On Not Being Immutable

Economist 2/1/25

Regulation of cryptocurrencies was an issue in last November's US election. Molly White documented the immense sums the industry devoted to electing a crypto-friendly Congress, and converting Trump's skepticism into enthusiasm. They had two goals, pumping the price and avoiding any regulation that would hamper them ripping off the suckers.

Back in November of 2022 I added an entry to this blog's list of Impossibilities for The Compliance-Innovation Trade-off from the team at ChainArgos. It started:

tl;dr: DeFi cannot be permissionless, allow arbitrary innovation and comply with any meaningful regulations. You can only choose two of those properties. If you accept a limited form of innovation you can have two-and-a-half of them.

Fundamental results in logic and computer science impose a trade-off on any permissionless system’s ability to both permit innovation and achieve compliance with non-trivial regulations. This result depends only on long-settled concepts and the assumption a financial system must provide a logically consistent view of payments and balances to users.

This is a semi-technical treatment, with more formal work proceeding elsewhere.

Two years later, the "more formal work" has finally been published in a peer-reviewed Nature Publishing journal, Scientific Reports, which claims to be the 5^th most cited journal in the world. Jonathan Reiter tells me that, although the publishing process took two years, it did make the result better.

Below the fold I discuss Tradeoffs in automated financial regulation of decentralized finance due to limits on mutable turing machines by Ben Charoenwong, Robert M. Kirby & Jonathan Reiter.

It Was Ten Years Ago Today

Ten years ago today I posted Economies of Scale in Peer-to-Peer Networks . My fundamental insight was:

• The income to a participant in a P2P network of this kind should be linear in their contribution of resources to the network.
• The costs a participant incurs by contributing resources to the network will be less than linear in their resource contribution, because of the economies of scale.
• Thus the proportional profit margin a participant obtains will increase with increasing resource contribution.
• Thus the effects described in Brian Arthur's Increasing Returns and Path Dependence in the Economy will apply, and the network will be dominated by a few, perhaps just one, large participant.

In the name of blatant self-promotion, below the fold I look at how this insight has held up since.

Lie Down WIth Dogs, Get Up WIth Fleas

Source

It is generally quite difficult to upset the denizens of a wretched hive of scum and villainy by further besmirching their reputation, but recently the Trump family has succeeded.

Below the fold I explain how they did it, and why the denizens of the wretched hive are not happy.

More Cryptocurrency Gaslighting

SEC vs. Consensys

On 30^th June Amy Castor and David Gerard reported that SEC sues Consensys over MetaMask Swaps and Staking:

The SEC is charging Consensys for unauthorized sales of securities through MetaMask Staking and for failure to register as a broker and a dealer while offering crypto trades and staking services through MetaMask Staking and Swaps. The SEC says that Consensys took $250 million in fees as an unregistered broker.

MetaMask is Consensys’ main money maker — a popular browser-based wallet that also lets you stake ETH and buy and sell crypto via decentralized exchanges with “swaps.”

Consensys' defense strategy poses potentially serious problems for the concept of open source, because they are gaslighting about the software that is the basis for the SEC's complaint being open source. Were the court to (a) fall for their gaslighting but (b) agree with the SEC's complaint it could provide a basis for imposing liability on open source developers.

I am afraid that the explanation for why this is so is necessarily rather long but I and others think that it needs to be understood. So stock up with supplies for the journey and follow me below the fold.

The Great MEV Heist

The Department of Justice indicted two brothers for exploiting mechanisms supporting Ethereum's "Maximal Extractable Value" (MEV). Ashley Berlanger's MIT students stole $25M in seconds by exploiting ETH blockchain bug, DOJ says explains:

Anton, 24, and James Peraire-Bueno, 28, were arrested Tuesday, charged with conspiracy to commit wire fraud, wire fraud, and conspiracy to commit money laundering. Each brother faces "a maximum penalty of 20 years in prison for each count," the DOJ said.

The alleged scheme was launched in December 2022 by the brothers, who studied at MIT, after months of planning, the indictment said. The pair seemingly relied on their "specialized skills" and expertise in crypto trading to fraudulently gain access to "pending private transactions" on the blockchain, then "used that access to alter certain transactions and obtain their victims’ cryptocurrency," the DOJ said

Below the fold I look into the details of the exploit as alleged in the indictment, and what it suggests about the evolution of Ethereum.

One Heck Of A Halvening

The fundamental idea behind Bitcoin is that, if you restrict the supply of something, its price will rise. That is why the system arranges that there will only ever be 21 million Bitcoin by halving the reward paid for mining the next block every 210,000 blocks (about every four years), an event called the "halvening" (or more recently just the halving). It is an article of faith among the crypto-bros that, after the halvening, the price will rise. For example:

In the image below, the vertical blue lines indicate the previous three halvings (2012-11-28, 2016-7-9, and 2020-5-11). Note how the price has jumped significantly after each halving.

