Austere Capital

The following is a sample of our bi-monthly newsletter — “Wolf Trails”.

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Updates
Fundamental Use-cases for Blockchains
Musings on Consensus Mechanisms and Token Economics
Featured Project
Further Reading/Additional Sources

Updates

The more research we conduct into these protocols, the more we realize that the entire crypto universe is vastly more complex than initially thought. Indeed, as Bitcoin Core developer Jameson Lopp and Lightning Network head Elizabeth Stark pointed out on Twitter last week, additional funding is certainly not the issue when it comes to scaling and security issues — it’s simply the lack of talent. There is a severe shortage of people who have the brains to come up with specific and secure decentralized scaling solutions.

Fundamental Use-Cases for Blockchains

With the current crypto euphoria, I think it would behoove all of us to go back to the basics in this newsletter, specifically on the inherent use-cases of a “blockchain.”

Fundamentally, a blockchain (synonymous with a decentralized database or ledger) is simply another method for storing information (i.e. data). To fully understand blockchain technology one must understand the way information is stored and transferred in modern society.

Generally third-party entities manage and store our data by utilizing servers in one location or several locations. This is how society has always functioned — we trust third party entities with our data. The downside is that centralized sources are vulnerable — “trusted third parties are security loopholes” ala Nick Szabo.

Blockchain technology, first introduced via bitcoin, “decentralizes” data storage and transfer, which is all underwritten thru computer code. Hence, the reliance on a trusted third party is removed, which arguably gives us greater freedom and control (power) over our lives. One no longer must rely on (or trust) an entity for etc. — this is the most fundamentally important aspect of blockchain technology, and has multiple implications. It allows for every participant to have individual control, yet prevents one or more individuals from holding enough power to dictate the rules. It is a significant technological breakthrough for human society, allowing for the transfer of value sans the need for any authority. This removal of allowance and trust in central authorities is directly correlated — inversely — with our own individual empowerment and control.

However, many industries simply do not make sense to be decentralized from a pure practical standpoint. Decentralization arguably gives us greater control, yet, we must scrutinize the tradeoffs of decentralization. The “decentralize everything” mantra is philosophical, but not necessarily practical. The biggest tradeoff is speed — decentralization greatly affects the rate at which information is transferred. Hence bitcoin’s inability to be fully functional as an instantaneous payments system such as Venmo or PayPal. But sacrificing for instantaneous payment, we have complete ownership of our information, meaning we are not relying on anyone for the security of our data. Additionally, no third-party such as a government/state entity harbors any control over this data. This is what’s known as censorship resistance. Thus, the ten-minute confirmation period in order to transfer bitcoin is arguably miniscule when weighing the implications of the removal of a trusted third-party as well as censorship resistance.

Hence we must ask, where does it make sense for there to be this type of distributed control over information, where everyone who participates has some control, but also no one individual has explicit control.

Additionally, the other core tenet of blockchain technology is immutability — meaning once a piece of data is stored on the blockchain, it can never be undone without the whole network knowing. This has implications for reputational accountability — because the data hashed onto the blockchain cannot be undone, there is a great incentive for that data to be “true” and not misinformation.

Knowing the above, instinctively the ideal use case for a blockchain would be the maintenance of property ownership records — such as land titles/deeds, etc. — which would provide a “proof-of-ownership” and is not in the hands of a “trusted third party” such as the local municipality.

Musings on Consensus Mechanisms and Token Economics

In order for there to be no points of failure, the distributed protocol must be as decentralized as possible. The protocol’s consensus mechanism therefore must be scrutinized. Consensus mechanisms are the particular way nodes within distributed networks come to “consensus” on the information being transferred. When all nodes come to agreement (consensus) the blockchain is updated with the new information. The glaring issue in these open-sourced, distributed networks however, is preventing what are known in computer science as “Byzantine Faults” or nodes that purposely attempt to sabotage and overthrow the network by sending false information to other nodes. Therefore, how is consensus achieved considering the potential of these malicious parties? A consensus mechanism for any legitimate decentralized protocol must be designated “Byzantine Fault Tolerant” or BFT. There are various ways to achieve a BFT protocol.

Consensus mechanisms are an extremely complex and nascent form of technology — Nakamoto and co. was the initial party to solve the problem of achieving Byzantine Fault Tolerance (BFT) in a distributed network (i.e. Bitcoin) — that involve a deep understanding of several dense disciplines namely behavioral economics and game theory, public-key cryptography, as well as computer science and cyber security.

