Quotes"You need a way to import costliness into the digital space. This is what Proof-of-Work does. A proof of work is proof for the digital world that you spent resources in the real world." ~@hasufl, independent #cryptocurrency researcher Click To Tweet "#bitcoin is secured by people setting financial incentives and others responding to those incentives. Someone might have told you that #blockchain is the truth machine, but it's not true." ~@hasufl, independent #crypto researcher Click To Tweet “Poker is very much like mining in that it gets harder every year. There's a limited amount of money to go around… Players develop custom software or hire people to work for them." ~@hasufl, independent #crypto researcher Click To Tweet
Today’s guest is Hasu, an anonymous cryptocurrency researcher who writes for Uncommon Core and Deribit Insights. He used to be a professional poker player, an experience that informs his current work. As he explains, there is overlap between poker and cryptoeconomics. Both can be understood through game theory.
This conversation is split into 4 chapters:
- Chapter 1: Hasu’s background, both as a poker player and now as a researcher and writer
- Chapter 2: Proof-of-Work & Nakamoto Consensus
- Chapter 3: Game theory and the incentives behind Proof-of-Work
- Chapter 4: A Q&A covering Bitcoin maximalism, declining block rewards, and how China dominated crypto mining
Topics Discussed In This Episode
- How Hasu transitioned from poker to crypto
- Writing for Uncommon Core & Deribit Insights
- Mining as a way to establish consensus & distribute currency
- The limits of centralized solutions to the double-spend problem
- Nakamoto Consensus
- What is game theory?
- How to launch a 51% attack
- How shrinking block rewards impact network security
- The case for uncapping Bitcoin’s supply
- The hidden benefits of specialized mining tech
- How China became a crypto mining powerhouse
- The professionalization of online poker
Links Relevant To This Episode
- Popular Crypto Weekly Newsletter
- Clay Collins
- Uncommon Core
- Deribit Insights
- Bitcoin (BTC)
- Litecoin (LTC)
- Nic Carter
- Bitcoin Gold (BTG)
- Ethereum (ETH)
- Monero (XMR)
- Vertcoin (VTC)
- Ethereum Classic (ETC)
Clay: Welcome to Flippening, the first and original podcast for full-time, professional, and institutional crypto investors. I’m your host, Clay Collins. Each week, we discuss the cryptocurrency economy, new investment strategies for maximizing returns, and stories from the frontlines of financial disruption. Go to flippening.com to join our newsletter for cryptocurrency investors, and find out just why this podcast is called Flippening.
Clay Collins is the CEO of Nomics. All opinions expressed by Clay and podcast guests are solely their own opinion, [00:00:30] and do not reflect the opinion of Nomics or any other company. This podcast is for informational and entertainment purposes only and should not be relied upon as the basis for investment decisions.
Welcome to this conversation with Hasu, an anonymous cryptocurrency researcher who writes for Uncommon Core and Deribit Insights.
This episode was recorded in front of a live audience. If you’d like to attend a live Flippening Podcast recording and directly submit interview questions to guests, then please go to flippening.com and subscribe. After you have subscribed, we’ll be sure to send you email notifications before [00:01:00] live recording sessions so you can join us. Space is limited to 100 attendees per recording, so go to flippening.com to subscribe and join us for the next live recording of this podcast.
With that established, let’s get back to our guest presenter.
Hasu is one of the foremost researchers in the crypto space, and he used to be a professional poker player. This is actually relevant. As Hasu explains, there’s quite a bit of overlap between poker and cryptoeconomics. Both can be understood through game theory, which is the study of strategic interaction [00:01:30] among players who succeed by predicting each other’s behavior.
Our conversation is split into four chapters. In Chapter 1, we discuss Hasu’s background, both as a poker player and now as a researcher and writer. Chapter 2 is a deep dive on proof of work and Nakamoto consensus. In Chapter 3, we’ll use game theory to understand the incentives behind proof of work mining. Chapter 4 is a Q&A. We’ll take questions from the audience, and cover a range of topics including Bitcoin maximalism, declining block awards, and how China [00:02:00] came to dominate Bitcoin mining.
The transcript and show notes for this episode are available at flippening.com/hasu.
We’ll get to the episode in just a second but before we get started, I’d like to pause for a moment to tell you that this episode is brought to you by the good folks at nexo.io. Here’s a word from them.
Nexo is the only lender offering instant crypto credit lines, which let you use digital assets as collateral to get cash in 45 fiat currencies and stablecoins. You might remember Nexo from Episode 64, where we spoke with their co-founder, [00:02:30] Antoni Trenchev. If you haven’t heard this episode, I highly recommend checking it out as it’s one of our most popular episodes to date.
And Nexo has a big announcement related to credit lines. Their annual interest rates for credit lines are now starting at just 5.9%, which may very well be the lowest borrowing rate in the whole industry.