Source

The most recent halvening happened on Friday, April 19^th. It was eagerly awaited so, six weeks later, it is time to go below the fold and look at the effects.

"Sufficiently Decentralized"

Mining Pools 5/17/24

In June 2018 William Hinman, the Director of the SEC's Division of Corporate Finance, gave a speech to the Yahoo Finance All Markets Summit: Crypto entitled Digital Asset Transactions: When Howey Met Gary (Plastic) in which he said:

when I look at Bitcoin today, I do not see a central third party whose efforts are a key determining factor in the enterprise. The network on which Bitcoin functions is operational and appears to have been decentralized for some time, perhaps from inception.
...
Over time, there may be other sufficiently decentralized networks and systems

Below the fold, thanks to a tip from Molly White, I look at recent research suggesting that there is in fact a "central third party" coordinating the enterprise of Bitcoin mining.

Fee-Only Bitcoin

Mining a Bitcoin block needs to be costly to ensure that the gains from an attack on the blockchain are less than the cost of mounting it. Miners have two sources of income to defray their costs, the block rewards and the fees for the transactions in the block.

On April 19^th the block reward was halved from 6.25BTC to 3.125BTC. This process is repeated every 210,000 blocks (about every 4 years). It limits the issuance of BTC to 21M because around 2140 the reward will be zero; a halving will make it less than a satoshi.

Long before 2140 the block rewards will have shrunk to become insignificant compared to the fees. Below the fold I look at the significance of the change to a fee-only Bitcoin

Decentralized Systems Aren't

Below the fold is the text of a talk I gave to Berkeley's Information Systems Seminar exploring the history of attempts to build decentralized systems and why so many of them end up centralized.

More On Pig Butchering

Thankfully, pig butchering scams are getting attention. Three weeks after I posted Tracing The Pig Butchers, John M. Griffin and Kevin Mei posted How Do Crypto Flows Finance Slavery? The Economics of Pig Butchering:

Through blockchain addresses used by ‘‘pig butchering’’ victims, we trace crypto flows and uncover methods commonly used by scammers to obfuscate their activities, including multiple transactions, swapping between cryptocurrencies through DeFi smart contracts, and bridging across blockchains. The perpetrators interact freely with major crypto exchanges, sending over 104,000 small potential inducement payments to build trust with victims. Funds exit the crypto network in large quantities, mostly in Tether, through less transparent but large exchanges—Binance, Huobi, and OKX. These criminal enterprises pay approximately 87 basis points in transaction fees and appear to have recently moved at least $75.3 billion into suspicious exchange deposit accounts, including $15.2 billion from exchanges commonly used by U.S. investors. Our findings highlight how the ‘‘reputable’’ crypto industry provides the common gateways and exit points for massive amounts of criminal capital flows. We hope these findings will help shed light on and ultimately stop these heinous crimes.

Griffin & Wei Fig. 9

Their Figure 9 shows the flow of funds over time into the scammer's wallets at exchanges. This is how they estimated the $75.3B; their extremely conservative estimate is $35.1B, and their liberal estimate is $237.6B. Note the huge ~$45B increase from January 2021 to January 2023, partly driven by the cryptocurrency boom, and the slowing until January 2024. Presumably the ETF pump will accelerate the rate.

Below the fold, some commentary on this and other recent developments.

Clouds Over The Mines

In early December 2022 when I wrote skeptically about the economics of Bitcoin mining in Foolish Lenders the Bitcoin "price" was around $17K. It has now climbed 153% to around $43K and, below the fold, I am still posting skeptically about the economics of mining.

Tracing The Pig Butchers

"Vicky"

Chapter 18 of Zeke Faux's Number Go Up: Inside Crypto's Wild Rise and Staggering Fall is entitled "Pig Butchering". It starts when he receives a supposed wrong-number text from a "Vicky":

I showed my phone to my friend and explained that I was stringing Vicky along because I’d heard about a new kind of investment fraud that often started with a random text message. I had a hunch that this was why “Vicky” was texting me. The scam was called “pig butchering” because the scammers liked to build up the victim’s confidence with a pretend romantic relationship and made-up investment gains before stealing all their money in one fell swoop—like how hogs are fattened up before their slaughter.

This is a romance- and cryptocurrency-enabled version of the "Wee Forest Folk" scam we described in our 2003 SOSP paper.

