As a growing company we are always looking to bring on exciting new talent. It is our mission to be as successful and relevant in decades to come, as we are today. To do this, we recognise we need the right people, resources and capabilities to help us stay ahead of the market and continue to provide the best experience for our traders.
This is why we are thrilled to announce that HDR Global Trading Limited has appointed Derek Gobel as our group’s General Counsel. He will oversee the group’s legal function and help us move forward in today’s continually evolving regulatory environment.
Derek brings with him 28 years of experience working on a wide range of legal matters, including his most recent role as BNP Paribas’ General Counsel for APAC. Recognised in the 2017 Legal 500’s GC Powerlist in China and Hong Kong, we look forward to having him on board.
On 13 September 2019 at 08:30 UTC, BitMEX will list new quarterly futures.
Please see the following tables for listings and settlements for current and upcoming futures contracts for Q4 2019. Bolded rows are the new contracts.
The .TRXXBT index will retire on 27 September 2019. It will be replaced by the .BTRXXBT Index. TRXU19 will reference .TRXXBT until its Settlement Date, TRXZ19 will reference .BTRXXBT from its Listing Date.
Abstract: In this piece we look back at the history of Bitcoin, focusing in on “The Bitcoin Foundation”, once one of the most prominent organisations in the ecosystem. We look at Foundation’s origins and then examine its failings with respect to its governance, transparency and finances, which ultimately led to a total loss of legitimacy within the Bitcoin community. We conclude that an all-encompassing Foundation was never likely to have been a good idea given the high governance and transparency standards of some in the community, and that a constant stream of scandals damaged the Foundation’s brand to such an extent that its duties had to be carried out by other organisations.
(Screenshot of the Bitcoin Foundation’s website and logo in 2013)
The Foundation’s Origins
Following on from our July 2018 piece, which took us back to shenanigans and incompetence at MtGox in 2011, this second look at Bitcoin’s scandal-rich history takes us back to July 2012, when The Bitcoin Foundation was founded. The Foundation had seven founding members, or six if you exclude Satoshi, who was oddly included as a founding member.
Bitcoin Foundation Founding Members
Gavin Andresen, Bitcoin Developer
Peter Vessenes, CEO of CoinLab
Charles Shrem, CEO of BitInstant
Roger Ver, CEO of MemoryDealers
Patrick Murck, Principal at Engage Legal
Mark Karpeles, CEO of MtGox.com
Satoshi Nakamoto, author of the white paper “Bitcoin: A Peer-to-Peer Electronic Cash System”
The objective of the Foundation was never completely clear, with the original bylaws stating the following:
The Corporation shall promote and protect both the decentralized, distributed and private nature of the Bitcoin distributed-digital currency and transaction system as well as individual choice, participation and financial privacy when using such systems. The Corporation shall further require that any distributed-digital currency falling within the ambit of the Corporation’s purpose be decentralized, distributed and private and that it support individual choice, participation and financial privacy.
In practise the role of the Foundation appeared to be as follows:
To pay the salary of Bitcoin developer Gavin Andresen
To arrange Bitcoin conferences
To promote Bitcoin to regulators
During 2012 and 2013 the Foundation gained in popularity, attracting members from across the Bitcoin community, including prominent developers, businesses and community members.
The Foundation was funded by membership fees – the initial membership fee schedule is provided below. However, the Bitcoin-denominated prices did start to decline in 2013 as the Bitcoin price appreciated.
It was believed by many that due to the membership subscription fees, the Foundation had considerable financial resources to spend on its mission.
Approximate lower bound of member contributions in April 2013 (Assuming initial fee rates)
2 Platinum Industry Members * 10,000 BTC = 20,000 BTC
7 Silver Industry Members * 500BTC = 3,500 BTC
175 Lifetime Members * 25BTC = 4,375 BTC
Total Resources = 27,873 BTC
(Source: BitMEX Research)
As we see later on in this report, the Foundation only had around 8,000 BTC at the end of 2012, still a nice warchest, but a lower balance than many had expected. It is possible our estimate above could be an overestimate, as the timing of member subscriptions is unclear.
The Foundation Board
The governance structure of the Foundation was quite complex and arcane. There were three classes of members:
Founders
Individuals
Corporates
The board initially consisted of five members, one nominated by the founders, two nominated by individuals and two nominated by corporate members. The term of each appointee was expected to be 3 years. At the start of the Foundation, all five board members were appointed by the founders and all board members were founders, with the exception of Jon Matonis.
Bitcoin Foundation Board Members (2012 to 2019)
(Source: Bitcoin Foundation Website, BitMEX Research)
Critics can point to the fact that the governance structure gave too much power to the initial founders and that new members of the organisation should have been able to join as equals to the founders.
Board Elections
The first board elections took place in 2013, with Meyer Malka winning the Industry seat and Elizabeth Ploshay winning the vote amongst individual members.
Board Election – Industry Seat (2013) – Winners: Meyer Malka
At the start of 2014, the holders of the two founding industry seats resigned. Charles Shrem resigned on 28 January 2014, two days after his arrest at JFK airport for money laundering and unlicensed money transmitter related offences. Charlie was eventually convicted and sentenced to two years in prison in December 2014. The main substance of Mr Shrem’s felony appears to be that he continued to provide customer support to a user of his BitInstant Bitcoin purchasing service, despite him allegedly knowing the customer wanted Bitcoin for the purposes of purchasing illegal drugs on the Silk Road e-commerce platform (Or that the customer wanted to supply the Bitcoin to somebody else, who wanted to purchase illegal drugs, one extra layer removed). Mark Karpeles, the holder of the other industry seat, resigned on 24 February 2014, following the failure and insolvency of the MtGox Bitcoin exchange, where Mark was CEO.
Brock Pierce and Bobby Lee were then elected as the two replacement industry appointed board members.