Nexo is also a strategic partner of exchanges, OTC desks, and crypto funds, through its portfolio of structured financial products. Institutional counterparties can earn up to 8% annually on their [00:03:00] idle stablecoins, enter into asset swap agreements, or directly borrow crypto. Individuals can also park their cash and stablecoins at Nexo’s interest-earning account to get an annual return of 8%. What’s more, interest is paid out daily and you can add or withdraw funds at literally any time.
If you are looking to borrow, lend, or swap digital assets, Nexo is your go-to partner. Definitely explore nexo.io, or reach them at email@example.com.
This episode is also brought to you by CryptoTrader.Tax. [00:03:30] Here are 4 things you should know about them. (1) CryptoTrader.Tax automates the entire crypto tax reporting process and has partnered with the TurboTax team to bring cryptocurrency tax reporting to the mainstream. (2) CryptoTrader.Tax offers a complete Tax Loss Harvesting module, to help investors figure out their greatest tax savings opportunities, to reduce their taxable income. (3) CryptoTrader.Tax supports all fiat currencies, meaning users from all over the world can use the platform to calculate their gains and losses in their home fiat currency. Finally, [00:04:00] (4) CryptoTrader.Tax offers a suite for Tax Professionals to help them manage their cryptocurrency clients.
While I’m not a CPA and am not qualified to provide tax advice, I should note that I personally advise my family to never just hand over their exchange history to a CPA. Instead, I encourage them to let CryptoTrader.Tax analyze their trade histories, find the tax calculation method that’s best-optimized to save them money, and then submit summary documents to their accountant. This also saves you from having to pay your accountant to do the tedious work of generating [00:04:30] Form 8949 and other similar forms.
Creating an account and importing your historical data is completely free. You only pay when you want to download your tax report for the year. Just tell them that Clay from the Flippening Podcast sent you to get a discount on your tax reports. Go to CryptoTrader.Tax to sign-up today.
Finally, this episode is also brought to you by the Nomics API and CSV Data Export Service. If you need an enterprise-grade crypto market data API for your fund, smart contract, or app, or if you need historical CSV dumps of trading data or crypto market cap data [00:05:00] from top exchanges (or even obscure ones), then consider trying out the Nomics API or our historical data export service. Just go to nomicsapi.com to learn more, or email us at firstname.lastname@example.org.
Okay, back to our regularly scheduled program. Here’s my conversation with Hasu. Enjoy.
[00:05:30] Let’s start with Chapter 1, which is a dive into Hasu’s background and how he got in the cryptocurrency industry.
I’d love to discuss a little bit about your background and how you got involved in the space. I know you’ve got an avatar, and I imagine you might not be using your real name. That said, it would be great to get to know a little bit about you and the origin story of your involvement [00:06:00] in this crazy world we call crypto.
Hasu: I write in my Twitter that I am a cryptocurrency researcher, and really I just started as someone who’s deeply passionate about the idea of private money. I just found that my skill set, my interests met quite well under this new field. Around two years ago, I started reading and talking about Bitcoin and cryptocurrency [00:06:30] all day, and eventually started writing and publishing about it, first on Medium, then from Medium to my own blog, uncommoncore.co. Eventually, me and my friend, Suzu, who did the stock together with me—we got approached by Deribit—to create an equivalent to BitMEX Research, which has done an amazing job of publishing open-source research in this space (in my opinion).
[00:07:00] They offered us the ability to create Deribit insights. This is (of course) a dream come true for me. I managed to turn this passion of just reading and writing about crypto into a full-time job now. This is pretty much the second time that this happened to me because before cryptocurrency, I played online poker for 10 years. One of the longest standing [00:07:30] players in that field.
As that fizzled out, I had known about Bitcoin for some time. Bitcoin is actually quite present in the field of online poker and live poker as well just because it makes it very easy to transfer money around on a global scale. Evading capital control, moving money between countries, saving on […] fee instead of something that poker players, [00:08:00] at least life players who play in different countries; they learn pretty soon.
A lot of the OTC trading in this space is done against Bitcoin and Tether. I knew Bitcoin would be something that interests me, but I was making money with poker, and I did not want any distraction at the time. I deliberately pushed this away for the time when I decided I [00:08:30] would be done with one thing and then fully commit myself to the next thing.
Clay: Do you have a formal background in monetary research or monetary policy, asking these types of questions in an academic context, or are you primarily self-taught?
Hasu: I’m entirely self-taught. I do reuse when I said my skill set met quite well onto crypto, then I’m talking about things I learned about mathematics, [00:09:00] logic, and in particular, game theory. Game theory is probably the number one field that you study actively as a poker player.
Clay: That blends quite well into cryptoeconomics. That’s fascinating. I came across you first through some Medium pieces that you published with Nic Carter. How did you come to know Nic and start collaborating with him?
Hasu: I had been following Nic for some time, a few months I think. [00:09:30] I was just really impressed with him. I thought he was one of the most intelligent commentators in this space, on Twitter, in particular, and I just kept (I guess) messaging and not via PM, but just when he tweeted something I would engage with it; I’d respond. Eventually, he started responding back, and we just had more conversations.
