Alex B rejoins me on the show to chat about bitcoin security over the longer term and updates on his ETH centralisation thesis. We discuss:

  • Bitcoin’s long term security and blockspace market
  • How miner fees shifted over time in Bitcoin and why
  • Tail emission arguments are dumb
  • Which nodes matter? 
  • Lido and ETH centralisation
  • Will efforts to fix it work? 
  • Being open minded, but not to shitcoins



Stephan Livera links:

Podcast Transcript:

Stephan Livera – 00:00:00:

Alex, welcome back to the show.

Alex B – 00:00:02:

Hey, Stephan. It’s good to be back here. How are you doing?

Stephan Livera – 00:00:05:

Doing well. I think there’s lots to chat about from bitcoin arguments, as well as potentially a bit of an update on some of the earlier stuff we were chatting about last time you were on the show. I think it seems topical in let’s say the last month, there’s been some discussion about, let’s call it longterm security arguments for bitcoin. So I think part of what I’m hearing is this argument of there’s kind of this fee-pocalypse argument. So maybe if you wanted to, I guess, just recapitulate in your own words, how do you view this long term security argument in relation to bitcoin?

Alex B – 00:00:43:

Absolutely. I think I actually made a bit of a case on it as well last time we spoke. And honestly, it seems natural, bear market for these kinds of topics to come on. It’s a little unnerving that a lot of the debate is coming on, is coming from our side, unfortunately, especially from perhaps respected developers, not to name anyone. But generally speaking, the argument that I made in the earlier show that I still stick with is that there’s a very important distinction between the monetary policy aspects of things and the distribution schedule of bitcoin. And I like to think of it in a way where Satoshi never really designed bitcoin to have a monetary policy. Obviously, he was trying to replicate something that’s more akin to gold and decided to go with a fixed supply. And I think the notion of a strict supply is this hugely important selling point in the entire history and narrative of bitcoin. It is effectively the very first and most prominent and perhaps most important means in sort of this cultural movement, really, the idea of the hard cap 21 million. There’s not a whole lot of things that you could put before that in terms of what people associate with bitcoin when they think of bitcoin. And when you open up the discussion, I think when you move the overton window of argument into a different direction where people try to approximate, try to model a future economy at least ten years from now, I have to say I always sort of very much strongly disagree with people that say, hey, we’re only up till 2140 to think about this problem. In a more practical matter, we’re certainly a couple of decades at most away from actively relying on transaction fee for security of the network.

Stephan Livera – 00:03:03:

Let’s just recapitulate part of the argument just so people understand that if somebody is new and they’re listening, I guess part of the argument here is, oh, look, this idea that today, right now, there are two components to the block reward. There’s the block subsidy, and there’s the block as in the transaction fees. And so what we’re talking about here is over time, the block subsidy is coming down. And I guess the argument here is, will the transaction fees rise to replace that? And of course there’s different arguments back and forth about whether the transactions are coming up enough to make up for that. But that’s kind of the high level argument. Now, as you’re rightly saying, people say, oh, that won’t matter until 2140, but the other point to be said is that 99% of bitcoins will be issued by around 2035. So as we stand today, in August 2022, something like 91% of the total number of bitcoins that will ever be mined has been mined. So I guess that’s a little bit of background just for people who are trying to follow along. And so then if you could just spell out some of your thinking on those various arguments.

Alex B – 00:04:04:

Sure. I think a lot of the commotion around it is created by some of the activity that we’re seeing on other chains. They are certainly actively generating a whole lot of fees for the miners or validators on their alternative network. But I think it’s just fundamentally misunderstanding. It’s one that we struggle with throughout bitcoin’s history of being realistic about the evolution of bitcoin as a monetary phenomenon. The idea that we struggle with during the 2016, 27 block size debate where there’s a lot of focus on payments because people were seeing payments as this utility that bitcoin provided. It comes from this idea first and foremost that strictly holding bitcoin is not an utility in and of itself because users are incentivised on other networks to leverage their capital in ways that they’re not able to on bitcoin. There’s a lot of confusion that prevails and gives the sense that bitcoin might not be serving the purpose that it should, and that the monetary incentive for miners to secure the network when the subsidy starts going down. Looking at the data that’s available today in terms of what transaction fees are on network, it certainly seems like a moonshot for that to be sustainable. Unfortunately, it really is not sustainable, and that the data that we’re looking at is, from my perspective, mostly noise. I would discard most of the data in terms of transaction activity on the blockchain up until at least late 2017, if not late 2018, because the reasons why we had fee activity during that time was mostly two phenomenons, a very poorly well scaled infrastructure, both from the user’s point of view. So when we’re talking about wallets and UX and the fee bombing mechanism. Or just the estimation algorithms. Those were very poor. Generally speaking. As far as certainly especially within the ecosystems of wallets that were available in the house cued. The distribution of transactions per wallet was back then. A single entity that would manage fees in a proper way would end up congested network in a quite disproportionate way than they should. Really. The other aspect, obviously, was the network in and of itself. SegWit was a big bulb for some of that, and we found ways to better utilize the block space in several matter. And so that led to historical data that gives the perception today that network is less utilized than it was in the past. And people interpret some sort of trend from that. And there’s no clear indication, of course, that this trend seems to be reverting. Quite the opposite. Fees have been historically low for most of the last couple of years, except for a small little period last year. But looking at it from a bigger picture, you really realize that it’s just all a matter of bitcoin monetizing and where it was still at a very early and speculative cycle where bitcoin, the idea of bitcoin payments remains extremely marginal. As much as we’d like to get ourselves excited about various initiatives, whether it’s El Salvador or the growth of Lightning, in the grand scheme of things, I think that capital allocators don’t look at bitcoin certainly as a payment system yet. So there should be no expectation that activity of bitcoin, at least from a transaction perspective, gains any more significant traction two years from now, even perhaps four years from now. And I think that’s a view that a lot of people tend to share, but they also at the same time get nervous seeing some of the activity. It’s all very much gaslighting to a certain extent where people are made to believe that these are competitive networks. So people are made to believe that the gain of another is the loss of bitcoin. Where I think we should strongly reject that narrative and look at what these systems are for what they are. Which is that most of them. Admittedly nowadays. 99% of them are not trying to be money. And aside from Ethereum and where some of its proponents are certainly still advocating for this, you’re looking at an ecosystem of distributed consensus software basically is what I like to think of as sort of validators, as a service that provide opportunities for permissionless, development of markets and software and infrastructure that incentivize certain use cases that are obviously for very good reasons, not covered in bitcoin. But these are the kind of activities that are already very prevalent in the fiat world. So there’s a very good product market shift for these kinds of software offerings, applications, DeFi, whatever that is in this current historical period, because you don’t need to buy into a certain like you don’t really need to buy into a fundamental narrative. Like you need to really adopt bitcoin. You just got to look at it as just another playground within the whole financial system where capital allocators can gain an edge and can gain alpha and outperform, especially in this time of inflation and, you know, where everyone is trying to warm up each other.