Board Election – Industry Seats (2014) – Winners: Bobby Lee & Brock Pierce
The appointment of Brock Pierce to the board proved controversial, with some claiming the Foundation should have done more vetting before allowing Mr Pierce to stand. The allegation against the former child actor, who featured in the “Mighty Ducks” and Disney’s “First Kid” was related to his alleged involvement in the sexual exploitation of children in the late 1990s. Although only a teenager at the time, Mr Pierce was an executive and co-founder at the internet video startup, Digital Entertainment Network (DEN), which was accused of hosting several parties where sexual abuse may have taken place. The allegations resulted in co-founder and CEO Marc Collins-Rector, along with Mr Pierce, resigning from DEN and supposedly fleeing to Spain. Mr Collins-Rector evetually plead guilty to child abuse related offences and according to Reuters, court record show that Mr Pierce paid US$21,000 to settle a related civil suit, while other cliams were dropped, the article also states that Mr Pierce denies the allegations.
Towards the end of 2014, in the face of considerable pressure, the Foundation made the following improvements to its governance:
Board member terms were reduced to 2 from 3 years
The founder board seat was eliminated
The founder member class was removed
The Foundation’s Finances
The below table provides a basic analysis of the Foundation’s finances, in the period where most of the member dues were depleted (2012 to 2014). The data is based on the organisation’s IRS990 forms. With respect to the pay of the board, the disclosure seems reasonably strong. Most board members received no remuneration other than those acting as executives. Paying Gavin was one of the main aims of the organisation and Gavin’s pay appears to be disclosed in a reasonably clear and appropriate manner.
2012
2013
2014
Directors pay
Gavin Andresen
$15,000
$209,648
$147,917
Patrick Murck
$57,592
$115,001
Lindsay Holland
$160,652
Jodie Brady
$141,667
Jon Matonis (Contractor)
$31,250
$137,500
Other pay costs
$14,013
$118,047
$582,782
Total pay costs
$29,013
$577,189
$1,124,867
Conference costs
$418,413
$825,525
Other costs
$32,608
$472,302
$1,335,210
Total costs
$61,621
$1,467,904
$3,285,602
Foundation Revenue
Membership fees
$358,007
$335,723
Conference revenue
$377,883
$584,308
Other
$64,803
$35,728
Total revenue
$159,359
$800,693
$955,759
Surplus/(Deficit)
$97,738
($667,211)
($2,329,843)
Disclosed Bitcoin figures
Bitcoin (US$ value at year end)
$107,549
$4,512,316
$703,843
BTC sales proceeds
$749,157
$569,728
Realised Bitcoin gains/(losses)
$77,148
($40,316)
Unrealised Bitcoin gains/(losses)
$5,195,589
($1,966,768)
(Source: IRS 990 Forms, BitMEX Research)
The main criticisms related to the Foundation’s finances at the time appear twofold:
There was a sharp increase in spend in 2014, depleting the organisation’s reserves to near zero
There was a lack of transparency with regards to the Foundation’s Bitcoin balance
As for the first criticism, concerns did seem somewhat justified. In 2014 pay costs increased by 81%, the 2014 conference made a significant net loss and other costs increased significantly. As for the $1.3m in other costs, we have provided a breakdown below, therefore readers can judge the extent of the excesses. Compared to the excesses of the ICO bubble in 2017/18, where the total sum of the costs below perhaps represent a fraction of just one marketing party for the most egregious ICOs, the spend is moderate. However, some Foundation members clearly expected their funds to be spent more prudently. The main issue appears to be that expectations were not clearly set out in advance. Whatever your view, the fact is that by the start of 2015, the Foundation had almost run out of financial reserves and to that extent, its finances were mismanaged.
2014 breakdown of other spend
Other professional services
$307,767
Legal fees
$200,003
Travel
$159,166
Information technology
$158,021
Professional event expenses
$115,401
Public relations
$93,241
Exchange loss
$73,362
Accounting
$50,556
Office costs
$39,071
Grants (Foreign)
$37,314
Bad debts
$18,500
Payments to affiliates
$18,002
Occupancy
$17,949
Grants
$14,000
Advertising
$9,218
Insurance
$3,639
Other
$20,000
Total other spend
$1,335,210
(Source: Bitcoin Foundation IRS 990 form)
The lack of transparency with respect to the Foundation’s Bitcoin balance is another area of concern. At the end of each year the IRS990 form disclosed the USD value of the Bitcoin holding, the realised Bitcoin gains and the unrealised Bitcoin gains. Based on this information we calculated the following:
BitMEX Research BTC calculations
2012
2013
2014
Bitcoin price at year end
$13
$754
$320
Implied BTC balance at year end
8,216
5,985
1,381
Change in BTC balance
(2,232)
(4,604)
Implied sales price
$336
$124
Realised Bitcoin gains/(losses)
$719,945
($2,901,314)
Unrealised BTC gains/(losses)
$4,433,979
($599,354)
Lowest Bitcoin price figures
Lowest Bitcoin price in the year
$4
$13
$268
Implied BTC sales proceeds
$29,011
$1,233,739
Realised Bitcoin gains/(losses)
($201)
($2,237,303)
(Source: IRS 990 Forms, BitMEX Research)
The disclosures in the IRS990 forms lead us to the following apparent Bitcoin related discrepancies:
The Foundations closing bitcoin balance in 2012 seems reasonably low given the volume of Bitcoin donations (See the c.28,000 BTC figure earlier in this report)
The Foundation disclosed an unrealised Bitcoin gain in 2013 of $5.2m, however based on the annual price movement and the calculated year end balance, we calculated an unrealised gain of only $4.4m
The Foundation disclosed an unrealised Bitcoin loss in 2014 of $2.0m, however based on the annual price movement and the calculated year end balance, we calculated an unrealised loss of only $0.6m
The Foundation disclosed Bitcoin sales proceeds of $569,728 in 2014, while even assuming all Bitcoin were sold at the lowest traded price in the year, given the large reduction in the Bitcoin balance of 4,600 coins, sales proceeds should have been $1.2m
Although there were accusations of embezzlement, we do not consider these disclosures to indicate any such crime. The Foundation was probably receiving Bitcoin and spending Bitcoin throughout the period, therefore clear financial record of Bitcoin sales are not likely to be available. At the same time, rules related to the reporting of realised and unrealised gains with respect to financial assets are not strict for this type of organisation and the Foundation does have a degree of discretion with respect to the calculation methodology. Therefore, the filings themselves do not indicate wrongdoing in our view. However, what we can say is that filings do not clearly explain what happened to the Bitcoin balance and an explanation from the board could be helpful.