One day, [00:10:00] we got to talk about a particular topic. I think it was about the Ethereum presale. He encouraged me to write about this and I did. That was my first article I ever published, basically looking at the Ethereum presale against […] perspective. What I found at the time was that ICOs (and pretty much all) have a fatal flaw, [00:10:30] namely the issuer can invest in them for free. He can pretty much generate an unlimited amount of tokens for him if he wants to.
Clay: Is there a backstory behind your avatar? At first, I thought that was a Stewie from Family Guy, but I’m pretty sure that’s a character from Rick and Morty. Is that right?
Hasu: In Rick and Morty, there are several dimensions; it’s a multiverse. One of the two main characters from Rick and Morty is evil. [00:11:00] That’s the evil version of Morty from one of the many universes.
Clay: You’ve published quite a few interesting studies at this point. Some of them are larger, some of them smaller, some of them are a bit more formal, some of them are medium pieces, and some of them are on the Deribit blog. Is there a piece that stands out to you as being the most surprising in that, not only was the hypothesis that you came with wrong [00:11:30] and perhaps the null hypothesis was also not correct, but it was something completely different from the null hypothesis and your hypothesis going into the research?
Hasu: Yeah. For many of the articles that we released, it was the case that new information came to light later, that somehow made us update how we thought about basically the thesis. Interestingly I don’t think that anything [00:12:00] that I wrote about was totally invalidated after the fact. I can look at my work now and say I mean it. Just looking at the writing style and how I made some of the arguments would make me cringe today for sure. Just because I had no prior experience in writing, no idea how to structure an article, such when I started around two years ago. I’m used to telling myself [00:12:30] that I got a bit better over time, although still scrubbing for sure. The main points that I was trying to make headed up quite well.
Clay: Let’s move on to Chapter 2, which is about proof of work and Nakamoto Consensus.
It’s commonly understood that Bitcoin is secured by proof of work mining. What does that mean? Take us through what’s happening behind the scenes of proof of work.
Hasu: Mining and in [00:13:00] mining-related security, even though it’s 11 years after Bitcoin’s invention, stood the least understood aspect of the whole thing. Many people will give you wildly different answers to questions, like what secures Bitcoin, how dangerous is mining centralization, how much should we worry about specific attacks, and so on.
Just so we are on the same page, what has [00:13:30] Bitcoin tried to do? Bitcoin establishes an open permissionless ledger, and the state of that ledger that is basically who owns what in the system, in other words, Bitcoin’s UTXO (unspent transaction output). We want anyone to be able to submit updates to their ledger and transactions in the ledger should be finer at least eventually. [00:14:00] We have some confidence that when we receive money and the transactions in the ledger that it’s not going to just disappear in the future.
These are really the core properties that any digital money system should have. Mining fits into that picture in two ways. First, mining is used to establish distributed consensus. Second, mining is responsible for the initial coin distribution.
[00:14:30] All digital money systems basically have a fundamental birth defect, if you will, because digital tokens (unlike physical ones) can be copied. It is not logically possible to prove that a file has been destroyed after sending it. It can just be copied an infinite number of times and be sent to different people. The result is unfortunately that anyone can spend that same coin multiple times.
This is called the double-spend problem, and it effectively leads [00:15:00] to counterfeiting, inflation, and it just generally makes digital cash systems a really bad time. Any working digital cash system needs to stop the double-spend problem. It’s just digital cash, just any form of digital money.
You can solve it basically two ways. You can solve it in a centralized way, where you just use a server to check if balances have been spent, and then people can send messages to the server. For example, they can say, [00:15:30] “I want to send a coin to block.” I can also send message requests to the server and say, “Hey, tell me my own balance.”
The downside of using a central server is all the trust that is […] with it, and it also represents a single point of failure. The government or the rule of mob comes in, makes certain demands, maybe the central parties forced to freeze balances or block transactions (for example) to [00:16:00] WikiLeaks, or you are not allowed to move your money here or there, out of the country, you have to buy from this and this and this merchant. This is something that Satoshi really wanted to avoid.
Satoshi came up with a decentralized solution. There’s still the ledger that affects unspent balances, but the ledger starts on multiple servers instead of just one. You can still write and read requests, send […] requests to any one of them. Once you have more than one server, you run into another problem. Messages can arrive in [00:16:30] different orders and different servers.
Imagine a malicious party, Mallory, and she requests to spend a coin to Ellis at server one. Ellis gets a confirmation from that server, that she has received the coin. At the same time, Mallory also spends the same coin to Bob at a second server. He receives confirmation from the second server. So, whose coin is it now?
Either those two servers come to some sort of agreement in hindsight, and then Mallory spent counterfeited money or [00:17:00] much more likely they don’t agree, and then the network just splits. We really need a way for notes and that network to transition to a new state together. Whatever update one of them makes to their version of the database, we need some assurance that all other notes in the network make that same update, so they only move in lockstep. We can get that if the servers together come to consensus before users trust what they read. [00:17:30] This is very important.