Stephan Livera – 00:10:12:

Sure. And so there’s a lot of different ideas in relation to how the fee market has happened, or let’s call it the blockspace market, if we’re being precise. But there were things like in the 2016, 17 era, there were people talking about spam on the chains to try to as part of the argument for people to preference Bcash. And also, like you said, there were problems around fee estimation and the way people thought about using bitcoin transactions. A lot of exchanges didn’t have batching, a lot of them didn’t have SegWit. And we saw a very noticeable pressure being taken off the blockspace load, let’s say when, one of the large on chain transacting wallets, upgraded to SegWit. Additionally, we saw, I think it’s fair to say, previous to a lot of the stablecoin volume that we see nowadays, there was a lot more people in earlier years who were using just bitcoin natively to move between exchanges and they were very high time preference, they were willing to pay a lot. And so that sort of had this effect of pushing up the average fee that people would pay. But I guess it’s kind of funny in a sense, because there’s almost cycles moving to this thing, because I recall, I think it was around 2016 or 17, Vitalik and Co were making this argument that looks Ethereum has low fees, look how good we are, look at you bitcoin people, it’s so expensive, it’s not accessible. And now it’s sort of like the shoe is on the other foot. And now because back in those days, bitcoin people were making the argument, oh, look, see, it’s just like a restaurant and it’s a popular restaurant, nobody says, oh look, it’s too crowded, nobody goes there. Hang on, there’s something wrong. Like obviously if people are using it, they’re paying for that for a reason. And now it’s like the shoe is on the other foot. Now we’re seeing a lot of the Ethereum people saying, oh, look how much TVL and look how many fees are being paid on Ethereum chain and things like this. Whereas bitcoin has been relatively cheap in terms of transaction fees, at least that’s where it is today. But I think to your broader point, it’s that we’re looking at I think for many people, they are looking at it like a savings, they’re looking at it like a store of value. They’re not necessarily looking to transact day to day, although of course you can do that. And now we have the Lightning Network and it has improved in reliability now. So I think it’s fair to say that that use case is being served if you want it. But I think there’s all these different points going around and I think part of the argument around this whole long range security is this argument that bitcoin will not have enough people transacting or paying enough fees to give the networks and security against a potential attacker. But at least here’s the way I’m thinking about it. I’m curious what you think, but the way I’m seeing it is there’ll just be so many more people even in ten or 20 years time who are transacting on bitcoin, and they may be doing a lot of channel open and channel close transactions or refilling transactions to fill their Lightning node, or they may be doing coin joins. If anything, it might be the other way around. It might be really hard to get your transaction into a block because there’s so much competition. So at least that’s how I’m seeing it going. And it’s almost like I’m seeing it like the problem might be the other way around. But I’m curious what you think.

Alex B – 00:13:11:

No, I agree. I mean, I’ve repeatedly made the case, I was actually a little vocal for a while where I was suggesting that we would be revisiting block rewards upwards of ten bitcoins higher than the current subsidy for the very simple fact that when you consider a block reward that’s purely based off of fees, there’s really no ceiling. So I expect there to be some sort of equilibrium where users will opt for different payment mechanisms depending on their needs and depending on the need for confirmation finality and things like that. But the fact of the matter is that once Bitcoin monetizes, it will open up opportunities for, I would guess, most things we can’t actually imagine today. Right, that’s sort of the failure. I think that’s a repeated failure that we make with technology is that when we’re talking about those fundamentally sort of new paradigms, people always make the argument that you couldn’t possibly imagine Netflix in the early days of the internet because you didn’t even have the infrastructure to support something like Netflix. And so I’m fully in agreement with you that by the time that Bitcoin is monetized, we will see blocks that will persistently I imagined before, and those transactions will very rarely be retail users, will even rarely be strictly single individuals. It will be a composition of, yes, lightning hubs, settlements, perhaps federated, I expect it to be federated side chains or other software or consensus sort of distributed consensus models shown in Mints that ultimately settled the transactions of their users on a network. And so it used to be very I don’t know, it used to be very popular. I think people very much used to say it would be very expensive to transact on the Bitcoin network in the future. And I’m still convinced of that. And I think it will be because it’ll provide large, it’s really not only about the number of users that are transactions, but about the amount of capital that bitcoin is serving. And when you look at the amount of money transacting through the largest global cellular layers today within the fiat system, you’re talking about the amounts of money where if bitcoin manages to sell that, it only takes a very, I think a very conventional or not egregious percentage, let’s put it in percentage fee. The revenue will be there for minors to continue to add security to the network. Really, the question is this question of security budget, right? So the idea that there is a budget is actually very, I think should be hotly contested because the budget assumes that we are able to model and approximate the actual security that’s required for bitcoin to operate. But in fact, it’s really just a consequence of the market. And so users will pay for using the network and whatever demand is derived from that will translate into fees and that will be the amount of security that the network requires. Users might underpay but at which point the prospect of bitcoin not generating significant fees in the future is for me fundamentally an idea that lacks creativity and that ultimately sort of betrays a little bit of overall bearishness really on the bitcoin case. Because if you accept it’s going to be a global standard bearer of value. It seems very logical and self explanatory to me that the demand for that will be massive and probably larger than any possible use case. Right? That’s the important discussion if the use case of money launched all of them. And the numbers that we’re seeing today in terms of financial activity on alternative networks, while these are large numbers that are balloons by fake market cap, perhaps not fake, but very extravagant ways to estimate the market cap of these other crypto tokens. At the end of the day, in the grand scheme of things, it’s a drop of water in the ocean and so it’ll naturally take more time for bitcoin to establish itself because it attempts to claim the very biggest use case in the financial world.

