Biden administration wants to make it easier to seize bitcoin without criminal charges
• Lugano and El Salvador sign economic agreement to foster bitcoin adoption
• BitMEX renews Rene Pickhardt’s, Gleb Naumenko’s, and Chris Coverdale’s Bitcoin Developer Grants
• Vinteum nonprofit announces bitcoin Utreexo grant for Davidson Souza
• Popular Lightning analytics company 'Amboss' launches controversial data sharing feature that threatens Lightning privacy
• Bitcoin miner Core Scientific warns it might go bankrupt; stock plunges
• Bitcoin miner Stronghold Digital gave NYDIG 26200 ASICs in exchange for relief from $67.4 million of debt
• Blockstream launches Build On L2 (BOL2) community for bitcoin development (Obsidian Link)
• BLIP: encrypted chat powered by Lightning (Obsidian Link)
• How Lightning revolutionizes crowdfunding
• Tor Project releases annual financial statements
  • ~38% of revenue came from US government funds