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The Blind Trust Described in the Kleiman vs. Wright Lawsuit Is a Real Head-Scratcher

June 12, 2019 |

The Complexity Behind the Alleged Blind Trust Described in Kleiman v. Wright Lawsuit

There’s been a number of developments in the ongoing Kleiman vs. Wright lawsuit lately. After Craig Wright’s sworn deposition, the plaintiffs contend that Wright’s categorical refusal to answer questions about his bitcoin addresses and his marriage(s) needs to be reevaluated. Wright’s legal team say he’s done everything possible to comply with the court’s orders but the Kleimans believe the self-proclaimed Satoshi has been stonewalling for nine months.

Also Read: Satoshi’s Pre-Release Bitcoin Code Contains Fascinating Findings

The First 70 Blocks and the So-Called ‘Blind Trust’

The ongoing Kleiman vs. Wright lawsuit has started to heat up as the plaintiffs want more answers from Craig Wright, the man who claims to be Satoshi Nakamoto. The Kleiman estate represents the now deceased David Kleiman, a security researcher that some believe may have been a member of a pseudonymous group operating under the Satoshi Nakamoto monicker. According to Ira Kleiman, his brother David’s inheritance was manipulated during a multi-year partnership with Australian native Craig Wright. More recently Wright was deposed and refused to answer questions about his current and former wife and certain questions in regard to his alleged bitcoin addresses. Wright did claim to own the addresses to the first 70 blocks mined on the Bitcoin blockchain and provided some information concerning an ostensible blind trust.

The Blind Trust Described in the Kleiman vs. Wright Lawsuit Is a Real Head-Scratcher

Not long after the once redacted list of bitcoin addresses was unsealed, bitcoin security specialists Wizsec researched the addresses and stated Wright’s claim of ownership was still meaningless. Moreover, one of the addresses allegedly used in the case (Wright claims the address is a forgery) was signed by the real owner on May 16, 2019. The legitimate owner of the address in question called Wright a liar and a fraud in the signed message. Wright’s legal team explained that he could provide the public addresses for the first 70 blocks, but also said: “he did not have public addresses for bitcoin that was mined after those blocks because that information is held in a blind trust.” A court filing from June 11 describes in great detail the reasons why Wright presumably cannot disclose certain information tied to the purported trust. Wright’s lawyers did emphasize to the court that “Dr. Wright is the best person to explain the complex manner by which bitcoin was mined and held in the trust.”

The Blind Trust Described in the Kleiman vs. Wright Lawsuit Is a Real Head-Scratcher

Describing the Blind Trust’s Complexity

According to the court document, after he mined the first 70 blocks of bitcoin, Wright allegedly designed a unique algorithm. This algorithm automated the key generation process so that after block 70 was mined, blocks that followed would be assigned to a different public address. This supposedly means the coins were mined directly into the blind trust after this scheme was implemented. The document also says that Wright disposed of all of his mining rigs used to process bitcoin blocks throughout 2009 and 2010. “[Wright] did not keep any list of the public addresses associated with the bitcoin he mined after block 70,” the document explains. “Dr. Wright ceased mining by the end of 2010 — At that time, the value of bitcoin fluctuated between $ 0.06 and $ 0.29.” The defense filing continued:

The private key needed to access the encrypted file with the data necessary to retrieve information about bitcoin Dr. Wright mined after block 70 has been split into multiple key shares (in lay terms, multiple parts) through a version of “Shamir’s Secret Sharing Algorithm”, an algorithm created by Adi Shamir to divide a secret, such as a private encryption key, into multiple parts.