One idea would be to have some kind of vote, some kind of election. The problem with that is you can’t really tally up votes the way that you can in the physical world because there’s a very run on problem with a similar tech where one party can just appear as a much larger number of people online. They’re using different identities different servers, [00:18:00] so there’s really no way to prove your personness (if you will) in the digital realm.
We need a way to put a weight behind what the servers say. You need a way to import costliness into the digital space. This is what proof of work does. A proof of work is proof for the digital world that you spend resources in the real world.
In proof of work, miners play in a lottery, where they [00:18:30] constantly try to bundle state updates, basically they take a lot of transactions, put it in a block, and then they bundle it with a proof of work. The proof of work succeeds if the hash block header is smaller than the current difficulty requirement in the network for the proof of work. It is checked effectively by looking at how many zeros does that hash start.
[00:19:00] If it starts with sufficiently many zeroes, then it serves as a proof of computation, and is accepted basically as a valid block by the other notes. Imagine that I present to you 10 dice, and all of them have a six showing up.
Also, there’s no way for me to have forged this. You look at the dice and you know that I must have rolled them a lot of times to come up with this. To be precise, [00:19:30] 6 to the power of 10 times or 60 million times. Every roll costs me a little bit of energy. Then just by showing you that I was able to roll 10 sixes, then that’s how that I spent a certain amount of energy to get to this result.
Clay: That’s a really good way of putting it. I’ve never heard that analogy before. If you can prove that something that’s highly unlikely to occur has occurred, then you can trust that you did the work to lead to that conclusion or to get to that end state. [00:20:00] That’s really interesting.
Hasu: It is still the only known way to do a trustless proof of work pretty much. But proof of work alone does not give you consensus yet. It is just a similar control mechanism, but it must also be paired with a chain selection rule. Using the proof of work, you can prove that you did a certain amount of work, but there’s still going to be some protocol for how others are to interpret that.
[00:20:30] And that rule in Bitcoin is always switched to the longest chain. In Bitcoin, proof of work plus the longest chain rule, that is what we call Nakamoto consensus. Nakamoto consensus is Bitcoin’s consensus algorithm, not proof of work. In theory, you can have other similar controlled mechanisms as well. You can have proof of stake, you can have proof of burn, you can have proof of authority, you can have all kinds of new stuff. Proof of optic work, [00:21:00] or proof of space-time and whatnot. The original concept of proof of work is still (to my knowledge) the only way to trust the proof that you expanded energy in the real world and only on that.
Proof of stake cannot do this, for example, because stake itself is digital and there is still the possibility for you to basically sign several branches of a chain with the same stake because [00:21:30] the act of signing itself is not costly.
Returning to the idea of Nakamoto consensus. Let’s look at one full example of how this plays out. First, users broadcast transactions to miners. Then, miners take these transactions, bundle them in a block. Then, they take the head of that block, they hash it over and over again with a different non set a magic number, they just increase it [00:22:00] by one every time, and they look for an output to that hashing function that is lower than the current difficulty requirement in the network.
Basically, the way to prove that they came up with 10 sixes. They find it and they broadcast it to the network. Other notes, both mining and non-mining notes see it. They look at the block, they run it against their own validity rules. That means rules that the block does [00:22:30] not break any of the important network rules, and also represents a longer chain, then they would switch to it. This is reliable because we know the update was expensive to make and that expense increases with every new block that is mined on top of the block that you care about.
This is what people mean when they say that Bitcoin has probabilistic finality or is eventually consistent because [00:23:00] we really hope that this consensus algorithm maximizes the chance that many subjective use of our respective databases, ultimately converge to one objective view over the long run. That’s when you can really trust that your transaction is included in the ledger.
Clay: Hey, I wanted to pause for a second to let you know that this episode of the Flippening podcast is brought to you by our friends at CryptoTrader.Tax, which makes the excruciating task of reporting [00:23:30] your cryptocurrency gains and losses a breeze. Indeed, sorting through transaction records from your exchanges and reporting each trade in US Dollar terms is not how most crypto investors want to spend a weekend.
CryptoTrader.Tax is a software platform that automates the entire cryptocurrency tax reporting process. It’s basically like TurboTax for cryptocurrency investors. All you have to do is connect your exchanges and import your trade history into the platform. CryptoTrader.Tax will do all of the number-crunching and spit out your auto-filled tax reports with the click of a button. [00:24:00] Simply give these generated tax forms to your accountant or even import them into your preferred tax filing software, like TurboTax or TaxAct.
You can join more than 10,000 cryptocurrency investors who are automating their crypto tax reporting with CryptoTrader.Tax today. Creating an account and importing your historical data is completely free. You only pay when you want to download your tax report for the year. Just tell them that Clay from the Flippening Podcast sent you to get a discount on your tax reports.
This episode is also brought to you by our longtime and [00:24:30] trusted partner, Nexo. As someone who personally uses Nexo, I want to point out a few things that I especially like about their crypto-backed loans.
First, when the price of your collateral grows, so does your credit line. Let’s say you borrow against your Bitcoin when each Bitcoin is worth $5000, but over the course of your loan, the price grows to $10,000 per Bitcoin. This means that the size of your credit line in Nexo just doubled as well. I personally haven’t seen anyone else doing this.
