Bitcoin Perversion

Please note that this is my personal blog and does in no way reflect the opinions of my employer Uphold.?

Last week we saw over $400 million in liquidations of derivatives in the crypto market. Bitcoin nosedived right after recording over $3 billion in ETF inflows the week before. After rising sharply following the low inflation numbers, markets plunged when the Fed did not lower interest rates and projected a significantly higher year-end target of 5.1% and at most one rate cut. Three had been expected.?

Critics accused the Federal Reserve of massaging jobs data and ignoring the fact that 600,000 jobs were lost in May in the US economy. The United Kingdom and the European Union are already in recession. Sooner later America will follow and Powell may be forced to cut rates in rapid succession as the economy falls off a cliff. We’ve been there before.?

The selling is coming from all sides, despite the ETF inflows. Both small and big holders are dumping their BTC every time it reaches the 70k zone. While unrepentant Bitcoin maxis don’t care about these short term fluctuations, a large number of older whales accounts are selling into every attempt to climb higher. ? It’s almost as if they knew a crash was coming. Crypto-assets other than Bitcoin have lost their independence, and altcoin lovers will soon lose the will to live. The last three months have been a nerve wrecking rollercoaster of euphoria interrupted by sheer terror. Notable analysts are now calling for a bearish 40k target. I wouldn’t be surprised.?

The events of this week showed two things clearly. Bitcoin is now responding to marco-economic data more than ever. It was supposed to be that independent asset under the people’s control, devoid of influence and free from the bounds of the traditional economy. It was supposed to bestow freedom.? The halving was supposed to be a defining catalyst that would send it much higher. Instead, it is being bogged down by a light change in inflation data and job numbers. That wasn’t the plan.?

Bitcoin NEVER was and never will be an e-cash system as the Satoshi group originally envisaged, and it never was“digital gold”, an appealing but misleading taxonomy. In times of extreme stress and crisis such as the outbreak of the Ukraine war, gold behaves quite differently. Plus there is actual demand for physical gold. Demand for Bitcoin is all in your head. Bitcoin is now nearly another risk in the ARSENAL? of fund? managers and financial advisors. In the words of a dear friend who has been in crypto as long as I have: Bitcoin has been perverted.?

Perversion has many aspects.?

The Oxford English Dictionary defines (non-sexual) perversion? as the act of changing something that is good or right into something that is bad or wrong. Other definitions include. to cause to turn aside or away from what is good or true or morally right, to cause to turn aside or away from what is generally done or accepted and ?to divert to a wrong end or purpose.?

Based on the definitions, I wholeheartedly agree and anyone who has been in Bitcoin and understands the original intent of a p2p cash system free of middlemen. must agree too. This was not the plan. Bitcoin ETFs are not a sign of adoption, they are a sign of perversion.?

But Bitcoin has metamorphosed more than once. LET’s remind ourselves what it originally was supposed to be:?

A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending. We propose a solution to the double-spending problem using a peer-to-peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. The longest chain not only serves as proof of the sequence of events witnessed, but proof that it came from the largest pool of CPU power. As long as a majority of CPU power is controlled by nodes that are not cooperating to attack the network, they'll generate the longest chain and outpace attackers. The network itself requires minimal structure. Messages are broadcast on a best effort basis, and nodes can leave and rejoin the network at will, accepting the longest proof-of-work chain as proof of what happened while they were gone.

This vision has not come true yet. The longest chain rule has been subverted already, the code of Bitcoin amended early on and probably soon again. Satoshi never considered network exigencies like latency. Securing the chain with slow block creation turned out to be a cul-de-sac. But Bitcoin has adapted. It has survived this far.?

The original code left out OP_CAT which would have (in a nutshell) enabled smart contract natively. It was thought back then that those would bloat the nascent chain. Now, we have inscriptions and Runes, BRC-20 tokens and a whole lot of other perversions that nobody saw coming. Some say that the only way to save Bitcoin is a hard fork.?