Some members clearly expected greater transparency and wanted to question the board about the funds, but they were never given such an opportunity. The following quote from Bitcoin commentator Andreas Antonpoulous (who at the time was a Foundation committee chairman), reflected the views of many in the community at the time.
You say they are funded. Where are those funds? Who controls those funds? When were the last audited? Are they actually solvent? Or have all of those funds disappeared into a big black hole? Just remember who was in the leadership until recently, who is in the leadership today and what their track record of ethics has been and I would suggest that I would not be surprised at all if the Foundation implodes in a giant embezzlement problem sometime down the line or funds get stolen, within quotes or without quotes, or something like that. It’s bound to happen because these things don’t happen due to technical failures of bad actors, they happen due to failures of leadership The Foundation is the very definition of a failure of leadership.
To make matters worse, there were also accounations of the Foundation’s entanglement in the MtGox insolvency:
The MtGoX CEO, Mark Karpeles, was a founder and founding board member of the Foundation, while the company itself was a platinum member of the Foundation
Founding member, Roger Ver, famously assured MtGox customers of the solvency of the platform shortly before the exchange failed
The Foundation’s founding chairman, Peter Vessenes (who may have believed he was entitled to some MtGox equity), has been involved in various legal disputes with MtGox dating back to 2013 as a result of a failed business partnership. Peter’s company Coinlab sued MtGox for US$75m in 2013. As of August 2019, Peter now claims a remarkable total of US$16bn (Y1.6 trillion) from MtGox, an amount large enough to effectively block distributions to MtGox clients, and a large source of frustration to creditors to this day.
Andreas compared the Foundation’s situation to MtGox as follows:
Its problems go directly back to a complete failure of leadership. A completely closed, insular, arrogant, sheltered, uncommunicative leadership. Part of which was Karpeles himself, but there are another couple of relics left on that board, who pursue the exact same approach with their leadership. The Foundation is the Gox of Foundations. I am surprised it didn’t blow up in the wake of the Gox scandal, because there were a lot of significant conflicts within that environment.
However, perhaps it is unfair to make much of the association between MtGox and the Foundation, afterall, the ecosystem was small and MtGox was the dominant exchange, therefore a degree of association was inevitable to some extent.
The Amsterdam Conference (May 2014)
In May 2014 the Bitcoin Foundation arranged what was, up until this point, the largest conference in the space. It was the first conference (at least one which we attended), with characteristics familiar to many in the 2017/18 era. Unabated enthusiasm, unrealistic expectations about the underlying technology, expensive catering and countless booths representing new businesses with plans that appeared to make little commercial sense. As the figures above indicate, despite the expensive ticket prices of up to $800, the conference appears to have generated a net loss of around US$250,000.
The conference was split into two sections, a commercial section in the main exhibition hall, and the Bitcoin Foundation annual meeting (or technical track), which was down the hallway in a hotel conference room, entry to which was free for Foundation members. The technical discussions were followed by the Foundation members’ meeting
Journalist Ryan Selkis (now founder & CEO of Messari), was one of the key lifetime members at the event trying to hold the Foundation to account. At the annual meeting he asked several challenging questions to the Foundation board members, asking for greater transparency. Up until this point much of the debate and complaints had taken place on online web forums and this real world interaction marked a significant and novel change. In response to his challenges, one board member said the following:
We can spend a lot of our time trying to be transparent as much as we can and higher resources can be transparent or we can spend a lot of time in the board level making sure that we [have the] resources to make bitcoin bigger. It’s possible but right now, honestly, we’re in an environment where bitcoin is not well perceived. You asked for prioritise at least from my side as a board member, it’s more about [making bitcoin bigger]
It was clear from this response that, for whatever reason, some board members had chosen not to tackle the transparency and governance concerns, leaving some members feeling frustrated and more convinced of wrongdoing on the part of the board.
The Blockchain Election (February 2015)
Given the issues that the Foundation had faced and the concerns in the community about transparency, governance and the purpose of the Foundation, this was a relatively important set of elections. There was a large number of candidates and a reasonably good quality debate among the candidates, for example a dedicated Let’s Talk Bitcoin podcast on the election.
The Foundation decided to conduct the 2015 individual board seat elections on the blockchain. As the chair of the election committee, Brain Goss said:
I believe in the concept of using the block chain for storage of compact proofs/hashes (as the market dictates), and I’m a big believer in transparent voting that any one can verify
However, the blockchain voting process did not run smoothly and the following issues arose:
The first round of voting took place using the Helios voting system. However, no candidate achieved more than 50% of the vote, as required by the by-laws, therefore a second round was required. The Foundation then made the odd decision to switch the voting platform to Swarm between the voting rounds, a decision met with widespread opposition. Despite initially starting the final round voting process on Swarm, during voting the Foundation then decided to switch back to Helios, invalidating the Swarm votes
The decision to reduce the number of candidates to four after the first round of voting appeared arbitrary
Registering to vote was widely regarded as a cumbersome and complex process and some candidates complained
(Source: Email received as part of the Swarm voting process)
Board Election – Individual Seats First Round (2015)
(Source: Helios voting system records)
Board Election – Individual Seats Final Round (2015) – Winners: Oliver Janssens & Jim Harper
After the voting controversy, Patrick Murk told Bitcoin Magazine:
This clearly struck a nerve with folks that think blockchain technology should only be used for transferring Bitcoin and not other [applications] like voting. [It] sparked a debate on how people use the blockchain
Removal of Directors & The End Of Board Elections (December 2015)
In December 2015, the two newly elected board members, Oliver and Jim, were removed by the other board members, due to a disagreement over the best way forward for the Foundation. Oliver and Jim had recently succeeded in competitive elections from individual members, giving them a considerable democratic mandate. At the same time the two year election terms of Elizabeth and Meyer had already expired, while Brock and Bobby had been elected by the industry and not individuals. Therefore, from the point of view of the individual members, Oliver and Jim were the only two board members with a significant mandate and they had been removed. In a violation of the by-laws, the Foundation then decided not to conduct any further board elections. As the executive director Bruce Fenton put it:
I used to believe that public, open elections were a great thing. I’m not as convinced now…. We unfortunately don’t have the time or resources for more process.