The Blind Trust Described in the Kleiman vs. Wright Lawsuit Is a Real Head-Scratcher

After using Shamir’s Secret Sharing Algorithm, Wright insists that the key shares were then distributed to multiple individuals included in the blind trust. The system Wright and his partners imposed made it so no single participant could extract the information and Wright alone does not have the ability to access the encrypted file. “Dr. Wright does not know the public addresses of the bitcoin held by the trusts (i.e., the bitcoin mined by Dr. Wright in 2009 after block 70, through 2010).” Because of the blind trust complications, the document seems to suggest that Wright doesn’t have enough information to claim ownership (sign) because the keys were transferred into the blind trust with multiple owners.

The Blind Trust Described in the Kleiman vs. Wright Lawsuit Is a Real Head-Scratcher

Plaintiffs Don’t Buy Wright’s Argument and the Crypto Community Continues to Fact Check

However, the plaintiffs still want a comprehensive list of the public addresses of all the bitcoin Wright allegedly mined before December 2013. An order signed by the Judge shows that Wright must produce this list by June 17, 2019, and if he cannot comply the court may conduct a show cause evidentiary hearing. The defense believes that the Kleimans’ demand that “Dr. Wright authenticate every single document related to the trusts is facially overburdensome and unreasonable.”

“Dr. Wright has produced hundreds of documents related to the trusts including documents that he did not sign or prepare,” Wright’s litigation team noted on June 11.

The Blind Trust Described in the Kleiman vs. Wright Lawsuit Is a Real Head-Scratcher

The last few weeks of documents stemming from the Kleiman vs. Wright case has opened more doors within this seemingly never-ending rabbit hole. Wright’s recent motion, Document 187, for a protective order, was heavily redacted because he feared criminals would seek retribution against him and an unredacted footnote also showed the name, Paul Le Roux. This information opened up another rabbit hole where some people have suggested that Le Roux may have participated in designing the Bitcoin network. In addition to Le Roux being added to the story, many cryptocurrency fans watching the case from abroad have been questioning some of the statements made by Wright so far. For instance, Vin Armani from Cointext and Dustin Dreifuerst from the podcast Didyouknowcrypto.com (DYKC) asked how the coins from blocks 1-70 can be in a blind trust if he used the private key from block #1 to sign in front of Gavin Andresen.

“Craig signed a message that I chose (“Gavin’s favorite number is eleven. CSW” if I recall correctly) using the private key from block number 1,” Andresen told the public three years ago. “That signature was copied on to a clean USB stick I brought with me to London, and then validated on a brand-new laptop with a freshly downloaded copy of electrum.”

In addition to this showing, Bitcoin Foundation member Jon Matonis revealed in a blog post written on May 2, 2016, that he also witnessed the signing and verifying of messages using private keys from blocks 1 and 9. Crypto enthusiasts have further pointed out that the coins from blocks 1-70 have never moved and the blind trust story sounds extremely far-fetched. As the legal battle continues to unfold in Florida, many onlookers still think that more information will uncover some of the mysteries behind this case and whether certain particulars are true or fabricated.

What do you think about the latest details in regard to the ongoing Kleiman vs. Wright case? Let us know what you think about this subject in the comments section below.


Image credits: Shutterstock, Wiki, Twitter, Pixabay, Court Listener, and Pacer.


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The post The Blind Trust Described in the Kleiman vs. Wright Lawsuit Is a Real Head-Scratcher appeared first on Bitcoin News.

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Cuba Gooding Jr. says ‘I trust the system’ as he reveals plan to surrender to police over groping claims

June 12, 2019 |

Cuba Gooding Jr. addressed a woman’s claim that he groped her at a Manhattan nightclub, saying he is “absolutely not” guilty.
FOX News

Don’t Trust Bitcoin Mixers and Other Opsec Lessons From the Darknet

May 6, 2019 |

Don’t Trust Bitcoin Mixers and Other Opsec Lessons From the Darknet

When darknet markets are shut down these days, the arrests don’t generate much fanfare. There’s a day of press at best, and then the media moves on to bigger stories, leaving the fate of the DNM operators unreported as their case grinds through the courts. This is a shame, as the indictments for the accused reveal valuable insights into how law enforcement caught their quarry, providing opsec lessons that every bitcoiner should take to heart.

