Venture Capitalist, Partner @HYPE Capital, Board Advisor, Ex-Fed Reserve, IBM, HP, Entrepreneur 2x
An interview with Ray Dillinger (This particular interview will be published in two episodes due to technical content)
I meet and connect with many inspiring entrepreneurs, innovators, thought leaders and academics, working relentlessly in the blockchain space. Some of them are in the public lights and some are not. I thought it would be great to dive into the mind of such known and unknown blockchain innovators. Hence, I’m starting this interview blog. This is a highly technical interview, so if you are new to Blockchain, you may want to get up to speed with CoinDesk.
I cannot start my first episode of the interview blog without acknowledging and introducing some of the grand old people who have worked with Satoshi Nakamoto. Ray Dillinger is one of the few that Satoshi has worked with, besides Hal Finney, James Donald, and Nick Szabo on the peer-to-peer digital transaction code and the reason we all are so euphoric to be a part of the movement of the democracy of money and an immutable information ledger. He had been working on projects in a consulting capacity in the areas of Artificial Intelligence, Cryptocurrencies, Cryptography, Forensic Documentation, and Security technology. But now, he has moved on to different things professionally. Currently he is the founding partner and head of algorithms research of artificial intelligence and machine learning company ne12.
My discussion with Ray ranges from cryptocurrency code, blockchain innovation to the geo-political world. I consider him more of a mentor. Ray is a thought leader in this rancorous political atmosphere that’s so palpable yet in a malaise. The idea of defying the traditional centralized financial system led to Bitcoin’s creation. More as an antidote to the top-heavy financial system and to syndicate a distributed decentralized parallel currency into the fundamental model of the market. When I requested Ray for this interview, he said “ to whatever extent I can help de-mystify things for people, I’d be happy to”.
Thank you Ray, for giving your time for this blog interview. He has spent incredible hours from his valuable time to answer these questions.
Q. I’ll first address the very evident question, why we needed a parallel currency like Bitcoin, when we have the most powerful currency in the world, the dollar?
Ray Dillinger : So many issues. You ask a short question with a very long answer.
Because it sets everybody on an even status. In its fully distributed network nobody gets special treatment. There are no central banks, no national boundaries, and no one can be more important than anyone else. Nobody is too big to fail or too small to treat fairly. Nobody can loan money that doesn’t really exist. Unfair legal actions don’t matter because the law of the block chain is math and code, and those are one hundred percent impartial. And, nobody can take what’s yours without your cooperation because nobody else has your keys. The block chain is evidence that you haven’t been cheated, but it is more than that. It is evidence that nobody is allowed to cheat anywhere ever, no matter who they are. At least with respect to the rules the block chain can enforce.
If you lived in Cyprus at the wrong time, you woke up one morning and your government had just announced that everything you’ve saved in banks, beyond some amount that they’ve arbitrarily decided, is now theirs. In India, where people were keeping their savings in cash because the government of a previous generation had done something just like that, people woke up one morning to discover that their cash was no longer officially money. If you lived in the Wiemar Republic after WWI, your money became worthless because your parents’ generation had lost the war and the entire world had piled its economic woes on you as a penalty. In Zimbabwe, someone did something stupid and the inflation rates started jumping a thousand percent a quarter. If you happened to be in Venezuela, you might have had a decent future ahead that you’d worked all your life for, and then you had to cope with the economic policies of Nicolas Maduro. If you had accounts in any of dozens of countries when diplomacy broke down or when there was a revolution, you had them seized. If you’re a Cuban, you now have what’s left after nearly a century of brutal economic sanctions that started when your great-great-great-grandparents revolted against American mafiosi that had bribed and murdered their way through your government when rumrunners took it over during American prohibition. Or you might just be a traveler in a foreign country and discover that suddenly you can’t get at your money — even to buy a ticket out — unless you pay a completely arbitrary, artificial exchange rate that devalues it a hundred-to-one.
All of these legal actions victimize people who did nothing wrong. And all of them are unfair, because they work in favor of those who are “too big to fail”, at the expense of those who are “too small to care about.”
And if you lived in America, in 2008, even here in the nation of the strongest currency in the world, and you had the wrong financial position or were overextended in debt, you got what was probably your own first taste of this treatment. People lost their homes, their cars, their jobs, their savings, their kids’ college funds, their own retirement funds, and were forced to move into shabby apartments that some of them couldn’t even afford to heat, buying groceries on credit cards whose interest rates had suddenly been jacked up to thirty percent while their wages in the crappy new jobs they’d been forced into got garnished. This happened at the same time they were watching the bankers and financial institutions who had lured them into fraudulent loans, repossessed their homes, seized their accounts, and were now enforcing the garnishment of their wages, not only not going to jail, but also getting bailouts because they were “too big to fail.” At the same time those bankers and financial institutions were being allowed to further victimize them personally by jacking up rates on credit cards they were being forced by the garnishment to carry balances on even though they’d never missed a payment. They felt that it was unfair. They felt disenfranchised and betrayed by the government and absolute rage at the financial institutions, and many of them still do.
