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BitMEX Crypto Trader Digest Sep 22, 2017 android-chrome-512x512.png
From the Desk of Arthur Hayes
Co-Founder & CEO, BitMEX

From The BitMEX Research Desk

The SegWit Transaction Capacity Increase – Part 1

Abstract: SegWit replaces the old 1MB blocksize limit, with a new, more complicated, 4 million unit "block weight" limit.  This should double the transaction throughput of the network, but only after wallets upgrade to send new SegWit style transactions.  This piece analyzes how the network throughput could increase, as users gradually upgrade to SegWit.


The SegWit Transaction Capacity Increase – Part 2 – The First Month After Activation

Abstract: SegWit adoption has grown at a steady pace since activation one month ago and this has surprisingly coincided with a large reduction in transaction fees. Although we think this may be a coincidence, as the absolute level of SegWit adoption in the first month is reasonably low.


Mining Incentives – Part 1 – The Economics of the Difficulty Adjustment

Abstract: This piece contrasts mining economics between Bitcoin and traditional resource mining. We look at how the difficulty adjustment can impact profitability in the mining industry and some potentially perverse incentives.

Mining Incentives – Part 2 – Why Is China dominant in Bitcoin Mining

Abstract: This piece explores why China appears to be in a dominant position in the Bitcoin mining industry. We look at the massive hydropower boom in China over the last 10 years and how Bitcoin mining could be the inadvertent beneficiary of over investment in hydropower, linked to aluminum production, in remote regions in China.

Haters Gonna Hate



Why do we, as an industry, look for validation from the finance industry we are trying to disrupt? It's difficult for most to ignore statements from two of the most powerful financiers of our age: Jamie Dimon of JP Morgan and Ray Dalio of Bridgewater.


Jamie felt the need to distract the crowd away from his bank's disastrous quarterly trading revenue results by launching a diatribe on Bitcoin. He called it a fraud and said he would fire employees who traded it. Ray said that Bitcoin was in a bubble because it provided no utility; it is too volatile to be used as a currency in everyday commerce.


One of the most common criticisms of Bitcoin is that it is too volatile to be used as anything but a tool of speculators. Bitcoin cannot be a store of value like gold because its value fluctuates too wildly.


But why is gold put forward as the epitome of stability? Yes, it has over a thousand years of history as the symbol of wealth and international commerce. However, at one point in time using gold as a currency was revolutionary and possibly heresy.

A Gold Thought Experiment

Imagine yourself part of a early human civilisation thousands of years ago, before gold was accepted as money. Your tribe or village uses shells as money. The shells are sufficiently rare that they hold value. They are easily recognised and hard to counterfeit. However, it is hard to store the shells in vast quantities, and over time the shells degrade. Carrying a large quantity of shells is also quite difficult. Elon Musk hasn’t been born yet. Few of these shells are self-driving.


One day you discover specks of a yellow metal. Its lustre entices you to pick up a few small rocks and study them. Unlike many rocks and metals you deal with, gold is quite soft. Over a hot fire, you melt some of these gold nuggets together and find it is quite easy to work with this new metal.


The next day you tried to remember where you discovered the gold. After a few weeks of searching you were able to locate another few nuggets. Another thought: perhaps gold is rare.


As a civic-minded person, you arranged a meeting with the village leaders and showed them your new discovery. You asked if possibly gold could replace shells as the accepted currency. They laughed at you. A gold rock as money, how silly. Everyone knows that shells are money, and shells will always be money. You feel deflated but not defeated.


Yet - a woman at the meeting thought the gold would make good jewelry. It was very shiny and looked much better than the drab trinkets townspeople wore. She asked where you acquired the gold and if you could help her fashion it into jewelry.


You were able to find a location where if you dug, gold appeared fairly regularly. It was a hit. Everyone loved their new gold jewelry, it looked much better, and it held its form over time.


Given the primitive tools at your disposal, it was very difficult to find large quantities of gold. Gold jewelry began to function as a proto currency. Those who wore it were richer, as it required more and more shells each year to purchase a standard bauble.