In our view, this logic seemed difficult to justify, given many of the problems were caused by the boards apparent lack of accountability to individual members, with Elizabeth Ploshey being the only board member elected by individual members who served on the board for any meaningful amount of time. If the Foundation did want to revive itself, it could have reinstated Oliver and Jim and allowed further elections to replace the other board members who could have left. Instead, the Foundation decided to distance itself even further from members, avoiding the challenges this accountability would have imposed, and consequently the Foundation appeared to lose any remaining legitimacy it had left.
After this point, between 2015 and 2019, four new board members were appointed from the pool of candidates that were defeated in the previous elections, except this time appointments were made by the board rather than members.
Conclusion
The Foundation still exists today, with Brock as Chairman and Bobby as Vice chairman, although their elected terms have long since expired and no more elections are in sight. The Foundation has no significant financial resources and is largely irrelevant. The activities the Foundation used to conduct are now carried out by others, for example Coin Centre does some regulator lobbying, and Bitcoin development is funded by other organisations such as Chaincode Labs, Blockstream, MIT’s DCI and other industry players. In many ways the conclusion to this piece writes itself. Bitcoin never needed a Foundation, it is stronger without one, and any all-encompassing Foundation like this was always doomed to fail.
The outrage at the lack of transparency at the Foundation exposes some of the key divergences in expectations and culture between members of the Bitcoin (now cryptocurrency) community. Some Bitcoiners, especially those involved since the early days of the Foundation, were often highly conspiratorial, paranoid and expected radically high levels of transparency, accountability and financial prudence. The Foundation seems to have misjudged these expectations, lost the backing of the community and ultimately failed. However, compared to the excesses of the coin offering era, which picked up from around 2014 onwards, peaking at the start of 2018, the financial accountability and transparency of the Bitcoin Foundation was almost impeccable, relatively speaking. Some members of the cryptocurrency community (not all newer ones), had radically different expectations, focusing more on what they perceived as game-changing technology, changing the world and getting super rich, rather than governance. Even in this new climate, irreparable damage to the Foundation’s brand had been done and it never again found its place.
To encourage efficient trading strategies and incentivise behaviours that improve the executable liquidity of the market, BitMEX will be gradually introducing a number of trading rules for the platform. These rules are specifically designed to improve the quality of the exchange offering for users and are the result of a large amount of research over the past few months. This concept is nothing new and indeed most traditional venues employ similar rules.
You can read more about the first Trading Rule to be introduced in our API Announcement on the Quote Fill Ratio Threshold. This rule aims to discourage the use of strategies that submit quotes to the market without the intent to trade and therefore further strengthen the quality of liquidity on the platform in addition to freeing resources for other market participants.
We believe the introduction of these rules to be a positive step forward for the industry and we are committed to continuing innovation in the space.
Background
For many years now, BitMEX has been the most liquid market offering cryptocurrency derivatives. A key indicator of the quality of a market is the depth and size of the quotes in the order book: liquidity is often measured by price slippage for a given volume to execute. Sk3w.co offers a visual comparison of the price slippage across various cryptocurrency markets. In the sample below, the implied bid-offer spread for executing 1000 XBT worth of contracts on BitMEX’s XBTUSD market fluctuates around 0.5%. Compare this with other venues, where price slippage is roughly 10x higher, ranging from 3% to over 15%.
Since day 1, BitMEX has provided unprecedented access to the platform through our industry-leading API. Every action that can be performed on the BitMEX.com website, can also be performed via our API. In fact, the BitMEX.com web interface is just a client of our public API. This open approach has been a key contributor to BitMEX becoming the most liquid market in the industry.
Liquidity is only useful however if it is genuinely executable liquidity. In the month of June, fewer than 2% of active users on BitMEX accounted for over 60% of the order management requests processed, and less than 2% of the volume traded. Users fitting this behaviour profile are incredibly inefficient with their use of the API, submitting a disproportionately high number of orders per contracts traded.
There are a number of explanations for this kind of API usage. We often discover accounts that have signed up to an online automated trading service (or “bot”), entered their API keys, and then forgotten entirely about the account whilst it continues to place/amend/cancel thousands of orders every day. Other times, it could be a misconfigured trading system or client algo, which is quoting too wide and very rarely trades.
This kind of behaviour, whilst not currently against the rules, takes resources away from participants genuinely looking to trade on the platform. We believe that discouraging this kind of behaviour will further strengthen the liquidity of the market and provide a better overall experience for users.
In 2014, HDR Global Trading Limited (HDR) was founded in Mahé, Seychelles as a small, dedicated team of young entrepreneurs focused on a simple mission: to build a crypto trading platform geared toward experienced traders first. We focused on building the most responsive interface, featuring groundbreaking products, controlled by a complete and seamless API, with the tightest security. From those ideals, BitMEX was built.
The market has spoken: BitMEX has succeeded. We are proud to have built the most innovative, reliable, and secure cryptocurrency platform in the world.
