Castles in the Air

by Markus Spiske via Stocksnap
by Markus Spiske via Stocksnap

Reuters reported today that Fidelity Investments Inc has joined IC3. This is intriguing, on many levels.

IC3 (Initiative for CryptoCurrencies & Contracts) was set up by faculty members of Cornell University, Cornell Tech, UC Berkeley, UIUC and the Technion-Israel Institute of Technology, and is based at the Jacobs Technion-Cornell Institute in New York. It has a “partners program” to encourage interaction with the business community, through which enterprises can pay an annual fee and participate in the development of new ideas and prototypes.

According to IC3’s website, partners can participate in monthly webinars, receive regular updates on and early previews of IC3 projects, access faculty and students (which could be used for recruiting purposes), and send up to two visiting researchers or embedded developers. The cost is $150,000 a year (or $450,000 for a higher-level partnership with even more access), a lot more expensive than Hyperledger’s $50,000 (or $250,000 for premium).

Fidelity joins Chain, Intel, IBM and Digital Asset, making it the first non-tech partner. According to Reuters, Fidelity wants to study how blockchain technology could make financial systems more secure and efficient.

So why not join a finance consortium? Why not sign up with Ripple, R3, Hyperledger or the Enterprise Ethereum Alliance?

While even academics acknowledge that a technology with no practical applications is not exactly useful, IC3’s approach seems to be blatantly “science first”. On its website it claims to “meets the blockchain community’s urgent need for world-class expertise in computer science” – notice that business models are not mentioned. Hyperledger, on the other hand, is also based on computer science, but seems to place the business applications front and center.

The motivation behind the choice of a consortium that takes a more scientific approach raises questions about Fidelity’s goals and strategy.

It’s important to note that Fidelity Labs will join as partner, not Fidelity Investments. Fidelity Labs was created in 1998 as the innovation arm of the financial corporation, and currently has over 100 patents to its name. This is just one indication that the multinational conglomerate has been investing heavily in technology for decades. Back in 1965 Fidelity Investments was one of the first investment firms to install a mainframe, and Fidelity Labs currently owns two of the first NVIDIA DGX-1 “artificial intelligence” computers.

But that doesn’t deter from the bigger question of “why IC3?”.

Perhaps Fidelity is looking to escape what they see as an overcrowded space in “mainstream” consortiums. Perhaps it feels that the higher fees and focus on research give IC3 a certain cachet. Perhaps it has a specific idea that aligns with a project already underway in IC3.

Or perhaps it is the beginning of a shift in priorities: business cases are interesting, but without academic proofs, you’re building castles in the air.

Bitcoin volumes and volatility – now what?

trading 700

CoinDesk reported yesterday on the change in the pricing strategy of the three largest Chinese bitcoin exchanges: BTCC, Huobi and OKCoin. This weekend they announced that they were suspending their “no fee” policy and moving to a 0.2% flat fee, “in response to guidance from the People’s Bank of China”.

Today we reported on the impact of this decision on trading volumes. No surprise – they’re much lower.

A bit of background: the “no fee” model may sound like an extraordinary business strategy (not charging for your main business), but it’s actually not very different from the “Freemium” models we see all over the place, in which most stuff is free, but some things not. The basic service is available to anyone, but for better content or service, you pay something. It’s an old strategy, even used by physical retail outlets – to get you in the store, they price some products so cheaply that they lose money on them. These are called “loss leaders”. The idea is that while you’re there, you’ll buy other stuff as well, and the store will make money there.

In the case of bitcoin exchanges, they don’t make money on the trades they execute, but they do charge a fee for entries and withdrawals. If you want to put money into your account, there’s a fee for that. If you want to take money out, also. But the trading you do in between, no charge.

The practice recently seeped into European exchanges, with London-based Coinfloor (number 25 in terms of fee-based bitcoin trading volume, according to Coinmarketcap, and the largest in the UK) announcing last week that it would adopt this pricing strategy.

The objective is to bring in liquidity. The result is to inflate volumes.

Since there is no charge for buying and selling, traders feel that they can churn holdings as much as they wish. And even small gains are worth it, especially if repeated several times during the trading day, since there is no associated monetary cost.

So, volumes are much higher under a “no fee” policy than they would be otherwise, and the PBoC regarded this as “fake volume” which added unnecessary volatility to the market.

In fact, the impact of no fees is so stark that Coinmarketcap (where I get my relative exchange volumes) only includes exchanges with fees in their main ranking (although you can get the whole list in another tab).

So, the volume hit was not a surprise. The announcement last week that the exchanges have halted margin trading (in which the exchange lends you the money to trade, which further encourages speculation) is no doubt also likely to have an impact.

The question now is: will this lower volatility? Or will it increase it?

