Update: SegWit transaction capacity increase compared to Bitcoin Cash

Abstract: In September 2017, we wrote a piece on the SegWit capacity increase. Here, we provide an update on SegWit adoption with six more months of transaction data. We also compare the transaction throughput to that of Bitcoin Cash, an alternative capacity-increase mechanism.

SegWit vs. Bitcoin Cash

The SegWit upgrade to the Bitcoin protocol occurred in August 2017. After this, users had the option of upgrading their wallets and using SegWit, which provides the benefits of about 41% more scale (assuming no other users also upgrade).

Around the same time, Bitcoin Cash provided an alternative mechanism for increasing capacity, in which one also needs to upgrade to a new wallet and adopt a new transaction format to get the benefit of more transaction throughput, although a main difference between this and SegWit’s approach is that Bitcoin Cash resulted in a new coin.

The transaction volumes of Bitcoin Cash and the new SegWit Bitcoin transaction format have been reasonably similar. Since the launch of Bitcoin Cash, 6.1 million SegWit transactions have taken place, only 20.1% more than the cumulative number of Bitcoin Cash transactions. These figures are remarkably close — although supporters of the SegWit capacity-increase methodology could claim that Bitcoin Cash had a one-month head start and that the Bitcoin Cash chain has lower transaction fees so that a comparison is not appropriate. Adjusting for the one-month head start, SegWit has 31.5% more cumulative transaction volume than Bitcoin Cash, larger than 20.1% but still reasonably close. Of course, its possible that at some point either or both of these figures could be manipulated.

Although the data suggests that SegWit transaction have been adopted slightly faster than Bitcoin Cash, resulting in more transaction volume, Bitcoin Cash advocates could argue that the Bitcoin Cash token is more about a philosophy of larger capacity in the long term, rather than the speed of the actual increase in transaction volume in the short term. Therefore Bitcoin Cash supporters can still claim that Bitcoin Cash will eventually have more transaction volume than Bitcoin, once adoption of the coin increases.

Cumulative transaction volume since the launch of Bitcoin Cash. (Source: BitMEX Research, Bitcoin blockchain, Blockchair for Bitcoin Cash data)

As these charts indicate, there was a sharp spike in Bitcoin Cash transaction volume when it launched; in contrast the SegWit upgrade was more gradually adopted. This is likely to be related to the investment flows and excitement of the new Bitcoin Cash coin, which may have driven short term adoption, as some of the spikes in the chart illustrate. Three months after the launch of Bitcoin Cash, on 31 October 2017, SegWit transaction volume overtook Bitcoin Cash and has remained in the lead ever since.

Daily transaction volume. (Source: BitMEX Research, Bitcoin blockchain, Blockchair)

The chart below shows that the adoption of SegWit has continued to grow since August 2017, perhaps increasing in steps as large corporate entities switch to SegWit. Adoption currently hovers around 30% as a proportion of the number of transactions, although the adoption rate only measures around 22% as a proportion of block space, which is possibly a more important metric.

Percentage of transactions that use SegWit. (Source: BitMEX Research, Bitcoin blockchain, Blockchair)

SegWit has begun to meaningfully impact system-wide capacity, potentially reducing fees and benefitting even users who choose not to upgrade to the new transaction format. However, the transaction fee market is still immature and, in our view, transaction prices are likely to remain volatile going forward.


Adoption of both the new transaction format for SegWit and Bitcoin Cash has been reasonably slow. At the same time, as our earlier piece shows, adoption of new consensus rules can also be gradual. This illustrates why it may be important to construct network upgrades in the least disruptive way possible, perhaps an upgrade mechanism which is safe even if users and miners do not upgrade at all.


Whilst many claims made in this note are cited, we do not guarantee accuracy. We welcome corrections.

Tether: New financial data released by Puerto Rico

Abstract: Following our earlier research piece on Tether a few weeks ago, further financial information has just been released by Puerto Rico. The new data supports our speculation that Noble Bank could be Tether’s primary reserve bank and that the region may be a major cryptocurrency centre.

Over the weekend, the Commissioner of Financial Institutions of Puerto Rico released aggregate financial-system data for the calendar year ended 2017. Bank deposits in the International Financial Entities (IFE) category, which includes Noble Bank, were $3.3 billion, up 248% in the quarter ended December 2017. Total assets in the category were $3.8 billion, up 161% in the quarter. This extraordinary growth coincides with a large increase in value of cryptocurrency assets, which has likely resulted in large cash inflows into cryptocurrency-related banks.

Over the same period, the value of Tether in issue has increased by 215% to $1.4 billion. This new data supports the thesis in our recent piece on Tether, in which we speculated that Noble Bank is Tether’s primary reserve bank.

We have updated the chart below from the version in our earlier piece, with an initial data point for the end of 2017. It illustrates the sharp growth in bank deposits in the IFE category in Puerto Rico, coinciding with the recent cryptocurrency boom.

Puerto Rico’s IFE aggregate deposits versus the Tether balance in millions of USD. (Source: IFE Accounts, BitMEX Research, Coinmarketcap)

Cash as a percentage of total assets (an indication of full-reserve banking) also increased in the quarter, from 72.2% to 85.8%. This also indicates cryptocurrency or Tether-related activity, as we explained in the previous piece.

Puerto Rico’s IFE aggregate cash balance as a percentage of total assets. (Source: IFE Accounts, BitMEX Research)


Whilst many claims made in this note are cited, we do not guarantee accuracy. We welcome corrections.

The Volocaust and method actors

BTFD was the rallying cry of crypto traders throughout 2017. The beginning of 2018 will test even the most stalwart HODLers. When is the right time to back up the truck? It surely wasn’t at $15,000, $10,000, or $8,000.

One of my best friends, once a top-ranked bond salesman, describes himself as a first-rate method actor. When he showed up to work, he had the perfect coif, wrist watch, and tailored suit. Seeing him after he left all that behind, you would think he was a wannabe K-Pop star. When the play was over, he became himself again.

The actors in the financial-services theatre don their costumes to drape themselves in an air of respectability. The right accent, pedigree, and clothing allow them to convince the unwashed heathens that the financial products and advice they peddle is not snake oil.

I wore my costume too, although my performance was not as convincing. Every Friday at Deutsche Bank, we were allowed wear casual clothing. One Friday, while I was a first-year analyst, I decided to wear a pink polo shirt, acid-washed jeans, and yellow sneakers.

Later that afternoon, the head of Equities walked past my desk and saw me. He asked my boss, “Who the fuck is that?”, referring to me and my baller outfit. The next week, I learned that casual Fridays were cancelled for the whole office. Thank you, Arthur Hayes!

The firms employing these troops of actors still have an aversion to Bitcoin. They are hypocrites, and the latest volatility gyrations that REKT thousands of retail punters invested in products they sold is case in point.

A primer on leveraged and inverse ETFs

A traditional ETF is a product used to go long on a particular basket of assets. An example is SPY, the SPDR S&P 500 ETF. It gives holders exposure to the S&P 500 index by holding a basket of stocks.

One of the biggest reasons why ETFs are so successful in the US: investors can purchase them in their retirement accounts. Retirement accounts have various restrictions on the type of assets that may be purchased. Usually, these accounts do not allow investors to hold futures contracts or trade on margin.

Investors crave leverage and the ability to go short. Futures contracts are the most cost-effective way to gain this type of exposure. However, the minimum size of many contracts prohibits small investors from using them. Also, small investors cannot use them in their retirement portfolios.

To satiate this demand, ETF issuers began launching leveraged and inverse ETFs.

Let’s assume we launch an inverse ETF on the S&P 500 index (SPX). The purchaser of this ETF will profit if the index declines.

daily ETF performance = -1 * daily return SPX 

Say that on day 1:

SPX Close0 = $1,000
SPX Close1 = $500

Return = -50%

ETF performance = -1 * -50% = +50%

And on day 2:

SPX Close1 = $500
SPX Close2 = $1,000

Return = 100%

ETF performance = -1 * +100% = -100% (Bankrupt!)

This simple example illustrates that inverse ETFs are path dependent. In other words, holders take on convexity while holding this ETF. Unfortunately, they are short, not long.

Leveraged and inverse ETFs are ticking time bombs. If held long enough during a period of suitable volatility, there is a significant likelihood that holders will severely underperform their intended strategy.

In addition, the fund manager must constantly rehedge his portfolio at the end of each trading day. The more a manager trades, the more fees must be paid to investment banks and the exchange. These fees are passed on to the client.

The client is short gamma, underperforms the benchmark, and pays more in fees. Can you spot the sucker?

The Volocaust

Selling volatility has been the sure bet to riches for retail and institutional investors alike since 2009. The CBOE VIX futures market took off after the crisis, and enterprising ETF issuers began listing products to allow retail punters to participate in this esoteric corner of the financial markets.

Retail punters took to VIX ETFs like a Donald Trump to Propecia.

As volatility continued to collapse, exchange-traded notes (ETNs) and exchange-traded products (ETPs) that allowed retail investors to short VIX futures proliferated. Retail punters got a double whammy of goodness.

The first whammy: VIX futures contango. Because investors feared another 2008 market crash, they bid up call and put prices. This led to enhanced implied volatility, which meant VIX futures traded at a premium to spot. Because volatility continued to realise lower and lower, VIX futures sellers picked up that premium.

The second whammy: central banks, crushing all market volatility. At any hint of crisis, the printing press went spastic and punished shorts.

One of the most popular products was the VelocityShares Daily Inverse VIX Short-Term ETN (XIV, get it?) that Credit Suisse issued. XIV invests in the VIX short-term futures contracts, not the index itself. This is awesome when the market doesn’t move and the futures basis tends to zero, but if the term structure shifts dramatically higher, it will exacerbate the losses.

Things were going swell until the market dropped last week, and the VIX and its associated futures spiked. It went up so much that the net asset value (NAV) of the ETN declined by over 80% in one day. Remember, the ETN decreases in price if the VIX rises. There is a clause in the prospectus that allows the issuer to redeem the ETNs if the NAV drops by more than 80% in one trading session. Investors at that point get back what they can get back. Given that the short-term VIX futures basis spiked as well, these investors are pretty much guaranteed to receive a bagel.

Entire fortunes and accounts were destroyed overnight. Traders who saw steady profits as volatility ground lower were wiped out.

Bitcoin ain’t so volatile anymore

After witnessing a retail product that went from hero to zero in one trading session, how can any banker say with a straight face that crypto coins are too risky for retail investors? These same investment banks gladly structured toxic ETFs, ETNs, and ETPs that gutted the portfolios of those investors they claimed to care so much about.