Also read: Europol Claims New Scalps – Chaos as Darknet Markets are Downed

Opsec Lives and Dies on the Darknet

You don’t have to be operating a multi-billion-dollar darknet market (DNM) to require privacy. Maintaining anonymity, or at least pseudonymity, when operating online is an aspiration that everyone should harbor, cryptocurrency users especially. Even if you’ve no desire to launder cash or sell copious quantities of cocaine for crypto, there’s a plethora of reasons to hide your online activities.

If you’re wondering how much data you leak simply by sending or receiving cryptocurrency, or transacting on a darknet marketplace, last week’s Wall Street Market (WSM) indictments provide the perfect case study. Buried in these criminal complaints are opsec lessons that should give everyone pause for thought, whether you’re the next Dread Pirate Roberts or simply a staunch libertarian who wants to be left the hell alone.

Don’t Trust Bitcoin Mixers and Other Opsec Lessons From the Darknet

Lesson 1: Don’t Trust Bitcoin Mixers

According to the United States of America v. Tibo Lousee, Klaus-Martin Frost, and Jonathan Kalla, aka the three Germans charged with operating Wall Street Market, “The United States Postal Inspection Service learned, through its analysis of blockchain transactions and information gleaned from the proprietary software described above, that the funds from Wallet 2 were first transferred to Wallet 1, and then “mixed” by a commercial service … through thorough analysis, the United States Postal Inspection Service was able to “de-mix” the flow of transactions.”

Centrally operated BTC mixers of the sort referenced here include Mixertumbler, Bestmixer.io, Blender.io, Bitcoinfog, and Gramshelix. There is no means of knowing which mixer the authorities succeeded in deanonymizing – which they achieved on no less than three occasions – but as one recent article on mixers notes:

Centralized database systems’ server logs can easily be accessed by anyone (hackers and other malicious individuals or groups, law enforcement etc). Even though bitcoin mixers often claim not to store transaction details for more than 24 hours, this still poses an unknown risk of being found out.

This doesn’t mean you should avoid using mixing services – they are still a good privacy preservation tool. However, it would be foolish to stake your freedom on the irreversibility of a mixing service, and inadvisable to rely on a centrally operated service which could be compromised. Use a decentralized peer-to-peer mixing service instead like Coinjoin for BTC, or Cashshuffle for BCH. These services can’t guarantee your funds can’t be traced back to their source, but they are at least free of backdoors.

Don’t Trust Bitcoin Mixers and Other Opsec Lessons From the Darknet
The WSM indictment references the use of blockchain forensics tools

Lesson 2: Configure Your VPN Carefully

The WSM three were all technically proficient, with two holding down day jobs in IT – Lousee was a computer programmer. Despite these skills, VPN leaks appear to have been a contributor to their downfall.

As the complaint reads, “the WSM administrators accessed the WSM infrastructure primarily through the use of two VPN service providers. The BKA [German federal police] determined that one of the administrators … used VPN Provider #1. Based on the BKA’s analysis of the WSM server infrastructure, the BKA noticed that on occasion, VPN Provider #1 connection would cease, but because that specific administrator continued to access the WSM infrastructure, that administrator’s access exposed the true IP address of the administrator. The BKA then investigated the true IP address.”

Don’t Trust Bitcoin Mixers and Other Opsec Lessons From the Darknet

Lesson 3: Don’t Recycle Identities

One of the ways in which Dread Pirate Roberts was busted was through reusing the nickname “frosty” which tied his Silk Road identity to his real life persona. Six years on from that hard lesson in opsec and DNM operators aren’t any wiser. One of the WSM trio, Frost, used the same PGP public key on Wall Street Market as he had used previously on Hansa Market, making it easy for his BTC transactions on the latter DNM to be associated with other wallet transactions he’d made for services in his real name. As the complaint notes, a “PGP public key, in the context of darknet investigations, is likely a unique identifier to an individual.”

