July 25, 2016 10:21 pm

A Tale Of Two Networks

As the head of finance for Dash, I naturally spend a lot of time thinking about Dash’s strategy, funding and expenses and how to optimize them for our network’s growth.

About a week ago, I did the unthinkable… I replied to a troll on Bitcointalk. I know, I know, “just push the ‘ignore’ button”, you say. However, this particular troll was describing our model as “taxing the miners” and it got me thinking, and that got me typing.

After posting a response, a number of people reached out to me — both privately and publicly — to let me know they found my perspective valuable on the issue of “taxation”, and to encourage me to write something more formal and comprehensive on the topic.

Trolls aside, this is not the first time I have encountered criticism of our funding model. I suspect many people in the digital currency field have an issue with splitting the block rewards between different needs the way we do. But why is there such widespread skepticism?

Bitcoin allocates 100% of their block rewards toward miners, which I suspect has established a paradigm in the minds of many in the digital currency industry that block rewards belong to the miners. Any attempt to allocate them any differently is therefore a tax on miners. This viewpoint is so pervasive in the digital currency field that the industry jargon for block rewards is “mining rewards”.

This paradigm — that all block rewards inherently belong to the miners — is a false one, and it is holding the entire industry back from dramatic potential progress. I’ll get into the reasons why in a moment, but first let me explain an alternative point of view, one that I believe the entire industry needs to embrace.

What’s a little taxation between friends?

First, let’s frame who is really being “taxed” in any blockchain that increases available supply over time. It’s actually the users of the currency. Why?

When a government needs to raise funds, it can directly collect money from its citizens and corporations in various ways… fees for licenses and permits, income tax, property fees, et cetera. These are all taxes of one form or another. But there is another way that many governments tax their populace… by issuing new money.

When a central bank prints money, especially in large numbers, the increased supply doesn’t actually increase the value of all currency in circulation. It simply proportionally dilutes the value of the currency in circulation, and shifts that portion of the value to the central bank’s newly printed money. In essence, this is a tax on the holders of a country’s currency. In most countries, the effect is rather subtle, perhaps 2% per year. But in extreme cases, like Zimbabwe, inflation has eroded nearly 100% of the value of existing currency and the above described effect is impossible to escape notice. Today, the Zimbabwean 100 trillion dollar bill isn’t worth the paper it’s printed on.

In the case of Bitcoin and other digital currencies, therefore, the creation of new currency is an effective tax on all holders of the currency (currently at a rate of about 4% per year). The network itself is the beneficiary of the newly “printed” currency. In the case of Bitcoin, the network protocol just happens to state that the tax should be allocated 100% to miners.

No such thing as overkill, right? Right?!?

The questions every user of Bitcoin and other digital currencies should be asking, therefore, is “Are my taxes being spent effectively to provide me with the most value? If not, how should it be spent?”

Bitcoin and most other digital currencies have explicitly decided that network security is the only expense worth receiving these taxes. In doing so, their protocol implies that the value of any incremental transactional security that can be funded — no matter how expensive it is or how little incremental security it provides — is worthwhile. In effect, transactional security:

  • Has a value that is infinite (it has no bounds)
  • Can only be delivered through greater hashrate (e.g., mining)
  • Offers more value to its users than any other potential use of those funds

Here at Dash, we think all three of those assumptions are false. Debunking any one of the three invalidates Bitcoin’s approach as the “right” one.

Transactional security, TO THE MOOOOOON!!!

Let’s start with the value of transactional security. I often hear people expressing the concept that “Bitcoin is x number of times more secure than Dash because its miner reward is x times as high”. As a sound bite, it sounds logical enough. But is that actually true?

If you double the hashrate of Bitcoin, would it become “twice as secure”? Unless you think Bitcoin transactions are less than 50% secure today, this is a mathematical impossibility. The maximum upper bound for transactional security is 100% secure. If Bitcoin were (and I’m making this number up) 99.999% secure after six confirmations today, it simply can’t double from there, no matter how much resources you allocate toward miners. In fact, if you were to spend ten times as much on mining, transactional security might increase to 99.9999%, but that is anything but a “doubling” of security.

So as I’m buying my triple venti soy no-foam latte, is 99.999% good enough for the retailer? Probably. That’s way more secure than a credit card. Can a value be assigned to that last 0.001% insecurity? Sure, it’s worth about 0.001% of the cost of the latte to the merchant, which is a long way from infinite.

If you graduated middle school math class, it quickly becomes apparent that there are decreasing returns with each incremental unit of hashpower the network purchases. It simply becomes increasingly and infinitely expensive to close that remaining 0.001% gap towards achieving “perfectly secure” transactions, at least through the use of hashrate increases.

So when people say that Bitcoin is x times as secure, what they really mean is that it is x times less insecure. These are NOT the same thing.