Going long on Bitcoin could result in an investment worth nothing in the near or long-term future. But at least that is an investment with positive convexity. The maximum you can lose is what you put in, but the upside is infinity. Contrast that to any number of inverse ETFs. The maximum unlevered return is 100% and the maximum loss is also 100%. However, as I have shown, the path dependency of these products assures that you will underperform your benchmark in the long run.

If the banks that issue these carpet bombs also pooh-pooh Bitcoin, ignore them. The only reason why they don’t like crypto coins is that they have no way to profit from them. They don’t own the exchanges nor can they facilitate agency trading of these assets. A dollar invested into Bitcoin is a dollar not invested in the casino that they operate.

That negative attitude is changing fast. The “vampire squid” Goldman Sachs invested money in Circle, who just acquired Poloniex. It seems that crypto money isn’t that bad after all.

As compliance departments are browbeaten into allowing banks to trade crypto coins, the banks’ tone will shift. Suddenly, an allocation of crypto coins will be investment canon. Jamie Dimon and his ilk will flip-flop into crypto enthusiasts. But don’t hate on Jamie for dogging Bitcoin — he is just playing his part in the financial-markets theatre.

Bitcoin March/June calendar spread

The above chart shows the Bitcoin price and the annualised premium of the March (XBTH18) and June (XBTM18) Bitcoin/USD contract spread.

The calendar spread is calculated by the following function:

annualised premium = [(XBTM18 price - XBTH18 price) / Bitcoin spot] / 0.2493

0.2493 represents the annualized time value between the March and June expiry dates.

The calendar spread is a useful gauge of how bullish or bearish traders are in a forward starting-time period. In early February, Bitcoin lost close to 70% of its value measured against its December 2017 all-time high. The spread reached a low of 0.42% annualised during the same period.

Catching knives is deadly for most mortal traders. Some are able to bottom-tick the market, but they are few and far between. After rebounding close to 100% from the recent low of $6,000, the market has entered choppy waters.

Trading the chop is a skill in and of itself. The chop will take a healthy stack and make it look sickly before the next breakout happens. Therefore, using derivative spread trades with a view on the direction of the spot market is a better risk-adjusted way to express a view.

For those who believe we are in the midst of a full retrace back to $20,000, going long on the XBTM18/XBTH18 calendar spread is prudent. To go long, you must go long XBTM18 and simultaneously go short on XBTH18.

If the market indeed continues to push higher, XBTM18’s price will increase faster than that of XBTH18’s. That is because XBTM18 possesses more time value, so the interest-rate component will make up a significant percentage of its value relative to XBTH18.

This trade comes relatively cheap. Currently, the spread is trading at positive 3.15% annualised. Because the spread is positive, the trade has negative theta or time value. XBTH18 expires at the end of March. By the end of March, if XBTM18 doesn’t outperform, you will lose an outright 0.78%, making your daily theta 0.026%.

Historically, the quarterly contracts trade at a 30% to 40% annualised premium. If we assume the curve’s annualised premium stays constant, the calendar spread should trade at a similar premium. Therefore, in the upside scenario, we expect a 10-fold increase in the annualised calendar-spread premium.

The reason why you put this trade on rather than going naked long is that the market-to-market losses on this trade are capped at 0.78% unlevered. Imagine you bought Bitcoin at $10,000, then it crashed to $6,000. As a weak hand, you panic-sold the bottom. But the price quickly recovered back to $10,000, and even though your trade broke even over less than one month, you lost 40% because you could not mentally handle the mark to market.

With a calendar spread, you know from the outset your unlevered maximum loss. If you are uncomfortable with that loss a priori, you can refrain from putting on the trade.

For those who want to juice up the returns, add more leverage to both legs. However, be cognisant that BitMEX does not use portfolio margin — that is, gains in one contract will not offset your liquidation price on the other. You must monitor the liquidation price of the contract with an unrealised loss and continue to top up your account to avoid liquidation.

Diagram of a Bitcoin block: Covert versus overt AsicBoost

Abstract: We present a graphical illustration of a Bitcoin block, including the Merkle trees and explain why the additional Merkle tree in the block, associated with the Segregated Witness upgrade, is necessary. We then take a closer look at some of the potential negatives of both overt and covert AsicBoost, following on from our September 2017 piece on the subject. After the recent announcement from the patent owner, we conclude that the new Blockchain Defensive Patent License (BDPL) scheme, if robust, could result in limited downsides to the use of overt AsicBoost on the network. On the other hand, there may still be some issues with the less efficient covert AsicBoost.

This is a simplified depiction of the structure of a Bitcoin block and the Merkle trees inside it. Other, more detailed illustrations have been produced by Jeremy Rubin and Timo Hanke. (Source: BitMEX Research) 

Components of the diagram

Block header

The header of the Bitcoin block (in grey) is around 80 bytes and includes the version, the hash of the previous block, the Merkle root, the timestamp, the bits (difficulty), and the nonce.

Block header candidate

This includes all of the above, with the exception of the nonce.


The diagram above shows that the Merkle root is split between two chunks, which are required to conduct Bitcoin’s SHA256 proof-of-work function. An explanation of this can be found in our earlier piece on AsicBoost.

Second Merkle tree

The SegWit upgrade introduced a new Merkle tree, which has the same structure as the main Merkle tree, except that it includes the witness data and excludes the coinbase transaction. The relative position of each transaction must remain identical to that of the main Merkle tree.

Why a second Merkle tree?

The second Merkle tree increases complexity, which some may consider a disadvantage. SegWit was an upgrade to the Bitcoin network that fixed bugs, such as the quadratic scaling of sighash operations and transaction malleability. The witness data could not be added into the main Merkle tree, as otherwise old nodes would consider these transactions invalid, which would be a hardfork.

However, it is not true to say the additional Merkle tree could be avoided by making SegWit a hardfork upgrade rather than a softfork upgrade. A hardfork resulting from the inclusion of witness data in the main Merkle tree would lead existing wallets to consider the new transaction format invalid, and these wallets would not be compatible with the new transaction format whether they were fully verifying nodes or not. The effect of this would be that some users would be unable to interact with each other and funds could appear to go missing. This type of upgrade may not be possible in a live network such as Bitcoin without significant disruption. Therefore, the additional complexity of a second Merkle tree would be necessary even if the SegWit upgrade were a hardfork.


As we explained in our previous piece on AsicBoost, covert AsicBoost involves finding a collision in the last 4 bytes of the Merkle root, exploiting the fact that the hashing algorithm splits the Merkle root between the two chunks. Covert AsicBoost messes with the transactions, something that overt AsicBoost avoids. The second Merkle tree can make covert AsicBoost more difficult unless the blocks are much smaller, which could be detectable. 

Potential negative issues with AsicBoost

  Covert AsicBoost Overt AsicBoost

Patent protection

This potential negative of AsicBoost applies to both the covert and overt type. AsicBoost is a patented technology and, as we explained in our previous piece on patents, these can be particularly damaging in the blockchain space. This appears to be one of the primary negatives of AsicBoost, as it could potentially give one mining company an insurmountable advantage over the competition, resulting in a gap that could not be closed due to legal restrictions. This could undermine Bitcoin’s core value proposition. It is possible that the Bitcoin community would conduct a softfork to block AsicBoost if the patent problem becomes significant.

To mitigate this problem, the patent owner could open the patent — for example, by making a defensive patent pledge. It appears as if the AsicBoost patent owner may have recently made such a pledge. If the pledge proves robust enough, this issue may now be resolved, at least in the regions the patent applies.

Smaller blocks and lower capacity

Covert AsicBoost can incentivise the production of smaller or even empty blocks, which makes covert AsicBoost more efficient. This can then reduce the capacity of the network and increase transaction fees.

Smaller or empty blocks have a negative impact on capacity, since they still maintain the network difficulty but do not make a significant contribution to any transaction backlog.


Unwillingness to upgrade to SegWit and potential dishonesty over the reason

Perhaps the most damaging negative of AsicBoost was that it may have caused some miners to be unwilling to upgrade to SegWit. This in itself may not be much of a negative, but the supposed dishonest and divisive misinformation campaign about SegWit may have had a large negative impact on the ecosystem.

However we would like to point out that this is merely an uncertain, unsubstantiated accusation, and it is not clear if this was a motivating factor behind opposition to SegWit.


Incentive to adjust the Merkle trees or transactions

As the diagram above illustrates, covert AsicBoost relies on the ability of the miner to adjust the Merkle tree or the transactions. This could have detrimental effects on the network other than smaller blocks. Overt AsicBoost appears to be a much cleaner solution, needing only a field in the block header to be changed.


Secret advantage over competition

Covert AsicBoost may be undetectable and therefore may provide some miners a secret advantage over the competition, compared to a known advantage.

Although in general we think transparency is a good thing, it’s not clear whether or not the network on which covert AsicBoost operates suffers any direct disadvantage from the secrecy, apart from what is mentioned elsewhere in this table.


Reduced ability to conduct softfork upgrades via version signalling and a warning message in Bitcoin Core


Overt AsicBoost uses the version field, seen on the top left of the illustration above. This has been used as a signal, to indicate that a miner is ready to upgrade via a softfork. Overt AsicBoost may use space in this field, which may prevent its use as an upgrade-signalling system.


1. Overt AsicBoost may not require all 4 bytes and therefore some bytes may be left for softfork signalling. This could reduce the number of softforks that can occur simultaneously.

2. Many regard the softfork signalling system to have been a failure anyway. Miners often provide simultaneous contradictory signals, rendering the signal methodology unreliable.

Another downside of overt AsicBoost is that Bitcoin Core software may see an unusual version field and think the network is upgrading in an unknown manner, resulting in a  warning message to the user.

In our view, AsicBoost is not necessarily a negative for the network. Although covert AsicBoost has problems with an incentive to produce smaller blocks, most of the issues related to overt AsicBoost can be mitigated. In particular, if the BDPL system proves robust, there may be no significant negatives resulting from the use of overt AsicBoost — at least none which we can currently predict.

NEO $100K Giveaway winners announcement

Thanks to all of the participants for helping to make another BitMEX giveaway a success, and would like to congratulate all of the winners! We were very impressed with the performance of the top two traders, and as a result decided to name them both grand-prize winners. Special congratulations to both of you.

Winners, please see the email you received for prize details.

To see the giveaway details, click here.

When I dip, you dip, we dip

BTFD was the rallying cry of crypto traders throughout 2017. The beginning of 2018 will test even the most stalwart HODLers. When is the right time to back up the truck? It surely wasn’t at $15,000, $10,000, or $8,000.