As BitMEX grows, so the world grows with it. In 2013, only months before we began, Bitcoin had just crashed from its second major bull-run. The dreams and wallet balances of the greater crypto community crashed with it. A new set of priorities emerged, focusing on safety, security, and stability. Financial regulators started to pay more attention to Bitcoin, and rightly so. It was clear to all of us that new standards were needed for this new industry.
Since then, the cryptocurrency landscape has changed dramatically, and leaders such as BitMEX have been working with regulators to help shape the industry, creating the standards that will help it go mainstream.
The increased involvement of regulators with all the major players in the industry is not only to be expected, it is to be welcomed. It is the mission of good regulators to ensure that honest citizens are not being cheated. Regulators bear the burden of ensuring that risks are clearly communicated, products are fair, and taxes are collected. Through this process, we will see a new era of legitimacy for cryptocurrency exchanges: a future where market operation standards are clearly stated and maintained, where security is paramount, and where financial reserves are independently and frequently audited.
We believe fervently in these goals. And we understand that nothing is more sacred than the safety of your funds and the stability of the platform.
For this reason, we have decided to restrict access to BitMEX for users in the jurisdictions in which HDR-affiliated employees and offices are located. Seychelles, Hong Kong and Bermuda will be added to the list of jurisdictions already restricted from access to BitMEX. This change will have no financial impact on the business and will affect very few people. The BitMEX team will be reaching out to those who are affected.
The BitMEX platform is entering a new and exciting era. This conservative action is not taken reactively, but proactively. We want to ensure we lead the industry not just in innovation but also in standards.
We are extending the transparency of our systems so that our customers and stakeholders can better understand how BitMEX operates.
We are showing third-parties why we believe BitMEX is a safe place to trade; how our innovative contracts are structured; why we keep an Insurance Fund; how auto-deleveraging is orderly and fair; how we know all accounts are 100% backed; and why we believe BitMEX has one of the safest custody solutions in the world.
We are working on independent audits of our Insurance Fund, market making activities, and tradeable contract structure and we hope to share the results of these processes in the near future.
We believe success in the cryptocurrency space lies in the ability to think long-term, not short-term. And in that long-term view, we believe this course of action affords us the best opportunity to engage regulators in deep, thoughtful, and productive explorations of the risks and opportunities present in the cryptocurrency market.
BitMEX will not just be the most liquid, innovative place to trade. It will also be one where customers may rest assured – with independent affirmation – that accounts are solvent, settlements are honest, and all participants enjoy the same access and opportunity to Trade More.
Abstract: BitMEX Research has upgraded its lightning nodes to include watchtower functionality. The watchtower functionality is a mechanism for connecting to another friendly node, which monitors your lightning channels for you and prevents a dishonest counterparty from stealing your funds, even when you are offline. We successfully conducted an experiment, proving the watchtower concept actually works, at least in our case. It is encouraging that the watchtower concept, which has been around for years in theory, now actually works in practise.
On 29 June 2019, LND 0.7.0 (Go implementation of lightning) was released and this included the watchtower functionality. A watchtower is a third party lightning node, that can detect if a dishonest party attempts to steal funds and then broadcast a justice transaction, sending the funds back to the honest party, even when the honest node is offline.
There two modes of watchtower functionality
Client/Tower User
Server
Description
The client connects to a watchtower server. Whenever the lighting channel states change, data is sent over to the watchtower server with the latest channel state. In the event of a channel breach, the watchtower can broadcast a justice transaction, sending the funds to the honest node’s onchain wallet.
The watchtower server does not need to have any lighting channels or make any payments. The server connects to a lightning client and monitors the client’s lightning channels for them, on their behalf.
Operational details
To connect the node to a watchtower server, one needs to add the following line to the lightning configuration file:
Where the public key and IP address is provided by the watchtower server.
To activate a watchtower server, one needs to add the following line to the lightning configuration file:
> watchtower.active=1
After this, one can run the command:
> lncli tower info
The watchtower server should then display the watchtower public key (different from the lightning node public key). This key is needed by the watchtower client. Due to potential denial of service threats, it is currently not advisable to publish the watchtower public key.
One can check if the watchtower is working by viewing the logs.
It is possible for a node to be both a watchtower server and client at the same time. If you run two nodes, each node can be the watchtower server of the other. BitMEX Research currently has three operating lightning nodes and the nodes all watch over each other in a loop configuration.
Successful test of the watchtower
On 30th July 2019, BitMEX Research successfully tested the watchtower system. Much like our previous piece on justice transactions, we tried to cheat ourselves, but this time used a watchtower. In an encouraging sign, the watchtower functionality correctly worked and the would-be thief was punished.
In order to do this test, we needed to run three nodes:
The dishonest node – BitMEXThief
The node using the watchtower service – BitMEXTowerClient (the user of the watchtower service)
The watchtower itself – BitMEXResearch
Manually constructing a watchtower justice transaction
(Source: BitMEX Research)
The eventual justice transaction, broadcast by our watchtower can be seen here.
Conclusion
All BitMEX Research lightning nodes are now protected by watchtowers. While a watchtower is a large improvement in security, in our view, a greater problem than dishonest channel breaches, is the risk of a lightning node’s memory becoming accidentally lost or destroyed – under such circumstances the node could lose the latest channel states. A watchtower does not fix that problem, although there have been improvements in this area, with Static Channel Backups (SCBs). Using SCBs, as long as no new channels were created post backup, all the funds should be safe.
A successful test of the watchtower does provide us with a greater degree of assurance about the robustness of the lightning network. It is encouraging that ideas such as watchtowers, which have been theoretically discussed for years, finally exist. However, when it comes to improving the robustness and reliability of the lightning network, there is still a long way to go.