Below the fold, I look into the details of pig-butchering scams, and how the tracing techniques I discussed in Criming On The Blockchain are being applied to identify the cryptocurrency companies facilitating it.

Criming On The Blockchain

I apologize for the delay in posting but, as you will see, the post I was working on grew rather long.

It seems obvious that doing crimes and writing the receipts to an immutable public ledger is risky, but many criminals have been convinced that there is no risk because cryptocurrencies such as Bitcoin are anonymous. Although there are cryptocurrencies with anonymous transactions, such as Monero and zCash, they are much more difficult to use and much less liquid than pseudonymous cryptocurrencies like Bitcoin. As many criminals have discovered, without an unrealistically intense focus on operational security (opsec), the identity behind the pseudonym can be revealed. An entire industry has evolved to do these revelations, tracing the flow of coins through their blockchains.

Below the fold I discuss the techniques and results of blockchain tracing, based on four main sources:

• Andy Greenberg's new book entitled Tracers in the Dark: The Global Hunt for the Crime Lords of Cryptocurrency.
• Chainalysis' report 2024 Crypto Crime Trends: Illicit Activity Down as Scamming and Stolen Funds Fall, But Ransomware and Darknet Markets See Growth and his ‘Stablecoins’ Enabled $40 Billion in Crypto Crime Since 2022.
• The UN Office for Drugs and Crime (UNODC) report Casinos, Money Laundering, Underground Banking, and Transnational Organized Crime in East and Southeast Asia: A Hidden, Accelerating Threat.
• Recent posts on ChainArgos blog.

Good News For Tether

USDT "market cap"

The good news for Tether is shown in this graph, with two huge surges in "market cap" this year. One of about $15B early in the year, and another of about $6B recently. It looks like the euphoria over the prospect of spot Bitcoin ETFs has solved the Greater Fool Supply-Chain Crisis with the cryptosphere experiencing a massive inflow of around $20B actual dollars. As one might expect from injecting $20B whose only uses are to HODL or to buy cryptocurrency into the market, the result has been a massive bubble in cryptocurrency "prices".

BTC "price"

Bitcoin has gone from about $16K at the start of the year to around $42K recently. Ethereum has merely doubled, from about $1.2K to about $2.4K.

So all is well with the world; Tether gets to keep the interest on another $20B, which at say 4% is an extra $800M/year on their bottom line, and the Bitcoin HODL-ers see their investment gamble return a 160% gain. Is all really well with the world? Follow me below the fold.

Why Worry About Resources?

The attitude of the crypto-bros and tech more generally is that they are going to make so much money that paying for whatever resource they need to make it will be a drop in the ocean. Amd that externalities such as carbom emissions are someone else's problem.

I discussed Proof-of-Work's scandalous waste of energy in my EE380 talk, Can We Mitigate Cryptocurrencies' Externalities? and elsewhere, since 2017 often citing the work of Alex de Vries. Two years ago de Vries and Christian Stoll's Bitcoin's growing e-waste problem pointed out that in addition to mining rig's direct waste of power, their short economic life drove a massive e-waste problem, adding the embedded energy of the hardware to the problem.

de Vries Fig. 1

Now, de Vries' Bitcoin’s growing water footprint reveals that supporting gambling, money laundering and crime causes yet another massive waste of resources.

But that's not all. de Vries has joined a growing chorus of researchers showing that the VC's pivot to AI wastes similar massive amounts of power. Can analysis of AI's e-waste and water consumption be far behind?

Below the fold I discuss papers by de Vries and others on this issue.

Desperately Seeking Retail

Source

The SEC has a long history of refusing to approve spot Bitcoin ETFs, on the reasonable basis that the Bitcoin market was heavily manipulated. Crypto-skeptics like Bitfinex'ed and Davd Gerard have been pointing out obvious instances of manipulation for many years, and there is a considerable academic literature demonstrating manipulation, such as Crypto Wash Trading by Lin William Cong et al, which demonstrates:

abnormal first-significant-digit distributions, size rounding, and transaction tail distributions on unregulated exchanges reveal rampant manipulations unlikely driven by strategy or exchange heterogeneity. We quantify the wash trading on each unregulated exchange, which averaged over 70% of the reported volume.

Unfortunately, despite knowing about the manipulation, the CFTC approved Bitcoin futures ETFs. Among the requests that the SEC refused was one from Grayscale Bitcoin Trust. Grayscale sued the SEC and, back in August, the panel of judges ruled in their favor:

The court's panel of judges said Grayscale showed that its proposed bitcoin ETF is "materially similar" to the approved bitcoin futures ETFs. That's because the underlying assets— bitcoin and bitcoin futures - are "closely correlated," and because the surveillance sharing agreements with the CME are "identical and should have the same likelihood of detecting fraudulent or manipulative conduct in the market for bitcoin."