Trading both ways is intellectually challenging. The gains one made by faithfully adhering to one very profitable strategy can evaporate in days. Things change, and so should your trading strategy and mindset if you are actively punting crypto.

Because the financial media always needs a reason why crypto gyrates the way it does, they descend upon their trusted sources and hound them for any explanation at all. I will go through some of the reasons routinely put forward.

The CME and CBOE effects

The day the CME Bitcoin futures contract launched marked the top of this bull run. The BitMEX Bitcoin Index (.BXBT) flirted with $20,000 on that fateful morning. The following two months proved that it was an amazing top at which to short Bitcoin.

Now that large financial institutions could short Bitcoin by only posting USD, the thinking was/is that they will use their financial might to short Bitcoin into the ground. The first thing most financial reporters fail to understand is that on a futures exchange, there is a long for every short. By definition, a futures exchange has no net impact.

If the shorters at the margin are willing to accept lower prices than buyers at the margin, the contract will trade at a discount. At that point, market makers will be net buyers, and then sell or short-sell Bitcoin on the spot markets. If the open interest is sufficient large, then this backwardation can negatively affect the price.

The above is a graph of the open interest in XBTUSD since January 2018. It is relatively small. The maximum open interest over the period is $164 million.

Assume that all market makers are net long, which means they must short-sell Bitcoin spot to remain price neutral. That means that $164 million of Bitcoin must be sold. That is not a per-day flow but a stock of short Bitcoin positions. The spot market on exchange trades exceeds $1 billion per day. The OTC volume is unknown, but it is not insignificant.

The short pressure at its logical maximum emanating from the CME and CBOE contract holders is meaningless. Therefore, the effect on the broader market in actual flows is negligible. The contracts mainly bolster traders’ bullish sentiment.

In terms of trading volume, BitMEX continues to blow both of these contracts out of the water. In the year to date, the BitMEX XBTUSD, XBTH18, and XBTM18 products traded a combined $53.14 billion versus CME and CBOE combined Bitcoin futures volume of $4.48 billion. BitMEX is 12x more liquid.

Wall Street is shorting Bitcoin spot

The evil bankers can’t stand a coterie of misfits becoming millionaires and billionaires, so they crashed the party by aggressively shorting Bitcoin in the spot markets.

The large financial institutions do not own Bitcoin in large quantities, if at all. They are hamstrung by KYC/AML concerns surrounding Bitcoin. That means that if they wanted to sell Bitcoin, they would need to borrow it from a credible counterparty. Hey, Cumberland Mining, can we borrow $100 million of Bitcoin?

Assuming banks borrowed Bitcoin with the intention of shorting it, they would need to sell it on an exchange. Given the skittishness that inhibits counterparties globally from placing large amounts of capital on an exchange, I highly doubt any compliance department at a bulge-bracket bank would approve opening an account.

Let’s suspend reality and assume they allowed trading desks to open accounts on the largest Bitcoin spot exchanges. The maximum the desk could make is 100% if Bitcoin went to zero. But, if the market instead face-ripped them by 50% on a $100-million position, that loss would reach the global head of trading and of the investment bank.

If you were the line executive that green-lit that trade, you would lose your job. You shorted Bitcoin, and lost a huge sum of money. That would make it into the financial press; you and your bank would be ridiculed.

The career and operational risk of trading Bitcoin and then shorting it would dissuade any bank from acting.

Korea trading ban

After the Chinese passed the crypto trading baton to South Korea, all policy actions emanating from South Korean territory were closely watched. When a South Korean Department of Justice official proclaimed that they would attempt to ban crypto trading in Korea, the market crashed.

However, unlike China, there is legal due process in South Korea. Also unlike China, South Korea’s economy is open. When the dust settled, the legislators clarified that they merely wished to have more visibility into who was trading what. Korean punters must now use real-name accounts; minors and foreigners are prohibited from trading. This is hardly draconian or a ban on trading.

The South Korean government is captured by crypto. The country’s National Pension Fund even holds equity investments in many of the largest trading venues. Korea’s most successful technology startup, Kakao, owns the largest exchange by trading volume, Upbit. Is the government really going to torpedo an industry that millions of voters love, and an industry that is creating high-paying jobs? No. Your average Kim will keep the faith, and continue to trade crypto.

The exchanges were halted from accepting new accounts. That measure will be lifted sometime in February. With more new blood in the market, expect the negative sentiment to wane.

China bans crypto again

I don’t know why markets continue to react to negative policy announcements from China. The regulators instructed all financial institutions to do a self-assessment and ban any payments connected with crypto trading. This was in response to the rampant OTC trading occurring after they shut down public trading of crypto on the large exchanges.

While the on-ramp into crypto is more cluttered, Chinese punters will find ways to obtain any financial exposure they wish. If people can find a way to build illegal power plants in China, they can surely figure out how to buy and sell crypto against Beijing’s wishes.

Tether big-bang theory

Like many religions, the prelate deems us laypeople unworthy of speaking the their language of the gods. As such, the majority of the crypto world, myself included, has no idea how Tether works.

The CFTC subpoena relating to Bitfinex and Tether spooked the markets. However, I don’t believe this is a net negative event.

If Tether were in serious trouble, FinCEN and the US Treasury would be the agencies inquiring into its inner workings. If they wanted to shut it down, the first action would be a cease-and-desist order. Given that it was the CFTC that issued the subpoena and that Tethers continue to be created, what the agency is after most likely is not fatal to the currency.

Even if a cease-and-desist order were issued, that would cause a market spike in the value of most large-cap cryptos instead of a plunge. Traders who wished to receive any real value at all would sell Tether and buy any crypto they could.

The price of Bitcoin/Tether would spike, and this would drag the Bitcoin/USD value higher as well. This is similar to what happened when the banking issues on Bitfinex drove people to sell USD IOUs on Bitfinex and purchase Bitcoin, and then withdraw it. Bitfinex led the market higher, and the rest of the exchanges followed.

If you believe there is actually trouble in the Tether Hotel California, then go long on Bitcoin. But the market action suggests that the latest legal issues are benign.

What has fundamentally changed?

The prices of the entire crypto complex crumpled. However, on a year-over-year basis, Bitcoin is up multiple hundreds of percent. Maybe your favourite shitcoin isn’t, but that’s just the game. Don’t let CNBC fool you into buying tops and selling bottoms.

If the publicity surrounding this asset class diminishes, that could elongate the bear market. However, the financial presstitutes, as Nassim Nicholas Taleb calls them, are hooked on crypto. There is real pathos in this industry. The most-read financial stories will continue to be about this space and people therefore will continue to wonder what all the fuss is about. That will continue to drive new money into the system.

For short-term traders, the amount of new fiat entering the system is the most pressing concern. If you believe the correction results in no new blood entering, then as weak hands cash out they will drive prices lower on the margin. However crypto traders are volatility junkies. Once you trade crypto, even when the equity market “crashes” 5%, you merely brush it off your shoulders.

For long-term “investors”, nothing has changed about the technological merits of Bitcoin or your favourite shitcoin. Either the coin or token will be useful or it won’t. The market gyrations are irrelevant.

The only certainty is that price volatility will rise as the crypto complex is chopped into bits. For us crypto traders, this is going to be an amazing first quarter.


Abstract: Tether is a crypto token based on top of Bitcoin and Ethereum’s blockchains, the value of which is pegged to the US dollar by centralised USD reserves. There is scepticism about Tether, with accusations that the system is not backed by sufficient reserves. We think that this Tether scepticism is mostly focused on the wrong issue. We have found possible evidence in published financial data that the impact of Tether is visible in Puerto Rico’s banking system. Tether is likely to be, or is already, encountering problems related to regulation and we think this should be the primary long-term concern for Tether holders.

About Tether

Tether is a scheme that allows fiat currencies such as the US dollar to be used on the Bitcoin (and Ethereum) blockchain. The abstract of the Tether white paper explains:

A digital token backed by fiat currency provides individuals and organizations with a robust and decentralized method of exchanging value while using a familiar accounting unit. The innovation of blockchains is an auditable and cryptographically secured global ledger. Asset-backed token issuers and other market participants can take advantage of blockchain technology, along with embedded consensus systems, to transact in familiar, less volatile currencies and assets. In order to maintain accountability and to ensure stability in exchange price, we propose a method to maintain a one­-to-­one reserve ratio between a cryptocurrency token, called tethers, and its associated real­world asset, fiat currency. This method uses the Bitcoin blockchain, proof of reserves, and other audit methods to prove that issued tokens are fully backed and reserved at all times

The Tether token therefore exists on top of the Bitcoin and Ethereum blockchains, with around 97% and 3% of its tokens existing on each chain respectively. On Bitcoin, its tokens exist similarly to coloured coins and use the Omni layer, whose protocols interpret extra meaning from some surplus Bitcoin transaction data — for example, the creation or transfer of Tether.

The primary use case of Tether appears to be financial speculation, with many exchanges allowing their customers to buy and sell Tether in exchange for crypto tokens such as Bitcoin. Currently, around 2.2 billion Tether, representing US$2.2 billion, exist. As the chart below illustrates, about 85% of Tether holders are known, with the largest holders being the biggest crypto token exchanges. There is likely to be some mechanism by which these large holders can redeem Tether directly for USD, which we speculate on at a later point in this report.

Tether owners in February 2018 listed in millions of USD. (Source: Tether rich list, Tether transparency report)

The Tether hack

It appears as if the Tether treasury wallet was hacked in November 2017. US$31 million was stolen and sent to an external Bitcoin address, where it remains in quarantine. On 21 November, Tether released a forked client of OmniCore. This froze the stolen funds and was essentially a hardfork of the Omni layer. Since the Tether company backs the Tether token with real USD, Tether users had to upgrade, since Tether would obviously only back the tokens on their chosen side of the fork. As Tether put it:

We strongly urge all Tether integrators to install this software immediately.

The hacking incident demonstrated that Tether is effectively in complete control of the ledger, as they can force a hardfork at will and reverse any transaction — although there may not have been any doubt about Tether’s control beforehand. This raises the question of why Tether bothers to put the database on the Bitcoin and Ethereum blockchains at all — it would be far cheaper for Tether to create its own public database without needing to pay fees to the miners. Although the Tether company was and is able to freeze funds, the process is technically difficult and time consuming, as it requires new software to be written and released and for all Tether exchanges to upgrade.

Who controls Tether?