The"longest chain rule is a fundamental concept in blockchain technology, particularly in Bitcoin. It refers to the consensus mechanism used to determine the valid and accepted version of the blockchain in a decentralized network.

In a decentralized blockchain network, multiple nodes (computers) maintain a copy of the blockchain. To ensure agreement on the state of the blockchain, nodes follow specific rules, including the longest chain rule, to reach consensus on the valid version of the blockchain.

According to the longest chain rule, the valid version of the blockchain is the one with the longest chain of blocks. In other words, the blockchain with the most cumulative proof of work (for Proof of Work-based cryptocurrencies like Bitcoin) or the most stake (for Proof of Stake-based cryptocurrencies like Ethereum) is considered the canonical chain.

Occasionally, multiple blocks may be mined at roughly the same time, leading to competing branches of the blockchain, known as forks. When this happens, nodes follow the longest chain rule to determine which branch is the valid one. Shorter branches are discarded, and nodes reorganize their view of the blockchain to follow the longest chain.

If a single entity or group controls more than 50% of the network's hashing power (in Proof of Work systems), they could potentially manipulate the blockchain by creating a longer chain of blocks with fraudulent transactions. This is known as a 51% attack.

Miners may engage in selfish mining strategies to gain an advantage over other miners by withholding mined blocks to create forks and manipulate the blockchain. MEV is another form of abuse that has yet to fully hit Bitcoin if it can. Not only do we now have some selfish miners, we have practically only selfish miners left, with quarterly earnings reports.?

To mitigate the risk of a 51% attack, cryptocurrency networks aim to increase their overall hashing power through the participation of a diverse set of miners and mining pools. This diversity is shrinking. Mining of Bitcoin is increasingly concentrated in centralized mega-mining facilities controlled by listed companies. That too is a perversion.?

The Satoshi era coders thought it would be a network where anyone in the world could participate by using idle cycles on their PCs. PCs have all but disappeared from households, and small mining operations are now pointless. Due to latency effects, small miners will never get to sign off on a block. That too is a perversion. Bitcoin was supposed to be the people’s coin. It’s now the miner’s and asset managers' cool new toy.?

Some cryptocurrencies are exploring alternative consensus mechanisms, such as Proof of Stake, which rely on validators staking their own coins to secure the network rather than expending computational resources. There are now several projects that want to combine Bitcoin-style mining security with the advantages of PoS. Modular chains are on the rise.?

Designing economic incentives to discourage malicious behavior and encourage cooperation among network participants can help mitigate the risks associated with the longest chain rule. Those incentives, however, now accrue only to the big miners. That also is a perversion.?

By continuously refining consensus mechanisms, improving network security, and fostering decentralization, blockchain developers and communities can work to strengthen the resilience of blockchain networks against potential flaws and attacks.

In Nakamoto Consensus, “Proof-of-Work” defines a mechanism which enforces an easily verifiable but difficult to compute delay. That one block every ten minutes thing you heard of. Originally defined by Adam Back’s Hashcash paper 2, PoW is effectively used by many cryptocurrencies to place a control on the rate of block generation, and to provide a mechanism for block proposers (miners) to be chosen.? Unfortunately, with ever more centralized mining operations, this no longer conveys an advantage to small miners.?

Proof-of-work is hard to produce and easy to verify. An algorithm exists for adjusting the work parameter, ensuring that the time to create each block maintains relatively constant. Therefore, in theory,? the longest chain must be considered to be the chain with the most invested proof-of-work:

Unfortunately, that is not true. Equating longest with most proof-of-work done is false. Reaching a consensus by simply choosing the longest chain is a security risk, conveniently ignored and denied by Bitcoin maximalists.?

In many common blockchain designs, longer proof-of-work chains may exist that contain far less work. This is due to the fact PoW is a probabilistic process controlled by mining difficulty. Mining difficulty is a function of timestamps, and hashrate is not constant.

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The Bitcoin white paper briefly outlines a framework for evaluating the probability of an attacker mining a longer chain than the “honest” chain, using a binomial random walk. However, this model fails to consider certain mechanics of the proof-of-work difficulty adjustment algorithm. There are ways to attack the network and create usurping chains that appear longer but do a lot less proof-of-work.?