Since that time there’ve been honest efforts to serve justice, bailouts have been paid back with interest, fines have been levied, etc. But from the point of view of the people who lost everything, it was and is still grossly unfair. The victims they defrauded have never been, and will never be, made whole. Lives ruined and opportunities stolen can never be restored.
But if you were a particular, extremely unusual kind of person, instead of mere rage, it led you instead to consider the whole problem, see all those other times and places as well, and try to formulate a solution. Not just for yourself but for the whole world, and not just for now but for all time. And then set to work writing code.
That’s what Bitcoin is. And that’s who Satoshi is. He’s a guy who wanted to solve a problem.
A lot of people these days are saying Bitcoin is mostly for money laundering and otherwise facilitating crime, but for its early adopters, that’s definitely not the case. Hal Finney for example would have told you instead that they were taking refuge from the real criminals. And I will still say that I’m completely happy that it provides one. For anybody, anywhere, all the time. But a lot of the early adopters are passionate. They are people who had lost everything, and they flocked to this unlikely, strange, sort-of-imaginary form of money precisely because unfair treatment as they understood it had taught them an absolute burning hatred of bankers and financial institutions and an absolute distrust of governments’ financial competence. And they’re right enough, often enough, in enough places around the world, that the world genuinely needs Bitcoin.
And as the fiscal mismanagement that led to the 2008 crisis, the European Sovereign Debt crisis, The Dot-com bubble, etc, have demonstrated, even in responsible countries with strong economies and strong currencies we still get the occasional crisis that results in actions which are just plain unfair to people who’ve done nothing wrong.
Q. There were hashcash, ecash, torrent in 90s and I have worked in cryptography and RSA technology before. Why do you think that the Bitcoin white paper was the one to start the conversation for a changed market behavior that made the big banks start their own permissioned ledger?
Ray Dillinger : First, for the simple reason that it was successful. ecash and torrent both crashed hard when people attempted to launch them. So did e-gold, beenz, and a bunch of other things. Things that never generated classes of fungible instruments collectively having a large value never attracted the attention of people whose jobs are, let’s face it, concerned exclusively with handling classes of fungible instruments collectively having large values. With the exception of the Mark Twain Bank and its ill-fated experiment with ecash, they were no more interested in previous cryptocurrencies than they were or are interested in printable coupons for 35 cents off your next can of Friskies cat food.
Second, because once they became interested enough in it to look at it (which they never would have done if it had not become fairly successful) they observed that block chains could also solve trust problems that they themselves experience in, among other things, interbank and international settlement. But doing trillions in interbank settlements using something that all these nerds already owned more of than themselves, would be literally giving away more than half the world’s money supply, leading to a financial crisis that would make previous crashes look like a joke. Besides they couldn’t make Bitcoin itself conform to their requirements vis-a-vis their regulatory relationships with governments. The obvious solution was to copy the block chain technology and make the adjustments necessary so that their requirements could be met legally and the world’s money supply would remain secure.
Hashcash was never a store of value or a medium of exchange. It was only a proof that you cared enough about what you were asking permission to do, to have spent some resources to do it. As initially proposed by Adam Back, it was a barrier to spamming. The idea was that, because spammers send enormous amounts of email each of which have almost no incremental value, and ordinary users who actually use email for some useful purpose send a few emails daily, each of which they care about and get real value from, imposing a tiny cost on transmitting email would not inconvenience legitimate users, but would make sending the mail too expensive for the spammer to get a positive return-on-investment. The proposed cost was a small, adjustable, amount of CPU time, which could be imposed by requiring the mail sender to hash until they meet some target. Ordinary people who send less than a hundred emails a day would hardly notice (assuming they had a multi-threaded mail application) if each one sucks up about three seconds of CPU time to send. But a spammer, who has to send tens of millions of emails to make ten bucks, now finds that each machine can send slightly less than 29000 emails a day and can’t even pay his electric bills by spamming.
That was a beautiful idea slain by an ugly fact. Spammers don’t pay for the electricity to send their spam, nor the bandwidth, nor even the hardware. What spammers do is steal it by getting malware installed on the machines of naive users and building botnets. Then they have tens of thousands of ordinary people whose computers have been virus-infected, paying for the resources they’re using to steal resources from other people. They even steal the email addresses from those people’s contact lists, and send them more spam. And more malware, of course.