A second thing I really about Nexo is that you only pay interest [00:25:00] on the amount that you borrow. I’ve seen Nexo competitors require you to take out loans and force you to borrow the entire amount. With Nexo, you get a credit line, can borrow only the funds you need, and pay them back whenever you want, with interest assessed daily. Again, this just isn’t something I’ve seen other providers do.
The final aspect of Nexo I’d to highlight is that they give you the ability to borrow against a basket of crypto assets. For example, if you post BTC, ETH, and BNB as collateral to your Nexo account, the Nexo Oracle calculates [00:25:30] the real-time market value of those assets and adjusts your credit line accordingly. To my knowledge, other providers in this space only allow you to borrow against one asset per loan.
Finally, this episode is brought to you by the startup that produces it, nomics.com. Nomics is a crypto market cap website and aggregator going head to head with CoinMarketCap. We stand as a transparent alternative to many of the sketchy market cap websites out there. We won’t name names, but I think you know who we’re referring to.
Anyway, if you haven’t been to nomics.com in a while, I encourage you [00:26:00] to visit our website. We offer transparent volume statistics for nearly every cryptocurrency and crypto exchange in the space, and I believe we have the only credible crypto exchange index in the space at the time of this reading. If you’re sick of scammy ads, bad design, and manipulated data provided by companies whose founders hide from public view, then check us out at nomics.com.
Okay back to Hasu.
Hasu: Mining sounds really useful, right? But it’s also costly, so why do miners do this? They do this because we network incentivize [00:26:30] them to do with block rewards. Block rewards are the block subsidy and transaction fees. This mining of blocks is also how Bitcoin distributes its coins initially to the world. That’s any new currency needs a way to distribute units.
Generally speaking, mining works like an auction. For every block, miners get […] to the blockchain, and they get new coins. If they are smart, then they [00:27:00] will bid in this auction with their computing power, but they won’t bid more than the coin is worth to them. There’s always some balance there.
There are coins to get for them, and they start hashing. By doing that, they establish a consistent state and that state has value to users. This is the economic feedback loop of mining.
But I thought Bitcoin was secured by cryptography. [00:27:30] I feel so cheated. It’s dirty humans behind the curtain all over again. You could cry out and this is totally true. Bitcoin is secured by people basically setting financial incentives, and other people responding to these incentives. If someone has told you the blockchain is the truth machine and all that, then it’s pretty much not true.
Clay: That’s a really good point. Everyone talks about how Bitcoin is money [00:28:00] backed by math. That’s true but it’s also backed by people building empowering machines that use math. The economic components of what’s underpinning the success of Bitcoin is it’s appreciated, but it’s just not talked about a lot, so it’s a solid point.
Hasu: If you react to anything like me after hearing this, then you would think to yourself how can we possibly know this is secure? [00:28:30] Luckily there’s a study of incentives and strategic situations; it’s called game theory.
Clay: With that, let’s transition to Chapter 3, Game Theory, and why it’s a useful lens through which to examine the incentives behind proof of work mining.
Hasu, what is game theory and what does it tell us about Bitcoin mining?
Hasu: Game theory is the way to look at how people behave in certain situations, and they know the outcome depends on what other people do. There’s some strategic interaction [00:29:00] between different parties. This is what we want to understand, and we want to know if and how mining is secure. For that, we have to know how miners and users react to the incentives that they create for each other.
Typically, game theory assumes that people are rational. That just means they do what’s best for them. That can really mean all kinds of things. Rationality does not mean you maximize [00:29:30] for money. It just needs to maximize what is important to you. That’s really a fine framework in my opinion because you can represent everything under that umbrella.
There is a very famous quote by Charlie Munger. He said “Show me the incentive and I will show you the outcome.” This is not always true but remarkably often so. It is also the best we can do because we are left with this system where the state is [00:30:00] established by economic incentives.
There’s not really a known way to replace that. Even all the new systems, even proof of stake and all the other consensus algorithms that we have not touched on, all depend on setting incentives for the block producers in the system. This is unlikely to be ever replaced by math or cryptography.
When we think about game theory, we try to [00:30:30] model real situations as games, and we leave out everything that we don’t need. We acknowledge the real world is incredibly complex, but sometimes it’s possible to reduce a strategic situation that might seem really complex at first to just a few key parameters. When we manage that, then we can actually make it much easier to reason about.
These parameters typically are [00:31:00] who are the players, what are their options, when do they act in relation to each other? Do they act sequentially or simultaneously and what are the payoffs from them to action. The players (in our case) are the miners. Miners first have to decide which transactions to include in their block. They can include any transaction they want. They can exclude particular transactions of people they don’t like. They can even include [00:31:30] no transactions at all.
How could you possibly prevent this with cryptography? It’s not possible to prove that a miner has actually seen a transaction. Second, he has to decide which previous block header hash to reference and this determines where their block will be appended. If I reference the most recent known block, then my new block will extend that chain. [00:32:00] It will extend the already longest chain.