Ever since the arrival of MEV or maximum extractable value or front-running, the entire discussion around blockchain design has shifted towards the sequence of transactions in a block rather than block creation. With inscriptions, BRC-20 and Runes, the sequence becomes paramount. Other chains like Solana are actively discussing the sequencing issue, but solve it by introducing wanton elements of centralization, as do all the Ethereum L2. This treats the symptom, but not the cause.?

The only treatment of Bitcoin’s perversion is a rethink of the consensus and a possible fork. There are other projects that solve these issues from the ground? up, and they will ultimately turn out to be better e-cash implementations. Kaspa’s security is based on the Nakamoto Consensus which uses the longest-chain rule as its core protocol, but through the integration of A directed acyclic graph solves the issues inherent in Bitcoin by focussing on transaction sequence and network latency from the get-go.?

Bitcoin’s original vision has been perverted, and now the code has been perverted to shift the focus to something Bitcoiners never had to worry about. This is the exact reason why most of the Bitcoin L2s, including the Lightning Network, don’t work as advertised. It is incredibly difficult to solve this issue without redesigning Bitcoin from the ground up, which is a clear impossibility.?

At first it was the inscriptions and the BRC-20 tokens that last year began the technical perversion of Bitcoin. That pure cash system, that pure digital gold was suddenly subject to Bored Apes-style indignities. Miners actively supported these developments, for they would yield income in the form of transaction fees. They desperately need that income. As long as Bitcoin stays below 70k, they are barely profitable. Should inflation and energy prices rise again, they will all be unprofitable. They have an active interest in perverting the course of Bitcoin.?

Most of the metamorphoses Bitcoin has undergone have been technical in nature. The latest one, Runes, shows some promise in changing the functionality of Bitcoin once again.?

Runes, refer to a new type of token standard built on the Bitcoin blockchain itself. This standard allows for the creation and management of fungible tokens on the Bitcoin network. Unlike Bitcoin itself, which is unique for each satoshi, Rune tokens are fungible, meaning any one Rune token is interchangeable with another. This makes them suitable for representing things like loyalty points, in-game currencies, or even stablecoins pegged to a specific fiat value.

Rune tokens leverage the security and immutability of the Bitcoin blockchain. Transactions involving Rune tokens are recorded on the Bitcoin ledger, inheriting the robustness of the Bitcoin network.

Runes utilize the Unspent Transaction Output (UTXO) model, a core principle of Bitcoin transactions. When a Rune token is created, it's essentially linked to a specific UTXO on the Bitcoin blockchain. Information about the token, such as its ID, total supply, and ownership, is encoded within the UTXO data. The creation and transfer of Rune tokens happen through OP_RETURN outputs in Bitcoin transactions. OP_RETURN allows for embedding data within a transaction, which in this case is used to manage Rune tokens without actually spending any Bitcoin.

Runes offer increased utility for Bitcoin as they enable the creation of various tokenized assets on the Bitcoin network, potentially expanding its use cases beyond just a store of value. The UTXO-based protocol and utilization of OP_RETURN outputs aim to make Rune token creation and management efficient and relatively simple. By building on the Bitcoin blockchain, Rune tokens inherit the security and immutability that Bitcoin is known for.

The Rune protocol is a relatively new concept and is currently designed for fungible tokens. Representing non-fungible tokens (NFTs) with unique properties requires further development. The success of Rune tokens hinges on their integration with wallets, exchanges, and other applications within the Bitcoin ecosystem.

Runes represent a significant development for the Bitcoin network. If they succeed, Bitcoin will undergo another metamorphosis. Their ability to create fungible tokens on Bitcoin opens doors to new possibilities and potentially broader adoption. However, it's still early days, and the long-term viability and impact of Runes on the Bitcoin ecosystem remain to be seen.

