Crypto Market Commentary
30 June 2019
Doc's Daily Commentary
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Decred – The Competition
Cryptocurrency networks are one of the most fascinating technological and financial developments in history. They comprise not only the operational distributed code, but importantly, a community of humans with a shared belief in the digital currency unit and network value proposition.
As the network reaches the degree of decentralisation where it is resistant to coordinated attacks, they begin to develop characteristics akin to digital life, often analogous to anti-fragile fungi (Quittem, 2018). Anti-fragility is necessary to survive the in extremely hostile environment faced by an emergent global money with attack vectors spanning from nation state assaults, social and cultural stigmatisation, aggressive legal and regulatory policies and fierce competition but other networks for mind-share.
Bitcoin was the first digital organism and Ralph Merkle summised it beautifully saying “[Bitcoin] lives because it can pay people to keep it alive…[and] performs a useful service that people will pay it to perform”. Bitcoin (and the market) is proving itself to be the apex predator of money and it will be no small feat to compete with this organism.
What I want to explore in this article is the characteristics of Decred (DCR) which I believe make it the most competitive alternative digital organism that lives today. Decred is unique in that it has opted to compete with Bitcoin in the 100 year race rather than the speculative short game. It does not succumb to the typical hype driven momentum common in this industry, instead capturing an ever stronger community of stakeholders and one of the most proficient developer teams in the industry.
The 100 Year Race and digital instincts
History has shown that sound money, Gold being the primary example, can maintain its status as the base monetary unit for thousands of years. The emergence of a new sound money is a rare event and for any of Bitcoin’s competitors to displace it, requires an extremely compelling feature set and survival instincts that make it viable for hundreds to thousands of years.
The base assumption in this analysis is that the likelihood of Bitcoin becoming the de-facto store of value asset by displacing Gold increases every 10 minutes.
To compete with Bitcoin as money, I posit that digital organisms therefore require mastery of five essential digital instincts for success to be an option:
Decentralisation which provides permission-less access to censorship resistant money. These organisms must become decentralised enough that they resemble a Hydra, to the extent that the threat of nation-state censorship is insufficient to undermine its security, anti-fragility and immutability.
Impenetrable Security to build the trust and reliability that are severely lacking in modern centralised systems. One must be confident that transactions written to the ledger are permanent from a probabilistic standpoint and that their private keys guarantee ownership indefinitely.
Verifiably Scarce to provide a sounder monetary medium than Gold at a minimum and at least comparable in scarcity to Bitcoin. Bitcoin has the advantage of the immaculate conception and 10 year Lindy effect and as such, a competitor must attain ‘unforgeable costliness’ rooted in the cost of production which must be equal or more expensive than Bitcoin’s. Only with extreme and verifiable scarcity can a digital organism attract investor capital, else it will be outcompete by the more salable asset for liquidity.
Sustainable evolution which is necessary as a distinguishing feature to the rapidly calcifying Bitcoin code-base. Bitcoin’s strength is its hand-coded and arduous development and consensus cycle. Thus for a digital organism to be competitive, it must be able to evolve and adapt over the 100+ year race to capitalise on the constraints in Bitcoin’s design, namely complex off-chain governance and early calcification. Further to this, the ability for the organism to pay for service providers and development capital is critical and few cryptocurrencies have sustainable funding models to support this.
Human mind-share is arguably the most important digital instinct. A cryptocurrency is only as valuable as the community of humans that elect to sustain it either by providing security compute power, developer capital or financial accumulation support. Hard-forks are entirely destructive to these communities and controversial ones weaken the community layer as it forks both code and people.
Decred is alive
Decred is one of the few digital organism that excels in all five digital instincts and in my mind is the front-runner asset capable of challenging Bitcoin’s dominance as as sound money in the long run.
Decred knows that it cannot replicate the immaculate conception origin story of Satoshi Nakamoto, a key element in Bitcoin’s unforgeable costliness. It also knows that it does not have 10 years of battle scars to justify the same Lindy effect and resilience.
Bitcoin has rightfully been justified in the market as the dominant cryptocurrency and is a hardcore example of unwavering resilience, uncompromising security and a robust set of trade-offs. It survives as a result of its undeniable monetary premium (refer to Plan B) and subsequent market liquidity.
So in order to compete, Decred has done something no other network has thought of. It installed a hive-mind of human governance, who all have serious skin in the game, to give it the evolutionary edge of collective intelligence.
The precision and detail that has gone into Decred’s design would require many pages on each element so I will touch on each of the five instincts and follow up in more detail with future articles.
architecture for the ages
What is so crucially important about Decred is the Hybrid Proof-of-Work (PoW) and Proof-of-Stake (PoS) architecture and the meticulous balance of incentives. From each block reward, 60% is allocated to PoW miners in return for their electrical and hardware demands; 30% is allocated to PoS stakeholders which incentivizes participation and contribution to Decred’s hive-mind governance system Politeia; and 10% is allocated to the development fund which is soon to be transitioned to a fully functioning DAO and subsequently managed entirely on-chain by stakeholders.
