A few thoughts - Tuesday, October 7, 2014

[Steve Sokolowski]

Good afternoon! A few thoughts for lunch today:

Has the trend reversed?

The simple answer to the question of whether the trend has reversed is that if nothing changes for a week, then it has. The world of bitcoins is ruled by patterns which repeat over and over again, and one of those patterns has just concluded. We saw a huge fall of over 20% in a single day, followed by a sharp rebound, and then stability at a higher level. This pattern happened every time the trend reversed in the previous cycles: in April, the July before that, and so on.

What all those periods have in common, and which we didn't have until Sunday, was incredible volume and volatility. Throughout the slide during the past month, there was never a period of high volume, just slow decline. On Sunday, unlike the month before it, the price rose and fell by 10% in the matter of an hour several times, and at one point over 30,000 bitcoins changed hands.

Now that two days have passed, and the price is beginning to stabilize around $330, I suspect that this is the point in the cycle like in early May, where the sellers have sold out and the buyers have yet to arrive. While I previously had maxed out the amount I wanted to ever contribute to bitcoins, this price is a huge opportunity. If there is no movement after a week, then I'll probably decide the tide has turned and put in some more money. If the panic continues, then I'll wait a week after it subsides and re-evaluate.


Beware of effect of spam on statistics

Recently, some people have started sending transactions with huge numbers of outputs in an effort to get people to visit websites by searching for the sender's address. This tactic is reminiscent of referrer log spam, where programs visit websites and set their "referer" field to the advertiser's website. People who are curious look for the source and, supposedly, discover products.

Besides the effectiveness being dubious (I would immediately write off any product that came to my attention by such underhanded tactics), the spammers are significantly inflating the transaction count. People at bitcointalk.org are contributing to the problem by posting huge lists of addresses to collect free money from the spammers. The spam bots apparently parse bitcointalk.org posts and send money to addresses they find.

The effect these spammers have is essentially to waste their own money, so the spam itself isn't a problem. The disk space and bandwidth taken up by the spam is negligable. On the other hand, some people look at "transaction count" charts and notice that there have been huge spikes recently. A closer inspection shows that while transaction count has been increasing, a large proportion of the transactions are these spam transactions, which don't represent any real economic activity. Making the case that the fundamentals are getting stronger using transaction count alone is a poor argument for that reason.



A note about bitcoin statistics

As someone in /r/bitcoinmarkets recently pointed out, it doesn't make sense to evaluate the health of the bitcoin industry based on numbers like "number of wallets." Metrics like "blockchain.info My Wallets" and "Coinbase accounts" suffer from a similar problem. The issue with these figures is that they can never go down, because wallets never disappear. Even if a wallet is empty, it still shows up in figures of the "number of wallets." Furthermore, since Coinbase and blockchain.info have interests in promoting how many people are using their services, they will never eliminate inactive accounts from their systems.

With the number of wallets unable to decline, it doesn't make sense to argue, as some do, that as long as the number of wallets is increasing, the system is in good shape. Furthermore, someone can create lots of non-empty wallets easily by sending spam to them, or can create a new wallet while abandoning an old one.

If I were looking for a statistic to determine the trend of bitcoin usage, the most accurate would probably be how many purchases are being made at merchants. While that statistic doesn't help with determining how many people use bitcoin solely as a store of value, it is more useful than counting the number of wallets.


The fatal flaw of merge mining

Recently, I've been working on implementing merge mining of scrypt coins. The speed at which other pools have adopted this feature is breathtaking, and I'm not sure how they could have done it so quickly, or how we missed that it could be so profitable. Merge mining is the most difficult computer-related task I've encountered in my life, far more challenging than any computer science course puzzles or any system that I've designed in my normal employment. Nevertheless, once I complete implementing it, we should easily be more profitable than the other pools again.

At the same time that I'm gaining an understanding of how merge mining works, I'm losing an understanding of why coins would want to implement it. The theory goes that if you take some of the hashpower that is devoted to other coins and add it to your coin's network, then your network will be very secure and immune to 51% attacks, and therefore will be more valuable. I don't agree with either of those points.