So the fundamental flaw in hashcash as a spam limiter was that penalties paid in hashcash were going to cause the machines of innocent people infected by malware to spend all their time doing hashes, at no actual cost to the spammers.
But hashcash as a fundamental proof that someone cared enough about a task to expend some adjustable amount of resources to do it was a valuable idea, found a few uses in network load balancing, and eventually became part of the Bitcoin protocol as the central mechanism of mining. So whenever you raise a glass to Satoshi, don’t forget to raise one to Adam Back for giving Satoshi one of the key pieces of the solution.
Q. I have so many discussions about this with some of the top fintech Venture Capitalists about this topic. Human greed and abysmal behavior has integrated well into the fundamental model of the market. Do you think the introduction of options and futures market by the centralized institutions skew the crypto market and manipulate the price strategies?
Ray Dillinger : It’s very hard to say at this point — what fundamental forces move the market in cryptocurrencies is still fairly mysterious in the first place, and that makes it hard to identify distortions. We see what’s in front of us without knowing yet whether it’s really what’s normal or if it’s a transient stage that we won’t see again after investors and companies have both learned more lessons about how to use this market, or if we just happen to be trying to learn what’s normal while looking at a distorted example caused by criminal activity. Sorting this out until we see patterns start to make sense, takes a long time. Figuring out why those particular patterns and that particular kind of sense takes longer. And then after that is when the distortions start becoming obvious.
When coin or token sales are used to raise money for business operations, it should be regarded as a financial market; its purpose is both the efficient distribution of resources to companies capable of using them to generate real value, and to reward investors for correctly identifying those companies. Right now investors are still learning and companies are still learning how to use that market, and things are in flux. Patterns are still emerging, and very difficult to read.
Options and futures trading, in general, change the market dynamics but do not substantively interfere with achieving its purposes. In fact, options and futures used properly to mitigate or isolate risks can increase the efficiency of the market, or blunt the bad effects of crashes. Obviously people can do the equivalent of casino gambling with them too, but people who do that tend not to affect the market much because they rapidly become poor.
Saying they don’t have much effect on the market is true, but on a human level it’s a really really sad thing to say. ‘Bubble’ psychology like we have now is the number one thing that leads people into using options and futures like casino gambling, and once they lose they’re one paycheck away from a shelter. It sucks, but naive is naive and I have no idea how to warn them in a way they’d hear.
Bad behavior on the other hand, as you point out, deliberately manipulating the market with pump & dump scams, fraud, etc, distort the market to the detriment of everyone except the crooks. Companies that would have made the best use of funds go unfunded, investors lose money, naive investors lose everything, and analysts get bad or distorted data that don’t impart understanding of real underlying market dynamics.
What we’re faced with here, however, is the combination of both, and that’s fraught with even more peril. With access to futures and options markets, crooks can multiply the effect of their frauds and manipulations — both in terms of market distortions and in terms of cost to legitimate investors and companies. So unless a market is both fairly large, so that billions would need to move to manipulate it, and fairly well policed, so that anyone fraudulently mobilizing those billions would immediately be noticed, futures and options are more likely to be misused and distorting than they are to make that market more efficient.
I have egg on my face here because a couple of months ago I honestly believed that Bitcoin had gotten to the stage where it was too big and too closely observed for any kind of price manipulation to be a viable criminal operation. It would have to involve billions, it would require people who had too much to lose, etc. Now I’m afraid I underestimated the boldness or the stupidity of some crooks, for the sheer scale of their criminal operations. Now there are indications that price manipulation was indeed happening during the time I believed it wasn’t.
If options and futures had been available in the timeframe before large investors became aware of that market manipulation, the crooks doing that could have magnified its effect, using it to cheat the investors and businesses of even more money.
So I’ve been overoptimistic at least once, and it is hard to really trust that I’m not still being overoptimistic. I think Bitcoin and Ethereum are probably mature enough for futures and options, but now mostly because the oversight of people who arrest fraudsters is closer. Hopefully, now that we’ve had this little object lesson, it may be as close as I thought it was a couple of months ago. But that may still be optimistic.
A cautious investor, IMO, would be staying away from options and futures except in markets where they’ve been trading for a year and not causing disasters, and would not be touching options and futures unless there is a very well-defined role for them in reducing, not increasing, a specific downside risk.
Q. We have publicly talked about this, but can you again address the coherent problems with Bitcoin’s 21million controlled supply and its deflationary spiral?