Individually, PoW and PoS consensus mechanisms have undeniable limitations and it is Decred’s ingenious hybridization of these that makes the architecture so compelling.
Proof of Work
PoW is a fiercely competitive environment where cryptocurrencies must attract sufficient hardware (CAPEX) and electricity (OPEX) investment by miners to secure the chain. Given the enormous costs associated with such operations, it is extremely unlikely that more than one or two PoW coins can co-exist in the long term. Miners will ultimately switch to the most profitable network which is likely to converge on the dominant chain servicing as money.
The most important part of the PoW consensus mechanism, is that it roots the costs of production of mined coins to real world expenditure and the constraints of physics. In order to attack a PoW chain, one must commit financial capital, hardware, time and electrical energy, all with associated costs and implications outside the digital realm (Refer to Dan Held’s article PoW is Efficient). The difficulty adjustment ensures that as hash-rate grows, the same coin issuance schedule is maintained which forces the supply to be inelastic and thus price will increase heavily with growing demand.
ASICs are an essential ingredient to PoW security that ensures miner hardware is both ultra-efficient yet completely useless for any other application. This discourages bad actors from attacking the network as it becomes an immediate threat to their CAPEX investment.
The key limitation and risk introduced by ASICs is the increased centralisation of hash-power with significant mining operations converging to fewer industrial scale operations. This may be seen as a point of weakness for miner collusion and/or nation-state attacks. There also remains the argument of high energy expenditure and environmental costs which is a topic unto it’s own. For Bitcoin, it’s massive size and mining trends to date suggest that Bitcoin’s security is fine, however this miner centralisation remains a risk for smaller PoW chains.
Figure 1 – Bitcoin (red) and Decred (blue) hash-rate difficulty showing a steady and constant increase in network security over time.
Proof of Stake
Proof of Stake is a relatively new consensus mechanism (at least in practice) and requires stakeholders of a network coin/token lock-up collateral and provide block validation computation in exchange for a block reward.
In pure PoS chains, there is very little real world expenditure on electricity and hardware to provide validation services and it can usually be run on a laptop or even a raspberry pi computer. The advantage here is that if we assume owners of a coin on average will act in the best interest of the network, a more distributed network of nodes can be achieved at lower electrical demand.
However, there is a complication termed the ‘nothing at stake’ problem where in the event of a hard fork, validators can support both forks at little cost thus collecting the fees on both and hedging for whichever is the winner. Additionally, there are challenges in nodes achieving consensus on the dominant chain in the event of a network split, fragmentation or period of nodes going offline. This lowers the conviction of the consensus mechanism and means PoS systems generally have decreased resilience to black swan events.
Decred is secure and decentralised
This is where the Decred hybrid consensus mechanism is ingenious. The primary security mechanism is the Proof of Work which anchors the cost of production of block rewards to real world CAPEX and OPEX expenditure. ASICs are now available for Decred’s Blake-256 hashing algorithm and hash-rate has now reached 500PH/s, around 1% of the Bitcoin hash-rate.
As a check and balance to PoW, Decred employs an incentivized PoS protocol where stakeholders must lockup a set number of DCR coins in the form of a Ticket for an average of 28 days. Each block, 5 tickets are randomly selected from the mem-pool to vote on the validity of the last block mined.
Similar to PoW difficulty adjustment, Decred automatically adjusts the price of tickets to staking demand targeting 40,960 tickets in the mem-pool. As such, Decred has inelasticity in both supply issuance and in staking rights. This results in an increasing demand for tickets, a high proportion of DCR locked out of circulation with typically 40% to 50% of DCR locked in staking, higher than almost any other protocol.
Figure 2 – DCR ticket price over time showing a near linear increase in demand for tickets and stakeholder voting rights. The current ticket price fluctuates around 115 to 125DCR (although ticket splitting is available)
Figure 3 – near linear increase of proportion of DCR locked in staking. It is currently approaching 50% of circulating supply. Few crypto projects are able to get 1% voter participation so this is exceptional.
In order to capture the Decred chain and double spend, a bad actor not only needs to capture 51%+ of the PoW hash-rate, but also needs to capture 60%+ of the ticket stake which must be held in the mem-pool for almost 1 month. As an additional precaution, once a ticket has voted, there is a 24hr period of immaturity which leaves the attacker’s coin locked long after a double spend will be discovered, effectively destroying their investment.
This hybridization effectively nullifies the centralisation risk of PoW whilst delivering significantly higher network security than pure PoS at a much lower energy expenditure to pure PoW. Decred’s consensus mechanism has mitigated the risks of both PoW and PoS whilst enhancing the strengths of both. In fact, a study by Zubair Zia (2018) showed Decred to be 20x more secure than Bitcoin on a like-for-like hash-rate basis. If Decred were to attract 5% of Bitcoin’s hash-rate, this would put them on par in terms of security with an extremely wide set of stakeholders that enhances decentralisation, an impressive feat.