I could also ignore that lock. I can also reference my own most recent block, even though it may not be the most recent one. Or I can even reference a very old block. This is what’s happening typically when we talk about 51% attacks, where miners start out by referencing block that’s maybe 4–5 blocks [00:32:30] in the past, and then they mine 10–20 blocks faster than anyone else. They publish these blocks all at once and present a longer chain. Because of the chain selection rule, the other miners’ network would switch to that chain, and that chain could include doubled spends, could include basically anything.
Clay: Hey, this is Clay cutting in from the editor’s booth to explain a bit more about 51% attacks. [00:33:00] Once an actor controls more than 50% of the hash power of a network, they can get away with double-spending.
In other words, they can spend Bitcoin by going back to an earlier block, and using their superior computing power, to quickly build a new, longest chain that doesn’t include the spent transaction. And because it’s the longest chain, the other miners will recognize it as being the definitive chain, even though it doesn’t include the spent Bitcoin. This enables the bad actor to spend the same Bitcoin again or double spend. [00:33:30] In 2018, Bitcoin Gold suffered a 51% attack that cost the network an equivalent of $18 million.
Okay, back to the show.
Hasu: Finally, there are payoffs. The payoffs typically look at them as rewards minus costs. On the cost side, we have miners. No matter what other decisions they make, if they hash, then they incur real-world costs. [00:34:00] Both in terms of fixed costs, they have to buy hardware, they have to get a place to put the hardware, they probably need engineers, they need access to energy, they are rewarded for mining with tokens from block rewards. They can also extract rent from being a temporary dictator over what transactions to include. The block that they make they can do anything they want with it.
[00:34:30] All of these rewards miners get only if the block is included in the main chain. It really depends on the actions of the other miners and users, which leads us to the idea of Nash equilibria. Nash equilibrium is a game state in a game where no player can unilaterally improve their outcome.
Satoshi had such an equilibrium. We call it honest mining because that ensures [00:35:00] the best outcome for users. It goes as follows. Miners include the highest paying transactions, meaning they don’t censor any transactions, and they always reference already longest chain. They don’t go back in time. They don’t reference any past blocks to double spend. They don’t mine empty blocks. They just do what Satoshi wanted them to do.
We can use game theory to look at how well mining [00:35:30] actually implements this and what factors it depends on. Mallory sends transactions to miners that she has already spent before. She’s attempting to double spend. Our miner has to decide if he should include her transaction in this block.
Let’s look at what happens. The miner definitely incurs a cost. No matter if his block is accepted by the network or not he incurs a cost. What happens next? [00:36:00] Let’s assume he includes the invalid transaction and the other miners and notes he broadcasts the block. It’s picked up by other notes and miners. They run it against their validity rules. They see that it contains an invalid transaction, and that makes the whole block invalid. They reject it and all the work done by our miner was wasted.
This is true for all blocks with insufficient proof of work, anything that includes invalid transactions, [00:36:30] and there’s really no point in doing this at all. This just shows us that some strategic options always suck no matter what, and they should be minimized at our cost.
Clay: Let’s transition to Chapter 4, which is our Q&A. In this section, we’ll cover several topics including Bitcoin maximalism declining block rewards, how China dominated Bitcoin mining, and the professionalization of online poker.
Are you personally a Bitcoin maximalist? It just strikes me [00:37:00] that as the block reward approaches zero over time, there could be an appeal to Ethereum, Moreno, or some of these systems that will never stop granting some block reward to miners. Of course, the theory was moving to proof of stake, but do you consider yourself a Bitcoin maximalist?
Hasu: Bitcoin has such a large head start, and is in such a good position. Yeah, I would say that I believe the most [00:37:30] by fire and the success of Bitcoin, but not for any ideological reason to say.
Clay: In a scenario where Bitcoin continues to be one of the best-performing assets of all time and the transaction fees are meaningful, how would you summarize the major risk around the reduction of miner fees? How does that play out in your view? What should be done? I mean the idea that there [00:38:00] should only be 21 million Bitcoin is so sacred that to even question that would incur the ire of much of Crypto Twitter. How would you summarize the vulnerability? Do you have a proposal for what should be done?
Hasu: we touched on this, but the decision for miners what blocked to mine on and what transactions to include and on really depends on cost reward calculation for them. If the reward for [00:38:30] appending blocks to the longest chain is really low, then I think we would see much more frequently double-spend attacks at the chain tip, for example. That’s one.
One thing that I would expect that we will see. The […] from this is that basically right now, you can look at basically one confirmation. Bitcoin is incredibly secure. But if some [00:39:00] more future blocker rewards are very low, then this money that miners have basically at stake their vested interest in it is really low. That’s when the texts become more likely.
As a result of that, we no longer can look at transactions as secure after one week. Maybe not even after 10 blocks. Maybe people in 10 years will say, “Oh, you get to wear 20 blocks before your transaction is final.” That’s the result of how little revenue the miners get and [00:39:30] subsequently how little they have at stake to protect the network. This can have pretty bad effects. If users have to wait 20 blocks for their transactions to finalize, then what would they do to demand?