The Tether “About us” page only appeared between 5 December 2017 and 7 December 2017, and it revealed that Tether had the same management team as the Bitfinex exchange, as the table below illustrates. This is approximately when Tether is said to have received a subpoena from the US Commodities Futures Trading Commission (6 December 2017). Prior to this point, Tether did not disclose its management team — on the website, at least — although it was widely believed that Bitfinex was behind Tether. The timing appears to suggest that the subpoena may have prompted the greater transparency.

Bitfinex Senior Team Tether Team
JL van der Velde (CEO) JL van der Velde (CEO)
Giancarlo Devasini (CFO) Giancarlo Devasini (CFO)
Philip Potter (CSO) Philip Potter (CSO)
Stuart Hoegner (general counsel) Stuart Hoegner (general counsel)
Matthew Tremblay (chief compliance officer) Matthew Tremblay (chief compliance officer)
Paolo Ardoino (CTO)
Chris Ellis (community manager)

Tether and Bitfinex have essentially the same management team. (Source: Tether, Bitfinex)

The Paradise Papers, released in November 2017, revealed that Bitfinex’s CFO and CSO are owners and directors of Tether respectively. There was already little doubt about the link between Tether and Bitfinex prior to full disclosure on Tether’s website.

Tether management and owners. (Source: Paradise Papers)

Some think that Tether may have previously implied that Bitfinex doesn’t control Tether. For example, Craig Sellars, a Tether founder and advisor — and a former CTO of Bitfinex — stated on Reddit in spring 2017:

Bitfinex is a customer of Tether. If Bitfinex wants more USD, they make a request to Tether, just like all other Tether customers. Tether waits for USD to show up, and when it does, creates the necessary tethers and credits Bitfinex.

That comment left much open to interpretation but certainly did not explicitly state that Bitfinex does not control Tether. In this comment, a month prior to the above one, Sellars specifically states that he and Bitfinex CSO Phil Potter were discussing how to improve Tether. Sellars was also open about his simultaneous involvements in Tether and Bitfinex, as his LinkedIn profile indicates:

  • April 2014 to present: Tether founder and advisor
  • January 2015 to May 2016: Bitfinex CTO
  • April 2014 to May 2016: Tether founder and CTO

We do not think there is evidence that Tether misled the public about Bitfinex’s involvement, which some have claimed.

The Tether audit

The Tether homepage states that:

Our reserve holdings are published daily and subject to frequent professional audits.

The accounting firm Friedman LLP (FLLP) published a report in September 2017 in which  it confirmed that the USD balances that Tether was supposed to hold. The report stated that as of 15 September 2017, a bank held $382,064,782 in an account in the name of Tether.

However, the report did not disclose the names of any of the banks nor did it mention the jurisdictions in which the banks operate. The report also stated that:

FLLP did not evaluate the terms of the above bank accounts and makes no representations about the Client’s ability to access funds from the accounts or whether the funds are committed for purposes other than Tether token redemptions.

In January 2018, Tether ended its relationship with FLLP and explained with this emailed statement.

We confirm that the relationship with Friedman is dissolved.  Given the excruciatingly detailed procedures Friedman was undertaking for the relatively simple balance sheet of Tether, it became clear that an audit would be unattainable in a reasonable time frame. As Tether is the first company in the space to undergo this process and pursue this level of transparency, there is no precedent set to guide the process nor any benchmark against which to measure its success.

The statement indicates that there is a lack of transparency and the audit processes appears inadequate, or at least inconsistent with the promises made on the Tether website. This  likely contributed to the rumors in the cryptocurrency community — for example, claims that Tether is a Ponzi scheme.

Lack of transparency does not necessarily indicate fraud

Tether allows its users to send and receive USD. Transactions cannot easily be blocked and users require no permission — although one notable exception to this is Tether requiring all users to upgrade to a new client in order to block transactions, which is the cumbersome process that occurred after the $31 million hack.

Tether also potentially allows users a degree of anonymity when making or receiving transactions. Its characteristics potentially make it attractive to criminals, just like Bitcoin. While those with the ability to issue and redeem Tether, such as exchanges, are required to go through approval and KYC processes, individual users can use Tether merely by generating a public/private key pair, again just like Bitcoin.

Regulators are unlikely to be particularly happy about this and banks are likely to consider Tether with scepticism. Tether also requires the use of a bank, to hold the USD reserves required to back Tether. Many banks are likely to approach Tether cautiously, and accepting Tether as a client may violate a bank’s compliance procedures such as rules meant to prevent money laundering.

Therefore, Tether may have a problem: either the company may try to conceal aspects of how Tether operates from the reserve bank or the company may need to find a bank with compliance procedures that are not as strict as those of the most prominent financial institutions. We suspect that Tether may have struggled to find appropriate banking relationships and may have had accounts with many banks in many jurisdictions as it tried to find the right partner. We believe this is likely to be the primary reason for the apparent lack of transparency, rather than a lack of USD reserves. The transparency that some Tether stakeholders seem to expect may not be possible in the financial sector when the underlying activity is not clearly authorized or regulated by the authorities.

The Bitfinex exchange may have revenues in excess of US$1 million per day during the recent crypto currency bubble (assuming 100,000 BTC volume per day, 0.1% commission, and a $10,000 BTC price). Even if Tether were experiencing problems, Bitfinex may have resources sufficient to bail out the system. This wealth may also remove some of the incentive to run a fraud or a Ponzi scheme of the type some of the Tether sceptics allege.

Financial data from Puerto Rico

Rumors have been circulating that Tether may have some link to the unincorporated American territory of Puerto Rico. We decided to analyse public financial data to look for signs of unusual activity or strong growth.

We noticed strong growth in the cash balance (and the deposit balance) in the International Financial Entities (IFE) banking category. This sharp increase in cash reserves could be related to Tether. It is also possible for this growth to be related to a non-Tether aspect of the crypto currency ecosystem — for example, plans to make Puerto Rico a crypto utopia.

The chart below compares the value of Tether issued versus the deposit balance for the IFE banking category in Puerto Rico. The match is far from perfect and we cannot draw any strong conclusion from the data. It will be interesting to see what figures the regulators in the region produce going forwards.

Puerto Rico’s IFE aggregate deposits versus Tether in millions of USD. (Source: IFE Accounts, BitMEX Research, Coinmarketcap)

In addition to the growth of the total cash balance, we noticed that the cash balance was growing as a proportion of total assets, as the chart below illustrates.

 Puerto Rico’s IFE aggregate cash as a proportion of total assets. (Source: IFE Accounts, BitMEX Research)

This kind of balance-sheet structure is unusual. Normally, banks lend most of their assets and only keep a small balance as cash. The table below shows a simplified typical structure of bank balance sheets.

Illustrative example of the balance sheets of a typical bank and a 100% reserve bank respectively. (Source: BitMEX Research)

Full-reserve banking results in a different balance sheet, which should be detectable by financial analysts even when looking at macroeconomic data. As of the end of September 2017, the ratio of cash to total assets for this category of financial institution in Puerto Rico rapidly climbed to over 70%. This may indicate the presence of full-reserve banking in the territory and that the practice is growing.

Full-reserve banking

Full-reserve banking (also called 100% reserve banking) is when a bank does not lend deposits but keeps all deposited funds either in the form of physical cash or electronically on deposit at a custody bank or the central bank. Full-reserve banking is a fringe concept in modern finance often associated with the Austrian School of economics and libertarianism (or even a Bitcoin type of philosophy). Full-reserve banking is said to make the financial system less susceptible to credit expansion, something Bitcoin is also said to be able to achieve. The main benefit of this is that it could make the economy less likely to experience business cycles, as we explained in our earlier piece.

Noble Bank

We looked at all the financial institutions in the IFE category in Puerto Rico, and identified two banks which claim to be full-reserve banks: Euro Pacific International Bank and Noble Bank International. Full-reserve banks are rare, so while we can’t rule out the existence of any others, it may be unlikely that any others are operating.

Extract from the list of registered IFEs in Puerto Rico. Noble is highlighted in red by BitMEX Research.(Source: Commissioner of Financial Insitutions of Puerto Rico)

Euro Pacific Bank is run by Peter Schiff, a well-known Austrian economist and Bitcoin sceptic. Due to this scepticism, we think it is unlikely that Schiff would become involved in a Bitcoin-related entity like Tether.

Noble Bank, however, is involved in the crypto space and therefore could be involved in Tether. Evidence of Noble’s involvement in cryptocurrency includes the following extract from a letter to the regulator that the bank sent in 2015:

Noble intend to operate an integrated financial market network for the trading, clearing, and settlement of real currency, Bitcoin and other digital currencies

Noble is also the bank that entered into a Bitcoin-related business partnership with Nasdaq in 2015. We suspect that the growth in reserves in this section of the financial services industry in Puerto Rico is related to Noble Bank and cryptocurrency, whether or not this involves Tether.

The founder and CEO of Noble Bank, John Betts, was also behind the 2014 Sunlot Holdings move to take over and potentially rescue MtGox. Sunlot was backed by Brock Pierce, one of the founders of Tether.

Of course, a previous professional relationship between the Noble Bank CEO and one of the Tether founders proves nothing, and the blockchain ecosystem is a small space so such connections are likely. We would like to emphasize that even if Noble Bank is the primary reserve bank of Tether, none of this is evidence that Noble Bank has done anything inappropriate or illegal.

In a Medium post, Noble describes how it lets “clients to create their own pools of credit” and explains the structure of this system with the following illustration.

(Source: Medium)

It is possible that the above model could be the underlying structure behind Tether, and this could explain how it is backed by US dollars. This would indicate the USD that back Tether are inside the Puerto Rican banking system with the reserves held by BNY Mellon, Noble’s custody bank, which is the largest custody bank in the world. If true, this would imply that Tether is not a Ponzi scheme, since the USD reserves are present and being reported to the authorities, and that the reserves may be relatively safe. Although, as we explain later in this report, this should not provide complete comfort for Tether holders in the long term.

Case studies

As we mentioned above, Tether has the following characteristics:

  • No permission is required to send or receive Tether.
  • Transactions cannot be easily blocked.
  • Tether users may be able to obtain a degree of anonymity.

These characteristics may make the system attractive for criminals and money launderers — and if criminal activity becomes too prevalent, the authorities may wish to shut the system down. This has already happened numerous times in the past, as the case studies below demonstrate. In a later report, we may dig into the history of these case studies in more detail.