Intuitively, less “churning” of holdings should make prices more stable. Trades are more “real” in that they are not about grasping at small gains. Positions are (in theory) held for longer, since changing them now incurs a cost. Less “fake” volumes, the PBoC’s reasoning goes, means more stable markets and less risk for non-professional investors.

But, lower volumes means lower liquidity, which means more vulnerability to swings due to large buy or sell orders. With higher liquidity, large orders have less of an impact as there are more funds available to settle those orders. Lower liquidity means that prices move more to tempt traders to take a side.

That, at least, was the argument that LedgerX gave in a CoinDesk interview yesterday. Here we have a derivatives exchange arguing that approval by the Commodity Futures Trading Commission (CFTC) would decrease bitcoin’s volume. Yes, you heard right, derivative trading can decrease volatility. Or so they say, and maybe they’re right, but I’m having a hard time getting my head around this.

The argument is that the increased liquidity from regulated bitcoin options will provide the market with a cushion to absorb large orders and avoid the price swings that usually result. My skepticism stems from the fact that it often is the need to close out derivative positions that generates these large orders in the first place, orders that often need to be filled in a hurry, at any price.

I do buy the argument that increased derivatives trading enhances price discovery, as future expected prices tend to react less to current events. And I understand that an active (and regulated) futures market can reduce the need to place large market-moving buy orders to “bet” on a certain direction – it’s cheaper and easier to buy futures contracts instead. They can also reduce the need to liquidate large positions, by “insuring” them at a relatively low cost.

However, here’s what has me worried: with derivatives, it is not very costly to accumulate large enough a position to benefit from sharp moves. It is conceivable that a speculator could accumulate a ton of puts, and then attack the bitcoin blockchain. The potential profit from the derivatives position from a sharp plunge in price could outweigh the cost of the attack.

And, I am not yet convinced by the increased liquidity argument. It could reduce volatility, but it could also increase it by encouraging speculative positions. That seems to be the PBoC’s position, that “fake” volumes are not good for the market nor for its investors.

As always, time will tell. And no doubt, other factors will throw in additional complications. Attributing changes in trends to any one announcement, in bitcoin as in life, tends to miss the bigger picture.

 

Blockchain and IoT examples

The Internet of Things is such a broad and confusing space, with so much potential impact in business, society and home life, that talking about it feels a bit like talking about the universe. After all, what isn’t a “thing” that can be connected to the Internet? When we’re referring to the Internet of Things, do we include our smartphones? Our cars? Our televisions? What about our satellites and our aeroplanes? Our 3d printers and our factory robots? And getting metaphysical on the issue, what about Facebook pages? Video games? Bank accounts? They’re things too, right? But to bring the discussion of the impact of the Internet of Things into the realm of practicality, most studies and businesses focus on gadgets, either big or small. The smartphone is so obviously a thing connected to the Internet that it is usually not featured in the sector studies, except as a conduit for information from other things. The same goes for computers and sensors. Those obviously-connected devices are what we embed in physical things to get them talking to us and to each other. So, when we refer to the “Internet of Things”, or IoT, we’re really talking about things connected via other things. Sensors, computers and phones talking to each other is the backbone of today’s development. But it’s not new and it’s not news. It’s what those sensors, computers and phones are talking about, what data they are transmitting and what objects they represent, that is of interest.

by Todd Quackenbush for Unsplash - blockchain and IoT
by Todd Quackenbush for Unsplash

For this discussion, I’m just focussing on physical gadgets not related to transport, the supply chain or to the energy sector (there’s so much going on there that we have the basis for a separate series of studies). While IoT is already a reality, its impact so far has been useful but fragmented, more an indication of what’s possible tomorrow than what we can change today. Blockchain technology is increasingly looking like a potential unifier for the different device-specific, manufacturer-specific and sector-specific networks currently in operation or under development. Yet its application is still fraught with obstacles and issues, most of which will be overcome with experimentation and creativity. Here I look at some of the more advanced projects participating in this journey – I fully expect that we’ll be hearing more from them in the months to come, as well as adding interesting newcomers to the list.

As with most blockchain activity these days, experimentation in the Internet of Things space is not limited to startups. In one of the first major papers on the subject, at the beginning of 2015 IBM revealed ADEPT (Autonomous Decentralized Peer-to-Peer Telemetry), a proof-of-concept of a universal IoT blockchain platform that combines P2P messaging, BitTorrent and Ethereum. Two interesting case studies were included: a washing machine that can manage its supply of detergent, self-diagnose and solve maintenance issues, and “negotiate” with other household devices the optimum time for an energy-consuming cycle run; and electronic billboards that manage, allocate and automatically charge for ad display. The proof-of-concept code was supposed to be shared on GitHub, although as far as I can tell it hasn’t yet, perhaps because the project leader left IBM at around the time of the paper release. IBM have certainly not been idle, though, and a few months ago revealed that they are working on combining the blockchain with Artificial Intelligence to manage IoT ownership, access and diagnostics. This is part of IBM’s commitment, announced in March 2015, to invest $3bn in the Internet of Things. Yes, that’s billion with a b. This should be fascinating.

