An Evaluation of How Money Is Issued in the Age of Cryptocurrencies

Who Really Owns Your Money?

This might seem like a question with an obvious answer. But do you really have complete ownership of the value of your money? Noting that the purchasing power of money is its most important property, consider an example of a 68-year-old individual in say Venezuela or Zimbabwe, who spent his or her years working and saving for their older years. And just as this individual begins looking at a future where they could live off those life’s savings, the amount saved become worth say a tenth of their value due to monetary policies enacted by the issuer of the currency. This example while extreme illustrates that the issuer of a currency or asset can also mostly determine its value. If you hold currencies worth a certain amount, and the issuer suddenly prints or issues double that amount, resulting in a virtual halving of it’s value, the effect is similar to the issuer effectively recalling half the worth of your money. Simply put, the issuer of your currency has a significant impact over the money you own that is denominated in that currency.

This is no less true in a less inflationary jurisdiction than those two examples, it is just usually less obvious. Each year, the non-leveraged savings of most who hold currencies issues by nearly all nation states, reduces in value each year. During the same duration, in many cases, the GDP of the entire state may increase in value, representing the sum gains of the economic activity and labor in the jurisdiction. And yet the worth of an individual with holdings in the region’s currency effectively reduces, all things being equal. This is how currency and money works before the age of currencies not issued by traditional nation states.

Are there Good Reasons for an Inflationary Currency?

There are possibly good economic reasons for a slightly inflationary currency. Maybe nation states need to retrieve some value from everyone in their jurisdiction to help maintain the security, structures and processes in the state? But then most countries already require and collect taxes from subjects within their jurisdiction. If more was needed, why not just collect that through taxes rather than implicitly through monetary policy? This article is not intended to answer this specific question.

Besides being a progressive way to implicitly tax passive wealth, there are also possible economic merits to an inflationary currency. Economists contend that deflationary currencies, or a currency that rises in value rather than reduce in value, result in excessive savings and less economic activity. However, the desire for a slight inflationary rate still does not explain why the inflationary process can not be completely transparent. For instance, if a target of 3% annual inflation is a desired, mathematically and financially, the means to consistently bring the resulting rate close to that value can be very transparently dispensed. Somehow, the citizens of most nation states have not been able to bring the authorities in those jurisdictions to this level of transparency regarding monetary policies; regardless of the system of government. This article will not go further in evaluating the reasons behind this situation. However, this lack of a transparent issuance mechanism was a key impetus behind the creation and subsequent progress of cryptocurrencies starting with Bitcoin in 2009.

Have Crypotcurrencies Delivered an Answer to Non Transparent Monetary Policies?

Bitcoin has a very clear, simple, and transparent issuance and monetary policy. New bitcoins are minted with every block created, where each block contains new transactions added to the ledger. The amount minted is predetermined, starting with 50 new bitcoins with every block, and halving about every 4 years, until 21million bitcoins are created. After this point, no more bitcoins can be created.
This scheme is indeed transparent. However, it suffers from some different deficiencies as a monetary policy as cleared described in an article some two years ago, on a more ideal cryptocurrency policy. Firstly, if an economic system becomes predominantly denominated on a currency such as this, the scheme is deflationary and will lead to mostly savings and hoarding of the currency, potentially stifling spending and economic activity. Secondly, the scheme has no means of reacting to market fluctuations and thus has no control mechanism needed in an ecosystem. A currency with excessive daily fluctuations leaves businesses and individuals with no easy means to conduct business and solidly anticipate their actual profit and losses on a daily basis where currency fluctuations can sometimes be larger than the margins of products and services. A third factor that was not raised in that paper is who owns and controls the currency. This is considered in this article.

If the issuance policy of your currency is clear and transparent or even if it is simply constant supply, but the governance allows the currency to become duplicated via arbitrary hard forks, then your currency issuance is not truly fixed supply and certain.

