Bitcoin: The Decentralization Fake Story

This newsletter does not represent the views of the author's employer and is not a financial or investment advice.

It is intended as a psychological, philosophical and systemic approach to the Bitcoin phenomenon, with the aim to elevate the consciousness levels in the finance industry.

The content is solely related to Bitcoin and should not be generalised as views to the wider theme of Blockchain technology.

The Pareto Principle

In 1906, an economist named Vilfredo Pareto discovered what became known as the "Pareto Principle," or the 80/20 rule.

While studying the distribution of wealth, he noticed that 20% of the people owned 80% of the land in Italy.

To his surprise, he found the same phenomenon held in other countries.

One would have expected some level of imbalance everywhere, but not of this magnitude, nor consistency across different countries.

Nevertheless, since the 1950s, numerous studies have confirmed the application of the 80/20 rule in many different areas of business and our professional lives.

The Pareto Principle is a counterintuitive relationship between cause and effect, reflecting a Power-Law statistical distribution.

From a systemic lens, one can understand it as a consequence of feedback loops —? the more success you have, the more opportunities you have and the higher your confidence will be.

It becomes an upward spiral dynamics as in game theory.

The opposite holds for failure.

The more you fail, the fewer opportunities you have and lower your confidence - a downward spiral feedback loop.

One may argue that this is the flaw in a centralised economic system and that Bitcoin, a decentralised monetary system, brings more power to people than before.

Therefore, in an economy built around the Bitcoin monetary system, one would assume that the Pareto Principle would no longer apply.

Is that so?

Bitcoin Flawed Decentralization

Bitcoin has promised to solve the current problems of the Financial system by creating a fully decentralised monetary system, giving power back to people and away from the Central Banks.

Such a narrative is very appealing to all those affected by the 2008 Financial crisis and, more recently, due to the increase of inflation following the Covid-19 impact on the economy.

Bitcoin is decentralised in the sense that it is making use of Blockchain technology, where we have a non-reproducible network with nodes distributed throughout different machines across the world.

However, such "node technical decentralisation" is far from being the same as a "power decentralisation" for two main reasons:

• Nothing prevents the creation of node concentration ownership
• Layers built on top of the blockchain can develop into power concentration

What follows are example cases that question the narrative of "decentralisation" being promoted in social media regarding the Bitcoin phenomenon.

Surprisingly, you will see a deeper relationship between Bitcoin and the Pareto Principle, testifying how relevant the Principle is in game theory.

Systemic thinking is, therefore, crucial to move away from the linear narratives promoted in social media designed to create simple mental models that do not correspond to reality.

Remember: Bitcoin is a highly complex topic and more often than not, what you see is NOT what you get!

Case #1: Bitcoin Oligarch System

Bitcoin wallets are associated with account addresses, and according to the address ownership, the top 1% of Bitcoin owners hold ~90% of its total wealth.

The stats are based on the "address ownership" and may not represent precisely the individuals who actually own it; each address can hold the accounts from different users, and each user can have accounts in different addresses.

Considering such a correction, we come to the top 1% of network entities controlling ~68% of all Bitcoin and the top 2% controlling ~71.5% of it.

As Stephen Diehl writes in his blog, "(...) the use of the word "decentralise" in technology is used to dubiously anthropocentrize a concept that has different meanings when moving between the strata of humans and the strata of network technology.

(...)

However in technology, there's a much simpler definition simply in terms of the connections and responsibilities of software running on servers.

But rarely do those nodes correspond to individuated humans or their interests. "

Such imbalance ownership clearly reflects the Pareto Principle, regardless of the Bitcoin "node decentralisation" technical design.

It goes in line with this study showing that Bitcoin ownership resembles more of an oligarch system than anything else.

The narrative that "Bitcoin gives the power back to people" couldn't be further from the truth.

Case #2: Bitcoin Miners Power Law

There are only 21 million Bitcoins available, and 90% of it was mined already, with the remaining 10% projected to be mined for the next 100 years or more.

This is yet another clear reflection of the Pareto Principle, translated into the Power Law as per the graph below; there was substantially less effort to mine the first 90% of the Bitcoins than what will be required to mine the final 10%.