So the course of Bitcoin may be “perverted”? once again. What if DeFi on Bitcoin and all the rest of it succeeds. It will prove the point we’ve made at the beginning, namely that Bitcoin is just another Blockchain, with flaws and shortcomings, advantages and disadvantages. It is not “digital gold”.?

Yet it is now the big fund managers and issuers of ETFs that are perverting the course of Bitcoin once again. They have an interest to sell their paper Bitcoins and earn fees for it. Ultimately they do not care about Bitcoin, and whether it survives or dies. They care about fees charged? for their ETFs, which is good old fiat-style hard cash, not crypto.?

So all of the services around Bitcoin do not care about Bitcoin, its vision, or its design. They care only about the fees in dollars they can earn from their services. That flies in the face of the crypto ideals and is the most blatant perversion of the Bitcoin dream.?

Maybe this perversion of the cause is exactly the reason Bitcoin seems unable to break above its previous new high. It has now attempted a breakout 4 times, and came back thousands of dollars each time. This week was brutal, and there is no end to what optimists call “consolidation” and pessimists call “the end game” .?

Of course, we still believe in the Bitcoin story. We still think that this turmoil and uncertainly is but a temporary hiccup, and that the original projections for Bitcoin to rise and rise and rise is true and neither the inscriptions, the runes nor? the paper Bitcoin ETFs will change the story. And I want to believe that too. But Bitcoin is, after all, a religion of sorts. And even the most exalted gods can tumble and fall.?

There are no guarantees that Bitcoin will succeed in the long run. If centralization continues at the current pace and attempts to give Bitcoin a purpose through DeFi or non-fungible assets fail due to the rigidity of the main code, Bitcoin’s security budget will drop to zero in a few years, and mining will no longer be profitable. The elimination of centralized mining operations would cause the price of Bitcoin to drop dramatically. It would need to fork immediately and introduce concepts like ASIC-resistance in order to return to its original mission statement. That is not fear-mongering, that is a real scenario considered by many respected researchers.?

Miners are now sitting on their lowest BTC reserves since 2012, because they need to sell every coin they produce to make ends meet. At this stage after the halving, Bitcoin was supposed to be trading above 100k, and they would be making handsome profits. Instead, these behemoths are looking for other things to do with their machines. This week we heard miners pivoting to outsourced AI, because artificial intelligence companies are having trouble finding capacity.?

It is entirely conceivable that the big mining operations will fail, hash rate will drop, and Bitcoin will enter a long and? slow decline. It is unlikely, but it is possible. And as long as there is reasonable doubt that Bitcoin could fail, there is hesitation to put large portions of a portfolio or retirement fund into what is now not e-cash, not digital gold, but merely another risk asset, and treated as such. Bitcoin has gone mainstream, but it bears no resemblance to the original vision. Bitcoin has been perverted in every sense possible.?

There are many agents in the virtual blockchain-based computing field, and even more so in zero-knowledge research who would be more than happy to use Bitcoin if it were more reliable and cheaper than Ethereum for all kinds of things. Inscriptions and RUnes are milestones, but they may be just the beginning of another metamorphosis of Bitcoin.? Or, if you like, another perversion.?

Using the Bitcoin blobspace meaningfully isn't necessarily the end of Bitcoin. What would destroy the Bitcoin mystique is what Taproot and now Ordinals make possible, something that already has a bad reputation on Ethereum and elsewhere: MEV

Maximal extractable value (MEV) refers to the maximum value that can be extracted from block production in excess of the standard block reward and gas fees by including, excluding, and changing the order of transactions in a block.?

MEV talk isn't new to Bitcoin. We've come across it back in 2013, when a Bitcoin Core developer suggested offering bounties for any user able to show a hash collision against a number of cryptographic algorithms, particularly SHA-1. The community realized that a transaction proving a collision, once submitted, would allow miners the ability to delete the block containing the user’s transaction to create an identical transaction then and collect the bounty. That is basically the maximal extractable value by any other name.?