In addition to recycling PGP keys and wallet addresses, one of the accused, Lousee, is believed to have used the handle “coder420” to access the WSM test server. This was subsequently correlated to “Pictures of LOUSEE consuming marijuana” and “Numerous references to “420,” including a license plate of LOUSEE’s vehicle and a sign on a bedroom wall with “420.””

A separate criminal complaint against WSM moderator “MED3L1N” reveals a string of similar errors, with recycled usernames, passwords, and duplications making it possible for LE to identify their suspect with little more than some diligent internet detective work. For instance, in one public profile, the accused, Marcos Annibale, is pictured alongside a bookshelf with “Gomorra,” written by Roberto Saviano, visible in the background. MED3L1N later recommended the same book in a thread on WSM.

Don’t Trust Bitcoin Mixers and Other Opsec Lessons From the Darknet

The thousands of hours law enforcement pours into tracking down darknet market operators is is an affront to those who see the war on drugs as an assault on personal sovereignty and a gross intrusion into citizens’ private lives. It is not time wasted, however. Whatever your take on darknet market prosecutions, we should be grateful for the intensive pen testing these investigations entail. Through piecing together the clues found in criminal complaints and reading between the redacted lines, we can learn better ways to protect our privacy and preserve our right to transact anonymously.

What are your thoughts on the war on drugs and the authorities’ attempts to close down DNMs? Let us know in the comments section below.


Images courtesy of Shutterstock.


Did you know you can verify any unconfirmed Bitcoin transaction with our Bitcoin Block Explorer tool? Simply complete a Bitcoin address search to view it on the blockchain. Plus, visit our Bitcoin Charts to see what’s happening in the industry.

The post Don’t Trust Bitcoin Mixers and Other Opsec Lessons From the Darknet appeared first on Bitcoin News.

Bitcoin News

Analysis Shows Lightning Network Suffers From Trust Issues Exacerbated by Rising Fees

March 30, 2019 |

Analysis Shows Lightning Network Suffers form Trust Issues and Rising Fees Makes it Worse

Over the last two years, the Lightning Network has been touted as the scaling solution for the Bitcoin Core (BTC) network. However, the solution has been heavily criticized for its lack of security, and on March 28, Bitcoin Unlimited’s chief scientist Peter Rizun wrote an interesting evaluation of the Lightning Network’s “dirty little secret.”

Also read: Mempool ‘Spam’ and Rising Fees: The Consequences of Veriblock’s Mainnet Launch

Visualizing the Lightning Network from a Different Perspective

This week, Bitcoin Unlimited’s Peter Rizun wrote a critique concerning the often controversial Lightning Network (LN). In delving into the project, Rizun asks the reader to visualize the LN as a string of beads (Fig. 1) extended between two individuals, Alice and Bob. In essence, Alice can send Bob funds by pushing one of her beads to Bob, utilizing the string which represents an LN channel.

Analysis Shows Lightning Network Suffers From Trust Issues Exacerbated by Rising Fees
Fig. 1. Alice can send a payment to Carol by routing it through Bob. Because beads cannot leave the string they are on, Bob ends up with one more bead on his string with Alice, and one fewer bead on his string with Carol.

Rizun’s essay notes that the foundation of the network is the reason for LN liquidity problems because “the beads can move from side to side but cannot leave the string they’re on.” From there, Rizun discusses the LN security model which depends on Hash and Time-Lock Contracts (HTLCs).

Analysis Shows Lightning Network Suffers From Trust Issues Exacerbated by Rising Fees
Fig. 2. The hash-lock opens when a password is entered that hashes to the specified value (45f8 in this case). The time-lock opens after the specified time has elapsed (48 hours in this case).

