A few thoughts - Thursday, September 4, 2014

[Steve Sokolowski]

Good afternoon! A few thoughts for lunch today:

Stark difference between venture capitalists and adoption figures

http://bitcoinpulse.com reveals a stark difference between the minds of venture capitalists and the minds of the general public. It should be obvious by now that venture capitalists are throwing money into the bitcoin industry at completely unsustainable levels. In a discussion, I told Kristof Toth that Ethereum put down $16,500 in security deposits for one out of their three offices, which are going to be geographically distributed in three countries. As a friendly reminder, probably because they are wasting their valuable time on looking for offices that could instead be spent coding, the Ethereum developers have not released anything yet.

The most recent statistics at bitcoinpulse show an interesting tale. Most of the statistics show contraction (number of wallets and number of transactions are not important; transaction volume is). The sole exception that consistently has growth is venture capital funding. The VCs continue to pump funds into an industry that, at the current time, cannot support and does not need additional investment. At some point, this will lead to spectacular failures as companies run out of money.

Look at the job statistics. There are hundreds of companies and thousands of employees working with bitcoins in some way. There are about five people who are trying to solve the actual problems with the protocol (like the 1MB transaction limit), and petty personal conflicts combined with underfunding have limited even their productivity. The math doesn't compute here; when you make a company with 100 developers depend on a product that is created by five developers, the company is going to be limited by the capabilities of the product.

There will be a moment of truth where one of the VCs will lose a lot of money in a spectacular failure. It is even feasible to argue that that moment is approaching rapidly. Remember, the final panic that rolls over moral_agent's charts from "going down" to "struggling" tends to happen about 4.5 months after the bubble pops. If you agree with me that there was a bubble that ended May 31, we should be expecting that panic to occur in mid-October. While the cycle does not react directly to the news, the event that people look back at for that fallout could be the failure of a large bitcoin company - not due to incompetence or fraud, but because it simply didn't make enough money.


Speculating about prices

I remain bearish, as I have for the past two months. There is some discussion in /r/bitcoinmarkets today where people are speculating that the price will bottom out at $440. I said two months ago that this downturn would hit $440. I will add now that if I have to err in one direction, it will be that the bottom will be lower than $440, not that we will somehow rebound before reaching that point. I'll also add now that if I have to err in one direction, it will be that the top to bottom time will be less than 4.5 months, not longer than 4.5 months.

Talking about the panics above, the cycle isn't going to turn until there is one final panic, just like there has been about five times before. Again, while you can say things like "past performance doesn't guarantee future results," people who bet against the past are often fools. The April panic hit $339 before recovering. I don't make TA predictions because I don't know enough about TA, but the panic will be severe and will recover within a day just like all the others have.


Remembering the 2011 bubble

I first heard about bitcoins in 2011, before the big "megabubble." Then, as now, I realized that the only way that bitcoins would be unsuccessful is if people decided not to use them, because the technology itself was groundbreaking (but people are far more difficult to understand than computers). I didn't make the connection that one could earn money by buying bitcoins and holding them at the time, but I did see that there was money to be made in the creation of a secure wallet service.

As many know, the wallet services at the time used databases to store users' balances, and dumped all the coins into one huge wallet. The bitcoin client itself is largely responsible for this trend because someone implemented the idea of "accounts," an archaic feature that allows one wallet to appear as multiple wallets within the Bitcoin Core client. Services were hacked and, because people had no control over their own coins, all their money was lost.

My idea was that such services could be made hackproof if our servers never wrote users' private keys to disk. I created a system using bitcoinj 0.1 where users could register accounts, and a wallet was created for them, encrypted using their passwords. Since we only stored the SHA-256 hash of the passwords, and the wallets on disk were encrypted using the passwords themselves, we did not have enough information at our disposal to decrypt users' wallets. A hacker who stole the database and wallets would also be unable to steal money, unless people used weak passwords that could be brute-forced. The only attack vectors would be a man-in-the-middle attack, and if another process on the server somehow managed to access the memory of the Java wallet program during the milliseconds a key was stored in memory to send funds.

In October 2011, after implementation was completed, transaction volume continued to plummet, and I had to decide whether to start spending money on hosting and advertising for launch. I made a decision to abandon the project because bitcoins were not being accepted by the public. I moved on to lifecentral.info, a medical tracking database. At the same time, a company called blockchain.info appeared and stuck with bitcoins even during the downturn. Blockchain.info essentially implemented what I did in that "secure wallet" hosting service a year later and became successful doing it.

This should serve as a reminder to people who are interested in bitcoins and then decide to give up because "bitcoins are dead." This time, I stuck around and will continue to develop things because the situation has been far worse in the past.