Stephan Livera – 00:18:14:

Yeah, and as you said, with security budget, that can be a misleading term. And arguably that was also created by some essentially some shitcoiner who was trying to argue about the security level. And I think it’s also important to point out that even with bitcoin’s halvings, so long as bitcoin doubles every four years, and of course it’s not going to do that forever, but I’m saying at least in this initial period, then at least even on the subsidy point of view, in fiat terms, the so called security budget in quotation marks remains the same. But as you said, I think it’s important to actually disaggregate that down into its components because really what are we talking about here? What we’re talking about here is, are you as a miner profitable, and two, are you as a transactor able to get your transaction into a block? Or in this case, if you’re doing a Lightning channel, et cetera, to open or close, you need to get that bitcoin on chain transaction confirmed into a block, to have your channel opened or closed, etc. So that’s really what we’re talking about. And so if we’re talking about security budgets, it’s really more appropriate to think of it more from that perspective. And I think once you see it from that point of view, then you can understand that, let’s say if you are a user and you are unable to get your transaction confirmed into a block, well then the answer is you have to pay more. That’s just the answer, isn’t it?

Alex B – 00:19:25:

No, absolutely and from my perspective, the fallacy of the argument also and one of the reasons why I think it’s a massive waste of time is that there really is no alternative. The reason why this debate is being brought up. Of course one of the main reasons why it makes a lot of noise is that certain parties and certain interests are trying to prop up POS as an alternative for a future security model and we can go into details later on and why that’s very. Very unlikely to be the case but the other alternative that we brought up. Or we actually perhaps didn’t mentioned explicitly. But one of the reasons why we’re talking about that today is this idea that’s been propped up of tail emissions the general idea being that as long as the supply is fixed. The argument goes that the nature of bitcoin remains the same. So it wouldn’t matter so much whether we have a fixed supply or a fixed inflation rate. The argument is as long as the economic model persists and doesn’t change, then that’s good enough. There’s so many reasons why that doesn’t hold from my point of view but if we’re just going to perhaps address the tail mission argument so fundamentally naive that it kind of befuddles me that people are actually interdisciplinary because the fundamental premise of the argument is that. Well. It’s such small inflation for users 10, 20 years from now that users are not going to care if you’re paying .5% inflation. You’re not going to mind as long as that’s the social contract and that’s not going to change. But when you’re looking at you can look at it from the user perspective but what really the problem that they’re trying to address is minor security, right? Incentives for minor to secure the network and so the share of value that’s being taken away, taken away literally by users is small enough that aircraft is not going to notice then why would you assume that this amount of value gives any more incentive for minors to secure the network? Because you just made the argument that it was too small of a fraction of the monitor supply to make an impact on the holding of users. So it’s a very contradictory approach to me and again, it needs to assume that you get it right, whatever telemission you choose, you get it right one time and then there’s no changing it. It’s an obvious slippery slope. I think most people understand why it’s certainly unlikely that this become even mildly considered in the future though I don’t think we’re going to stop hearing about it, it just doesn’t fundamentally address the problem, it really does not. So, yeah, there’s really no alternative. We bought into a system with a promise that there will be any economy around Bitcoin that will provide enough demand for it to be sustained on a transaction fee model basis. And as far as I’m concerned, if that doesn’t work then we’ve got to go back to the drawing boards because anything else that I’ve seen out there just doesn’t fit the current model and incentive models that are required for a global mutual layer of money.

Stephan Livera – 00:23:06:

Well said. And I particularly like your argument there around the contradiction because some of the proponents of this whole tailor mission idea have been arguing both things. They’ve been saying on one side, oh look, the users won’t really noticed. But on the other hand they’re also saying oh look, the current system as it is, oh no, the apocalypse is going to happen and the miners won’t have it. Well pick one. Right? And I think you’ve said that before publicly on Twitter and you just made that same argument. I think that’s a very strong one. So I think we can pretty much consider most of those arguments dispatched. I think I would just kind of summarize really it’s unethical as well. Like the users bought in on this premise. Like most of the users, the vast majority of them were told this is the limit and is never going to change. To now try to retrospectively pull the rug out from underneath them and change the rules of the game when there’s no need, there’s obviously no proven need for this because we believe that it’s either going to go boom or bust. Right? Obviously most of us are bullish on bitcoin. We think it’s going to go very high and a lot of people are going to be transacting on bitcoin and therefore there will be a lot of transaction fees. So anyway, I think that’s probably the key point on some of that aspect of it. I guess I was also curious as well to get some of your thoughts on this idea, and I know we’ve spoken about this a bit offline. Is this idea around economic nodes and which nodes really matter? Because I think that concept came up particularly in the 2017 block size war debate because there was a discussion around okay, yes, when you run your bitcoin node you are in some sense defending your chosen rule set. So as an example for listeners who aren’t familiar, when you run your bitcoin node you’re in a sense you’re asserting what you think bitcoin really is and if somebody tries to send you invalid bitcoin, your node is going to essentially reject that or it won’t see that transaction as valid. So I guess from your perspective, I know you have perhaps an interesting point of view on this. How would you frame that idea of which economic nodes matter?

Alex B – 00:25:03:

Right. I think it’s funny. It’s very timely that conversation. Because there was the anniversary. As you probably know.

Stephan Livera – 00:25:13:

Of course.