People who merge mine are mining a primary coin and an auxiliary coin (for many people, the primary coin is litecoins). Most people who are merge-mining dogecoins aren't doing so because they like dogecoins; they see it as a free revenue stream. In fact, our pool will likely sell close to 100% of all dogecoins that we mine to convert them to either the primary coin or whatever coin the customers want to be paid. Every block we mine will go right to the exchange and get sold, driving the price of dogecoins down.

But you might suggest that what we will do was the case before; there were plenty of people who primary mined dogecoins and then immediately sold them. The key here is that there is a subtle, but important, difference. Primary miners of dogecoins had an interest in their success, if only for a short while until they sold. They incurred an opportunity cost: by not mining feathercoins, they made a conscious choice that dogecoins were (at least temporarily) worth supporting more than feathercoins. Even if they didn't believe in dogecoins, miners wanted the dogecoin network to remain viable so that they could make money off of mining them. We can say that miners of dogecoins had a "proof of stake" in the dogecoin network.

There is no opportunity cost in merge mining, so therefore merge miners have not proved any stake in dogecoins. People like me, for whom merge mining has been a colossal waste of manpower and energy that could be put into other features, would in fact be extremely happy to see dogecoins go away solely for the fact that there would be one less feature to fix bugs in. The only reason I (and most likely other pools) are implementing merge mining is to remain competitive. If the dogecoin network gets sold down to zero, none of the pools care, because the relative profitability of the pools remains the same. Miners aren't going to switch between pools as merge mining profitability changes, because the grass isn't any greener on the other side.

Pools' behavior demonstrates the fatal flaw in merge mining. What merge mining has done is to ostracize a group of dedicated dogecoin miners, who cared about the network, and replaced them with a huge group of miners who largely see merge mining as an annoyance or as "free money." Unlike namecoins, which serve a different purpose than bitcoins, dogecoins are being mined by people who support coins that are in direct competition with them. There are undoubtedly a substantial proportion of litecoin miners who see dogecoins as a threat, because there is only so much money to go around. Namecoins are a domain name system, and therefore are not a threat to bitcoin miners. Why would people put the future of their coin in the hands of their direct competitors?

If there are two coins that dislike each other, and I wanted one to succeed, I previously had two choices, each of which had an opportunity cost. I could mine the first, or I could attack the second. Now, I can do both. At the same time that I support my coin, I can, for free, attack the rival coin.

It gets even worse. Pools who 51% attack a primary coin waste their own resources while other pools make money mining different coins. On the other hand, it is in the best interest for a pool who can 51% attack dogecoins to do so, because they won't lose any more money than anyone else. Pools that don't have 51% of dogecoin hashpower can still degrade the network with impunity; practicing malleability on transactions, for example, still earns money while making life difficult for dogecoin users. Once it is shown that merge mining doesn't work, the value of non-merged coins will rise proportionally, and the pools can make more money by not having to maintain merge mining code.

Dogecoins are in a bubble, and as more pools bring merge mining online, we will start to see both selling pressure and also shenanigans that degrade the dogecoin network. Once some pools start to conduct attacks against dogecoins, the dogecoin developers won't be able to do anything about it, because they made the price or survival of the network irrelevant to the people who are actually securing it.

[Chris Sokolowski]

You make good points about merge mining. I think it's worth mentioning that Namecoin is so far the only merge mined coin to have any lasting success in the market, which I agree with you is because it provides a unique service.

Dogecoin is preceded by many other merge mined coins (e.g. Pesetacoin) that declined to zero value and were subsequently delisted from exchanges. While the Dogecoin community is arguably stronger than most altcoin communities, the implementation of merge mining is a clear acknowledgment that there is no chance of Dogecoin ever surviving on its own. At this point the only thing that can keep Dogecoin relevant is an enthusiastic community supporting it, which as we both know can be fleeting.

The price of DOGE is up only because of all the publicity the release of merge mining created. Once this bubble ends, focus will shift to the other coins that are releasing new features and people again will forget about DOGE. As you have said many times in the past, if you aren't constantly innovating, then you're falling into irrelevance.