Right now, Bitcoin spends (and this is after the 2016 “halving”) over $400 million a year on payments to miners. How much incremental transactional security do you think the network achieves on that last $1 million? Here’s a hint… it starts with a whole lot of zeros. About 1/400th of whatever its current level of “insecurity” is. In the above example, that would be ~0.0000025% less secure. That’s one lost triple venti soy no-foam latte out of 40 million… if an attacker were to even try facing those long odds.

So clearly, the value of incremental hashrate is NOT infinite. There is an upper limit beyond which the incremental tax to the retailers and users exceeds the incremental value of transactional security. There is a point at which additional taxes are destroying value for the network due to the diminishing returns of additional mining.

Harder math… the solution to all of Bitcoin’s woes!

If there’s one thing I learned growing up, it’s that there’s more than one way to do just about anything. My mother insisted that I fold the towels a certain way before putting them in the linen closet. She insisted that they should be folded in thirds vertically and then folded horizontally twice. To this day, I have no idea why.

Obviously, that is not the only way to fold a towel. I often did it my own way, if only to be a difficult teenager.

Much of the digital currency industry has the same arbitrary mentality about transactional security as my mother did about the laundry. More hashrate and higher difficulty is seemingly the only way.

To me, this is utter nonsense, similar to arguing the only way to secure a bank’s vault is with thicker walls. Maybe instead you could add armed guards, move your bank next door to a police station, install closed circuit video monitoring, or replace the mechanical lock with a bio-metric sensor. Any one of these could deliver “more bang for your buck”.

Here at Dash, we have already shown that there are other ways to secure a transaction. With a little bit of development (OK, a lot actually) we developed InstantSend, which uses our masternode network layer to secure against conflicting transactions and ensures the network rejects blocks that violate the transaction locks. And no single entity could control the network because of a clever system involving collateral, and even if one could, they would risk their holdings if they successfully attacked the network. This multi-faceted software-driven approach delivers far more value than some incremental hashrate.

And it didn’t cost much… a few hundred hours of a developer’s time perhaps. Not only did it not cost much, but it delivered a whole new use case for digital currencies — you can now use it in a live retail point-of-sale setting without having to wait around an hour for six confirmations. How’s that for value?

Miners AND developers?!? What are those guys at Dash smoking?

So if that last incremental million dollars Bitcoin spends on miners is such a waste, then what else could it be spent on? I could see any one of the following being a tremendous value in comparison right now:

  • Fund some developers that aren’t in the pockets of big companies, government, or educational institutions — and who serve the needs of users
  • Fund the Bitcoin Foundation so that it isn’t constantly on the verge of bankruptcy
  • Conduct a major marketing campaign to build Bitcoin awareness
  • Hire security researchers to conduct a code review and try to find exploitable weaknesses in the code or new features
  • Hire lobbyists to prevent over-regulation and represent the interests of merchants and end-users in Washington and Brussels

The list could go on indefinitely, and is limited only by our own creativity. Dash is already allocating funding towards things other than mining. 45% of the block reward is directed toward the masternode infrastructure. Another 10% is allocated toward “everything else” like marketing, business development, coding, domain name acquisitions, public relations, software and hardware purchases, conference registrations, travel… you get the idea.

This is a vastly superior model, and a far more efficient allocation of the block reward than the standard approach of blindly allocating 100% to one way to achieve one thing. Over time, the other activities Dash’s network funds not only build new ways besides hashrate to secure our network, but they add utility for our users, and ultimately lead to a higher price.

Bitcoin’s “insurmountable” lead!

Bitcoin maximalists often point to Bitcoin’s vast lead in the market and assert that no one will be able to catch it. I don’t believe that to be true for many reasons.

Bitcoin is hardly a household name now. Less than 1% of the population uses it. We are in the first stages of adoption, similar to where we were with the Mosaic web browser, the Beta home video system, or the HD DVD. All of these were first to market, but none were the ultimate winners. It is still early enough that Bitcoin can be beat, and unless it changes, I postulate that it will. Mosaic lost to Netscape. Beta, which could only hold a short film, lost to the superior tape length of VHS. And HD DVD lost to the superior picture quality of Blu-Ray. All were unseated by the superior technology, despite their early leads.

Two different payment networks? But we can’t get them to use the first one!!!

Since the digital currency industry seems to think Bitcoin is somehow different and immune to competition, I find it helpful to present an analogy of sorts.

Imagine a world in which Visa was the first and largest credit card network. Imagine, too, that it allocated 100% of its revenue toward transactional security. They bought the best firewalls, hired security experts, built their own private internet, put smart chips into all their cards, hired armed guards to surround their datacenter, and generally went crazy with anything security related.

Sure, the network was really slow, it got congested with transactions during peak periods, suffered from lengthy delays for confirmations from time to time, it wasn’t very user friendly, and Visa didn’t offer support. In order to pay a merchant, consumers had to learn how to use a long cryptographic “public key” that looked like a bunch of gibberish to your average Joe. Consumers had to pay the transaction fee, which irked them a little. Merchants had such a hard time accepting Visa that they would hire payment processing firms to help them, so it wasn’t free to them either.