Essentially, HTLCs explain how the system prevents Bob from keeping the bead from Alice without sending one on to Carol. In order to bypass this issue, the LN project uses locks in the channel and in Rizun’s the locks are placed in the string in order to constrain the beads’ movements until the agreement’s conditions are met. “The hash and time-lock contracts (HTLCs) used in Lightning payments involve two types of locks (Fig. 2): the first is a lock that opens if presented with the correct password (we’ll call this a “hash-lock”), and the second is a lock that opens automatically after a time delay (we’ll call this a “time-lock”),” Rizun’s blog post details. The developer then returns to the example of a payment between Alice to Carol through Bob, and Rizun notes that in order to make the process “trustless,” Alice, Bob, and Carol need to be online simultaneously in order to settle the agreement.

“First, Alice asks Carol to think up a secret password and tell her the password’s hash. Let’s pretend the password Carol thought up was ‘boondoggle’ and its hash was ‘45f8’ — Next, Alice places a hash-lock between her and Bob, set to open when presented with a password that hashes to ‘45f8,’” runs Rizun’s critique. “At this point in time, neither Alice nor Bob can open the lock because neither knows the password — Alice then pushes a bead against the hash-lock. Lastly, she places a time-lock on the left side of the bead, set to automatically open after 48 hours (Fig. 3).”

Analysis Shows Lightning Network Suffers From Trust Issues Exacerbated by Rising Fees

Lightning Network Micropayments Are Not Trustless at All

The study further explains why Bob would bother to participate in this settlement in the first place if Carol had not been cooperative. Basically, the theory assumed is that Alice will send Bob a fraction more than what she asks Bob to send to Carol, as a fee to compensate for risks. It also reveals the purpose the time-locks serve in order to protect someone’s funds if a payment fails. An example of this situation would be if Bob becomes uncooperative after Alice shifts her bead over and adds the two locks, Rizun adds, and remarks that time-locks give Alice the ability to retrieve the funds. His essay says that even though this is possible, the Lightning Network has a dirty little secret which can be seen when the channel state involves three outputs: Alice’s coins, Bob’s coins, and the coin “in flight.” The problem occurs if the value-in-flight is below the BTC dust threshold, in which case it can’t be used as a third output in the channel-state transaction.

“It is thus not possible to use hash- and time-locks to protect the payment if the payment is too small,” Rizun paper emphasizes. “It is not exactly true that the number of beads on a string is constant. There is actually a bucket beside each string labeled “Miner’s Fee” that contains small fractions of beads. The value in this bucket gets claimed by the miner who confirms the channel-state transaction, should the channel state be pushed to the blockchain. Fractions of beads can move from the string to the bucket, or from the bucket back to the string, but only if the persons on both sides of the channel agree.”

The paper continues:

Rather than locking the value in-flight with hash- and time-locks, for small payments Alice and Bob just move the value-in-flight into the fee bucket (Fig. 8). Bob trusts that Alice will cooperate with him to take the value-in-flight out of the fee bucket when he reveals Carol’s secret password.

Analysis Shows Lightning Network Suffers From Trust Issues Exacerbated by Rising Fees

Bob can then dump the value-in-flight into another bucket he shares with Carol and manipulate the situation by asking Carol to tell Bob the secret password. Carol tells Bob the secret, and Bob and Carol together move the payment from the fee bucket to Carol’s side, Rizun states. Bob then goes back to Alice, tells her Carol’s secret, and if all goes well, Alice cooperates with him to take the value-in-flight out of the fee bucket and place it on Bob’s side of the string. The paper adds:

Unlike the HTLC scheme described earlier, this scheme relies on trust. For example, Carol could reveal the password to Bob, who could then leave the payment in the fee bucket yet still go to Alice and deliver the password in exchange for his payment.