Bitcoin Believers often use this fact of limited supply to argue that prices can only go up on a long trend, and so we are better not to miss the opportunity while we can? — creating a "fear of missing out" (FOMO) psychological fear in public.

Such limited supply is a fundamental reason for creating a price bubble as long as new demand continues to exist and HODLers keep holding.

From an efficient market hypothesis lens, much of such scarcity should be priced in already.

However, Bitcoin is far from following the laws of conventional Academic Economic schools but rather as an emotional, social network effect.?

The point is that no one can know for sure what will happen in the market dynamics as we start to reach a level where it's becoming harder and harder to mine new Bitcoins.?

It has been a long time since anyone could successfully mine Bitcoins.

The system is no longer "decentralised" in the sense that only major players can keep on the game of mining Bitcoin.

Miners know the game change they are playing, a race against time, particularly when governments raise additional challenges.

And the more pressure they will get from mining more effectively, the more we will see desperate acts from malicious players.

It will be interesting to see how this new tension from miners will play into the Bitcoin system, as the Pareto Law is no longer on their side in terms of mining efficiency.

Case #3: Bitcoin Code Developers

The implementation of Bitcoin is done with the rules of mathematics in an open-source code visible to the public.

Bitcoin Believers have used this fact as an argument of Bitcoin transparency and mathematical truth.

However, as one zooms into this fact, we can recognise a Pareto Principle applied in the Bitcoin code maintenance.

There are a total of ~360 active developers who contribute to the Bitcoin code architecture, but some contribute a lot more than others.

According to the bitcoin.org website, there have been a total of ~30,000 code commits to the Bitcoin architecture from ~360 developers - with the top 10 developers contributing ~70% of the total code commits.

The number of code commits per developer follows a staggering Power Law as inferred by the Pareto Principle.

Such a high level of knowledge power concentration on a handful of code developers is a concern for different reasons, and Bitcoin is not an exception to that.

Though Bitcoin is a "node decentralisation technology", its code development is highly specialised and not fully understood except for a few people.

Add that to the fact that many of the code developers don't provide their real names & faces but rather call themselves such as "S3RK", "cozz", "sdkfjlsfjlskdfjlsdjflsjf" and so on; it leads to the question about its trust & sustainability.

Case #4: Max_Money Centralization Power

From all the code implementation of Bitcoin, I believe one file is one of the biggest centralisations of power written in recent human history.

I refer to the file "amount.h", which sets the Bitcoin supply limit to 21 million defined in the variable "MAX_MONEY".

Such a file only has three code contributors.

Why 21 million?

Who chose it?

Why not link it with the world population?

Can it ever be changed?

In a narrative that Bitcoin is a "decentralisation system" giving the power back to people, at the same time, we had a central player who defined its limited supply of only 21 million coins.

That same central player mined the first 1 million of them and kept it in their power…

This is an example of the Pareto Principle on steroids.

Case #5: Bitcoin Social Copy Trading?

Taking together the limited supply of Bitcoin and its nascent implementation in society, one can foresee a possible lack of liquidity in the Bitcoin market.

The situation is exacerbated due to its complexity that most people don't understand but yet want to invest in.

Regardless of the amount of information available, the reality is that many Bitcoin Believers and Bitcoin Retail Investors end up following the advice or hints written in social media by a few people like Elon Musk or Kim Kardashian.

Following trends & bubbles is a characteristic of people who lack self-mastery, resulting in social copy trading.

They are not in the game using their critical thinking, analysing the market fundamentals and setting a strategy aligned with their risk appetite. Rather, they simply follow "what a friend is doing".

The Efficient Market Hypothesis no longer applies when people simply do copy social trading and overreact to Elon Musk's Tweets.

It becomes more of a social experience rather than anything else.

Bitcoin Believers have a point when claiming that there is too much concentration power in Central Banks, but at the same time, they act in the exact same way as a centralised system by following a handful of social media gurus.

Is the question now a matter of preference on reacting to a FED announcement or an Elon Musk's Twitter?

The difference is that FED meetings are announced in advance.?

With Elon Musk, you have to count on his mood.