Abstract: In our third look at the lightning network, we examine lightning channel closure scenarios and the incentives to punish dishonest parties and prevent them from stealing funds. This punishment mechanism is called a “Justice Transaction”. We explain how to arbitrarily construct a “Justice” scenario and present data on the prevalence of this type of transaction on the Bitcoin network. We have potentially identified 241 Justice transactions, representing 2.22 Bitcoin in value, since the lightning network launched at the end of 2017.
(Lightning strikes the city of Singapore)
Overview
Following on from our January 2018 discussion of the motivation behind the lightning network and our March 2019 analysis of lightning network routing fee economics, this third piece on the lightning network looks at channel closures and the incentives designed to prevent dishonest lightning nodes from stealing funds, by broadcasting an earlier channel state.
It should be noted that, by design, when a thief attempts to steal funds on the lightning network, if caught, they do not only lose the money they tried to steal, they lose all the funds in the relevant channel. This “punishment” is expected to act as a deterrent and is sometimes called “justice”.
The four lightning channel closure scenarios
Opening lightning channels is, generally speaking, more simple than closing them, there is only one way to open a lightning channel, cooperatively with interactive communication between the parties. On the other hand, when evaluating channel closures, one needs to consider four different scenarios, as outlined in the decision tree below (See figure 1).
Figure 2 – The four lightning channel closure scenarios explained
Closure type
Description
Onchain technical details and example transactions
This is the most common scenario.
A cooperative closure occurs when an honest node initiates the channel closure, while the node on the other side of the channel is online and communicating.
Funds are distributed to each party’s onchain wallet based on the latest channel state.
A cooperative closure requires only one onchain transaction.
Inputs are redeemed using a “normal” 2 of 2 multi-signature script and sent to two outputs, each belonging to the parties involved, with the balance based on the latest channel state.
This transaction is hard to identify as lightning and therefore it is the most private of the three channel closure types.
A non-cooperative non-breach closure occurs when an honest node initiates the closure, without directly communicating with the node on the other side of the channel.
Funds are distributed to each party’s onchain wallet based on the latest channel state.
These two different economic scenarios, are represented by one technical onchain scenario.
This scenario requires two onchain transactions.
Firstly the funds are redeemed using a 2 of 2 multi-signature witness and sent to two outputs. The node which did not initiate the closure is allocated funds based on what the channel closing party says is attributable to them, while another pot of funds is sent to an output which can be redeemed by using either an OP_IF or an OP_ELSE script.
In a second transaction, the funds sent to the OP_IF script, are claimed by the party that initiated the channel closure, using the OP_ELSE branch of Bitcoin script.
A non-cooperative breach non-justice closure occurs when a dishonest node initiates the channel closure, by broadcasting an earlier channel state, attempting to steal funds from the node on the other side of the channel.
The non closing node does not check the network within the locktime period, normally 24 hours and does not broadcast a justice transaction. Therefore the theft is successful.
Funds are distributed to each party’s wallet based on an earlier channel state, such that the non closing party losses funds and the dishonest channel closing party successfully steals funds.
A non-cooperative breach justice closure occurs when a dishonest node initiates the channel closure, without directly communicating with the node on the other side of the channel.
The non closing node does check the network within the locktime period, and creates a justice transaction, such that the attempted theft fails.
The would-be thief is punished and all the funds go to the honest non closing party.
In the justice scenario, two onchain transactions are also required.
In the first transaction, the funds are redeemed using a 2 of 2 multi-signature witness and sent to two outputs. The node which did not initiate the closure is allocated funds based on what the channel closing party says is attributable to them, while another pot of funds is sent to an output which can be redeemed by using either an OP_IF or an OP_ELSE script.
In a second transaction, the honest node, that did not initiate the closure claims all the funds sent to the OP_IF script, using the OP_IF branch.
This is the most revealing of the three channel closure types and provides the lowest level of privacy.
In the below arbitrary scenario, we manually created a justice transaction, using the following steps:
1. Spin up a new lightning network node (LND), with the alias “BitMEXThief” and open a channel, worth US$50 (400,000 Satoshis) with the BitMEXResearch lightning node 2. Switch off the BitMEXThief node and back up the .lnd directory 3. Restart the BitMEXThief node and make a lightning payment of US$25 (200,000 satoshis) to BitMEXResearch. The channel is now balanced, US$25 in both directions 4. Switch off the BitMEXThief node again 5. Switch off the BitMEXResearch lightning node (to prevent it broadcasting the latest channel state to the thief node) 6. Restore the BitMEXThief node back to its state prior to the channel re-balancing, the state in step 2 7. On the restored BitMEXThief node, attempt to close the channel from its earlier state and claim the full US$50 (400,000 satoshis) to the BitMEXThief node’s onchain wallet 8. Restart the BitMEXResearch node. The node then automatically detects the attempted theft and broadcasts the “justice transaction”, sending the full US$50 (less fees) to its onchain wallet. The would be thief was punished, by losing all the funds inside the channel. Note that the thief attempted to steal US$25, but ended up losing the full US$50.
The above experiment occurred successfully, providing some assurance that Lightning does actually work and if you try to steal, you will be punished.
Network Justice transaction data
After conducting our own justice transaction, we looked at the characteristics of this transaction (Inputs redeemed using the OP_IF branch) and searched for other justice transactions on the Bitcoin blockchain. We identified 241 transactions, which appear to be justice channel closures, dating back as far as December 2017. Mr. Alex Bosworth, from Lightning Labs, has created a tool to identify justice transactions, which may be more robust than our more basic search methodology.
Figure 3 – Number of justice transactions – monthly
(Source: BitMEX Research)
(Note: There is a possibility the data includes false positives)
Figure 4 – Value redeemed in justice transactions – monthly (BTC)
(Source: BitMEX Research)
(Note: There is a possibility the data includes false positives)
The justice transactions we identified had transaction inputs totaling 2.22 BTC, with the monthly total peaking at around 0.67BTC in February 2019, as figure 4 above illustrates. This does not necessarily mean thieves tried and failed to steal 2.22 BTC, as the dis-honest nodes may have punished thieves by a amount larger than the value they tried to steal (we do not know the latest channel state). The 2.22 BTC represents the total funds claimed by honest non channel closing nodes, part of this value is funds originally owned by the dis-honest nodes and part of the value will be the value they tried to steal.