Furthermore, each particular type of consensus mechanism all undergo specific trade-offs in terms of speed, decentralization, and safety (see Vlad Zamfir’s “Triangle” trade-off framework). One also must be familiar with information theory and the criticalness of data transfer amongst distributed hardware such as on a cargo ship or aircraft (where fault tolerance is of paramount importance, as well as network throughput and latency — also factors to consider in decentralized networks).

The most tried and tested consensus mechanism is “Proof of Work” in which miners must exert computing power via electricity costs to solve complex algorithmic problems — in this way, each node on the Bitcoin blockchain comes to consensus and the ledger is updated on average every ten minutes. The main issue with Proof of Work are that the miners are left with too much control over the network and can spawn new chains on a whim (i.e. Bitcoin Cash).

“Proof of Stake” is a relatively newer form of consensus mechanism in which miners are no longer needed. Consensus occurs through participating nodes “staking”the networks’ native cryptocurrency. Different cryptocurrency protocols utilize various forms of Proof of Stake by selecting “stakers” through voting or some rigorous, randomized selection process to prevent collusion.

There exist several variants of Proof of Stake, specifically Ethereum’s “Casper”, Cardano’s “Ouroboros”, as well as Cosmos’s “Tendermint.”

Other consensus mechanisms include the “Federated Byzantine Agreement” utilized by Ripple, Stellar’s Consensus Protocol as well as Hashgraph’s “Swirlds.”

It cannot be repeated enough that all cryptocurrency consensus mechanisms (especially the variants of Proof of Stake) are extremely new forms of open-source technology that have yet to be fully tested under the weight of millions of network participants.

Token economics are another untested area that needs much research, specifically token supply schedules, vesting schedules, as well as token velocity.

Supply schedules should harbor a fixed inflationary protocol, since deflationary protocols ensure “hodling” as opposed to usage.

Founder vesting schedules should be structured to mimic the length of the development timeline of the project (at the very minimum).

The issue of curbing token velocity as to sustain network value only becomes a true problem with rapid network usage — which has yet to be manifested within any decentralized protocol. Additionally, as Basic Attention Token’s White Paper explains, there is an equilibrium price that is naturally attainable to ensure an adequate balance between investors utilizing the inherent cryptocurrency a store of value versus network participants transacting the token on the platform as a medium of exchange.

There is another thorny issue in regards to token economics as well as valuation: what should the total supply of tokens be? And at what price should they be valued at?

In direct contrast to the equity/VC world where a company is valued according to discrete discounted cash flow analysis (DCF), in the crypto world these values are chosen more or less on a whim.

These two arbitrary variables have huge implications since they determine the so-called market capitalization of the network. It is known that the market cap metric is vastly misleading (as on Coinmarketcap.com).

Featured Project

We at Austere scrutinize projects that don’t get much initial attention. We looked at 0x (ZRX) prior to the attention it received, and thankfully pulled out after it shot up past $2. We remain long on Stellar (XLM), Basic Attention Token (BAT), Quantstamp (QSP), as well as our newest addition Chainlink (LINK).

Chainlink is essentially a decentralized oracle provider. Oracles, or trusted data sources, are a huge problem not just in the blockchain realm but in general. Chainlink attempts to solve the oracle problem by pooling together multiple oracle sources, as well as incorporating a specific consensus mechanism to prevent collusion as well as misinformation.

Further Reading/Additional Sources

Andrew Poelstra on Distributed Consensus — https://download.wpsoftware.net/bitcoin/pos.pdf

The Ethereum White Paper — https://github.com/ethereum/wiki/wiki/%5BEnglish%5D-White-Paper

Vitalik Buterin on Proof of Stake — https://github.com/ethereum/wiki/wiki/Proof-of-Stake-FAQ

Some thoughts against Proof of Stake — https://twitter.com/hugohanoi/status/951762596255838209

Paul Sztorc (a thought leader on the Oracle issue) — http://www.truthcoin.info/

Spectre Attacks (specifically on machine-based oracles — i.e. Intel’s SGX) -https://spectreattack.com/spectre.pdf

On Sidechains — https://blockstream.com/technology/sidechains.pdf

Preston Byrne Interview — http://investorfieldguide.com/preston/

Basic Attention Token’s White Paper — https://basicattentiontoken.org/BasicAttentionTokenWhitePaper-4.pdf

Chainlink’s White Paper — https://link.smartcontract.com/whitepaper