Alex B – 00:25:14:

Of yesterday. And I happened to be listening to a couple of I tried to listen every now and then to a couple of Twitter space to see if I can get anything out of it. Read a couple of articles or saw a bit of comments about it and it seems like it’s an issue that’s still very much misunderstood. Unfortunately, I haven’t read Jonathan Beer’s book on the block size debate and maybe I should. And it’s unfortunate because I spent a lot of time in the trenches with Jonathan back in 2016 and whatnot and actually met him in Milan back at the scaling bitcoin conference. But anyways, I think there’s still a bit of David versus Goliath narrative that persists and that strikes me as the wrong conclusion. I think it very much felt like that to a lot of people that were involved. But at the end of the day, what made us prevail in USF was that we did in fact have the lion’s shares of bitcoin’s economy behind us in an explicit or implicit way, regardless of the way the story is sold, is the Plebs running their nodes versus the big corporations. But to your point of economic nodes, economic nodes, the workplace behind those nodes have controlled a significant portion of the bitcoin monitor supply. And at the end of the day, but also of the purchasing power, not the purchasing power, but the demand, the current demand for bitcoin in terms of capital that’s yet to be allocated. These are the people that made the difference. And certainly it doesn’t take a lot of this game theory of USF, it doesn’t take the majority of the sleeping giants to raise up and say their peace for there to be enough disincentive for minors to work against what appears to be the consensus on the network. But I think on any sort of quote unquote blockchain or distributed monetary system like that, there’s still very much an argument that gold, gold, the those who own the gold make the rules because regardless of the node that you run, ultimately, besides who enforce the rules on the bitcoin network are those who are actively validating transactions and transactions that they’re personally involved in. And your influence on the network scales up according to the amount of capital that you validate through your node in a way that’s personally involved and in a way that’s suffering. And so running a node as an act of defense against the network without being financially motivated and the financial motivation scale is really around the amount of capital that you’ve got tied to this network. It’s a cool story, it’s cool bedtime story to tell to people, but it gives people the wrong idea about what enforces consensus rules. And it’s important because really, at the end of the day, there are failure models, there are risk models where if enough capital is captured within a single network, it could cause a fork that betrays the regional pieces to be victorious, to essentially squash the fundamentals, the fundamentalists that are trying to protect the original chain. And I think you’ll see that down the line with other blockchain. I think that’s something that’s likely to happen where even if not a fork, the amount of influence that certain interests might have on the capital infrastructure of the network gives them disproportional influence over some of the decision making with regards to protocol design and where things like whatever, like security models might be involved. So I think it’s a distinction that we’re keeping in mind when considering the game theory and sort of the incentive model that makes Bitcoin tick.

Stephan Livera – 00:29:39:

Right. And so I guess just to summarize and paraphrase a little bit just for beginner listeners, I think part of the point is when people are new, sometimes they get a perception that oh, if I just run this Bitcoin node, that’s kind of defending the network in some way. Well, not really. It’s more like if you are using that node in a meaningful way and the best way usually is in this case, if you are receiving Bitcoin onto your wallet that’s validated by this Bitcoin node and you are ideally rejecting invalid coins. So my node is rejecting Bcash or it doesn’t see those be cash transactions as valid in that sense. And if you are an economic actor in the network who is receiving a lot of coins and validating through your node, then in that sense that’s when you are helping enforce the consensus and enforce the validation in the network. So would you say that’s kind of like a fair summary of what you’re saying or how would you modify that?

Alex B – 00:30:31:

No, I think that’s a fair summary and I think actually one of the tension to the point that I like to make this distinction is very important also because there’s a strong tendency to underestimate the power over consensus that a user who holds a lot of Bitcoin but doesn’t initially validate their own transactions. There are scenarios where, for example, the block size debate, where it’s certainly blockchain info, where set processing like a third of the actual transactions on the network at the time. But the important thing to understand is they were doing it by proxy. At the end of the day, an actor that’s not necessarily always validating his own transaction with a node still has the opportunity to do so, if there’s a call for it, if there’s a need for it. And obviously that involves education and people understanding the importance of sovereignty and things like that. But it’s important to point out that I guess ultimately there is a strong argument to be made that those people on large quantities of Bitcoin can still influence consensus in different ways that are not direct even without running their own node, because they have a financial stake in the network, they can make financial decisions on the market and that has a huge influence on it. We saw people make the. Argument that some of the trading activity with bitcoin cash futures and associated force during 2017, 2018, a lot of people made the argument that this is what scared off the miners. You know, people saw that there was no actual demand. It’s a bit of a dangerous argument to make. It’s one of the reasons why people weren’t actually all that keen with those kinds of games, if you will, because it’s very easily manipulated. I think bitcoin is actually very, very fortunate that it found itself in a time where it was still small enough and you know, the liquidity and you know, the whole financial degenerative infrastructure on bitcoin wasn’t as large as it was. Because if it would have happened during this last cycle, I think there would have been a lot more incentive for people to try and manipulate opinions by those future markets. And unfortunately, they’re able to do it whether they own bitcoin or not. Perhaps pay for bitcoin or things like that. But I’m not making a point that running a node. I think it’s optional, certainly, but I’m not also making the point that people shouldn’t be running their own nodes. I think if they want to as an educational exercise, they absolutely should. Every bitcoin user should get the experience to run their node within the evolution to a bitcoin. But certainly it’s not a prerequisite. It doesn’t make you more of a bitcoin or if you’re running a node, than initially somebody else. I personally don’t actively run a node, and I haven’t for the last couple of years. And one of the main reason is really that I really have no source of revenue or income that doesn’t come from a party that I trust. And I do trust, you know, people that I do business with to a certain extent. And I have plenty of recourse if like, there’s no opportunity for these parties to double spend, for example, and I have recourse if I don’t receive the funds. So it’s not absolutely necessary. There’s no true scotsman when it comes to bitcoin. Running a node is an individual choice, and I think overall, my point is perhaps it’s overstated sometimes in terms of what effect it has on the consensus of the network.