It is also possible that many of the 241 justice transactions do not indicate genuine dishonestly, for instance it could be users testing the system, where the same user owns both lightning nodes in question. For example BitMEX Research is responsible for 5 of the 241 justice transactions, when there was no victim, as BitMEX owned all the nodes and funds.
241 justice transactions, with a value of just over 2 BTC is reasonably small relative to the size of the lightning network. The lightning network statistics website 1ml.com, indicates that there are currently 940 BTC locked up in 32,951 channels. The total number of justice transactions in the last 18 months is therefore only 0.7% of the current number of lightning channels.
Conclusion
In order for the lightning network to succeed as a robust, reliable and scalable payment system, the justice mechanism needs to be effective in deterring and preventing theft. As for the optimal justice rate, this is hard to determine, if it is too high and it shows that successful thefts may be too prevalent and the threat of justice may not be sufficient. If it is too low, it may mean nobody is attempting theft, thereby increasing the risk that users do not monitor their channels. This may lead to increases in the risk of large systemic channel thefts in the future.
For now, at least according to the data we have analysed, there appears to be a reasonable degree of justice on the burgeoning lightning network.
Effective 15 July 2019 at 15:15 UTC, BitMEX will reintroduce Kraken into its indices following the resumption of trading on Kraken. The updated indices are detailed in the table below.
All traders should be aware that these indices may fluctuate substantially, and should exercise caution when trading contracts that reference these indices.
Effective 14 July 2019 at 21:00 UTC, BitMEX will temporarily remove Kraken from its indices in response to Kraken’s scheduled downtime. This scheduled downtime is expected to last for 3-8 hours and will affect the 7 BitMEX indices as detailed in the table below. Kraken will be reintroduced once trading has resumed. We will announce their reintroduction 12 hours in advance.
All traders should be aware that the price of these indices may fluctuate substantially, and should exercise caution when trading these indices.
Following on from our 28 May 2019 announcement of a donation to the MIT Digital Currency initiative, we are delighted to announce a US$60,000 grant to Bitcoin Core contributor, Michael Ford (AKA fanquake). Michael has been a Bitcoin contributor since 2012 and has recently beenadded to the list of maintainers for the Bitcoin Core software project.
HDR Global Trading Limited (which owns and operates the BitMEX cryptocurrency trading platform) is proud to support Bitcoin development and engineering, aimed at improving Bitcoin’s robustness, scalability and privacy. The grant is non exclusive and requires Michael to work on Bitcoin Core. We are pleased to be Michael’s first financial supporter during his time as a Bitcoin Core maintainer.
Sam Reed, CTO and co-founder of HDR Global Trading Limited, made the following remark about the grant:
HDR Global Trading Limited, like all other companies in the cryptocurrency space, relies heavily on the (mostly-volunteer) work of coders dedicated to the mission and ideals of Bitcoin. This work is difficult, demanding, and often thankless. We believe it is the duty of corporations to give back to the projects from which they benefit – and from which their very business model stems. Without the millions of free man-hours from dedicated OSS developers powering everything from our operating systems, to our web servers, to our ops tools and Bitcoin itself, the BitMEX trading platform could not have been built. We don’t forget this gift. Therefore, HDR considers this grant, provided on a no-strings-attached basis, to be only a small part of an ongoing commitment to bolstering Bitcoin and other OSS projects for the benefit of all.
The event horizon has passed. With Libra, Facebook begins its foray into the digital asset industry. Before I begin my analysis, let’s get one thing straight; Libra is not decentralised nor censorship resistant. Libra is not a cryptocurrency. Libra will destroy all stablecoins, but who gives a fuck. I shed no tears for all those projects that somehow believed there was value in a an unheard-of sponsor creating a fiat money market fund that rode on a blockchain.
Libra could lay commercial banks and central banks low. It might reduce their usefulness to a dumb regulated warehouse for digital fiat money. And that is exactly what should happen to these institutions in a digital age.
Why Do Commercial Banks Exist?
Banks came about during a time of great danger for members of the human society. In feudal Europe you most likely worked dawn-till-dusk on the farm. Any meagre savings you or your feudal lord amassed were constantly under siege. Given that money was physical in nature, if you or your lord left the protection of the town, theft was likely.
Safety of assets has been the most important value proposition for traditional banks. They could store physical assets and records safely in their vaults. Therefore, governments and wealthy individuals stored money and assets with banks. Banks were and are engaged in a massive confidence game. That is why bank building edifices portray a certain fortified grandeur. In a generation, your assets will still be there, intact and ready for use.
Through their partnership with the government, banks obtain a license to issue credit and expand the money supply. They also rely on the legalised violence of the government to enforce contracts. Don’t pay the bank back, they will confiscate the encumbered asset. Should you defy the courts, a government goon will happily press boot to neck, and ensure your compliance.
In the last decade, human civilisation’s money and assets quickly transitioned from analogue to digital representations. Money and representations of ownership travel electronically rather than on the back of a horse. If assets and money are now digital, do we need institutions that provide physical rather than digital security?
As we have seen, commercial banks are terrible at securing digital information. Pick your large too-big-to-fail bank, and there will be a story about the “leakage” (euphemism for “we have no fucking clue how to safeguard your digital property”) of customer data.
Whoever has the customer, has the value
Previously banks held the most valuable information about customers. They had your whole financial history, and information about where you lived and what you bought.
In the past ten years, social media companies through voluntary actions of their users, amassed the most amount of personal information in human history. We share every detail of our lives on Facebook, Instagram, Google, Twitter, WeChat, LINE, Kakao Talk etc. We send billions of messages on centralised chat programs controlled by those same institutions as well. They now own the customer.