Decred is decentralised and secure and if its hash-rate was reaches 5% of Bitcoins, it will become the most secure blockchain in the industry.
Decred has retained many components of Bitcoin’s scarcity design including the deterministic issuance schedule and 21million fixed supply hard cap. Don’t fix what is not broken. Where Decred differs is in the distribution of the block reward and in the lack of halving events, instead following a continuous dis-inflationary supply curve that approaches Bitcoin’s over time.
Considering the stock-to-flow modelling and power law relationship between stock-to-flow and market value originally proposed by Plan B (@100TrillionUSD), Decred appears to be attracting a monetary premium. This is significant and it is one of the few cryptocurrencies that is showing signs of monetization so early in its life. DCR will go through the same stock-to-flow values as Bitcoin and if it retains this monetary premium, is likely to follow suit in a strong uptrend over time becoming a competing store of value coin.
Figure 4 – Decred stock-to-flow (blue) and projected network valuation (orange) based on the monetary premium relationship established by Plan B (@100TrillionUSD) for Bitcoin. This assumes Bitcoin has carved out the most organic relationship between scarcity and value which may be applied to any asset.
Now what is critically important here is that DCR has an extremely high cost of production. Not only does the electrical and hardware demands of PoW need to be accounted for, but also a community of ticket holders who have skin in the game locked up for a month. The ‘unforgeable costliness’ of DCR is the combined costs of the computational work AND the community, which is an extremely powerful proposition.
Decred has created an extremely scarce digital asset and one which will likely challenge Bitcoin in the long run.
Finally, we come to the most unique and unrivalled feature of Decred, it’s governance system. Decred has implemented an on-chain governance system that allows stakeholders in the network to vote on proposals made by any contributor. Contributors can be anyone (called contractors) who apply for funding via the on-chain governance portal Politeia (pronounced ‘Pol-it-aya’). This system pays contractors for approved proposals and delivery by drawing on the treasury which receives 10% of the block rewards and at the time of writing holds 621,847 DCR which is equivalent to $21.1million.
The treasury has recently been approved by stakeholders to be transitioned in full on-chain which will make Decred the first fully functioning, self-sustaining cryptocurrency DAO with over $20million in assets under management.
This is Decred’s competitive edge. Bitcoin is difficult to change and this is one of it’s soundest value propositions. Decred is able to evolve but only with explicit sign off from the stakeholders in the network. The ability to adapt and evolve with a sustainable funding mechanism effectively gives Decred near infinite runway for paying developers and allows for strategic implementations and features to be built to remain competitive.
The voting capabilities provided to stakeholders has shown to avoid contentious hard forks, and this results in the Decred community being one of the strongest and most resilient in the cryptocurrency industry. Decred is a master of capturing human mind-share and this is a digital instinct that should not be underestimated.
Decred is a hedge against an uncertain future
Bitcoin is the apex digital organism for a reason. It is the rawest example of digital life and it has bitten the bullet and made the most challenging trade-offs to attain its sound money premium. Bitcoin will calcify earlier than all other chains which will only add to its trust and reliability. I fully expect Bitcoin to persist as the dominant blockchain into the future.
However…the future is an uncertain beast. To compete in the 100yr race with Bitcoin, one must evolve or die.
Decred has all the hallmarks of a true competitor having adopted the key trade-offs from Bitcoin (extreme scarcity, decentralisation, security and reliability) yet supplemented it with the ability to self-sustain and evolve should the needs arise. Decred is the most future proof cryptocurrency projects outside Bitcoin.
Decred survives because it can pay people to keep in alive as well as pay people to make decisions from collective intelligence. The developer team who support Decred are easily one of the most proficient in the industry with many having origin roots as Bitcoin core developers, an elite group of consensus protocol engineers.
The similar architecture to Bitcoin allow DCR to implement the Lightning Network and perform atomic swaps with Bitcoin and Litecoin. Decred is building infrastructure that compliments Bitcoin and I can see a future where DCR acts as an infrastructure governance layer for Bitcoin where the sum is greater than the parts.
Decred is a completely sane hedge for any failings in Bitcoin and the uncertainty of the future. Most importantly, Decred the only digital organism I have encountered that is able to evolve whilst maintaining a genuine monetary premium. It’s hard for me to justify betting against Bitcoin, and equally hard to justify betting against Bitcoin if it had a brain.
Top resources on decred to learn more
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An Update Regarding Our Portfolio
We are pleased to share with you our Community Portfolio V3!
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We intend on this portfolio being balanced between the Three Pillars of the Token Economy & Interchain:
Crypto, STOs, and DeFi projects
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Here’s our past portfolios for reference:
RSC Managed Portfolio (V2)
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RSC Managed Portfolio (V1)