Analysis Shows Lightning Network Suffers From Trust Issues Exacerbated by Rising Fees

According to a few individuals on social media and cryptocurrency forums, the problems associated with the trust issue and micropayments are well known. At the time of writing, the dust threshold is less than 600 satoshis which means if fees were to spike considerably again, the Lightning Network wouldn’t be a feasible option. Rizun’s paper notes that the issue adds unneeded friction from layer one to layer two by “forcing complex and poorly-understood work-arounds to the L2 protocol.” Moreover, those who have been cheering for higher network fees in order to bolster more Segwit use (were the dust limit is even lower) and forcefully pushing for LN adoption do not seem to understand how impractical that would be.

What do you think about the issues involved with LN and the added friction that layer two adds to common settlements compared to traditional layer one transactions? Let us know what you think about this subject in the comments section below.


Image credits: Shutterstock, and Bitcoin Unlimited’s Peter Rizun.


Want to create your own secure cold storage paper wallet? Check our tools section.

The post Analysis Shows Lightning Network Suffers From Trust Issues Exacerbated by Rising Fees appeared first on Bitcoin News.

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The Daily: Market Cap Metric Attracts Flak, Trust Wallet Does Desktop

January 25, 2019 |

The Daily: Market Cap Metric Attracts Flak, Trust Wallet Does Desktop

In Friday’s installment of The Daily, we round up the latest debate over whether market cap should be used to rank cryptocurrencies. Members of the Ripple community are up in arms over new data that suggests their token’s market cap should be billions of dollars lower than currently stated. We also detail the latest update to the Binance-owned Trust Wallet, and take in a dash of drama from crypto Twitter.

Also read: Leaked Images Reignite Expectations for Crypto Wallet in Samsung’s Galaxy

Market Cap Metric’s Shortcomings Exposed

The Daily: Market Cap Metric Attracts Flak, Trust Wallet Does DesktopThe ranking of cryptocurrencies by market capitalization (i.e number of coins in circulation multiplied by price per coin) is a metric that has long been criticized for its inaccuracy. Theoretically, any altcoin can game the system by issuing billions of tokens or by selling a single token for a ridiculously high price on an exchange to make the network appear more valuable than it really is. The shortcomings of market capitalization were hit home on Jan. 24 in research published by Messari which found that the market cap of ripple (XRP) could have been overstated by as much as 46 percent or $ 6.1 billion. Should ripple’s market cap be updated to reflect the new data, the token would be relegated to third place in the cryptocurrency rankings, behind ethereum.

Ripple Is ‘the Theranos of Crypto’

Holders of ripple were unimpressed with the suggestion to reduce its cap, and the XRP army took to Twitter to voice their displeasure against Messari founder and longtime ripple critic Ryan Selkis. Selkis claimed to have been doxed and threatened by ripple acolytes, and hit back, describing the project as “the Theranos of crypto.” He also called upon Ripple leaders such as CEO Brad Garlinghouse to urge the project’s supporters to show restraint.

Crypto Twitter Influencers Shaken Out

Staying with crypto Twitter (CT), and influencers who shill dubious projects are finding themselves under the spotlight. It’s common practice for popular figures within the cryptosphere to lever their following to promote ICOs and share referral links to platforms such as Bitmex. For followers of these accounts, however, it isn’t always clear what’s being shared as impartial trading advice and what’s a paid promotion. Viacoin developer, trader, and unrepentant troll Romano has taken it upon himself to mercilessly expose the worst elements of CT, waging a one-man campaign against shills.

“This year we will take Crypto Twitter back from these influencers (normies in crypto clothes) who shill every scam for $ 250,” he tweeted, and has been as good as his word. This week, he focused his rage on the appropriately named “Crypto Shill Nye,” exposing previous business dealings and CT behavior that Romano deemed unethical. His takedown of Nye inspired other Twitter traders to pile in and share other skeletons from Nye’s closet. Crypto Shill Nye, for his part, hit back, claiming that “I have never scammed anyone and I never will,” adding “I am not asking for any money from my followers.”