With that in mind, the court ruled that the SEC was "arbitrary and capricious" to reject the filing because it "never explained why Grayscale owning bitcoins rather than bitcoin futures affects the CME’s ability to detect fraud."

The prospect of the SEC approving this ETF and others from, for example, BlackRock and Fidelity led to something of a buying frenzy in Bitcoin as shown in the "price" chart, and in headlines such as Bitcoin ETF Exuberance Drives Four-Week ‘Nothing for Sale’ Rally:

Bitcoin is climbing for a fourth consecutive week, with the digital token’s price lingering just below an 18-month high of $38,000, as more investors bet that US exchange-traded funds that hold the largest cryptocurrency are on the verge of winning regulatory approval.

Below the fold I look into where this euphoria came from, and why it might be misplaced

Alameda's On-Ramp

Tether has been one of the major mysteries of the cryptosphere for a long time. It has never been audited, and has been described as being "practically quilted out of red flags". Matt Levine says "I feel like eventually Tether is going to be an incredibly interesting story, but I still don’t know what it is." He was commenting on Emily Nicolle's Bankman-Fried Trial Renews Conjecture About Alameda’s $40 Billion Tether Stablecoin Pile by Emily Nicolle. It includes a lot of interesting information, starting with this:

Alameda was Tether’s largest non-exchange customer between 2020 and 2022, with blockchain data showing it received almost $40 billion in transfers of its stablecoin USDT directly from the company — equal to roughly 20% of all USDT tokens ever issued.

Below the fold, I discuss the questions Nicolle raises, and go on to ask one she doesn't

Not "Suffficiently Decentralized"

Mining power 25 June 2018

Perhaps the most consequential result of the tsunami of Blockchain Gaslighting ocurred on 14^th June 2018 when William Hinman, the Director of the SEC's Division of Corporate Finance gave a speech to the Yahoo Finance All Markets Summit: Crypto entitled Digital Asset Transactions: When Howey Met Gary (Plastic). In it he hamstrung his own agency's ability to regulate the two most important cryptocurrencies by saying (my emphasis):

when I look at Bitcoin today, I do not see a central third party whose efforts are a key determining factor in the enterprise. The network on which Bitcoin functions is operational and appears to have been decentralized for some time, perhaps from inception. Applying the disclosure regime of the federal securities laws to the offer and resale of Bitcoin would seem to add little value.[9] And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value. Over time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required.

Follow me below the fold for both the evidence that Hinman was talking though his hat, and also yet another update on the theme of my Brief Remarks to IOSCO DeFi WG, that successful systems claiming to be decentralized, like Bitcoin and Ethereum, aren't.

The Oracle Problem

Source

If you read Molly White's timeline of cryptocurrency catastrophes Web3 is Going Just Great you will notice that many of the more expensive disasters are tagged "oracle manipulation" attacks. Last March, Chainalysis posted Oracle manipulation attacks rising: a unique concern for DeFi in which they wrote:

Overall, we estimate that in 2022, DeFi protocols lost $403.2 million in 41 separate oracle manipulation attacks.

What are oracles and how can manipulating them earn an average of $1.1M/day? Below the fold I attempt an explanation.

The Bitcoin "Lab Leak" Theory

In the late '80s and early '90s electronic cash was a hot topic among cryptographers. People such as David Chaum published extensively in journals such as Springer's Advances in Cryptology. Staff at the US National Security Agency (NSA) were naturally interested in developments in cryptography, so on 18^th June 1996 the NSA's Laurie Law, Susan Sabett and Jerry Solinas reviewed the academic literature on electronic cash and published HOW TO MAKE A MINT: THE CRYPTOGRAPHY OF ANONYMOUS ELECTRONIC CASH :

This report has surveyed the academic literature for cryptographic techniques for implementing secure electronic cash systems. Several innovative payment schemes providing user anonymity and payment untraceability have been found. Although no particular payment system has been thoroughly analyzed, the cryptography itself appears to be sound and to deliver the promised anonymity.

These schemes are far less satisfactory, however, from a law enforcement point of view. In particular, the dangers of money laundering and counterfeiting are potentially far more serious than with paper cash. These problems exist in any electronic payment system, but they are made much worse by the presence of anonymity.

Alas, this understandable effort by NSA staff has become the keystone in a bizarre theory that Satoshi Nakamoto is an alias for the NSA, who developed Bitcoin in secrecy as a "monetary bioweapon" a decade before it somehow leaked and infected the world.

I must apologize that, below the fold, I devote an entire post to this conspiracy theory.