But the network generally worked better than checks and was accepted at quite a few places and was highly secure. There were a bunch of other companies that were working on fixing its flaws by building something on top of it (and charging a fee).

Meanwhile, Visa set aside no money for marketing, public relations, business development, didn’t have any new services being developed besides payments. They had no customer service, no legal department, and certainly no developers. Instead, they set up the Visa Foundation to handle all that and asked the merchants and payment processors and end users to donate toward those things or perhaps do it on their behalf. Of course, the Visa Foundation was usually broke or close to it, so unfortunately, it wasn’t that effective.

Meanwhile, a few years after Visa got started, a rival to Visa emerged called Mastercard. Mastercard started out pretty small, wasn’t accepted anywhere and didn’t have very many account holders. But it did something Visa wasn’t set up to do… it funded all its needs. They had a sales department, marketing department, legal department, customer service call center (once they had enough users), etc. They started rolling out new services like speedy transactions, increased their capacity, developed entirely new ways to secure transactions, made their product super user friendly, added web-based account access, and (gasp!) actually helped merchants get set up on their platform.

Naysayers of Mastercard pointed out how “insecure” their network was. They laughed that it wasn’t accepted anywhere. They ridiculed that no one used it for much. They pointed out how puny their marketing budget was. Many, dubbed “Visa-maximalists” even scoffed at the idea that there could be more than one credit card payment network… after all, surely the confusion of two payment networks would only confuse customers and slow the adoption of this amazing new technology called credit cards! And the idea that they want to pay their developers directly from their revenue streams and NOT through a donation-driven foundation? What are those guys over at Mastercard smoking anyways?!?!

Which network do you think survives in this scenario long term? Which one will be forced to adapt or will inevitably fail? In hindsight, it will be blindingly obvious which network should have won all along and how stupid Visa’s approach was. When you paint the picture of two payment networks in terms of two credit card networks, it suddenly becomes obvious what the better approach for a payment network is, which project will win, and which will fail (or be forced into adaptation). But for some reason, people in the industry have their blinders on simply because the underlying technology is different. Why!?!? Does the underlying technology trump all other tenants of common-sense business practices? Is a payment network built on blockchain immune to disruption?

Positive feedback loop-de-loop

Dash is poised for explosive growth. Since the introduction of the budget system on August 14th, 2015, our price has increased over 200%. This growth directly impacts our budget, which now exceeds $800,000 annualized (nearly as much as the Bitcoin Foundation’s total funding in 2014, the most recent on their website). This funding is now substantial, and is allowing us to fund new partnerships, hire top development talent, hire PR firms, conduct marketing campaigns, and purchase tools and software.

The added investment leads to more end-user utility and increased investment in our project, which creates a virtuous cycle of a higher price and higher budget.

The projected impact is not simply talk… It is already happening. The digital currency industry is actively coming around. Mycelium — one of the most popular Bitcoin wallets — is adding Dash support in October. Top exchanges like Exmo, BTC-E, and BTC38 have added Dash trading pairs. Lamassau ATMs (the largest install base) can now offer Dash. Two Dash debit cards are about to be released. And many more services spanning the digital currency ecosystem are in the pipeline.

Where to now, Captain?

Perhaps Bitcoin’s lead is too large to overcome. Only time will tell. Maybe it won’t be Dash that forces it to change. But make no mistake, the waste inherent in Bitcoin’s approach (which almost all other coins replicate) almost guarantees a competitor will surpass it if it fails to adapt.

Dash’s “tax rate” and allocation is almost certainly sub-optimal. Ideally, it should adapt these rates to produce the best possible outcome for the merchants and end-users it serves. But Dash also has the mechanisms to change and adapt through its governance approach.

Bitcoin has no governance mechanism, except for the hashrate of the miners directed toward the version of the software they prefer. In order to embrace a model like Dash’s now, the miners would need to run a version of the software that allocated a portion of “their” rewards to someone else. I imagine this is not something they are anxious to do unless a last resort. By the time they come around, it may be too late for the network they are responsible for overseeing.

In the future, I imagine researchers will come up with new ways to secure the blockchain, and Dash can incorporate them. Maybe research will produce ways that we need much less hashrate to generate adequate transactional security, and we could adjust our allocation towards that activity accordingly, and direct it toward something more valuable to our users, like a high-quality customer support call-center.

There is a lot I don’t know about the future. But the one thing I do know is that Bitcoin has only scratched the surface of what’s possible. As disruptive as it was a few years ago, the lack of innovation is mind-boggling. It is now behaving like the future dinosaur of the industry — a slow, unfriendly, inefficient competitor that is taking its position in this brand-new industry for granted. The competition is becoming more intense, and unless they start to change, someone else will eventually take their place. I hope Dash is the one to do it.

About the author

Ryan Taylor