Trust Wallet Announces Major Upgrade

Trust Wallet, which was purchased last year by Binance, has unleashed a slew of updates lately including new features and coin additions. The mobile wallet, which recently added support for bitcoin cash (BCH) is now to be complemented by a desktop counterpart. Trust 2.0 will comprise a new desktop wallet as well as integrated support for Binance coin (BNB) to facilitate trading on the forthcoming Binance DEX.

The Daily: Market Cap Metric Attracts Flak, Trust Wallet Does Desktop

Trust Wallet users will be able to trade on the decentralized exchange while retaining full custody of their funds. The wallet developer will also be launching a hardware wallet, explaining that “with the rise of Bluetooth, NFC and QR capable hardware wallets, we think now it’s the time to finally bring you this feature.” Trust Wallet, which launched as an ETH-only wallet a year ago, now supports a string of cryptocurrencies including BTC, BCH, LTC and ERC20 tokens.

What are your thoughts on the stories in today’s news roundup? Let us know in the comments section below.


Images courtesy of Shutterstock.


Need to calculate your bitcoin holdings? Check our tools section.

The post The Daily: Market Cap Metric Attracts Flak, Trust Wallet Does Desktop appeared first on Bitcoin News.

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Ex-Nissan chief Ghosn charged with breach of trust; release on bail unlikely

January 11, 2019 |

Nissan’s ex-Chairman Carlos Ghosn was charged Friday with breach of trust, according to the Tokyo District Court, making the star executive’s release unlikely for months.

Ghosn, arrested Nov. 19, was earlier charged with falsifying financial reports in underreporting his income by about 5 billion…


L.A. Times – Business

Gambia’s journalists, free from dictator, work to win trust

December 31, 2018 |

Journalists in Gambia have launched a self-regulatory body they hope will offer legitimacy, and far more freedom, to media emerging from a dictatorship that ruled the tiny West African nation for more than two decades.
FOX News

Hawaiian Princess, 92, Alters Trust to Give Wife $40M

November 29, 2018 |

A 92-year-old Native Hawaiian princess has changed her trust to ensure her wife receives $ 40 million and all her personal property, including her Chihuahua “Girlie Girl,” according to court records. Abigail Kawananakoa inherited her wealth as the great-granddaughter of James Campbell, an Irish businessman who made his fortune as a…
Newser

Stablecoins Demand More Trust than Fiat Currency

November 16, 2018 |

Stablecoins Demand More Trust than Fiat Currency

This article about the problem with stablecoins was written by Kevin Murcko, the CEO at cryptocurrency exchange, CoinMetro, and forex broker, FXPIG.

Stablecoins — digital coins which peg their value rigidly to the dollar, the euro, or a collage of national currencies — are all the rage right now. Tether, in particular, is on everyone’s lips. In fact, it’s one of the most heavily traded cryptos in the market right now.

Also read: Stablecoins Fetch a Premium as BTC Hits Year Low

Stablecoins Demand More Trust than Fiat Currency

The appeal of Tether and other stablecoins is somewhat understandable. All cryptos are nascent assets; speculation, rather than the usefulness of the technology or the underlying asset, is what’s mostly been driving price movement. That’s led to wild volatility.

Traders love volatility, but not unreasonably, some people see a problem. Volatility is broadly incompatible with the concept of a day-to-day currency and a store of value. “Stablecoins” have arrived to fix this by, ostensibly, digitizing a fixed value in terms of dollars or an equivalent.

The Use Cases for Stablecoins

Certainly, there are a handful of legitimate use cases for stablecoins.

Let’s say a liquidity provider owes me $ 0.5 million. Maybe I need that money immediately to be able to rebalance my book — the traditional banking system isn’t the best way to do that. Even if we’re with the same bank, it can take a while to clear that transaction.

Stablecoins are useful because I can instantly clear funds back and forth. They offer the convenience and speed of using crypto without the caveat of volatility.