MEV allows for arbitrage, which may be beneficial to Bitcoin, for it would presumably lead to more efficient pricing. But here is the catch: MEV (some call it frontrunning on chain) is always a zero-sum game. The profit of one miner comes at the expense of another user. In the case of frontrunning, the market is left less efficient since a participant is forced to overpay for an unchanged asset and no new information is provided to the market.?

Thus, MEV incentivizes miners to actively deviate from the time order of transactions in favor of more profitable ordering. That means miners would even get more power than they already have, and the fairness of the Bitcoin blockchain would be threatened even further. Small blocks were supposed to avoid all this and keep Bitcoin decentralized. Instead, miners are now more concentrated than ever, and they operate like any other business, with profits in mind. In order to stay solvent and cover operating costs, they need to sell the Bitcoin they produce. As long as bitcoin stays below 70000, they are barely profitable. So they have an economic incentive to extract every last drop from Bitcoin, including MEV. Large-scale use of maximum extractable value? on Bitcoin couldn't just hurt adoption or lead to additional regulatory scrutiny, but it could potentially break the blockchain. Some Bitcoin devs have let this fear be known on various forums and the discussion is heating up.?

Bicoin will need a strategy for MEV mitigation especially when it comes to open mining pools as hash rates usually center around the most MEV-enabled nodes (because they offer higher rewards).?

MEV is in fact already a problem with so-called meta-protocols. There will no longer be the game-theory arguments to avoid BIP300/301, drivechains, actual zkrollup softforks and other things aside from their own idiosyncratic and implementation-specific risks. There will likely be less resistance in supporting those softforks, as they won't introduce MEV, the MEV will already be there.

It is most certainly a momentous moment, but it has been coming for a long time. Developers have always been looking for ways to make Bitcoin useful. Those efforts ballooned after the creation of Ethereum. The purists have called Bitcoin “digital gold” and perhaps the “reserve currency” of the world. This discussion may now be put to rest. They were wrong. They idolized Bitcoin for something which it is not. Post Taproot Bitcoin can host anything, even … and here comes the nuclear warhead … malicious content.?

There is another argument, somewhat more technical, that BTC can only be a store of value if it is secure AND scarce. The problem is, unless it becomes very useful, with lots of transactions making money for the miners, it cannot be secure unless it increases its supply.?

Martin came across this position in conversation with Bitcoin developer Peter Todd and it was an eye opener for him. Core Bitcoin developers have all but ruined the original concept of Bitcoin with their misguided scalability upgrades. In order for it to remain secure in the face of ever more sophisticated hacking and especially AI-supported hacking, Bitcoin, in order to stay secure in a scalable Taproot setting, will need to add more blocks to enable those security features. Goodbye 21M. If that ever becomes common knowledge, there will be blood in the streets.?

Don’t get me wrong.? I’m still a huge fan of Bitcoin. I still believe in the dream of decentralization and? financial freedom. But I’m also a realist. I've seen the initial euphoria about the Internet evaporate and cyberspace become dominated by huge corporations. I’ve seen many a dream turn into a nightmare. And as an analyst and researcher, I have to accept that the changing nature of crypto markets and bitcoin itself can change the trajectory. The data speaks for itself and the market is always right.?

Innovation is the secret of economic and socio-political success. Bitcoin’s fate is not sealed with the original code. Changes are being made all the time. Blockchains may be immutable, but the narrative of Bitcoin is not.? I wouldn’t be surprised that after the full effect of ETFs becomes visible, there wouldn't be a fork and a “return to basic principles.” In the history of mankind, in politics and philosophy, periods of extreme enthusiasm for one creed were always followed by a reversal to the mean. The pendulum may swing in the opposite direction altogether, and Bitcoin may reinvent itself one more time. Maybe Bitcoin Cash will be the survivor after all. Who knows??

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But for now, let’s be clear, and let’s be honest: the course of Bitcoin has been thoroughly perverted, both technically, morally, and economically. This is not how things were supposed to work out. It was supposed to free us from middlemen and institutions, not become another asset they peddle to gullible investors.?

Satoshi is turning in his grave.