Liberty Reserve (2006-2013)

Liberty reserve was a Costa Rica-based centralized digital-currency service that let users  send and receive USD-denominated payments over the Internet. Payments could be made using email addresses and there was no procedure to identify those using the system. In 2013, Costa Rican authorities closed the service, accusing the system of facilitating the laundering of US$6 billion of criminal proceeds in the indictment. The founder of the service was arrested and sentenced to prison. The BBC described the service as follows:

Cash could be put into the service using a credit card, bank wire, postal money order or other money transfer service. It was then “converted” into one of the firm’s own currencies – mirroring either the Euro or US dollar – at which point it could be transferred to another account holder who could then extract the funds.

GoldAge (1999-2006)

Prior to founding Liberty Reserve, the same founders ran GoldAge, a gold-based payment platform that was also shut down by the authorities. As the US Justice Department put it:

The defendants had transmitted at least $30 million to digital currency accounts worldwide since beginning operations in 2002. The digital currency exchanger, GoldAge, received and transmitted $4 million between January 1, 2006, and June 30, 2006, as part of the money laundering scheme.

e-Bullion (2001-2008)

e-Bullion was a centralized Internet-based gold-payment system. In 2008, the co-founder of the system was murdered. As a result, the US government confiscated the company’s assets and the system was shut down.

DigiCash (1994-1998)

Perhaps one of the most interesting of the centralised pegged-payment platforms was DigiCash. Developed by David Chaum, DigiCash had strong anonymity technology based on blind signatures built into the system. The platform resembled modern distributed anonymity-based tokens like Monero.

Although DigiCash was centralised, the operator was unable to obtain details about the transactions because everything was anonymous, and therefore the transactions themselves were, in a sense, fully censorship resistant. However, the company eventually failed and in 1998 filed for bankruptcy.

Censorship resistance has two sides: one, that transactions themselves cannot be blocked and the second being that the entire system cannot easily be shut down. The first is relatively easy to achieve though anonymity-based technology such as ring signatures, while the second is more challenging.

The US Justice Department lists other examples of shut-down Internet-based payment systems, including the following.

E-gold (1996-2007)

On April 27, 2007, a federal grand jury in Washington, D.C., indicted two companies operating a digital currency business and their owners. The indictment charges E-Gold Ltd., Gold and Silver Reserve, Inc., and their owners with one count each of conspiracy to launder monetary instruments, conspiracy to operate an unlicensed money transmitting business, operating an unlicensed money transmitting business under federal law, and one count of money transmission without a license under D.C. law. According to the indictment, persons seeking to use the alternative payment system E-Gold were only required to provide a valid Email address to open an E-Gold account–no other contact information was verified. The indictment is the result of a 2½-year investigation by the U.S. Secret Service with cooperation among investigators, including the Internal Revenue Service (IRS), the Federal Bureau of Investigation (FBI), and other state and local law enforcement agencies. According to Jeffrey A. Taylor, U.S. Attorney for the District of Columbia, “The defendants operated a sophisticated and widespread international money remitting business, unsupervised and unregulated by any entity in the world, which allowed for anonymous transfers of value at a click of a mouse. Not surprisingly, criminals of every stripe gravitated to E-Gold as a place to move their money with impunity.”


On June 29, 2006, Andrew [Mantovani] was sentenced to 32 months in federal prison for cofounding Shadowcrew.com, an international online discussion forum with more than 4,000 members, many of whom specialized in identity theft and fraud. Shadowcrew members sent and received payments for goods and criminal services through digital currencies. One indicted member, Omar Dhanani, operated an illegal currency exchange, providing members a money laundering service in digital gold by anonymously converting their illicit cash. Dhanani stated that Shadowcrew members used digital gold in order to avoid traditional banking systems. A yearlong investigation by the U.S. Secret Service led to the October 2004 arrest of 21 individuals in the United States, with several other arrests in foreign countries.

Western Express International Currency Exchange Company (2002-2005)

On February 22, 2006, Vadim Vassilenko, Yelena Barysheva, and Alexey Baryshev were indicted by the state of New York for operating an illegal check-cashing and money transmittal business from 2002 through 2005. Their company, Western Express International, acted as a currency exchanger, knowingly exchanging criminal proceeds for digital currencies. Through its web sites, Western Express actively solicited overseas clients in eastern Europe, Russia, and the Ukraine to operate illegally in the United States. Clients using fictitious, often multiple identities committed a variety of cyber crimes, such as reshipping, phishing, spoofing, and spamming. Items purchased with stolen credit card numbers were resold for digital gold, which was further laundered through Western Express. A total of $25 million flowed through the company’s bank accounts over the 4-year period, in violation of New York banking regulations.


History has shown that centralised systems with certain characteristics (censorship resistance or anonymous transactions) tend to get shut down by the authorities. Tether shares some of the same characteristics as these extinguished services so it may also attract criminals and ultimately suffer the same fate.

In our view, Tether has two choices:

  1. Reform the system to include KYC/AML procedures that allow the operator to easily block transactions or freeze funds. In order to do this, Tether may need to fundamentally change its technological architecture and perhaps leave the public blockchains. Essentially, Tether would just be turning into a traditional (or full-reserve) bank.
  2. Continue as is and risk being be shut down by the authorities at some point.

If Tether is shut down, there is a risk that some users may lose access to their funds, perhaps temporarily. We do not recommend holding Tether for the long term, but not for the reasons some of the sceptics typically pronounce. We think that criminal usage of Tether is likely to be relatively low because of the use of Tether for financial speculation, which is probably the system’s dominant use case. Furthermore, we have not found any evidence of criminals using Tether to launder funds. As it stands, we think an imminent shutdown is unlikely.

The case studies above illustrate the two angles to censorship resistance (individual transactions and the system as a whole) and what distributed crypto tokens need to achieve in order to be sustainable in the long run. If a payment system cannot block transactions, doesn’t require permission for use, or offers anonymous use, it will probably eventually be shut down. This could be just as true for systems like Tether and Ripple as it was for Liberty Reserve, E-gold, and DigiCash. A potential way around this is to try to build a distributed system that cannot be shut down (i.e., censorship resistance for the system as a whole).  Whether Bitcoin or other proof-of-work-based systems can achieve this is still unproven, in our view.


Whilst many claims made in this note are cited, we do not guarantee accuracy. We welcome corrections.

A blockchain-specific defensive patent licence

Abstract: Although the impact of patents on society is debatable, they can have negative impact on the blockchain space. Opening patents up is potentially crucial to the blockchain industry. Unfortunately, however, technology innovators may need to obtain patent protection for defensive purposes. A defensive patent licence (DPL) may be able to protect the ecosystem from the harmful restrictions of patents or mitigate some of the risks. We explain some potential deficiencies and loopholes in the current DPL and take a look at a new, improved licence, a blockchain DPL (BDPL).

(Source: Mises Institute)

Patents in the blockchain space

The issue of intellectual property (IP) is somewhat controversial in the libertarian and blockchain communities. Although patents and copyrights are generally accepted by most, many libertarians regard these systems as unethical state-granted monopolies that impede economic prosperity. This negative view of IP is articulated by Stephan Kinsella in his article “Against Intellectual Property“, in which he describes a patent as follows:

A patent is a property right in inventions, that is, in devices or processes that perform a “useful” function. A new or improved mousetrap is an example of a type of device which may be patented. A patent effectively grants the inventor a limited monopoly on the manufacture, use, or sale of the invention. However, a patent actually only grants to the patentee the right to exclude (i.e., to prevent others from practicing the patented invention); it does not actually grant to the patentee the right to use the patented invention.  Not every innovation or discovery is patentable. The U.S. Supreme Court has, for example, identified three categories of subject matter that are unpatentable, namely “laws of nature, natural phenomena, and abstract ideas.” Reducing abstract ideas to some type of “practical application,” i.e., “a useful, concrete and tangible result,” is patentable, however.

Copyright, on the other hand, covers original works such as books, articles, movies, and computer programs. When it comes to the IP of blockchains or other technologies, patents seem to be more relevant than copyright, which applies more to works of art.

Whatever one thinks of the merits of patents, when it comes to assessing the efficacy of patents in the blockchain space, there are some specific considerations:

  1. A key feature of blockchains is their permission-less architecture, in which nobody has the ability to censor usage of the system (a.k.a. censorship resistance). If one patents a use or function in a blockchain-based system (such as a new transaction format), the patent holder and legal authorities may be unable to prevent its usage by others, potentially making patents unsuitable or unenforceable.
  2. A patent on a cryptocurrency mining technology could give the patent holder a competitive advantage over other miners. This could undermine the whole point of mining, which requires a degree of competition in order to be useful. If a miner or mining coalition achieves a significant proportion of the hashrate, they could censor some or all of the transactions, or even attempt to reverse transactions, potentially rendering the blockchain useless.

Therefore, although the efficacy of patents is debatable in general, many consider them negative with respect to blockchains and desire to avoid the usage of enforceable patents in the blockchain space altogether. Achieving this preferred outcome is not simple; it’s not sufficient for those who develop technology in this space simply to avoid patents. This approach would be vulnerable to so-called patent trolls who could patent these technologies at a later date and possibly hold hostage those blockchain businesses and users who use the patented technology. A form of protection against patent trolls is required.


One such tool to prevent or mitigate the risks of patent trolls is the DPL. Companies already using this include the Internet Archive and Blockstream. By signing the DPL, these companies essentially allow any company or individual to use all of their patented technologies for free, as long as they also join the DPL. In order to join the DPL, one must commit to put all one’s respective patents inside the DPL and to not make an infringing patent claim against any DPL member. This effectively forms a club, which anyone may join, whose members need not worry about using the patents owned by any other member. The use of DPLs is purely defensive, and the more entities that join the DPL, the better it is for the blockchain community.

Problems with the DPL

We have spoken to some patent holders in the ecosystem as well as legal experts, and some have identified potential deficiencies within the DPL. The DPL is a first-draft attempt at this scheme and many seem to acknowledge that there is significant scope for improvement.

Potential DPL loopholes include:

  1. The DPL mentions the licence can be revoked if a member transfers a patent to a separate, non-DPL entity that does not abide by the terms of the DPL. However, this restriction only applies once member has joined the DPL. It is possible, in theory, for an entity to transfer patents to an associated company before joining the DPL. In this scenario, the new DPL member who transferred the patent could collude with the company who received it to engage in aggressive patent claims against other DPL members, while still being free to use other patents in the DPL.
  2. Although the DPL prevents members from enforcing their patents among other members, it does not prevent third parties from enforcing patents. A third party may restrict some DPL members from using a patent while licensing that same patent to other DPL members. If this occurs, as in the figure below, any DPL members obtaining the rights to use the patent could have an advantage over other DPL members, which is exactly what the DPL was set up to prevent.