Figure 1. Blockchain Splits Can be a Source of Inflation of Cryptocurrency Supply

The Organizational Control of Cryptocurrencies is Very Important

It turns out that in the nearly ten years of its existence, we now see that a transparent and mathematic-based issuance policy might not be sufficient to assuage the demands for a predictable monetary policy. Hard forks or split of cryptocurrencies have shown to be a huge issuance mechanism that is not as predictable as the definite issuance scheme promised in their constitution. For instance, towards the end of the 2018 we saw Bitcoin Cash (a prior split from Bitcoin) split into two, which triggered a serious fall in the value of the currency, and likely contributed to the December 2018 drop in cryptocurrency values. The earlier mentioned 68 year old would likely be just as dissatisfied with denominating his life savings in this type of currency as at December 2018, as with most fiat currencies, if not more so.
However, potential impact of governance of the cryptocurrency goes beyond hard forks. Those responsible for administering the source codes and making changes to it, could conceivably take other actions that would influence its values.

Examples of Constitutional and Code Changes That Could Influence CryptoCurrency Value

Over the past few years, we have seen several decisions that can be taken by a cryptocurrency management team that could influence it’s value or supply. Some of these include.

1. Decisions on technical features of the cryptocurrency; such as block sizes. An example is the decision by Bitcoin to keep blocksize at 1MB, which some believe necessitates solutions such as Lightning as its scaling mechanism and makes the currency essentially a settlement layer.

2. Direct changes to the issuance mechanism. An example is Ethereum’s EIP-1234 where programmers decided on reducing block rewards to 2 ETH, from 3 ETH, but also delayed the block production difficulty bomb.

3. Arbitrary decisions to conduct air drops, which are essentially free coin giveaways; or new coin offerings; release team rewards; or other policies that increases supply. An example was NPXS’s decision to create a completely new initial coin, which was called FX, with the initial announcement resulting initially in a fall in NPXS value. Since that event we have now seen many ICO projects come out with new coins as a means of raising additional revenue or funding different sub-projects, including Crypto.com (formerly Monaco) with CRO and Tron with BTT.

Types of Cyrptocurrency Governing Structures

For fiat currencies there are not too many variations in the governing structure. The currency is usually governed and administered by some agency created by the central government, or some independent body appointed by the central government. For cryptocurrencies, since there isn’t always a central authority, there are more variations in governing structures, which includes the following:

1. Bitcoin Type Governing Structure
   In this type of governing structure, decisions on aspects not explicitly laid out in Bitcoin’s founding constitution as delivered in Satoshi’s original paper, are determined by the programmers who develop and maintain the code. As it turns out, some of these decisions are very consequential to the overall trajectory and value of the cryptocurrency.
   Decisions such as the supply rate is enshrined in its constitution, as is the decentralized block creation structure. It turns out that who can contribute changes to the code is also decentralized. Any programmer is able to make changes and submit them for consideration. However, decisions on what changes are admissible to the code, and who can commit those changes, leaves a lot of room for changes that can and has determined the trajectory of the cryptocurrency. What should the block size be? Should the signatures for every transaction be included in the block?
   An article by Jameson Lopp, a Bitcoin developer, that is titled: Who Controls BitCoin Core is a good read for anyone interested in more details of how changes to bitcoin code get admitted. There are five maintainers that decide on what pull requests or changes to merge into the core. Their decision is loosely guided by “if a patch is in line with the general principles of the project; meets the minimum standards for inclusion; and will judge the general consensus of contributors.” There is also a lead maintainer whose job it is to coordinate overall final releases. This was Satoshi Nakamoto from inception to 2011, then Gavin Andresen until 2014, then Wladimir van der Laan. It should be noted that the article focuses on the commendable structural integrity measures put in place to secure changes to the code, but does not address the fact that decisions on what changes to admit in the first place represents a privilege that still reposes some power in the hands of a few.

2. Evolving or Less Decentralized Versions of the Bitcoin Type Governing Structure
   Several other cryptocurrencies follow the bitcoin governing structure, although many have greater centralized aspects to their governing structure. Some of that centralization is considered evolving if the stated constitutional goal of the project is to eventually transition to a more decentralized structure. To provide some clarity behind this, we will use the following matrix that highlights the level of centralization in aspects of a decentralized cryptocurrency’s governing structure, using Bitcoin as an example. Many other cryptocurrencies can be evaluated along similar scale.