Suddenly, people don’t want to hold Bitcoin anymore. It’s not their preferred medium of exchange. There’s even fewer transactions. You get into this kind of, the term death spiral is really overused, [00:40:00] but in this case, it really applies because people today don’t realize that they say Bitcoin has all these magic assurances, that it’s so secure.
But what secures Bitcoin? It is secure because we spend a lot of money to secure it. The moment we stop spending money for security, then miners will have a smaller vested interest in protecting the network. Together with that, the assurances that we value today would disappear [00:40:30] as well.
What does that do to demand? Again, demand might be lower, being even fewer fees, to even less future block rewards, to even weaker assurances, to even less demand and on. You really get into a very problematic cycle there.
Clay: Do you think there is a solution other than uncapping the supply?
Hasu: We made a case for uncapping the supply or instituting [00:41:00] some kind of tax on the system. I realized that this is highly contentious politically. We just did it to show how we think about the system from the perspective of Americans and designers. If you want to design a very sustainable, very robust system, then you would use basically a tax or a permanent issuance because it has this very nice [00:41:30] property that the money that is dedicated to secure your system scales directly with the size of that system. If Bitcoin has a Bitcoin database then the money that is basically reserved for that it’s paid to miners doubles as well right repurchasing power.
This is a really really nice property and you guarantee this property to yourself, even if you have this tax on all users. Even if that leads to lower [00:42:00] demand, that’s fine because the system would just find a new equilibrium at a lower price, and then basically you also pay less for security. It’s always politically very easy to lower the interest rate, but it is incredibly difficult to increase it, so better start a bit on the safer side and then you can lower it [00:42:30] if you think the system is too secure than ever going in the other direction.
Clay: Christine asked, “What impact does innovations to mining technology making block production more efficient have on the equilibrium and incentives of the Bitcoin system?”
Hasu: First, hardware tends to get more efficient over time. This is true for any endeavor that humans make pretty much. If there’s money to be made, then we [00:43:00] are smart and innovative, then we try to do better. We research new technology and ways to do the same thing better. Whatever we do, any industry it gets way more optimized over time.
The same is true for mining. We started with CPU mining. Later, we had a long phase of GPU mining, and eventually, we moved entirely to application-specific circuits, which is where we are now. Now, there’s even chips that got even smaller [00:43:30] and now there’s immersion cooling and whatnot. Probably also innovations in other areas like miner mobility. I think in the future, mining farms will be more mobile than they are today. Miners can better make use of regional energy costs pretty much.
If there’s someone worthy of respect for the mobile supply of energy, then basically miners will relocate there. The result of that is, of course, more and more [00:44:00] hashes will be produced, the difficulty keeps increasing in the network, and if some miners improve and others don’t, then the miners who do improve will get a larger share of the pie and the miners who don’t will fall by the wayside. This is really a very competitive business. And the specialization has another large benefit, actually has two large benefits. The first large benefit is that the more specialized Bitcoin [00:44:30] mining is, the harder Bitcoin is to attack with general-purpose technology.
If you look at how Bitcoin, […], Vertcoin, the CPU mine coins, even if you […] classic an attack, they all have general-purpose mining technology because […] ASIC resistance. The entry side is unfortunately that anyone can rent hash power online on [00:45:00] general computing marketplaces like Amazon Web Services, or even some specific club mining market places NiceHash. It can rent the hash power that is necessary and just attack these networks without having any vested interest in them at all.
This is of course very different to how we showed Bitcoin works because in Bitcoin, miners have to go deep [00:45:30] into debt to the network. They have to incur very large upfront costs, because there’s no way to rent hash power, and also because there’s no way to sell this hardware once you’re done with it. It’s not just the tangible assets of the mining, but it’s also the intangible assets like knowledge, intellectual property, knowing how to run a highly, highly [00:46:00] specialized mining operation. All of these are assets for the mining space that would become useless if Bitcoin ever disappeared.
Clay: I have a question around incentives for miners. If you want to participate in the upside of the Bitcoin network and prices increasing over time, probably the easiest way is just to purchase Bitcoin. You don’t have to deal with the logistics of [00:46:30] getting access to a lot of power. You don’t have to worry about racks and racks of ASICs, et cetera. That begs the question, what are the incentives for someone to mine? And how are those incentives distributed geographically?
Hasu: If we talk about the incentives of mining, we have to talk about the $4–$5 billion a year that Bitcoin pays to its miners. This is really the pie that is distributed [00:47:00] between miners, and the block reward was half this year, so the reward that miners get, but still it’s a lot of money. It’s a very good question why mining has been focused in China and Turkey (I think). I’m not an expert on this topic, but I’ll give you my guess. This is somewhat largely a cultural thing I would say.