At this point the village elders began to worry. Their wealth was stored in the form of shells. In the face of a better monetary instrument, gold, the shells depreciated in value every year. Even worse, because gold is rare, inert, impossible to counterfeit, and easy to transport, some merchants preferred to sell goods for gold rather than shells.


Because the village had a limited history handling gold, its value fluctuated wildly. No one know what it should be valued at vis-a-vis real goods and services so it still wasn’t as stable a monetary instrument as shells. The elders used this fear and price volatility to warn the plebes not to consider gold as money. Why should gold be money, it was just a shiny rock used for beautification purposes.


Overtime the village could not ignore that gold and metallic monetary instruments in general were technologically superior. Slowly then quickly, the value of gold vs. real goods and services skyrocketed. Those who had “invested” in gold, saw their purchasing power increase dramatically as the society switched to a better monetary technology.

Monetary Transition

From barter, to commodity money (gold), to paper fiat money, to cryptographic money, each one of these transitions features extreme volatility then stability. The new form of money at one point will not be able to purchase any goods and services, then all of a sudden its purchasing power increases quickly. The network effect ensures that the transition between different forms of money is chaotic.


A monetary instrument can only have value if a sufficient percentage of the network will price their goods and services in said instrument. However, no one wants to be first. The chicken and egg problem of monetary adoption ensures that once the switch happens it occurs quickly.


For savvy speculators, properly positioning oneself in front of a monetary shift is extremely profitable. Because money has no value without its network, it essentially goes from being worth nothing to something. Bitcoin is no different.

From Zero to Pizza

Bitcoin Pizza Day (May 20th 2009) is the first time Bitcoin was exchanged for a real good. Since then, as the network grew and people valued the characteristics that make Bitcoin a possible monetary instrument, its price vs. real goods and services increased dramatically.


If Bitcoin were not volatile then we would not be experiencing a monetary system transition. As traders, investors, and speculators participating in such a transition is the privilege that most humans will never experience given their infrequency.


Monetary transitions are zig zags not straight lines. Also these transitions take time. No monetary instrument completely replaced its predecessor in under a decade. Therefore it is foolish to pooh pooh Bitcoin because of volatility that is entirely due to a phase shift in monetary instrument preferences of a society.


Becoming the CEO of a multinational bank is incredibly difficult. CEOs like Jamie Dimon dedicated their lives to the organisations they lead and have made many personal sacrifices. Being human, it must irk them that youngins have become worth $100 million plus in a few years due to a belief in a different way of transferring value.


It also is annoys senior financiers that these same pups’ stated goal is to dismantle the monetary system that they sacrificed everything to lead. The smart financiers are busy buying crypto assets while they publicly deride them. The dumb ones double down on the supremacy of central bank printed fiat denominated assets.


The world is more connected than ever. A move from analog to digital cryptographic money will be chaotic and volatile. I consider myself lucky to be alive, and fortunate to be able to stake my personal fortune betting against the old and for the new.

Pay to Play



Chinese Miner: I would like to build a new mine in China.


Beijing: Well Sheeeeeeit. Partner, you're gonna have to pay to play.


The recent actions by Chinese authorities to stymie the growth of Bitcoin reminded me of John D. Rockefeller’s quest to tame the infantile oil market. Rockefeller was able to exert god-like control over the oil industry because he eradicated wildcatters.


Wildcatters were small outfits that drilled oil wells wherever they could. They were not organised, and this chaotic drilling reduced the lifespan of oil patches and caused intense volatility in the price of oil. The ways in which Rockefeller culled the wildcatters earned him the title of a Robber Baron.


The Chinese government and Rockefeller have many things in common. The Chinese government wants to control every aspect of the economy. When a new sector emerges, they allow fierce competition. Once a few winners have emerged they decimate the small fish, and present the survives with an offer they can’t refuse. Pay to play, or die.


The payment can be in many forms. But essentially Beijing can tap dat ass whenever it likes, and you better smile during the session. The Bitcoin mining industry is no different.


Local governments all vie to post earth shattering growth numbers every quarter. They will do anything in their power to achieve growth. Success guarantees a seat at the table in Beijing, and riches for your family.