Stephan Livera – 00:34:27:

I see the way I see it, I think it is a vital step for many bitcoin is who are let’s say if you’re listening to the podcast and you’re thinking, I’ve never done this before, I would say definitely you need to learn how to use it. I personally do use a bitcoin node in terms of receiving payments and things like that. I find it really handy. But I think it’s a graduation step for a lot of people and depending on your situation, you’ll find different scenarios. So, for example, I use BTCPay server, which is an easy way. For example, people can easily go to like voltage cloud and spin up their bitcoin node there. I know that’s a cloud node, but you might be a merchant or whatever, it might be different scenarios there. But to your broader point, I think it was true to say that the futures markets on the fork coins so I know Bitfinex, for example, had they called it B1X and B2X around the SegWit 2X debacle, which came later in the year, in 2017. And as I off the top of my head, I think it was something like 0.15 for the SegWit 2X coin and it was something like 0.85 for the normal just bitcoin segment, one x coin or B1X coin. And so that arguably helped the market figure out. But like you said, it’s possible also that there’s paper bitcoin, but that’s it, you would have to see that across all the different exchanges too. So, you know, it’s kind of interesting to see if something were to happen like that today, how would it shake out? Well, who knows? But anyway, I also wanted to get your thoughts in terms of updates on some of the Ethereum centralization Lido staking derivatives stuff. So, listeners, I’ll put the show on at the earlier show there, but just, I guess the very high level summary is, as I understand your argument, let me just quickly recapitulate that for listeners as well. It’s that there are centralization pressures within ethereum. One of those is this concept of staking derivatives, or seen this Liquid staking derivatives, where there is centralization arguably being driven into one of the parties called Lido. And they have, I believe it’s over 90% of the Liquid stated ETH. And this represents some future potential governance risk around what happens with Ethereum. So I’m curious to get your thoughts on that. Firstly, do you agree with that summary? And then what are some of your updated thoughts on this since we last spoke?

Alex B – 00:36:41:

Right, I think since we last spoke, I’ve just been validated in my thesis times and times. Again, it’s not being recognized as a very public issue or even Ethereum. Foundation engineers and developers are acknowledging it as an existential threat to Ethereum. So we’ve come a long way. You mentioned 90% of the Liquid staking share. That hasn’t really moved. It’s always been dominant and should be expected to remain dominant. But I think one of the big conversation items last time we spoke by all was 15% of the overall fake Ethereum amongst all validators. And that was just a little less than, perhaps a little less than a year ago, really. Today it sits at 32. So it’s 100% increase in the last year. And generally, if you look at things, you look at the other numbers, I think more than 60% of the new east that is being staked on a daily basis is actually still being added to lito. So the centralization and the dynamics that would encourage people to further centralize into what I believe will now be a monopoly cured than ever. And with the merge possibly coming by the end of the year, it’s going to be extremely, extremely interesting to see this play out. Because while people might people in Ethereum camp might be very excited about the prospects of the merch, I think this is really when the dynamic sats for the centralization of liao really kicks into gear. And this is where you see opportunity for Lido as a validator to start capturing things like MEV in a much significant way. And I wouldn’t be surprised if within a year, from this interview, from this podcast, we’re looking at why it has owning over 50% of the stake on the Ethereum network, at which point it’s painfully transferred and blatant that the claims of neutrality of Ethereum are significantly diminished. And I think the big question mark, though that remains is how does that ultimately play out? Because people have always fantasized about Ethereum crashing down in a big ball of fire. Unfortunately of the opinion that it’s very unlikely to happen. It seems very much to me like Ethereum is destined to be captured by, I think, interest that remains. It’s a little unclear to me who will be driving, who will be behind the wheels Ethereum five years from now. It really survives and I think it’s possible that it survives that long. And I’ve put a bit of a tease this morning on Twitter. I’ve been thinking about some of this stuff and I was reviewing a couple of tweets in preparation for this chat and I just sort of had this eureka moment to me where it really crystallized the difference between a system like ethereum and a system proof of stake like Ethereum and something like proof of work. And I think I guess the exercise that I’m driving people at is considering what happens in a highly centralized, highly sort of almost monopolized context or scenario for both of them, where you have perhaps 51% of the hash rate that has consolidated under a single mining pool in Bitcoin, what happens then? Well. What we think happens then is that really in the best case scenario. Nothing happens because the underlying incentives thesis that was there from day one. From Satoshi. Is that even if people manage to obtain that amount of hashrate at such a significant amount of hashrate. The incentives are people to continue to work within the rules of the system because it is profitable for them to do so. Correct? And in proof of stake there are two incentives at play that challenge each other. And the main fundamental difference is that proof of stake validators proof of stake block producers, which is really what they are, are not only concerned about selling new inclusion into a block, they are also selling new priority in terms of your transactions. And obviously. Given all that we know about the state of MEV maximum expectable value on Ethereum and this notion that because of the applications that are popular on Ethereum require sort of incense analogy to a certain extent where you got many AMM decentralized exchange where arbitrage opportunities are available and if a certain actor recognizes that opportunity before another and manages to get their transaction that captures this inefficiency in the market before another then they can extract the associated value of that. And that has turned into a game where miners are not obviously as the one effectively responsible for transaction ordering on the Ethereum network. Miners play a central part in this extraction game. But this extraction game if really the prospects of Ethereum are to be fruitful you’re talking about billions like a billion dollar business. One of the largest, fastest growing industry in Ethereum is MEV. And the problem with that is that under a system like Lido where you have the staking derivative that creates an incentivized that has network effect that incentivize centralization because of liquidity first and foremost. And we had a great example of that during the Carolina crisis and Triado’s capital crisis where you saw the st eat, which is Lido staking derivative and the st eat and each pool what they call the curve pool which is this liquidity pool which basically allows people to sell their fat for Ethereum or sell their Ethereum for the staking derivative. And this exists because it is not possible until a certain time after the merge for people to onstage their Ethereum. People can stake today to Lido but cannot withdraw that stake. And that’s the same for every staking sats up whether it’s personal at home user or other validating tool. And so what happened is that there was a lot of volatility in the market and the peg, which is one fake eat is supposed to represent a claim on one eat. And this liquidity in this pool tried to maintain that one for one tag. Because of the liquidity the peg dropped significantly not in a perhaps very dangerous way but this just goes to its shape that taking derivatives are winners take all sort of formula because of that need for liquidity. If the liquidity around staking derivatives had been fractioned during this event the last couple of months ago then this would have significantly, perhaps damaged each and every single one of them being significantly smaller. So there’s this network effect of staking derivatives at play and then there’s the network effect of me being whoever controls a large portion of the stake on the network has the opportunity to capture more MEV purely because of effectively the concept of variance, right? The concept of variance that we know exist also within bitcoin is one of the reason why people get into a group together in pool is because otherwise as a single miner perhaps almost regardless of your ashing power there’s an effect at play where unless you’ve got a significant amount of ash and power you’re more likely to be less lucky. And so there’s this concept of luck in the ability to produce luck, that obviously the larger you scale up and the bigger you are, the more likely you are to get lucky and the more likely you are to get the opportunity to create more blocks in a perhaps disproportional way to your stake hashing power. So disproportional aspect is even more important in MEV, where MEV fluctuates and is not necessarily a smooth distribution. So the opportunity to capture a block of MEV that has much larger value than the next block or the 110 blocks behind. Then it leads to large stakers and entities like Lido in the future to be able to consolidate the capital that’s pulled into their infrastructure. Because they’re able to this MEV to offer larger staking rewards to their users and also use that capital to bolster their own investment into capture of MEV. Capture of MEV is effectively the digital equivalent of mining specialization. It is a little Bit the idea that perhaps in another way is that if you take a Bit main. For example. That would have such an outsized share of the market that they would be able to get so much capital that they’d be reinvesting into their chips and be able to gain such an outsized advantage because they are able to use that propriety chip that’s more efficient. Unfortunately, because Bitcoin is proof of work, is sort of bound by the laws of physics, there’s diminishing returns in terms of specialization. Of course you could get more efficient chips, your operational process can be more efficient and more cost effective. But the margins are extremely tight in MEV, the margin are as big as the market is. And so once you’re able to capture more of that activity than any other player, you can follow it in a very dangerous way for the network. So ultimately you are likely to create a monopoly. It’s very likely that the natural state of proof of state is a natural monopoly that is driven by the staking derivatives and that is driven by this market of MEV. And by creating a natural monopoly, you enable rent seeking and you enable the block producer to create a market for transaction priority that is completely separate from their responsibility to include you into blocks. Right? And the reason why that’s important is that within the silo of transaction priority, the single monopolistic block producer is allowed to do effectively whatever they want. And that activity is mostly confined to near term settlement transactions. Right? Because the idea is that you do not necessarily want to censor indefinitely a transaction or double. Even if you attain 51%, if you’re monopoly, you’re effectively the only person on network produces block. And you wouldn’t want to start mining invalid block or double spending because this flies in the face of the social consensus, right? This is when whoever runs an Ethereum node might step up to the plate and say hey, you guys are obviously acting in malicious ways they might slash you. That’s within the scope of what you’re doing. Slash your mistake means you lose money. Or they might choose to force the network and blacklist certain validators and stuff like that. So it’s a risky game for validators to play. But really all they need to do is sit on the top of this economy and just start making in money by being this rent seeking entity that enables you. If you want Stephan to get your block included as a priority in the next one. Well. Why don’t you pay me a little more money than the other people that are in line trying to capture. For example. That opportunity. That MEV opportunity. You can create private Mempool where some privileged people would broadcast their transactions strictly to you so that you may include them into the next blocks in a prioritized way. And that’s very important because if you manage to build this private Mempool of transaction where people are manually submitting their transaction to you and only to you, then that further consolidates your advantage as an entity that attempts to capture MEV. Right? Because if people start submitting their transactions, they are high value transactions to you. These are transactions that are not submitted to the other potential competitors, other validators, and this is value that they can never capture. So you can solve it in that way, but really, more importantly, and where it gets all twisted and you can see very different outcomes is, well, what if I decide that I don’t want you, Stephan, to be the one to capture that opportunity? What I’m going to do is I’m actually going to pay I’m actually going to pay the monopoly block producer to censor your transactions. I want to make sure that we’ve been playing the same MEV games. I know that you know what you’re doing, but I’m seeing this one transaction here which I really want to get my hands on. I’m afraid that perhaps you’ve also spotted it. So I’m going to make sure that you’re not able to capture it. I’m going to pay a premium on top of that. And you can see very quickly how this turns into a bidding war between who wants to get their block included, who wants to censor the other party for whatever reason. And when I say censorship, I only mean small, near term censorship because by the time the opportunity has gone, when I’ve captured it, the idea that you’ve been censored, it’s a transaction that provided no value to you other than if you were able to capture it in that moment. It’s not like censoring a user that’s trying to send money to a third party and whose transactions will never go through. It’s a temporary censorship, but it’s enough to have its effect. And so the monopoly block producer is able to get away with a lot of that stuff, create spinning wars between various users in this massive MEV ecosystem. And by doing that further consolidate their power, but most importantly further consolidate the capital within the network, right? You really have a system where you have these overloads more where you have no choice but to pay taxes. You have to pay taxes because you have to be staking your Ethereum in this world where potentially because of staking derivatives and how easy it is, if you’re not taking your Ethereum you’re getting your share of the supply diluted. It’s effective inflation as far as you’re concerned, or at least your purchasing power diminishes compared to people who are staking with Lido. But Lido as an entity itself also derives a fraction of that staking rewards. So they charge you effectively a tax and because you have a natural monopoly, then there’s opportunity for them to leverage very large taxation amount. So it’s all a bit of a as far as I’m concerned, it’s a bit of a mess and like I said, it’s been publicly acknowledged by very significant ethereal people. There’s been demands that Lido caps their stakeable supply at 25% and there’s been a vote on the Lido DAO recently where people suggested that perhaps they should limit the actual percentage of supply and well, what do you know, it was almost unanimous in terms of users voting against that proposal because it’s not within their incentives to do so. It was a landslide. It was 99% of users voting against that proposal. And so there really is the incentive problem at play with the Ethereum where I think they’re driving into a wall but unfortunately it’s a wall that like I said, it’s not something that’s going to explode today, so tomorrow and we’ll say hey, that was it. I think it actually leads to a very perverse system, a very pernicious system when people make the argument that Ethereum is fiat and is likely to be captured by bankers. I think there’s a very plausible argument where that’s the case because why people have this fantasy that governments are trying to kill Ethereum. That Gary Ganser is trying to kill Ethereum. Where if we truly believe those government entities and those fiat officials to be what we think they are. It makes a lot more sense for them to capture these networks and profit from and prop up these networks as much as they can for as long as they can because there is an opportunity for them to sit on the money tickets and it’s a new form. It’s just a different model for them to extract value out of people and it just makes too much sense for them to leverage that rather than try to figure out.

