What’s Wrong with Bitcoin

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There are many debates on the technical shortfalls in the design of Bitcoin such as the block size, transaction throughput, etc. But the biggest problem of Bitcoin is its anti-economics mindset.

Wrong Assumption

Although Satoshi Nakamoto never mentioned financial crisis in the Bitcoin white paper, many people believe that it was the reason (or at least one of reasons) that drove the mystical genius to create the cryptocurrency. Some people also believe that cryptocurrencies will be the cure to the next financial crisis. For example, a recent article in IEEE Spectrum starts with

Bitcoin was hatched as an act of defiance. Unleashed in the wake of the Great Recession, the cryptocurrency was touted by its early champions as an antidote to the inequities and corruption of the traditional financial system. They cherished the belief that as this parallel currency took off, it would compete with and ultimately dismantle the institutions that had brought about the crisis.

To be clear, financial crisis was not caused by what currency you used and won’t be prevented by a new currency, no matter physical or virtual, crypto or not. As history showed, the euro brought a lot of benefits to eurozone states but didn’t prevent the European sovereign-debt crisis even though the member states are meant to meet strict criteria, such as a budget deficit of less than three percent of their GDP, a debt ratio of less than sixty percent of GDP, low inflation, and interest rates close to the EU average.

The problem Satoshi tried to solve is how to make payments over a communication channel without a trusted party:

What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.

Bitcoin beautifully solves this problem, theoretically. If we live in a bitcoin-only world, we may achieve this noble goal. The reality is that there are third parties involved in the overall process. For example, we need brokers of Bitcoin for fiat currency and other cryptocurrencies. You probably heard of Coinbase, Gemini, or BitPagos, right? If we still need trusted third party in the ecosystem, will Bitcoin fully achieve its goal ever?

Even worse, the security of a system is as strong as the weakest link. Although Bitcoin itself is very secure so far, the ecosystem is not. Mt. Gox was a bitcoin exchange handling over 70% of all bitcoin transactions worldwide, as the largest bitcoin intermediary in 2013. However, Mt. Gox closed its exchange service and filed for bankruptcy protection in 2014 when it discovered that approximately 850,000 bitcoins (valued at $450+MM at the time) belonging to customers and the company were missing. Tokyo security company WizSec concluded that “most or all of the missing bitcoins were stolen straight out of the Mt. Gox hot wallet over time, beginning in late 2011.”

Even if we live in a Bitcoin Utopia where there are no third party at all in all payment transactions, can we avoid financial crisis for ever? NO. Getting rid of third party in payment doesn’t mean the elimination of banks, which Bitcoin lovers hate. Banks are mostly the brokers between capital and borrowers, not just the intermediary of payments. It is easy for us to point fingers to banks when crisis happens. Sure, banks played a notorious role in the financial crisis with their risk appetite and innovations of balance sheet “optimization”. But shall we not forget the unsustainable debt level created by ourselves? A cryptocurrency or any technical innovation is not the answer if we don’t change our financial behavior.

Decreasing Coin Supply Rate

Bitcoins are created each time a user discovers a new block. The number of bitcoins generated per block is set to decrease geometrically, with a 50% reduction every 210,000 blocks, or approximately four years. The decreasing-supply algorithm of Bitcoin approximates the rate at which commodities like gold are mined (actually Satoshi has never justified or explained many of the constants in the algorithm). But which modern economy links its currency to gold today?

The currency supply rate by a central bank is supposed to match the growth of the amount of goods that are exchanged so that these goods can be traded with stable prices. The supply algorithm of Bitcoin predicates the failure that it will never become the major currency of a stable economy.

Finite Supply

Because of the decreasing supply rate, the number of Bitcoins in existence is not expected to exceed 21 million. Everyday, we create more wealth but the cap of Bitcoin is fixed. No wonder the price of Bitcoin has been skyrocketing (let’s forget the speculation, a major driver of rising price, for a second). CFTC is spot on by treating Bitcoin and other cryptocurrencies as commodities rather than currencies.

No Governance

As a peer-to-peer system, Bitcoin has been sold to us that it is good without central governance. But we do need governance on the coin supply to better serve our economy. Given the extreme complexity and volatile dynamics of economy, any prescribed supply algorithm will fail. One may criticize central banks over imperfect monetary policy. But no governance is not a better alternative.

Environmental Cost

Satoshi argues that the transaction cost of traditional electronic payments is high because of the cost of mediation with financial institutions. It is intuitive that we can reduce the cost by removing the middleman. But the truth is that we the society pay very high cost for Bitcoin. The community of miners uses vast quantities of electrical power in the process. The current estimated annual electricity consumption is 23.32 terawatt hours. The innocent truth is that Bitcoin is not environmentally friendly.

New cryptocurrency is proposed almost everyday to improve some technical aspects of Bitcoin. But no one attempts to address aforementioned issues yet.