For this reason, as well as overinvestment in aluminum production capacity, many poor parts of north western China have an abundance of electrical generation capacity. The boom in Bitcoin mining meant that anyone with capital and some connections at the local government level could profitably mine Bitcoin. Read the BitMEX Research report titled Mining Incentives - Part 2 - Why Is China Dominant in Bitcoin Mining, for a more indepth discussion of this topic.


The Chinese mining industry is dominated by a few large pool operators and miners. However, there are scores of smaller mining outfits. Beijing has little visibility into many of the smaller outfits. That could not continue forever.


A recently leaked document outlines how Beijing may block the propagation of Bitcoin blocks via the Great Firewall (GFW). Many correctly pointed out that miners could easily evade these measures through the use of VPNs. I brought this up with a laowai mining friend of mine during the recent Bitkan conference. He said that the use of a VPN or other means to evade the GFW would slow down the broadcast of your successfully mined block to the point where someone else would beat you to the punch.


In his opinion, these actions will kill all small mining outfits. The big boys can afford direct lines that bypass the GFW. Beijing sells these lines to compliant comrades, and can monitor all traffic. The fees paid are akin to a bribe to the government to continue operation. Absent this, you will be too slow to compete internationally. Now Beijing has complete control over the success or failure of your business, and you will pay whatever they ask.


He further added:


For instance, Inner Mongolia has relatively low population and economic growth. No one wants to move there. A few years ago the local Inner Mongolian government offered Chinese companies large pieces of land if they moved operations from other provinces. Each company who moved there actually got two titles, one for building manufacturing facilities and the other for strip mining coal.


The companies could cheaply and easily mine the coal for sale or build their own smaller coal power plants to run their operations. This led to a staggering amount of coal power plants in Inner Mongolia, most of them fairly small, around 50 to 250 MW.


After these companies moved there they were hit by the global slowdown in the commodity industry. Almost everyone of these factories started mining Bitcoin on the side. They write off miners as an equipment expense, and use the higher electricity usage costs to lower corporate profit and tax. In return they get a consistent side revenue that is not taxed.


While Bitmain is certainly the biggest miner in China, it by no means dominates. The vast majority of factories in Inner Mongolia and neighboring provinces are all doing this and collectively represent a significant amount of hash power.


I think this is the most likely the reason for the mainland crackdown on mining as all these factories are avoiding tax and laundering profits. By shutting things down at a network level that will force a greater centralization, the large players will then get licensed, and the government can regulate and tax them. In my opinion I don't believe mining will be dead in China, I think it will become a permissioned industry.


The 21 million Bitcoin question is whether Beijing would use its new power to attempt to kill Bitcoin. Given that many local governments and senior members of the party profit from the continuation of mining racket, I believe the status quo suits Beijing.


Beijing’s treatment of the internet is an apt comparison for how I believe they will treat Bitcoin. Beijing tolerates the existence of VPNs, and sells private lines to bypass the GFW to certain organisations. Operation of a VPN seems cheap and easy to many readers; however, the vast majority of the Chinese masses are too poor to purchase a VPN, and more importantly have no desire. They are perfectly content with the China intranet, and have no desire to escape.


Beijing has no problem with the wealthy elite enjoying a few freedoms, as long as the mindset of the masses is not poisoned. A prime example is the job of a friend of mine in Shanghai. He re-taught elite Chinese students slated to study abroad the correct version of certain historical events. China has no problem with the masses being ignorant, but they don’t want their best and brightest to appear stupid vs. their international peers.


The recent closure of exchanges, banning of ICO fund raising, and the probable disruption of the Bitcoin network by poisoning block propagation, ensures that the masses may not enjoy the fruits of cryptocurrency, but the wealthy few can.


Time will tell whether Bitcoin and other cryptocurrencies present a real value proposition to the Chinese masses. If cryptocurrencies are like water, they will reach the lowest point given enough time. If they are not, then a small percentage of Chinese investors will continue to trade, invest, and use the technology.

Risk Disclaimer

BitMEX is not a licensed financial advisor. The information presented in this newsletter is an opinion, and is not purported to be fact. Bitcoin is a volatile instrument and can move quickly in any direction. BitMEX is not responsible for any trading loss incurred by following this advice.


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