Basically, the US has been very focused [00:47:30] on making software that they forgot how to make hardware. This is something that China has been very big in for the last decades already. It was natural for them to discover Bitcoin mining as well. It’s all specialized […]. So, the foundries are in China and some of the big hardware makers are always [00:48:00] from China. Of course, once you have that infrastructure there, then this gives the local miners a certain benefit there because shorter supply chains, shorter maintenance, there’s more local knowledge for how to operate these machines.
Also, China has a lot of cheap electricity. For some time, China was very big in the refining of aluminum. [00:48:30] This is the single most electricity-intensive work that exists to my knowledge. All aluminum refineries are built next to places where you have an abundance of cheap electricity because this is really a way to export electricity. You have this cheap electricity (for example) [00:49:00] from hydro dam. You converted it into aluminum as an input. The electricity is an input to the aluminum, but it keeps its value, and then you export it to another country that has high electricity costs.
This is something that China was very big in and that the Scandinavian countries in Europe also are very big in the refining of aluminum. But the price of aluminum and the demand from the world market crashed pretty hard [00:49:30] in the 2000s. As a result of that, several large refineries had to close down, but the hydro dams are still there. If you have this infrastructure in place, it’s very hard to transport electricity from one place to another. It’s typically consumed by its creator or is very close to it. This is really a hotbed for Bitcoin mines.
Clay: Are you still doing online poker? [00:50:00] Are you trading as part of your research activities? What caused you to make the transition? It’s very clear from the rigor of the work that you do that it’s time-consuming, that a great deal of discovery goes into it. Even just taking blockchain data and organizing it in such a manner where you can ask interesting questions or at least novel questions. It’s getting easier over time, but there’s still a lot of work to do there. What made you make the switch [00:50:30] and are you doing research full-time or are other things as well?
Hasu: I’m pretty much done with poker entirely. I kept doing what I liked doing most, which is teaching. I’m still involved with some of the players and give them advice mostly these days on how to learn. It’s not much more that I give direct strategic advice more about how to best study this kind of stuff. And the main reason I quit (to be honest) is because it was no longer profitable.
Poker’s very much [00:51:00] like mining. It gets much harder every year. There’s a very big noticeable difference because there’s a limited amount of money to go around, and players are very crafty. They’ll do anything they can to get better and stay on the treadmill. Instead of falling off, they develop custom software, they hire people who work for them. [00:51:30] It’s really highly professionalized.
Nowadays, I would say any player that plays on the highest stakes in poker, any professional player probably has a team behind him, of people who just work for his success rate and participate in his bottom line. It’s just professional sports. It is a complete team effort, and by now it’s interdisciplinary. You have game theorists, [00:52:00] you have software developers, and then the players themselves are definitely more athletes who really need to watch out for their constitution, their nutrition and then to study a lot.
Back in the day, you could get away with just playing most of the time. Nowadays, I would say that’s probably more. A 3:1, 4:1 ratio between [00:52:30] studying and playing. The hour that you play you probably study three to four hours. So, it’s really that kind of intensity. It’s really at the level of pro-sports I would say.
Clay: Last question. If you could wave a magic wand and altruistically do something for the crypto space immediately, what would it be?
Hasu: Oh my. I don’t know. I would stay true to my character and say I have to [00:53:00] think about that.
Clay: When I interviewed CZ, he said that every government with a fiat currency would issue blockchain-based; they’d digitize their money supplies. Someone talked about regulatory clarity, your proposal on uncapping the supply of Bitcoin. There is a very religious element to the Bitcoin community, but I also think it’s really helpful to take a pragmatic approach and think about what is actually best for the space. That’s probably something that [00:53:30] should be in the running.
At the very least, it’d be great if people were a bit more data-driven and pragmatic when it comes to debates in the space versus a lot of the acrimonious back and forth that happens in Crypto Twitter, which gets me down some days. I don’t know about you.
Hasu: You raise a very good point. If it’s something around these lines, I would definitely not use that wish to dictate any proposal or solution because that [00:54:00] just defeats the point of Bitcoin, in my opinion. It’s not Bitcoin if it’s not consensus. I would like it if more people engage with the problem. I don’t claim to have any answers myself. I just think of the problem and more people should be looking at it.
Clay: [00:54:30] That concludes my conversation with Hasu. I hope you enjoyed it. Before you go, I want to invite you to subscribe to our newsletter called Popular Crypto. With the Popular Crypto newsletter, we don’t cover token hype or announcements of announcements. Instead, the Popular Crypto newsletter focuses on the mainstream products and services, taking crypto to the masses. To subscribe to the Popular Crypto Newsletter, go to popularcrypto.news, enter your email address, and subscribe.
All right. That wraps up [00:55:00] things for this week. Stay tuned for next week’s episode. Until then, take care.
That’s it for this week. To sign-up for our free crypto investing newsletter, listen to other episodes, or get the show notes from this episode, please visit flippening.com. I also invite you to check out the startup that funds this podcast, Nomics at nomics.com. Finally, if you got value from the show, the biggest thing you can do to help us out is to leave a five-star review with some comments and feedback on iTunes, [00:55:30] Stitcher, or wherever you listen to podcasts. Thanks for listening and see you next week.