Thursday, August 17, 2023

New York Fed: "What Makes Cryptocurrencies Different?"

Basic stuff for our readers but I am trying to puzzle-out why it was posted/if there is any deeper meaning

From the Federal Reserve Bank of New York's Liberty Street Economics blog, August 16:

Permissionless blockchains, which support the most popular cryptocurrency networks like Bitcoin and Ethereum, have shown that it is possible to transfer value without relying on centralized trusted third parties, something that is new and remarkable (although perhaps most clearly useful for less developed financial markets). What makes permissionless blockchains able to transfer value without relying on a small number of trusted third parties is the combination of several components that all need to work together. The components themselves are not particularly new, but the combination of these components is more than the sum of its parts. In this post, we provide a high-level overview of these components and how they interact, taking Bitcoin as an example.

Payments and Trust
Payment systems traditionally operate with a small number of economic agents playing key roles, such as making sure only authorized transactions take place. This requires participants to trust these agents to perform their duties. This trust is bolstered by law, rules, and regulations that provide incentives for the agents playing these central roles not to misbehave. Nevertheless, bad behavior, while rare, cannot be ruled out.

Cryptocurrencies, such as bitcoin, were designed to operate using a different model of trust, one that does not rely on law and regulations. Instead, they rely on two features, open access and a set of incentives to induce good behavior. Open access, or “permissionlessness,” is necessary to eliminate the risk that a gatekeeper could exert power to their advantage. Mechanisms that offer incentives aimed at limiting misbehavior by participants in the system are necessary since open access permits anyone to opt into any role in the system. While each feature is important on its own, we argue that the combination of the two is necessary for a permissionless blockchain to work as intended. We now describe each feature in more detail.

Open Access or Permissionlessness
In permissionless blockchains, anyone can use the payment system without restrictions. In addition, anyone can choose to take part in any of the roles necessary for the operations of the payment system. If any role that is essential to operations has limited access, then select groups could be positioned to gatekeep those roles and misuse their power.

An important role in a blockchain is forming new blocks. Miners perform that role in Bitcoin. They validate transactions, for example by checking that the same bitcoin is not spent more than one time and add new blocks of valid transactions to the blockchain. Because of open access, anyone can choose to be a miner and Bitcoin has a large number of them. Validation is an important function in any payment system. If the validator, or validators, cannot be trusted, they could authorize transactions that are not valid or exclude transactions that are, whenever favorable, at the cost of other participants.

Permissionless blockchains are transparent, meaning anyone can observe the ledger, know the state of accounts, and see all transactions. It is necessary that the state of the ledger be visible to everyone, so that anyone who wants to propose a new block can verify that proposed transactions are indeed feasible. Transparency also facilitates the detection of attempts to tamper with the ledger.

If governance of the blockchain is too centralized, so that a small number of individuals can make decisions that affect the entire system, then the system is more vulnerable. Bitcoin does not have a single owner. Governance is quite open as anyone can propose a change to the core code through a Bitcoin Improvement Proposal (known as a BIP). However, implementing changes to the core codebase of Bitcoin is restricted to a small number of developers, who could make changes that favor them. That said, any changes these developers make must be accepted by the miners and other nodes in the system to have influence. In this way, the participants of the network also contribute to deciding what rules are executed.

A Set of Incentives for Good Behavior...


In contrast/contradistinction some of the recent headlines at Web3 Is Going Just Great:

August 16, 2023
$1.7 million lost in broken bridge to new Shibarium network

August 16, 2023
SwirlLend rug pulls for around $460,000

August 15, 2023
Prime Trust files for bankruptcy

August 14, 2023
RocketSwap exploited after key compromise

August 13, 2023
Zunami Protocol exploited for more than $2.1 million

August 10, 2023
Bittrex settles with SEC for $24 million

August 9, 2023
SpiritSwap to shut down after Multichain collapse

August 9, 2023
Multiple wallets compromised due to irresponsible encryption in Libbitcoin project

August 9, 2023
Hundred Finance shuts down after hacks

That wasn't even a busy week. When she really gets typing you can almost smell the smoke rising from her keyboard. 

If interested see also: “Web3 Is Going Just Great” Creator On Why It Isn’t