Ray Dillinger : One of the things we worried about with the controlled supply was people continuing to have incentive to mine blocks in the future when block subsidies become small. The unlikely scenario of widespread adoption and blocks actually filled with transactions (in fact overfilled) has come about, and now miners are making 10 to 20 thousand dollars per block in transaction fees. And that means that one of the first problems with the controlled supply has been avoided; miners will continue to have an incentive to mine, even when they aren’t harvesting new coins out of every block. Of course, saying that there is now a competitive market bidding for the right to make transactions is another way to say that the block chain is having some scalability problems, but I see a separate question about that coming up so I won’t address it here.
This is not the only problem with the finite supply, however.
Another potential problem with Bitcoin’s money supply is that it is unresponsive to economic conditions. There is no economic policy to regulate money supply in order to hold economic conditions stable, and that means that if it were to be used as a society’s primary currency, the society would experience an endless, unescapable, uncontrolled sequence of boom-and-bust cycles, as most of the ancient world did up until regulating the money supply to prevent the economy from overheating in a bust cycle became widely known and understood. The boom-and-bust cycle though, is not nearly as bad as the extreme crises brought on by some of the more spectacular acts of economic stupidity committed by nations in the grip of the most kleptocratic, insane, or just plain stupid governments in the world. People deserve a choice of their economic regime. If they have a decent government with sane economic policies, they can (usually) do better than a boom-and-bust cycle. But if their alternative is the economic policies of [REDACTED] then the relatively mild boom-and-bust cycle is a life-saver.
There’s no way around this in the context of a block chain, really; you would need information from outside the block chain to decide when and how to regulate it, and if it’s information from outside the block chain, then all the clients out there who have the block chain to look at, don’t have enough information to verify that it’s valid. There are a lot of proposals for cryptocurrencies that apparently come from people who do not understand this law. A transaction must be consistent with the information that’s in the block chain, and if the information in the block chain doesn’t invalidate it, then the clients don’t know enough to reject it.
Finally we come to the ugly one, the one that a lot of the early adopters are emotionally invested in rejecting. And this is a point on which Satoshi and Hal both sharply disagreed with me. They regarded inflation as a symptom of fiscal policy failure and an avoidable evil. I regard it as a tax on non-productive hoarding.
Inflation is a tax on just letting your money sit there not doing anybody any good. And having some kind of incentive to do something that isn’t just letting it sit there not doing anybody any good is kind of important. If you have a bunch of gold in a box in your basement, good for you — but the society you live in would be a heck of a lot better off if you had invested money in a bunch of businesses that were out there actually performing economic activity and making things and doing things and actually generating wealth.
Because there’s a difference between wealth and money. If you have a suitcase full of gold, in some place where nobody actually produces anything for sale or does any business or makes anything, you have money, but you have no wealth because there isn’t anything that money can do for you. If you’re flat broke, but you’re a celebrated hero who saved a town where everybody works and creates value, that’s different. If everybody wants to invite you to dinner, celebrate that you’re here, gift you anything you like from their shops, etc, then you may have no money, but the goodwill of the people there means you have wealth.
We’re accustomed to thinking of them as the same thing in a capitalist society, but a currency with no inflation means everybody can just stash their suitcase full of gold (or bitcoin) in the basement of their house, forever, without any risk at all and without any loss of value, and as a result without enabling or producing any wealth either. And if your society, your people, are not producing wealth, you’re kind of screwed because no matter what money you have there’s nothing worthwhile to buy.
Well, Bitcoin actually goes a step further. Not only is it not inflationary, but to the extent that people do lose keys, Bitcoin vanishes. It disappears forever, making the money supply smaller, making whatever you’ve got stashed in the suitcase in the basement a larger share of whatever remains. So not only do you have no risk and no loss of value, but with Bitcoin you have an actual incentive: you know that the longer you hold that suitcase, the greater the fraction of the money supply you’ll have in it! This seems awesome, but the caveat of course is that if everybody thinks this way then there’s no economic activity and no matter how great a fraction of they money supply you have, it’ll count as no wealth.
On the whole, I believe that a better choice for a cryptocurrency would be that each year about five percent more coins should issue than in the previous year. This isn’t a popular opinion among the current crop of cryptocurrency ‘true believers’ but I expect that it won’t be very controversial among the more mainstream businesspeople and folks who’ve studied economics and investment.
End of Episode -1
The questions asked expresses Gayatri’s opinion and not of any company or any institutions or any groups.
This interview expresses Ray’s opinion and not of any company or any institutions or any groups.
This interview does not endorse any company, institutions or any groups.
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