One of the best-funded startups in the blockchain + IoT area is US-based Filament, which has received $7.35m in investment from VCs such as Bullpen, Pantera, Verizon, Crosslink, Samsung, Digital Currency Group and others. Its focus is long-range wireless networks, and its main product is the Tap, a device registered on the blockchain with environmental sensors that can integrate with other sensors, and which has a wireless range of over 15km that does not depend on wifi or cellular networks. These sensors help farmers to monitor soil quality, cities to control outdoor lighting, and vending machine operators to optimize inventory, among a host of other potential applications. While most uses at the moment do not need universal registry, the blockchain base will enable connectivity in the future, which will encourage the development of additional efficiencies and possibilities. Running on the bitcoin blockchain allows for micro-transactions, which will open up the project to a wide range of new business models. And if things are going to talk to and transact with each other, they’re going to need Filament’s blockchain-based help with decentralized identity creation for inanimate objects. The Patch, their other main product, is an embeddable version of the Tap that adds wireless connectivity to any hardware. Filament is one of the most advanced IoT and blockchain companies, in that it actually has paying clients and a seemingly viable business model: it owns the sensors, and charges for the configuration, the data, the maintenance and the updates.

IOTA approaches the issue from the other direction. Instead of focussing on the devices, it has created a cryptocurrency to facilitate micro-transactions between devices. Rather than a heavy blockchain, though, it runs on a lightweight “Tangle”, a “block-less” distributed ledger that makes it possible to transact without fees. Tangle doesn’t have miners that need incentivizing, but “verifiers” that are also users. They process transactions as they use the network, which allows for transactions at no cost, ideal for the high-frequency, low-value, light and constant transactions of the Internet of Things. Technically IOTA does not use a blockchain, but I include it here for its decentralized, trust-less approach to the exchange of value, and its innovative approach to the sticky problem of micro-transactions (still relatively expensive, even on the blockchain), both of which could put the goal of a viable and efficient Machine Economy within reach.

Chainofthings focusses on the security of the data collected and uploaded by the Internet of Things. Run as a consortium composed of several startups and established businesses active in the IoT and blockchain space, it supports and collates research and organizes events designed to promote solutions-based exploration. Participants and supporters include blockchains Ethereum, Lisk and Emercoin; IoT startups Filament and IOTA (mentioned above); blockchain businesses Skuchain and Everstore; bitcoin node hardware manufacturer Bitseed; solar power startups SolCrypto, SolarCoin and ElectriCChain; advisory businesses such as Zerado and Neuroware; and large international conglomerates such as electricity company RWE. Its first case study, revealed at a recent Chainofthings event in London, looked at the application of distributed ledgers to solar power generation, and the next one will focus on sensor mobility.

UniquID is a young project that was first presented at the Consensus conference in May 2016. Based in the US and in Italy, it allows users (still in beta) to create a private blockchain which acts like a sort of “wallet”, on which they can register their devices. All devices registered on that blockchain can communicate with each other, without the need for external authentication. Access to these “wallets” could be from a range of configured devices, which would give flexibility to the format and the deployment of these “local” IoT networks. Unlike other efforts in the sector, UniquID’s idea seems to be to maintain the separation of IoT networks, and it remains to be seen how this is better than a simpler database approach.

Riddle&Code is another young project in development, with an interesting twist. According to its website, the platform “connects blockchain technology to real world objects”, which is what most participants in the sector want to do. The twist is that it uses NFC technology that permits the secret exchange of data and of the cryptographic keys that determine who can access that data.

As you can see, the intersection of blockchain and the Internet of Things is attracting attention, but not yet at the scale the potential warrants, and not yet with a “success story” business model (Filament seems to be on the right track, but there is little public information, and it’s still early days). The ideal balance between hardware and software, centralization and decentralization, complexity and convenience will be difficult to find. But it will emerge as the sector gets more competition and as the businesses move along the timeline from idea to implementation to revenues. This progress is worth encouraging, as the end results will not only open up new potential Internet of Things business models. They will also teach us even more about the potential and actual real-world applications of blockchain technology and its derivatives, which will lead to more innovation and creativity. It won’t be easy – there are many conceptual issues revolving around identity and data that will need to be addressed – but the most important things in history never are.

(If I’ve gotten anything wrong on any of the businesses mentioned, please let me know! I don’t ever want to mis-represent a company or an individual, ever. A similar version of this post was published on LinkedIn. I twitter away at @NoelleInMadrid, come and say hi!)