Or, as claimed by Bitfury's chief executive Brian Brooks, "Liquidity is so limited — he estimated about 80 per cent of bitcoin holders have never sold — that when a big crypto investor sneezes, everyone gets a cold."

Emotional False Beliefs

I had a close friend who believed that the Moon was made of cheese with holes in my childhood.

As he was pointing to the Moon and explaining his belief, I told him that his story was nonsense and that the Moon was actually made of rock just like Earth but with no atmosphere or water.

I explain that what he believed to be cheese holes were nothing but craters from meteors that collapsed in the Moon due to the inexistence of an atmosphere.

What do you think his reaction was?

NOT happy!

I've made the mistake of questioning his belief, even more so when it was something that his parents have told him.

So not only I was telling him his belief was false but that his parents were liars too.?

Not that I told him that — I was not even aware the belief was something that his parents told him along with the Santa Clause story — but it was implicitly taken from confronting him with scientific facts that I had read in books on Astronomy.

This is the same exact phenomenon when dealing with Bitcoin Believers!

When pointed to the system's flaws by zooming in the details… that it is little related to a decentralised power system… that there is a lot of market manipulation reflected on price jumps as opposed to high volatility, and so on… what do you believe to be their reaction?

The same exact one as little children who got their dreams stolen from them?— an attack on their belief systems that are not sustained by logic or reasoning but rather by being highly emotional attached to it.

Either that being a "centralised" or "decentralised" system, the fact is that the Pareto Law is a reflection of hidden forces present in game theory and denying it is living in a utopian world made of false narratives.

In a way, the belief of false narratives reflects a lack of self-mastery to handle reality as it is.

A History of Bitcoin Narratives

I don't know for how long you have been following the Bitcoin phenomenon, but it is worth summarising the different narratives that we have had since its creation.

Back in 2010, we started with the narrative of being a digital currency that would validate all transactions without a central player.

This did serve well to the usage of certain lines of commerce as the "Silk Road".

But as soon as we had it implemented in some coffee shops in Manhattan, the public started to realise the time it took to validate a transaction - people ordered a coffee, and by the time the transaction was concluded, the coffee was already cold.

We then started to hear the first voices raising the flaws of the system.?

Bitcoin reinvented itself by changing the narrative from a Digital Currency to Digital Gold.

Since then, such a narrative of "store-of-value" has been used to hedge inflation.

Recently, with the introduction of Institutional Investors, Bitcoin seems to behave more as an Equity and not a hedge to inflation.

On the other hand, there are concerns that Bitcoin should not be qualified as an investment - even having health warnings in the small print of investment adverts risked giving it 'undeserved credibility'.

According to this pool, almost half of the people see Bitcoin not as a financial asset but rather as gambling.

Could that be the new Bitcoin narrative simply be a '24/7 Online Game'?

Conclusion

We have seen how the Pareto Principle results from an upward spiral dynamics from a systems thinking in game theory.

Regardless of how the technical monetary system is designed as "node centralisation" or "node decentralisation", there are hidden forces that develop into pockets of power concentration as predicted by the Pareto Principle.

Whether that be in Bitcoin ownership, open-source code maintenance or social copy trading, the fact is that we have strong evidence to defeat the narrative of a "decentralised" system perpetuated in social media.

Still, Bitcoin Believers refuse to acknowledge it or downplay its relevance when faced with such evidence, quickly switching their conversation to point out the problems with the central banks.

It is not hard to understand why such reactions - such evidence - are perceived as threats to their belief system in the same way as little children who cry once they are told of the true story of Santa Claus.

Bitcoin Believers are impotent to present solutions to valid flaws in the system because their actions are more based on emotion than reason.

And in a market with an artificial scarcity of 21 million coins available, playing this game has become highly skewed to benefit the bulls as opposed to the bears.

Nevertheless, the house of cards can be unfolded in different ways, which I will describe in the following newsletters.

As for now, this will be the last newsletter of 2021 and will resume in 2022 due to the holiday season.

I wish you Merry Xmas and a Happy New Year…

…and that Santa Claus brings you a lot of cheese from the Moon!

Nuno Reis

Former Bitcoin believer turned into a Bitcoin sceptic.?

Disclaimer: Opinions expressed here are on my own.

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