Company H is not a member of the DPL but it licenses the use of its patented technology to DPL member company A while engaging in enforcement action against the other DPL members. This gives company A an advantage, while company A is still a valid member of the DPL. (Source: BitMEX Research)

The new BDPL

A proposed blockchain-specific DPL scheme, the BDPL, aims to improve on the DPL with amendments and additional terms that hope to correct the loopholes identified above. The BDPL still retains the core defensive properties of the original DPL, granting a licence to all members who join the BDPL.

This first loophole is fixed with an amendment to one of the terms in the licence. The original DPL merely prevents a member from making any non-defensive patent claim against another member. The new terms also prevent a member, “whether individually or in collusion with each other or with any other person”, from making a non-defensive claim. This stricter requirement may make the type of collusion mentioned above more difficult.

The second loophole is fixed by adding a new term to the licence. This is a requirement that specifies that the licence will be revoked if members use any patent licensed by a third party, when such a licence “is or is likely to be” enforced and restricted from use by another BDPL member. This should prevent a scenario such as the one illustrated above.


In our view, this new BDPL offers an improved, more robust alternative to the existing system. However, it is more onerous in some respects than the old scheme — for example, there are stricter requirements about making public notices. In addition, closing the circumvention loopholes requires a tradeoff: a BDPL member could be caught between a rock and a hard place if it licenses a crucial technology from a non-BDLP member who then begins enforcement action against other BDLP members without the knowledge of the licensee. Fixing this problem within the licence may not be possible, although mitigating this risk could be possible with additional licensing terms preventing aggressive action against other BDPL members.

Providing patent owners with more choices can only be beneficial and this new licence is a positive addition to the blockchain space. This scheme may be more robust and therefore more attractive to patent holders, while maintaining the defensive nature that can protect the ecosystem from the harmful effects of patents. We have spoken to patent owners who have indicated that they may prefer the BDPL to older schemes. While it would be beneficial were such defensive schemes to become popular, it is difficult to predict which, if any, will succeed.

We think the BDPL is both a significant improvement and more likely to be adopted than the DPL. If adopted, the BDPL could substantially benefit the ecosystem, mitigating one of the risks silently looming over the blockchain space.


The Ripple story

Abstract: In this piece, we briefly look over the history of Ripple and examine various disputes between the founders and partner companies, typically over control of XRP tokens. We then explore elements of the technology behind Ripple. We conclude that the apparent distributed consensus mechanism doesn’t serve a clear purpose, because the default behaviour of Rippled nodes effectively hands full control over updating the ledger to the Ripple.com server. Therefore, in our view, Ripple does not appear to share many of the potentially interesting characteristics crypto tokens like Bitcoin or Ethereum may have, at least from a technical perspective.

Jed McCaleb (left) joined Ripple in 2011. Chris Larsen (right) joined the company in 2012. (Source: BitMEX Research)


On 4 January 2018, the Ripple (XRP) price reached a high of $3.31, an incredible gain of  51,709% since the start of 2017. This represented a market capitalization of $331 billion, putting Ripple’s valuation in the same league as Google, Apple, Facebook, Alibaba, and Amazon — the largest tech giants in the world. According to Forbes, Chris Larsen, the executive chairman of Ripple, owns 17% of the company and controls 5.19 billion XRP, worth around $50 billion at the time of the peak, making him one of the richest people in the world. Despite this incredible valuation, many of the market participants do not appear to know much about Ripple’s history or the technology behind it. In this piece, we provide an overview of the history of Ripple and look at some of its technical underpinnings.

History of Ripple

RipplePay: 2004 to 2012

Ryan Fugger founded a company he called RipplePay in 2004. The core idea behind the protocol was a peer-to-peer trust network of financial relations that would replace banks.

The RipplePay logo during that period of the company’s existence. (Source: Ripplepay.com)

RipplePay’s basic theory was as follows:

  • All banks do is make and receive loans. A bank deposit is a loan to the bank from the customer.
  • A payment from Bob to Alice in the traditional banking system is simply an update to their respective loan balances to the bank, with Bob’s loan to the bank declining slightly and Alice’s increasing slightly.
  • RipplePay held that one could replace banks by creating a peer-to-peer trust network in which individuals could directly loan each other, and alterations to these loan balances enable payments.
  • Payments, then, are simply updates to these loan balances, provided the system can find a path of relationships from the payer to the recipient.

In this example, the person on the far right side of the lineup makes a payment of $20 to the person on the far left. Although the payer and recipient do not directly trust each other, the payment transfers through a chain of IOUs forged of seven people who are linked by six trusted relationships. (Source: Ripple.com)

The network architecture is not dissimilar to the idea behind the Lightning Network, except with counterparty risk, something which Lightning avoids. In our view, this model is likely to be unstable and the trust networks are unlikely to be regarded as reliable — and therefore we are unsure of its efficacy. Either the system would centralise towards a few large banks and fail to be sufficiently different to the existing financial system or it would be liable to regular defaults. However, the current Ripple system is very different to this original idea.

At the start of 2011, Bitcoin was gaining some significant traction and began to capture the attention of Ripple’s target demographic. To some extent, Bitcoin had succeeded where Ripple had failed, building a peer-to-peer payment network with what appeared to be a superior architecture to Ripple. In May 2011, Jed McCaleb, an early Bitcoin pioneer, joined Ripple, perhaps to address some of these concerns.

McCaleb had founded the Mt. Gox Bitcoin exchange in 2010, which he sold to Mark Karpeles in March 2011. According to an analysis of the failure of Mt. Gox by WizSec’s Kim Nilsson, the platform was already insolvent, to the tune of 80,000 BTC and $50,000, in March 2011 when McCaleb sold it. Shortly after this, Ryan Fugger handed the reins of the Ripple project to McCaleb.

This video from June 2011 describes some of the philosophy and architecture of Ripple after McCaleb had joined the project:

OpenCoin: September 2012 to September 2014

The Ripple logo during the OpenCoin period. (Source: Ripple.com)

In 2012, McCaleb hired Chris Larsen, who remains on the board today as the executive chairman and whom the current website describes as a co-founder of Ripple. This marked the start of the OpenCoin era, the first of three name changes between 2012 and 2015. Larsen is the former chairman and CEO of E-Loan, a company he co-founded in 1996, took public in 1999 at the height of the tech bubble, and then sold to Banco Popular in 2005. Larsen then founded Prosper Marketplace, a peer-to-peer lending platform, which he left to join Ripple in 2012.

Larsen is not new to volatile prices and price bubbles. E-Loan experienced a peak-to-trough fall of 99.1% between 1999 and 2001. E-Loan’s IPO share price stood at $14 on 28 June 1999 before selling for $4.25 per share in 2005. (Source: Bloomberg)

To address the success of Bitcoin, Ripple now planned to allow Bitcoin payments on its network, potentially as a base currency for settlement. This period also marked the launch of the Ripple Gateway structure. The community realized that the peer-to-peer structure did not seem to work, with ordinary users unwilling to trust counterparties sufficiently to make the network usable for payments. To address this, Ripple decided to form gateways, large businesses that many users would be able to trust. This was said to be a  compromise, a hybrid system between traditional banking and a peer-to-peer network.

How Ripple gateways work. (Source: Ripple.com)

In late 2012, OpenCoin opposed the usage of the name “Ripple Card” by Ripple Communications, a telecom company that predated the launch of the Ripple payment network. This may illustrate the start of a change in culture of the company, with a willingness to use the law to protect the company, and a change in strategy to focus more on the Ripple brand.

Ripple Communications is an unrelated telecom company based in Nevada that held the Ripple.com domain and used the Ripple name before the Ripple payment network came into being. (Source: Internet Archive)

In October 2012, Jesse Powell, the founder and CEO of the Kraken exchange (which launched in 2011) and close friend of McCaleb, participated in Ripple’s first seed round with an investment believed to total around $200,000. Roger Ver is also said to have been an early investor in Ripple, apparently investing “before even the creators knew what it was going to be”.

XRP token launch: January 2013

Ripple released its XRP coin in January 2013. Like Bitcoin, XRP is based on a public chain of cryptographic signatures, and therefore did not require the initial web of trust or gateway design. XRP could be sent directly from user to user, without the gateways or counterparty risk, which was the method used for all currencies on Ripple, including USD. Ripple perhaps intended XRP to be used in conjunction with the web of trust structure for USD payments — for example, to pay transaction fees. The company set the supply of XRP at a high level of 100 billion, with some claiming this would help Ripple prevent sharp price appreciation. Critics argued that the XRP token may not have been a necessary component of the network.

In April 2013, OpenCoin received $1.5 million in funding from Google Ventures, Andreessen Horowitz, IDG Capital Partners, FF Angel, Lightspeed Venture Partners, the Bitcoin Opportunity Fund, and Vast Ventures. This was the first in many rounds of venture funding and it included some of the most respected venture-capital companies in the world.

McCaleb left the project sometime between June 2013 and May 2014. Although his departure appears to have only been widely discussed within the Ripple community starting in May 2014, later statements from the company indicates he ended his involvement in June 2013 when Stefan Thomas took over as CTO. Thomas had created the We Use Coins website in March 2011 and the 2011 “What is Bitcoin?” YouTube video.

McCaleb appears to have disagreed with Larsen on strategy and then was seemingly forced out of the project, based on support Larsen received from the new venture-capital investors. After leaving Ripple, McCaleb went on to found Stellar in 2014, a project said to be based on some of the original principles behind Ripple.

Ripple Labs: September 2013 to October 2015

In September 2013, OpenCoin became Ripple Labs.

In February 2014, Ripple implemented the “balance freeze” feature, which it activated in August 2014. This allowed Ripple gateways to freeze or even confiscate coins from any user of its gateway, even without a valid signature for the transaction. The motivation of this was said to be to enable gateways to comply with regulatory requirements, for example, a court order demanding the confiscation of funds. The default setting for a gateway was to have the freeze feature enabled, but it was possible for a gateway to disable this option by using a “NoFreeze” flag, such that tokens a gateway owed could not be frozen or confiscated using this feature. The largest gateway at the time, Bitstamp, did not opt out of the freeze feature.