   

   1. Delegated Decentralized Governing Structure
      These are cryptocurrencies that are constituted similar to how representative democracies work in nation state parlance. Here, the number of decentralized miners is fixed to a set number. Those miners are then elected freely in a decentralized manner by every participant in the network. Examples include EOS, Steem, and TRON, where the numbers are respectively 21, 50, and 27. However, as in the first two governing structures, the decision on who can make code changes remains in the hands of a few.

   2. Representative Decentralized Governing Structure Selected by Stake
      For this type of governing structure, a smaller subset of the network makes decisions via votes, as well as process transactions. One type of this structure are master-node type networks, where a certain amount of stake is required to become a decision maker or master node block processor. Examples include Dash and PivX. The subset of processors could also be selected by a weighted proof of stake (POS) algorithm. At this point, there is no notable cryptocurrency with significant use that is based on a POS algorithm, but networks like Peercoin are currently based on POS and Decred uses a hybrid proof of work (POW) and POS algorithm.

   3. Permissioned Governing Structure
      There are variations of the permissioned public processing network, but the main element is that transaction processors on the network are governed and appointed by a central authority. The code development and changes are also governed by a central entity. Networks that have this type of structure include Ripple and Stellar.
      Many in the cryptocurrency community believe that there is no point to a centralized public blockchain. However, it has turned out that some of the advantages of a blockchain such as transaction immutability still exists to a good extent, even where the network is governed by a centrally selected but still independent group of transaction processors. This is due to the fact that a transaction generated by a byzantine vote of a group of processors comprised of several separate entities such as different banks would be more difficult to reverse compared to a transaction on a ledger maintained by only one of the banks separately. Cryptocurrency decentralization purists ignore this subtle but powerful feature which will leave them baffled, as permissioned public networks will likely continue to thrive.

      Residual Challenges with Cyrptocurrency Governing Structures

      From the prior section, it is clear that there remains some concentration in the hands of a few, the control on the management of the codes, or interpretation of the principles that will be encoded for virtually all cryptocurrencies, to varying degrees. While there is usually much focus on how decentralized the block generation process is, the manner in which the rules are interpreted and then encoded is nearly as important, but also usually less decentralized.

      So How Can Forks and Cryptocurrency Splits be Minimized?

      As Jameson Lopp stated in the article on Who Controls Bitcoin: “This is the freedom of open source — anyone who is dissatisfied with the efforts of the Bitcoin Core project is free to start their own project. They can do so from scratch or they can fork the Core software.” It appears there is virtually no way to prevent a fork of a public decentralized cryptocurrency. However, as has been witnessed by several prior forks of Bitcoin, and the most recent fork of Bitcoin Cash that resulted in a significant plummeting of the combined value of both resulting strands, forks can affect the value of what you hold in the cryptocurrency. Second and third generation cryptocurrencies utilizing delegated structures have not been around long but so far have not shown to be as prone to forks and splits. It should be noted that measures to reduce the chances of affiliated forks of an open source cryptocurrency might involve the use of legal and nation state-enforced tools that are also contrary to making the cryptocurrency censorship resistant.

      Completely Decentralized Blockchain Transaction Processing has Not Been Scalable

      The status of completely decentralized transaction processing, separate from the governing structure, is one that can not yet operate on a mass scale. To be blunt, no decentralized cryptocurrency can currently handle enough transactions to accommodate mass use. Not bitcoin, or Ethereum, or any currently deployed and vetted decentralized cryptocurrency system. Bitcoin can handle about 7 transactions a second, while Ethereum can handle about 15, while the Visa network can handle about 24,000. On the other hand, systems based on centralized, trusted group of processors, or delegated decentralized structure with a selected but small and limited number of processors are able to handle millions of transactions at fast enough speeds, and closer to the order of the visa network. There is significant progress being made with second layer schemes such as the Lightning, and technological advancements such as sharding, which is planned for Ethereum, and which a form of it was recently deployed by a relatively newer cryptocurrency named Zilliqa. It remains to be seen if a completely decentralized transaction processing structure can be made to scale both in the number of transactions it can handle, and its speed.

      Is a Completely Decentralized Governing Structure Possible?

