A few thoughts - Tuesday, September 2, 2014

[Steve Sokolowski]

Good afternoon! A few thoughts for lunch today:

A "bitcoin rewards" program could equalize adoption

It's amazing how adoption is increasing so rapidly among merchants. Whereas before every time a single merchant added a bitcoin payment button was news, now nobody notices unless it is one of the big names. You can buy anything with bitcoins today. In fact, it's almost at the point where the only reason that an online merchant doesn't accept bitcoins is that they haven't clicked the button in their payment processing software to enable them.

There are several articles that propose the idea of Coinbase's creation of a "rewards program." The idea is that the cost of bank fees, fraud losses, and the cost of employees who deal with fraud is close to 7%. If Coinbase passed on 3% or 4% of these savings to consumers, they could save merchants the other 3% or 4% and consumers would be incentivized to spend bitcoins over dollars. However, there are a few problems with this scheme that make it less attractive for the short-term.

For one, Coinbase already charges 1% for purchasing and selling bitcoins. I've argued before that 1% is too much of a loss for people to spend bitcoins in day-to-day life. For example, when I purchased a PS4, controller, and game this weekend at Newegg, I lost $5.65 to fees with Coinbase to buy back the lost bitcoins. But fortunately, the only reason that Coinbase can continue to overcharge in this way is because they have little competition. As soon as other options become available, Coinbase will be forced to lower its margins on bitcoin sales.

There is also the problem of merchants having become accustomed to saving the entire 7%, rather than just the 3% they would save under this rewards program. There is likely a point at which merchants would state "I've had enough with this; the savings are too low to justify the expense of explaining bitcoins to customers and training employees."

Therefore, the end result of these "rewards programs," regardless of whoever implements the first one, will be an equalizing of merchant adoption with consumer adoption. If the savings become too much, merchant adoption falls and consumers find they can't buy what they want. If the savings are too little (as they are now), merchants pounce on bitcoins in huge numbers (which they are now), but consumers are not incentivized to spend them (as they aren't now). The market will find the percentage of savings to pass onto the consumer to make both parties happy. I suggest that the percentage will surpass credit cards' rewards programs, but this sort of program is still a ways off because Coinbase needs competition to undercut its profits and force it to seek out new sources of revenue.


The previous bubbles were irrational

The current theme is that a bubble can't occur again because adoption is too low. That, of course, is nonsense, because before Overstock started accepting bitcoins, there were slightly more than zero places that accepted the currency. During the last bubble, there were about as many places to spend bitcoins as there are places to spend litecoins today. Nevertheless, the price of bitcoins rose very high, as it did many times before.

The argument that "this time is different" because nobody is accepting bitcoins is ridiculous. It's possible to argue that there are technical flaws that need to be resolved, or that adoption is not occurring at a fast enough rate, but people in /r/bitcoinmarkets who believe a bubble is precluded because there simply isn't enough consumer adoption are wrong.

The previous bubbles did not start with consumer adoption; they started with people who were buying bitcoins to hold them for future adoption. There are no shortage of reasons today as to why bitcoins could become the world reserve currency. The previous bubbles were completely irrational, and there isn't any reason to suggest that the next bubble will be rational either. That's why I've stated that these bubbles don't follow the news, and looking to adoption numbers is unlikely to give warning of an impending bubble.


Altcoins are an even bigger mess than I thought before

A few weeks ago, I posted about how buggy altcoins were. It turns out that they are an even bigger mess than I thought they were at that time. I've come to the conclusion that the best choice is to simply discount these bugs from the pool's earnings and spend time on other optimizations to make money. Otherwise, we would be spending all our time trying to resolve errors specific to each coin.

To give an idea of some of the problems these altcoins have, here's a sample. Keep in mind that few of the coins log the timestamp of events, which is a basic requirement in any logging system, so problems are usually difficult to diagnose.

Some coins give a "sign failed" message when trying to submit blocks. "Sign failed" apparently means that the signature of the coinbase transaction that awards coins to the miner is invalid. But since the altcoin creators never spend time to write documentation, it's impossible to figure out exactly what the signature should look like. The only way to try to resolve this one is to guess what the format should be, by using public keys instead of wallet addresses in the signature, for example. I have yet to be able to figure out how to mine a single coin that has this error.

Some coins return "invalid proof of work," which is supposed to mean that the hash submitted to the daemon is not difficult enough to mine a block. However, these errors happen randomly about 30% of the time, and the hashes submitted are always correct according to the "target" in the block. After 15 hours trying to figure this one out, I abandoned the task.

Other coins log no error at all. They simply return a result of "rejected," which of course makes these coins impossible to debug. I read about this and one open source developer decided the solution was to simply submit the same block five times, because sometimes it worked on, say, the fourth try. That sums up the state of these coins pretty well.

Despite this, we are still able to remain more profitable than the other pools, at least during this testing period. The key seems to be simply accounting for these errors and writing them off as part of the job. We keep track of the percentage of blocks that are lost due to errors, so we don't actually need to know what is causing the errors to remain above water.