In May 2015, regulatory authorities in the United States fined Ripple Labs $700,000 for violating the Bank Secrecy Act by selling XRP without obtaining the required authorisation. Ripple additionally agreed to remedial measures, the most onerous of which are summarised below:

  • Ripple Labs must register with FinCEN.
  • If Ripple gives away any more XRP, those recipients must register their account information and provide identification details to Ripple.
  • Ripple must comply with AML regulations and appoint a compliance officer.
  • Ripple must be subject to an external audit.
  • Ripple must provide data or tools to the regulators that allows them to analyse Ripple transactions and the flow of funds.

Ripple: October 2015 to present

In October 2015, the company simplified its name to Ripple.

The current Ripple logo. (Source: Ripple.com)

In September 2016, Ripple raised $55 million in funding in a round lead by Japan’s leading online retail stock-brokering company, SBI Holdings (8473 JP). SBI acquired a 10.5% stake in Ripple. As we mentioned in our “Public companies with exposure to the crypto space” piece, this is part of a wide range of SBI investments into crypto. SBI and Ripple have set up a joint venture, SBI Ripple Asia, which is 60% owned by SBI and 40% owned by Ripple. The company is hoping to provide a settlement platform using Ripple’s “distributed financial technology”.

In September 2017, R3, another blockchain company, sued Ripple. R3 argued that Ripple agreed in September 2016 to give it the option to buy 5 billion XRP at an exercise price of $0.0085 before September 2019. At the peak, the intrinsic value of this call option was worth around $16.5 billion. R3 alleges that in June 2017, Ripple terminated the contract, despite having no right to do so. Ripple then filed a counter case, alleging that R3 did not honour its side of the original 2016 agreement by failing to introduce Ripple to a large number of banking clients or to promote XRP for usage in these banking systems. As of February 2018, the case is unresolved.

Ripple supply and company reserves

When Ripple was founded, it created 100 billion XRP tokens of which 80 billion tokens were allocated to the company and 20 billion were given to the three founders. Here is an approximate breakdown of the distribution of those tokens:

  • The Ripple company received 80 billion XRP.
  • Chris Larsen received 9.5 billion.
    • In 2014, Larsen committed to put 7 billion XRP of this 9.0 billion into a charitable foundation.
  • Jed McCaleb received 9.5 billion. Upon leaving Ripple:
    • McCaleb retained 6.0 billion (subject to lock up agreement).
    • McCaleb’s children received 2.0 billion (subject to lock up agreement).
    • 1.5 billion was given to charity and other family members of McCaleb (not subject to lock up agreement).
  • Arthur Britto received 1.0 billion (subject to lock up agreement).

When McCaleb left Ripple, there were concerns he was, could or would dump his XRP into the market and crash the price. McCaleb and Ripple constructed the following agreement to prevent this by restricting the sale of XRP. The agreement was revised in 2016 after Ripple accused McCaleb of violating the initial terms.

2014 agreement
  • McCaleb’s sales are limited to $10,000 per week during the first year.
  • Sales are limited to $20,000 per week during the second, third, and fourth years.
  • Sales are limited to 750 million XRP per year for the fifth and sixth years.
  • Sales are limited to 1 billion XRP per year for the seventh year.
  • Sales are limited to 2 billion XRP per year after the seventh year.

(Source: http://archive.is/cuEoz)

As for the 80 billion XRP held by the Ripple company, the plan was to sell or give away this balance, use the funds to fund company operations, and to use it to seed global money-transfer gateways. As the Ripple wiki says:

XRP cannot be debased. When the Ripple network was created, 100 billion XRP was created. The founders gave 80 billion XRP to the Ripple Labs. Ripple Labs will develop the Ripple software, promote the Ripple payment system, give away XRP, and sell XRP.

From December 2014 to July 2015, the company disclosed on its website the amount of XRP it held, the amount in circulation, and indirectly (by mentioning a reserve) the amount spent on company operations. The company did not distinguish between what it sold and what it gave away for free. The disclosure for 30 June 2015 is shown below.

(Source: Ripple.com)

Some time after July 2015 the disclosure was modified, with the reserve balance no longer available. Since at least late 2017 Ripple disclosed three figures, the “XRP held by Ripple”, “XRP distributed” and “XRP to be placed in escrow”. As at 31 January 2018, the balances are as follows:

  • 7.0 billion XRP held by Ripple
  • 39.0 billion XRP distributed
  • 55.0 billion XRP placed in escrow

We have been unable to link or reconcile the old Ripple reserve figure with the new XRP held by Ripple figure, therefore we are unsure how much the company has spent on its own operations across the entire period. However, we have analysed the information disclosed in the old way prior to July 2015, 12 data points in total, in addition to forum posts from the company’s current chief cryptographer David Schwartz (regarded as one of the main architects of Ripple’s technology, who goes by the name JoelKatz online and is said to have had 1 billion XRP). The following charts present our findings related to the distribution or spend of XRP.

XRP holdings from 2013 to 2015 – billion. (Source: BitMEX Research, Ripple.com)

XRP distribution (sales to partners plus XRP given away) and XRP spent on company operations – billions. The crosses represent points where information was available. We are not aware of why the amount spent on company operations appears to decline towards the end of 2015. (Sources: Ripple.com, https://forum.ripple.com/viewtopic.php?f=1&t=3645, https://forum.ripple.com/viewtopic.php?f=1&t=3590)

XRP in circulation – billions. (Source: Ripple.com, https://forum.ripple.com/viewtopic.php?f=1&t=3645, https://forum.ripple.com/viewtopic.php?f=1&t=3590, Coinmarketcap/new Ripple disclosure)

The data shows that Ripple sold or distributed 12.5 billion XRP from January 2013 to July 2015. We have been unable to determine how many XRP were sold, at what price, or how many were given away. The company spent at least 4 billion XRP on company operations between March 2014 and July 2015 but there are no details of what this was spent on, as far as we can tell.

Dispute between company founders

As we alluded above, McCaleb did not part with the company on the best of terms. In May 2014, early Ripple investor Jesse Powell described the situation:

Since Jed’s departure, the management of the company has taken a different direction. Sadly, the vision Jed and I had for the project in the early days has been lost. I’m no longer confident in the management nor the company’s ability to recover from the founders’ perplexing allocation to themselves of 20% of the XRP, which I had hoped until recently would be returned. Prior to Jed’s departure from Ripple, I had asked the founders to return their XRP to the company. Jed agreed but Chris [Larsen] declined — leaving a stalemate. This afternoon, I revisited the allocation discussion with the pair and again, where Jed was open, Chris was hostile.

Ripple responded to Powell with a claim that he was spreading false and defamatory information in violation of his obligations as a Ripple board member. The letter states:

In fact, as Chris has stated previously in discussions with you and Jed, he has been and remains willing to return most of his founders’ XRP to Ripple Labs.

Powell retorted that Larsen would return only a portion of his XRP to the company, and rather than giving it back, this would be a loan. Powell ends the letter by explaining how he sees the situation with respect to the 20 billion XRP granted to the founders and the formation of Ripple:

Jed and I got started with Ripple in September of 2011. I believe Chris joined sometime around August of 2012. Prior to Chris joining, the company had two investors. I’m not sure when Jed and Chris allocated themselves the XRP but they say it was before incorporation, which occurred in September of 2012. In my view, the two stole company assets when they took the XRP without approval of the early investors, and without sharing the allocation amongst the other shareholders. Whatever coin they allocated themselves prior to incorporation of Opencoin, I believe was abandoned. There had been several ledger resets between Sep 2012 and Dec 2012, and a new version of Ripple emerged, built by Opencoin, clearly with company resources. If Jed and Chris have continued to run the old software to preserve their Betacoin, I have no problem. Unfortunately, Jed and Chris again allocated themselves XRP in December of 2012. That XRP unquestionably was not gifted by Jed and Chris to the company, it did not exist prior to the company’s existence, and it was generated with company resources. That XRP has always belonged to the company and it was taken from the company by Jed and Chris. I’m asking them to return what they’ve stolen.

Powell continued to comment on the situation on the Ripple forum:

The board and investors have known about it for a long time. I’d been nudging them to return the XRP since I found out about it. Jed was always willing but Chris wasn’t, and Jed kept his share in case leverage was ever needed to more aggressively persuade Chris to return his portion. It wasn’t a regular topic of discussion and was just something I just imagined would work itself out when Chris got a grasp on the damage it was doing to Ripple’s image and adoption. If my goal had been to get my fair share, I probably would have been more proactive about it but I’d just assumed it would eventually be entirely returned to the company. I could have agreed to a small amount of XRP being paid out in lieu of cash compensation or instead of equity, but otherwise, we all should have bought our XRP at the market rate, like everyone else.

The company, through marketing VP Monica Long, then responded to the Powell’s continued public pressure with the following commitment:

Further, co-founder and CEO Chris Larsen has authorized the creation of a foundation to distribute his donation of 7 billion XRP to the underbanked and financially underserved. This plan has previously been in development but is now being accelerated and finalized independent of a formal agreement amongst all the original founders. He believes this is both the right thing to do and the best way to remove further distractions in pursuit of the broader vision of the company. Details of the foundation, its independent directors, and the giveaway will be forthcoming.

The above response appeared to divert the pressure on Ripple and Larsen that was building inside the Ripple community. The foundation that was set up is Ripple Works. We have reviewed the charity’s US tax filings for the fiscal years ended April 2015 and April 2016, which show the following donations of XRP:

Date Donor Amount (XRP)
November 2014 Chris Larsen 200 million
April 2015 Chris Larsen 500 million
July 2015 Chris Larsen 500 million
November 2016 Ripple Inc 1,000 million

As of April 2016, two years after the commitment, Larsen appears to have given at least 1.2 billion XRP out of the promised 7 billion XRP total to the foundation. We have not been able to obtain the filling for the year ended April 2017, as it may not be available yet.

The dispute and the Bitstamp Ripple freeze incident

In 2015, Ripple took advantage of the Ripple freeze feature instituted in August 2014. The Bitstamp gateway froze funds belonging to a family member of Jed McCaleb. Some consider this ironic: Ripple originally stated that the freeze feature was implemented to enable gateways to comply with orders from law enforcement yet the first actual usage of the feature appears to have been an order to comply with an instruction from the Ripple company itself, against one of the founders.

What appears to have happened is a family member of McCaleb sold 96 million XRP (perhaps part of the 2 billion XRP given to other family members and not part of the lock-up agreement) back to Ripple for around $1 million. After Ripple acquired the XRP for USD, Ripple appears to have asked Bitstamp to use the Ripple freeze feature to confiscate the $1 million Ripple had just used to buy the tokens. In 2015, Bitstamp took both Ripple and McCaleb to court, to determine the best course of action.