      Consider a cryptocurrency constituted such that every decision on every change proposal, or interpretation of its constitution was voted on by all holders of the currency, and not just transaction processors. Then any correctly implemented code change would also be voted on by its developers. Is this utopic arrangement feasible? Could such a system get overwhelmed by change requests that require a vote? What if a majority of developers vote to advance a malicious change inadvertently, or deliberately? While the merit of majority vote may even out positively over the long run, a single mistake by the majority could also doom such a system, in a way that is not as crucial in political democratic governing systems.
      In fact, the search of a perfect organizational structure for cryptocurrency governance, may not be that different from the search for the best ways for governing human societies. The best systems that have evolved seem to be based on representative democracy, where the many select a dedicated few to represent their interests. A completely decentralized equivalent where everyone votes on every detail could be ideal if the majority are able to commit their time to understanding the details, and becoming educated enough to do so, and are thus able to do away with the smaller representative group. There is no such system with a large population that has hitherto successfully operated this way, so far. It should not be a surprise if in the long run, systems built on a rotating group of decision makers and transaction processors selected periodically in a decentralized and fair manner by all stakeholders of a currency, become the dominant and successful models. This goes for operational decision making as much as transaction processing.

      References

      Jameson Lopp, “Who Controls Bitcoin Core?,” https://medium.com/@lopp/who-controls-bitcoin-core-c55c0af91b8a, Dec 15 2018. Accessed Feb 15 2019.

      Ken Alabs, Oct 25 2017. “The Ideal Digital Currency Needs Scaling Solutions,” http://www.trustnodes.com/2017/11/05/ideal-digital-currency-needs-scaling-solutions. Accessed November 5 2017.

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      Summary (TLDR)

      • The level of decentralization in the governing structure of a cryptocurrency is just as important as the decentralization of its transaction processing.

      • There appears to be three types of structures that have developed:

      1. Completely open governing structure where anyone can participate in the decision making, and in coding, and in seeing that coding committed to the repository. This seems like an ideal that is only being approached at different levels by the networks that have selected to potentially operate towards this ideal.
      2. Completely open governing structure where anyone can participate in decision making and block processing, but where the eventual decision makers and block processors are selected based on how much stake they have in the network. This selection can be made similar to master-node type networks where a specified staked amount is required to allow anyone to become a decision maker and/or block processor, or via a proof of stake algorithm that weights the selection based on how much stake the member has in the network.
      3. Decentralized structure and ledger, but where the decision makers and transaction processors are a subset of the users of the network and selected in some form by the users of the network.
         • Some of new networks based on Type 2 and 3 structures have proven so far to be more scalable in speed and capacity, while also being less prone to governing disruptions and splits. They also usually require less energy consuming and expensive methods of processing transactions. However, they are more prone to a few powerful decision makers effectively exercising what seems close to centralized control over the network.
         • For Type 1 structures, during the early stages of the network, the presence of a strong of a few strong influences on the network may result in a somewhat centralized decision making structure. This could actually be beneficial in the long term allowing the network the space to develop with some clear direction. No doubt Satoshi Nakamoto during the early days of bitcoin likely had a strong influence on the direction of the Bitcoin network for some time after the network went live.

         • Disrupting split of a cryptocurrency network, particularly when it includes a split of key decision makers can have significant effect on the value of the cryptocurrency. We saw that with Bitcoin Cash where a split in November 2018 resulted in two parts is a fraction of the former value of the cryptocurrency compared to bitcoin, even if the split values were combined.

         • Watching some of the recent contentions in the Ethereum community could be of some mild concern to holders of the cryptocurrency, as well as the entire cryptocurrency community, given the effect the Bitcoin Cash split likely had on the overall cryptocurrency values in late 2018.

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         About the Author
         Ken has a doctorate in Engineering, and a master’s in Computer Aided Engineering, An IT professional, programmer and published researcher with over thirty publications in various fields of technology, including several peer reviewed journals and publications.
         

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         Legal Disclaimer: I am not a financial adviser and this is not financial advice. The information provided in this post and any other posts that I make and any accompanying material is for informational and educational purposes only.

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