As the International Monetary Fund’s Christine Lagarde pointed out in a speech this month, Central Bank Digital Currencies (CBDCs) are another intriguing opportunity. While the benefits aren’t fully understood, CBDCs have the potential to limit costs and risks to payment systems, mitigate fraud and money laundering, and potentially even boost financial inclusion throughout the developing world.

Substituting Fiat Currency

Stablecoins Demand More Trust than Fiat Currency

Beyond these examples, however, stablecoins really struggle to prove their worth. Front-end, business-issued stablecoins (practically all stablecoins being traded at the moment) fall flat.

Currently, these stablecoins are used as substitutes for fiat on crypto exchanges that don’t have access to central bank-issued money. It’s not that these tokens are preferential to fiat. Rather, they’re band-aid solutions for retail exchanges which, for various reasons, can’t open and maintain adequate fiat on-and-off-ramps — usually because they aren’t properly licensed to offer fiat, or because they don’t have access to the necessary banking.

Why, in most circumstances, aren’t stablecoins preferential to fiat? It ultimately comes down to trust.

As we all know, crypto was originally intended to be trustless. The Bitcoin whitepaper laid out a vision to escape “to transact directly with each other without the need for a trusted third party.”

What stablecoins represent, in many ways, is the antithesis of that idea. The crypto community now uses privately issued tokens or coins that are pegged to the very currencies they originally wanted to pull away from. That’s problematic for a number of reasons.

Stablecoins require you to have confidence, not only in the government, but in an undependable, easily corruptible private company. We have to place our faith outside of the chain and in these companies’ ability to self-regulate supply and demand.

The Collateralization Problem

That’s a tall order. Stablecoins can be split into three states of collateralization, or the extent to which the coin is backed one-to-one by fiat. Some coins are fully collateralized, others are partly collateralized, and others are entirely uncollateralized. Unfortunately, all provide insufficient mechanics to properly regulate price.

For noncollateralized tokens, value is essentially suppressed by “printing” digital money. That’s all well and good, but when the price drops, it’s not possible to un-issue what’s already in circulation.

Here’s the snag. If the smart contract can’t keep the price at $ 1, then the algorithm is forced to issue bonds, promising users an entitlement to coins in the future. The bonds are then redeemed, and the price returns to $ 1.

That’s the theory, at least. The issue is, these bonds can only really be serviced if the platform is in an overall state of growth. The headache arises when the price keeps on dropping, and increasing numbers of bonds have to be issued until this price returns to trading level or above par. Bonds can’t be issued indefinitely.

The Fundamental Flaw: Artificial Inflation

Stablecoins Demand More Trust than Fiat Currency

Partial collateralization presents a minor improvement over the complete lack of reserve assets, but it still has a fundamental flaw: If confidence in the platform dips, then the company has to artificially inflate the price of its token by drawing on a finite pool of fiat reserves, preventing the price from plummeting. This, of course, has a limit. A company can only buy back so much of its own currency.

Presumably then, “fully collateralized” models like Tether are therefore reliable? Not really.

Even if we take the company for its word (there’s some uncertainty as to whether their assets are fully collateralized), it still doesn’t make much sense to abandon the relatively safe greenback for an inconvenient crypto that doesn’t always have fiat parity, provides no consumer protections, and is vulnerable to hacking.

Stablecoins: An Awful Idea

Central banks may not be the ideal institutions to trust, but many have stood resolutely for decades with the primary goal of maintaining our trust in their money. If privately backed stablecoins are designed to replace our reliance on these central banks with a reliance on a combination of both central banks and their loosely regulated businesses, then this seems like an awful deal to say the least.

Let’s not confuse lack of volatility with stability. That’s a dangerous mistake to make. Yes, many stablecoins do have relatively “stable” prices, but “stability” — in another sense of the word — is also about reliability, and that’s one thing that can’t be said of stablecoins, which demand far more trust than the original fiat.

Do you agree that stablecoins are overhyped? Can stablecoins solve the problem of volatility? What is the future of the stablecoin? 


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