The modern consumer technology companies own billions of the wealthiest customers’ data. Previous to now, these companies made money on advertising and selling a product. But as with all businesses, once you are successful capturing customers, you start offering financial services.
Facebook has almost 2 billion daily active users. It makes complete sense to own the financial existence of their chattel. That is Libra.
Libra Deconstructed
Libra is a stablecoin backed by a basket of fiat currencies. The fiat currencies sit in a dumb regulated commercial bank. Libra allows a privileged few the ability to create and redeem Libra at its Net Asset Value (NAV). Libra rides on a blockchain where certain parties operate permissioned nodes. These parties included VC firms, technology companies, retail merchants, cryptocurrency exchanges, and most importantly commercial banks and credit card processors.
Libra may invest into short term government bonds, or into anything the Foundation board allows. The income earned is not passed onto the pleb Libra users, but the node operators and Libra investment token investors. The Foundation is the governing body of the Libra ecosystem. The members are selected based on the industries they represent, and their economic investment into the ecosystem.
Libra does not connect real-world identities to addresses. However, you can bet that converting assets into Libra will encounter KYC. And let’s be clear, any request from a government agency to freeze a transaction will be met with compliance. Therefore, do not use Libra to buy your mood-altering substance(s) of choice.
Impact on Consumers
Many of Facebook’s users reside in places with low financial services penetration. Imagine a world where a Filipina helper can purchase goods sold in Europe with Libra. She most likely does not have great banking services where she works as an overseas foreign worker. Therefore, purchasing goods from foreign countries over the internet is difficult. With Libra, there is no issue.
The merchant in Europe receives payment in a basket of fiat currencies they already deal with. This transaction can happen completely inside of one of Facebook’s social media properties like Instagram or Whatsapp.
Facebook or a new financial services company it creates, can issue loans at the point of sale denominated in Libra. A user can opt-in to allow Facebook to use all its data on the individual to compute a credit score. Using that credit score, Facebook will lend Libra at a rate to purchase goods from merchants selling on the Facebook platform. Voila, the poorest members of our global society can experience the joys of purchasing mass-produced Chinese knick-knacks on credit. Welcome to Pax Americana!
Impact on Commercial Banks
Commercial banks make money lending. They use retail deposits to make these loans. Unfortunately, in this digital age, they no longer have the best information set about these retail depositors. The social media companies do.
Therefore, the Facebook, Google, and Alibaba’s of the world can originate a loan cheaper and offer a lower interest rate than a commercial bank. Libra and the plethora of copycats to come, allow technology companies to use a digital fiat representation in their ecosystems to extend credit and offer all of the most profitable banking products at a much lower cost. These global tech behemoths have billions of free cash flow on their balance sheets to lend.
Commercial banks can become node operators or regulated warehouses for the reserve assets of the stablecoin in question. There is still economic value in both of these verticals, but consumer technology companies will now sell the most profitable financial products themselves.
Any bank should be on notice, Libra and its clones are existential threats to their business models. Many will cheer as banks’ profit centers are eviscerated. But maybe society is trading one devil for another.
Impact on Central Banks
Commercial banks are not needed at their current largesse in a digital economy. With Libra, Facebook is assuming the role of a central bank. The Libra reserve is managed by a third-party foundation. The reserve managers choose the fiat currency weights, and how funds are invested. Sounds a lot like the job scorecard of a central bank governor.
Consumer tech companies can now issue, from their own balance sheet, credit directly to consumers. The only difference with this model is that they, for now, are not able to actually create money like commercial banks. This is the flow:
1. Take retained fiat earnings, and exchange for Libra with an authorised primary dealer. 2. Lend Libra to your customer in exchange for a good or service you offer. 3. Obtain Libra + interest in Libra back from your customer. 4. Sell Libra in exchange for fiat with an authorised primary dealer.
The money supply does not expand. That is the one major divergence from how a central bank issues credit into an economy. Central banks’ lending in most cases increases the aggregate supply of money.
Why trust a few crusty old men and women to manage the monetary health of the global economy. Let’s trust Zuck!
I have no love lost for US Representative Maxine Waters’ idiotic statements and actions on the US House Financial Services Committee. But her and other government officials’ outbursts of concern are not driven by altruistic feelings towards their subjects, but rather a fear of the upending of the financial services industry that lines their pockets and keeps them in office. The speed at which government officials rushed to admonish Libra tells you there is some potential positive value to human society embedded in the project.
Libra and Financial Privacy
It is amusing to see how many people rushed to complain about the potential loss of financial freedom Libra could represent. This fear is misplaced, financial privacy is already non-existent, nor will it ever exist in a digital fiat money system. Whether it be Facebook, The Fed, or The PBOC, centralised electronic fiat money is coming – cash will be outlawed.
The great thing about the launch of Libra is that it forces those concerned about the loss of financial privacy to explore alternatives. Bitcoin and other cryptocurrencies will benefit as curious plebs contemplate how secure financial privacy in this new digital age.
Libra and the conversations it sparked, is the best news for Bitcoin. Two billion people will now embrace and potentially be frightened of a corporate overlord controlling their financial wellbeing. Curiosity is the best food for the Bitcoin bull market.
Through their investments in augmented and virtual reality, it appears that Facebook wishes to create a completely new digital world. Libra could be the financial mana that powers this virtual existence. Let’s hope that while we are vegetating in our haptic pods, our physical shells don’t get Zucked too hard. Please Zuck me gently, and Zuck me long time.
On 27 June 2019, we set a new record for crypto: >$1B open interest on XBTUSD, >$13B traded on XBTUSD, >$16B on all BitMEX products. Yet, Nouriel Roubini still believes that cryptocurrencies are a farce. Watch him face-to-face next week in Taipei’s Asia Blockchain Summit vs our CEO, Arthur Hayes.