Court documents allege/reveal the following:

  • McCaleb had 5.5 billion XRP.
  • McCaleb’s two children held 2 billion XRP.
  • Another 1.5 billion XRP were held by charitable organizations and other family members.
  • In March 2015, Jacob Stephenson, a relative of McCaleb, offered to sell 96 million XRP to Ripple.
  • Ripple agreed to pay nearly $1 million to buy the 96 million XRP from Stephenson in a complicated transaction that “manipulated the market” to “improperly inflate the price per XRP of the transaction and mislead other purchasers”. As part of this, Ripple paid more than the cost and asked Stephenson to return an excess amount of $75,000.
  • Bitstamp’s chief legal officer was also an advisor to Ripple and as such there was a conflict of interest.

The dispute between McCaleb and Ripple continued until a final resolution in February 2016, when the company, implying that McCaleb had violated the 2014 XRP lock-up agreement, stated that a final settlement had been reached:

Jed exited Ripple back when it was OpenCoin in June 2013. He has played no role in the strategy or operations of Ripple since then. He has, however, held significant stakes of XRP and company shares. In August 2014, we shared the terms of a lock-up agreement that dictated timetables and limits within which Jed could sell XRP. The purpose of the agreement was to ensure distribution of his XRP in a way that would be constructive for the Ripple ecosystem. Since April 2015, Jed has been party to ongoing legal action related to alleged violation of the 2014 agreement.

McCaleb responded to this with his side of the story, indicating that he was also happy with the final agreement.

This week also sees the end of a longstanding issue. Stellar and I have finally reached a settlement with Ripple in the ongoing dispute between the parties. The settlement shows that Ripple’s claims were entirely baseless. Ripple has conceded in exchange for Stellar and I agreeing to settle the litigation.

Under the final agreement, McCaleb’s family member’s $1 million were unfrozen, Ripple agreed to pay all legal fees, and 2 billion XRP were freed for donation to charity. McCaleb would be free to sell his remaining XRP, perhaps over 5 billion XRP, consistent with the terms in the table below.

2014 agreement 2016 revised agreement
  • McCaleb’s sales are limited to $10,000 per week during the first year.
  • Sales are limited to $20,000 per week during the second, third, and fourth years.
  • Sales are limited to 750 million XRP per year for the fifth and sixth years.
  • Sales are limited to 1 billion XRP per year for the seventh year.
  • Sales are limited to 2 billion XRP per year after the seventh year.
  • McCaleb must donate 2 billion XRP to charity
  • McCaleb must retain title ownership of 5.3 billion XRP; however, Ripple will control the funds.
  • McCaleb and the charity will be able to collectively sell the following percentage of the average daily volume:
    • 0.5% in the first year,
    • 0.75% in years two and three,
    • 1.0% for the fourth year, and
    • 1.5% thereafter.

(Source: http://archive.is/cuEoz)

The Ripple consensus process

The consensus system

The Ripple technology appears to have gone through several iterations, but a core part of the marketing of Ripple is the consensus process. In 2014, Ripple used the image below to illustrate the consensus system, which seems to be an iterative process with servers making proposals and nodes only accepting these proposals if certain quorum conditions are met. An 80% threshold of the servers is considered a key level and once this threshold is crossed, a node regards the proposal as final. The image depicts some complexity in the process and the BitMEX Research team is unable to understand the detailed inner workings of the system or how it has any of the convergent properties necessary for consensus systems.

(Source: Ripple wiki)

In January 2018, the BitMEX Research team installed and ran a copy of Rippled for the purpose of this report. The node operated by downloading a list of five public keys from the server v1.ripple.com, as the screenshot below shows. All five keys are assigned to Ripple.com. The software indicates that four of the five keys are required to support a proposal in order for it to be accepted. Since the keys were all downloaded from the Ripple.com server, Ripple is essentially in complete control of moving the ledger forward, so one could say that the system is centralised. Indeed, our node indicates that the keys expire on 1 February 2018 (just a few days after the screenshot), implying the software will need to visit Ripple.com’s server again to download a new set of keys.

A screenshot of Rippled in operation. (Source: BitMEX Research)

Of course, there is nothing wrong with centralised systems; the overwhelming majority of electronic systems are centralised. Centralisation makes systems easier to construct, more efficient, faster, cheaper to run, more effective at stopping double spends and easier to integrate into other systems. However, some Ripple marketing, like the image below, contends that the Ripple system is distributed, which some may consider misleading.

(Source: Ripple.com)

In addition to the potentially misleading marketing, the construction involving the quorum process and 80% threshold may not be necessary and merely adds to the obfuscation, in our view. Defenders of Ripple could argue that the list of five public keys is customizable, as one could manually edit the configuration file and type in whatever keys one wants. Indeed, there is a list of such validators on the Ripple website. However, there is no evidence that many users of Ripple manually change this configuration file.

Even if users were to modify the configuration file, this may not significantly help. In this circumstance, there is no particular reason to assume that the system would converge on one ledger. For example, one user could connect to five validators and another user could connect to five different validators, with each node meeting the 80% thresholds, but for two conflicting ledgers. The 80% quorum threshold from a group of servers has no convergent or consensus properties, as far as we can tell. Therefore, we consider this consensus process as potentially unnecessary.

Validation of the ledger

Although the consensus process is centralised, one could argue that in Ripple user nodes can still validate transaction data from all participants. This model can be said to provide some assurance or utility, despite its computational inefficiency. Although moving the ledger forward is a centralised process, if the Ripple servers process an invalid transaction, user nodes may reject those blocks and the entire network would then be stuck. This threat could keep the Ripple server honest. However, this threat may not be all that different from the existing user pressure and legal structures which keep traditional banks honest.

Apparently, Ripple is missing 32,570 blocks from the start of the ledger and nodes are not able to obtain this data. This means that one may be unable to audit the whole chain and the full path of Ripple’s original 100 billion XRP since launch. This could be of concern to some, especially given Powell’s comments, which indicate that there may have been resets of the ledger in the early period. David Schwartz explained the significance of the missing blocks:

It doesn’t mean anything for the average Ripple user. In January of 2013, a bug in the Ripple server caused ledger headers to be lost. All data from all running Ripple servers was collected, but it was insufficient to construct the ledgers. The raw transactions still survive, mixed with other transactions and with no information about which transaction went in which ledger. Without the ledger headers, there’s no easy way to reconstruct the ledgers. You need to know the hash of ledger N-1 to build ledger N, which complicates things.


Much of this report has focused on disputes, primarily related to control over XRP, including accusations of theft. Perhaps such disputes are not particularly unique, especially given the rapid, unexpected growth in the value of the ecosystem. In fact, this story of the disputes might not be too dissimilar from that of some of the large tech giants mentioned in the introduction to this piece.

More significant than the disputes is the fact that the Ripple system appears for all practical purposes to be centralised and is therefore perhaps devoid of any interesting technical characteristics, such as censorship resistance, which coins like Bitcoin may have — although this does not mean that Ripple or XRP is doomed to failure. The company has significant financial capital and has proven somewhat effective at marketing and forming business partnerships, and perhaps this could mean the company succeeds at building adoption of the XRP token either among businesses or consumers. If so, the points that Bitcoin critics often raise may be even more pertinent and relevant in the case of XRP. These points include:

  • The lack of inflation is a naive economic policy.
  • The price of the token is too volatile and speculative.
  • Regulators will shut the system down if it becomes popular.
  • Perhaps most importantly, why not use the US dollar? Banks will build competing digital systems based on traditional currencies (if they don’t exist already).

The real mystery about Ripple is that, given the large market value of the system, why are all the Bitcoin critics so silent? Perhaps the answer to this question is just as applicable to some of Bitcoin’s proponents as it is to its critics. Most people seem to judge things based on what they perceive as the culture and character of those involved, rather than on the technical fundamentals.


Whilst many claims made in this note are cited, we do not guarantee accuracy. We welcome corrections.

系统开发概要: 2018 年 2 月 2 日

在今天北京时间 21:00 , BitMEX 平台的交易量和实时注册量都创下了记录。此流量导致我们云伺服器上的代理网络流量堵塞,导致数据被迫进行备份。这些数据流太大最终导致一连串的网站用户请求新的数据映像,这么大的流量最后令网站一度瘫痪。

我们通过暂时停止交易,重置了受影响的平台服务及交易功能。之后几个小时的表现仍然不佳,但是我们成功解决了导致网速慢的两个主要系统之一。在撰写本文时,我们的读数显示网络延迟远远低于 24 小时平均值。

第二个系统将很快迁移,并将缓解这个问题。即便作出上述容量扩充,我们仍然面临引擎层面速度缓慢的情况,导致许多用户收到吓人的“过载”信息。我们了解客户正面临着这个问题,我们的团队也在积极解决该问题。解决方案涉及重新构建 BitMEX 操作系统,因此我们正在进行大量的规划和测试。一旦该项工作完成,我们会告知您。



NEO $100K Giveaway

BitMEX is happy to announce a new $100,000 giveaway for NEO (NEOG18) contracts!  

Start: Wednesday, 7 February 2018 at 00:00 UTC
End: Saturday, 17 February 2018 at 00:00 UTC


1 Grand Prize of 50,000 USD: The trader who continuously quotes the largest two-sided volume within a 0.5% spread gets the grand prize.*

1 Second Prize of 25,000 USD: The trader who continuously quotes the second largest two-sided volume within a 0.5% spread gets the second prize.*

1 Third Prize of 20,000 USD: The trader who has the largest profit (in XBT) from trading the NEO (NEOG18) contract gets the third prize.

1 Lucky Prize of 5,000 USD: Any trader who trades at least one NEO (NEOG18) contract automatically enters a random draw to win this prize.

*BitMEX will take snapshots of the orderbook at frequent intervals throughout the competition. A trader will add to their quoted volume in each snapshot by taking the minimum of their quoted bids and quoted asks within 0.25% either side of the midpoint. BitMEX will then sum that volume in each snapshot, and the trader with the largest cumulative volume at the end of the competition will win.

It’s simple to participate:

The BitMEX Team

Terms & Conditions:

1. BitMEX reserves the right to cancel or amend the giveaway or giveaway rules at our sole discretion.
2. Users who engage in market manipulation will be excluded from the contest. This determination will be made at the sole discretion of BitMEX.
3. Profit is defined as realized profit (in XBT terms) of all trades where the trade was opened and closed during the contest period window.
4. No user can win more than one prize.
5. Winners will be notified via email on 22 February 2018.
6. All awards are paid out in Bitcoin at the prevailing price of the .BXBT index at 17 February 2018 at 00:00 UTC.