Stephan Livera – 00:55:53:

Let’s say there’s a lot of points there and I think you could argue that there is this regulatory capture aspect and that let’s say there may be now of course there are different departments of government. So let’s say one department of government might be trying not like some certain project and another might be thinking this is an opportunity for us. This might eventually be more power. More money. Etc. For so more fame, prestige, whatever the incentive is for that person. Now, it also reminds me because back in, I believe it was late 2013 or early 2014, there was a saga where at the time bitcoin mining and so this one miner was getting I think close to 50% of the network in terms of mining. But I think it’s kind of an interesting little parallel that Bitcoin had a moment like this in history. But of course I think they voluntarily restricted their supply or their mining percentage down. And in this case the users of this protocol, almost 99% or higher than 99% voted against that. Now, I have heard of one idea from the Ethereum camp, they’ve got this idea of as a response to this concept of the centralization Lido et cetera, this proposal builder separation. So I’m curious if you have any thoughts on that idea. So as I understand they would bid in real time to win the right to capture MEV in any validators block, whether it’s part of Lido or some homestaker as an example. I’m curious if you’ve looked into any of that or have any response to that particular argument.

Alex B – 00:57:29:

Yeah, I have. I think it’s a decent attempt to sort of part mentalize the division of labor within this MEV market or more generally speaking, block production. But certainly one of the driving motives behind that is the existence of MEV. And it seems to me like although there might be good intent behind it from some of the people working on that, it all seems to me like a masquerade because there is no because of the monopolistic incentive for taking derivatives. It makes a lot more sense for a dominant staking entity or dominant set of validators like Lido to vertically integrate across proposal builder relayers. Searchers and those all terms. Those are all different entities or ideally from their perspective. Those are different entities where they are hoping to create a market that will create competition amongst the people involved. The actors involved into the MEV business which hopefully will distribute it enough to avoid centralization. But the problem is that the incentives are just not there. There is very likely to be, like I said, a single monopolistic relayer, single monopolistic proposal. And what’s going to happen there is that certainly lito might be contributing themselves in terms of searchers and searchers are literally the one that link to transactions on the network, observe all of the distributed decentralized exchange activity and really spot those opportunities. And the rest of the actors are responsible for putting those blocks into what they call bundles. And it’s actually effectively constructing a block, effectively trying to construct a block that extracts as much value as possible so that the validators can then use that block to add it to the chain. So without getting furthermore into technical details, I think this alleviates one of the reasons why they’re doing this is this alleviates one of the major issues with Ethereum at the moment is that block production as it currently stands effectively has a single centralized point of failure in the flashbox infrastructure. And the flashbox infrastructure is what currently allows miners receive or create an auction market for these MEV bundles. For these MEV transactions and offer the opportunity for anyone that’s trying to partake in this to submit their bundles directly to miners so that they can put them into block and obviously depending on the value of them prioritize one over the other and then there’s a bidding gain going on. And the problem is that sitting sort of right in between these searchers and these people that are putting together the bundles and the miners is flashbots relays which are the ones effectively responsible for coordinating this entire dense and flashbacks. Relays as far as I understand it, are nothing more than software running on the cloud, probably AWS infrastructure or whatever that is. Most likely in a redundant way, most likely in a way that’s fairly secure and airtight. But certainly when we’re talking about billions and billions of dollars of value and systems that are supposed to be built in trust minimized ways to have such an obvious central point of failure, it’s quite perplexing and even more so that they’ve made the decision now with proof of state to I’ve made that thread just yesterday. I believe the two effectively bacon that part of the software into the various Ethereum clients and it was already kind of used by most if not all minors. I would assume that the original iteration of the Flashback software is used by all minors. But now the they went so far as to putting that into not the reference well, effectively yes, as an API in the reference client in a way that not enforces but makes it even more likely that every single validator down the line will use it. And this centralized relay will still be my mainstay of the Meg infrastructure until they plan to introduce this proposal. Builder separation where you might have them entities that can volunteer as relayers and create a market for real air. But it’s unclear to me how that’s going to play out. I think generally speaking, I see it playing out two ways. People are going to get very more vocal about it. I think there’s this sort of I’ve been rereading like Atlas Shrugged. It feels to me like in the Ethereum world development, world ecosystem there’s a bit of Who is John Gault sort of dynamic playing out where people are like why bother, we’ll just figure it out. People are actually not dejected, but there’s a bit of an apathy in terms of the conditions of the network and the trends that we’re seeing. I was listening to a podcast a couple of months ago where it was a couple of guys from the Ethereum foundation and the very notable and popular had to where they were openly entertaining cartelization on Ethereum and almost slavery and slavery’s peace and sort of like trying to make arguments for why this would not be such a bad state of things. So I think it’s going to be perhaps an upcoming battle where more fundamentalists who are perhaps more aligned with decentralization start to raise their voice and then it will be an interesting argument. But there really is so much dead weight, there’s so much people have invested so much into that venture that there comes to a point where it’s sunk cost fallacy where you’ll just play along with whatever happens because the admission of failure has become very costly. And so you’ll have this internal dynamic and then obviously you’ll have the competitors that I think we’ve seen come up in this life cycle and are probably likely to try to snatch network effect away from Ethereum. So I’m interested to see it play out. But unfortunately for the very vocal maxis and antiblock chain crypto scams on Twitter, I have to say you’ll have to continue to be very vigilant that these things are unlikely to go away.