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How to Kill Bad Projects

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It is an open secret how hard to kill projects in development. In the Harvard Business Review article “Why Bad Projects Are So Hard to Kill“, professor Isabelle Royer says that many projects are hard to kill because of a “fervent and widespread belief among managers in the inevitability of their projects’s ultimate success.” The desire to believe in something is primal. The excitement and exuberance associated with a project typically originate with the project champion, whose unyielding conviction that the project will succeed is often based on a hunch rather than on strong evidence. The champion’s exuberance spreads because others also want to believe, especially if the champion is charismatic and well networked within the company. Continue reading

The Future Business Model of Payroll

 ADP Paypal
Money Movement  $1.7 trillion  $354 billion
Revenue  $12.21 billion  $11.27 billion
Profit  $1.75 billion  $1.42 billion
Market Cap  $43.3 billion  $59.7 billion
  • ADP revenue includes full HCM services besides payroll.

Notice something here? ADP moves a lot of money than Paypal, but makes less revenue on money movement (less the revenue from other HCM services). It has a smaller market cap too. Why? Well, ADP is in the business of solution shop and value add process while Paypal is a facilitated network. Continue reading

Choosing The Best Tools

India is one of few nations that can buy military equipment from both western world and Russia. When building their destroyers, India does take this advantage to install best sensors from multiple countries to their ships. However, this choosing-best-tools-for-each-problem approach is an engineering nightmare. It is extremely challenging to make sensors from Russia, Italy, France, India, etc. work smoothly together due to various compatibility issues.

The issues are not in each module itself. Essentially every large engineering project is an integration work. We can easily lose the big picture when we focus on the performance attributes of each module. So be careful next time when your architect shows you a system architecture like the below.

Disruptive Innovation: When and Where?

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In the theory of disruptive innovation, Clayton Christensen argues that the incumbent companies introduce new and improved products year-by-year with the sustaining innovations, which eventually overshoot the performance that some customers can use because companies innovate faster than customers’ lives change. Overshooting creates opportunities for firms to change the basis of competition in order to earn above-average profits. After functionality and reliability have become goo enough, for example, the next competition dimensions could be convenience, customization, and price, etc. Continue reading

Risk Aversion and Sunk Cost Fallacy

In his book Misbehaving, Richard H. Thaler tells an interesting story. In a class on decision-making to a group of executives from a company in the print media industry, Thaler puts the executives to a scenario: Suppose you were offered an investment opportunity for your division that will yield one of two payoffs. After the investment is made, there is a 50% chance it will make a profit of $2 million, and a 50% chance it will lose $1 million. When Thaler asked who would take on this project, only three of twenty-three executives would do it. Then he asked the CEO how many of the projects would he want to undertake (suppose all projects were independent, that is the success of one was unrelated to others), the answer is all of them! Continue reading

Agile Software Development: China Navy

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The best demonstration of agile software development is probably the modernization of China Navy. Following a “Run Swiftly in Small Steps” strategy, China Navy has undergone a stunning modernization push that puts it near parity with the US. Look below how China Navy has steadily improved each class of their destroyers in gradually shorter and shorter time. They are the grand master of agile development. Continue reading

Payroll: An Overlooked Area in FinTech

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payroll-image

A lot of brain power and money have been poured into FinTech, especially lending and payment areas. These are indeed exciting areas with new business models and technologies. On the other hand, people rarely associate the sexy FinTech with payroll services. Although it may sound boring, payroll is actually an overlooked gold mine for innovators. Traditionally, payroll service companies make money by service fees. New HCM service companies such as Zenefits work as insurance brokers while providing free payroll and HR services. But if we lean under the hood and look at the process, there is an interesting opportunity. Continue reading

Smile 1.2.0 Released!

Dear Smilers,

We are proud to announce the release of Smile 1.2.0.

The key features of the 1.2.0 release are:

  • Headless plot. Smile’s plot functions depends on Java Swing. In server applications, it is needed to generate plots without creating Swing windows. With headless plot (enabled by -Djava.awt.headless=true JVM options), we can create plots as follows:
    val canvas = ScatterPlot.plot(x, '.')
    
    val headless = new Headless(canvas);
    headless.pack();
    headless.setVisible(true);
    
    canvas.save(new java.io.File("zone.png"))
    
  • All classification and regression models can be serialized by
    write(model) // Java serialization
    

    or

    write.xstream(model) // XStream serialization
    
  • Refactor of smile.io Scala API.
    • Parsers are in smile.read object.
    • Parse JDBC ResultSet to AttributeDataset.
    • Model serialization methods in smile.write object.
  • Platt scaling for SVM
  • Smile NLP tokenizers are unicode-aware.
  • Least squares can handle rank deficient now.
  • Various code improvements.