Stephan Livera – 01:05:32:

Yeah, and I think to your point as well about the competition that Ethereum will be facing, there may be other more openly decentralized solutions that just are cheaper and maybe people will just use those. I mean, of course it depends where the gambling, where the leverage is. Not that I have an issue with gambling per se. I just think there’s this perception that look how much TV or look how many transaction, they’re not really comparing the same thing as I think we’ve spoken about. Right? Like Bitcoin is seen differently, rightly? And rightly. So I think that’s probably how I think the key part to understand is that we’re looking at this fundamental new money, this new thing with certain assurances that really nothing else gives us. And we’re living in this world where there’s a war on cash, where literally maybe just a couple of days ago I saw this news article about how Emirates, emirates, the airline, is looking to decrease their flight frequency to Nigeria because they can’t repatriate the money back because maybe the Nigerian government is trying to keep the US dollar there because they don’t want to give that back. So it’s kind of like and it’s such an obvious use case here where Bitcoin obviously people could of course, maybe you could argue about how big Bitcoin is today. But I think there’s just that fundamental use case there where people just need to be able to transact and they may need to do it under adversarial conditions, they may need to do it even under conditions where, let’s say, the normal banking system is not working for them or where the government controlled banking system is not working for them. And that speaks to some of the issues around Centralisation that we’ve spoken of. So I think probably a good spot to finish up here. I enjoyed the chat. Any last points you wanted to mention for listeners? Anything else to keep an eye on?

Alex B – 01:07:14:

I will say, just to wrap up what I was just talking about, it, we didn’t get to touch too much on that, but I’ve made the case that it’s actually very from my perspective, as much as most people hate the prospect of it, I think we’re likely to live with a multi chain world for still quite some time. And with that in mind, I would encourage people to keep an open mind in terms of I’m not trying to turn into Eric here, but there are use cases that can be served by building distributed consensus technology, whether that’s via blockchain or via, like you said, Champion Bank Federation. There are opportunities for bitcoin to be perhaps leveraged down the line in ways that might make you uncomfortable, but that are just a consequence of market and this permissionless aspect of it. And so I think it’s very unlikely that the current actors of this blockchain, the current main component of this MultiChain world, exists five to ten years from now. Most of them will likely be extinct because they are fundamentally based on flawed economic premises, flawed technological premises. But I have personally the feeling that we will be exploring that in certain respects in the bitcoin ecosystem more and more. And I know some people that are building very interesting products that leverage concepts like that, products that are fully incentive, fully sort of aligned with bitcoin, with the bitcoin ethos. And there’s no shit coin involved and I’m not setting myself up to announce my next shitcoin, but although it might sound like that now that I’m listening to myself chat, but, yeah, I just encourage people to keep an open mind. There’s going to be, again, save vigilance, of course, because we haven’t seen our life cycle of scams and shit tokens and new narratives. But the bitcoin technological ecosystem should be encouraged to learn from whatever actual applicable technology is being developed in other spheres and see how they can leverage that to their benefit. Things like sediment, it’s not a one size fits all approach, a lot of people aren’t going to give up on chain transactions, self validation and things like that. But I think there’s a little bit of a hubris to the idea that our conception of bitcoin today is what should be the conception and the approach and the use case of bitcoin tomorrow for the billions of people that are going to follow.

Stephan Livera – 01:10:18:

Right. And a lot of that plays into what kind of scaling techniques are available. Some of that will be custodial, obviously, I prefer as much as possible it’s not custodial, but we’ll see what happens. So, Alex, thanks for joining me. Listeners, make sure you follow Alex on Twitter. His handle is @bergealex4. I’ll put the links in the show notes. Alex thanks for joining.

Alex B – 01:10:37:

Appreciate it. Stephan have a good day.

Comments (5)
  1. Hey Stephan, really loved this episode.

    One question: circa 33:44, you say “If you are receiving Bitcoin into your wallet that’s validated by this Bitcoin node…”

    As a node operator myself, I’m curious to learn more about this. Does this mean that you need to receive using the built-in software wallet that ships with bitcoin-core?

    Historically I’ve been using a node primarily for privacy purposes, and not super familiar with the mechanics behind how nodes perform transaction validation. My understanding is that generating a receive address is just a local operation to e.g. ColdCard and Sparrow, so if I’m understanding you correctly, this scenario does not actually use my own node to validate the receive transaction in any way.

    If you can refer me to any resources on this concept of an economic node, that’d be great!

    • Thanks Kobie, think of it this way, you can connect your software wallet to your bitcoin node so that it checks transactions against your own node. So yes your Coldcard and Sparrow together can generate the address to receive into, you still need to connect to a node to *know* that you received coins there.

      So for e.g. you can connect your Sparrow wallet to your own Electrum Server (which is running on top of a bitcoin node), this function is available in most of the node packages like Umbrel and so on. This would be how you can use your own hardware signing device + Sparrow + own node to participate in bitcoin transactions in a more self sovereign way.

      • Thanks for the reply, Stephan!

        I’m really interested in this topic of “economically active nodes”, and specifically how my node is participating in strengthening the network. Historically my main focus has been on running a node for better privacy and security, and I just kind of assumed I was strengthening the network in the process of doing that. Yeah my rig is Sparrow -> ElectrumX -> bitcoin-core

        Maybe I’m getting caught up in the philosophy here, but I guess what I’m saying is that “if a UTXO arrives at an address and there is no wallet observing it, did it make a sound?” line of thinking. I don’t see how a node is involved with receiving in any concrete way. The UTXO would arrive at the receiving address whether or not my node was off or on. My “knowing” that I received a UTXO in Sparrow is a cognitive function of my own brain and does not impact the Bitcoin network in any way. But I absolutely see that when spending, using your own node is 100% more sovereign than using some third party to broadcast the tx.

        But I think from what I hear there’s not much more I can do at this point, so time to move on to running some lightning nodes 🙂

        p.s. I really enjoy your show, regular listener.

      • I understand the point about “did it make a sound” etc, but remember let’s say you’re working for someone or selling them a product, you’d need to know whether you got paid, correct? So in checking that you got paid or not, you are in some sense, “defending your chosen rule set” of bitcoin. Because if you gave someone a Bitcoin address and they sent you Bcash instead or something else, you wouldn’t say “Ah yes, payment received and accepted!”, you’d say “hey hang on mate, you haven’t paid me for my services/product!”.

        Thanks for the support of the show. It only exists because of listeners who help promote and share it!

      • Damn straight I would say that, BCash lol.

        OK I think I get what you’re saying – thanks for spelling that out. Definitely has a meat space component which is what was throwing me off.

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