August 2018 ● Survey of distributed consensus on digital networks, its relationship to the rise of cryptocurrencies such as Bitcoin and Ethereum, possible applications

1. Cryptomania!
The Past and Future of
Digital Distributed Consensus
(First of Two Talks)
Dallas C. Kennedy
… ΣΤΡΑΤΗΓΌΣ …
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2. Problem of Distributed Trust
“The Internet needs an immune system.”
• Distributed trust: essential problem to solve for future of the Internet …
Full of machines and activities …
… that were never meant to be connected to a public network
• Core problem:
Reach decentralized consensus without central authentication or adjudication and
without guarantee all actors are honest. Full problem and solutions in second talk.
• Fundamental point:
Find systems that enable distributed, peer-to-peer applications of cryptographic
strength, generating irreversible, tamper-proof consensus with a distributed ledger.
• Major applications in a tamper-proof, disintermediated world:
• Records
• Contracts
• Monetary transactions
• Voting
Problem of validating, aggregating, and representing distributed knowledge or consensus –
“The Internet needs an immune system.”
PoW is BTC’s contribution to secure BFT. Large computational effort and slow time (one
block ~ 10 minutes) provides such a high hurdle to jump over that it’s practically not worth
it to attempt to “spoof” the BTC blockchain with fake or reordered transactions. After a few
more blocks are added, would take 100s or 1000s yrs to recompute the whole thing to alter
it; can’t be timely. Intensive electric power sink, high fees, bottleneck by design.
Peer-to-peer means, no single or small number of central servers. Everyone’s a node.
Some history: packet switching, distributed networks 1960s
PKE 1970s
Hardware BFT systems (limited) 1980s
Irreversible timestamps 1990s
Major applications:
• Records: Origination, change, authorization
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3. • Contracts: Origination, authorization, changes, conditional execution
• Monetary transactions: Authorization, ordering, validation
• Voting: Authentication, validation, aggregation
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4. P. Baran et al., On Distributed Communications, The RAND Corporation for the USAF, 1960-1964
N of N beats N of 1 or 1 of N.
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5. This talk is not about Bitcoin
What Bitcoin (BTC) offers:
Peer-to-peer alternative to “fortress” model for central authentication and ledgers
Major innovations:
Distributed blockchain as distributed ledger and tamper-proof record through
difficult numerical “proof of work” (PoW) that replace
“root of trust” authentication in secure networks
• 2013: Main competitor and possible successor, Ethereum (ETH), with similar but more
powerful technology that includes smart contracts
• 2014: Explosion in “alt-coins,” mainly tokens, built around applications. Some serious
(Ripple, EOS) ... some hoaxes (Dogecoin) … some rip-offs.
• Legal chaos! BTC is legal tender currency in Japan and South Korea.
BTC is a security in most developed countries.
Enables evasion of chaos in Syria, Zimbabwe, and Venezuela.
Beats capital controls in China, India, and Argentina.
The more and the less serious gradually emerging!
Blockchain: distributed, anonymous, secure public ledger. Paid for by newly minted BTC for
successful miners and by transaction fees. Eventually, only the latter.
Proof of work: inverse double hashing problem: hard (and getting harder) for a miner to
solve, easy for anyone on network to verify.
Smart contracts: Any digitized automated or semi-automated transaction. Misleading term,
more broad than it sounds.
The network’s miners compete to be the first to find a solution for the double hashing
problem with the candidate block. This problem that cannot be solved in any way other
than through brute force, requiring requires a very large number of attempts.
When a miner finds the right solution, the miner node announces it to the whole network
at the same time. The network checks the solution, which is far easier than originally
solving the problem. If the solution is verified, the miner receives a cryptocurrency prize
(the reward) provided by the protocol.
Technically, mining is an operation of inverse hashing: it determines a number (nonce),
such the cryptographic hash algorithm of block data yields a result less than a given
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6. threshold.
This difficulty threshold determines the competitive nature of mining: as more computing
power is added to the network, the higher this parameter increases, increasing also the
average number of calculations needed to create a new block. This method also increases
the cost of the block creation, pushing miners to improve the efficiency of their mining
systems to maintain a steady stream of new bitcoins. This parameter updates approximately
every 14 days, and a new block is generated every 10 minutes.
Each block verified about every 10 minutes (600 seconds). Each block has a 1000-2000
transactions, so about 2-3 transactions per second.
If BTC was “1.0,” then ETH and recent cryptotokens are 1.x. New “2.0” stage forming that will
embody broad distributed consensus in flexible, powerful platforms in the next few years.
After Bitcoin itself, Ethereum is currently the only serious “grown-up” blockchain system of
broad application. (E.g., Ripple is IOU-based money-transfer only, no application layer. EOS
aspires to be next Ethereum, but still pretty new.) This will almost certainly change, though.
The subway is an application platform, and its “currency” is a token. The application is to get
you from one place to another.
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7. From 2009 to now … Where is cryptomania?
Bitcoin price peaked early 2018 … major price crash now seems done.
Blockchain networks continue to grow as expected. But high transaction
fees and expensive “mining” rigs have slowed their adoption.
Emerging collective realizations:
• Blockchains are generally too slow. Only ~ 1 - 10 transactions per second.
• Irrevocable trust through proof of work (PoW) is too expensive and slow.
• BTC and blockchain not capable of doing what many expected or hoped.
Too many purposes being projected on to BTC that don’t fit its design.
… Main competitor to BTC: Ethereum (ETH), a cryptocurrency —
Also an application platform that supports a cryptotoken.
Enables smart contracts.
Main competitor and step beyond expensive PoW: proof of stake (PoS)
… mix of advantages and one major vulnerability (second talk)
Ethereum = true platform with token and separation of protocol and application layers. Like
the Internet itself. Options for centralized ledgers, anonymous or not, still permissionless.
Ether, a volatile currency tradable for USD and other national currencies
Gas, an internal application token used on the platform: USD <-> ether <-> gas
Also a PoW system, but plans now to move away from PoW toward …
Consensys, consortium for Ethereum application development
Ethereum also acts as intermediary for would-be investors to accumulate tokens for initial
coin offerings (ICOs) of alt-coins.
ICOs are dangerous! Buyer beware. Totally unregulated. Some are for real, many dubious,
some outright frauds.
Long-term price base slowly forming for major players (BTC, ETH).
Expense of running BTC miners, paid for in regular currency, puts a constant downward
pressure on BTC price.
Current mining reward for BTC: 12.5 BTC -- Current hash rate: 3-5 x 1019 hashes per second
-- Current BTC supply: about 17M, out of eventual 21M.
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8. About 1 MB of data and 1000-2000 transactions per block.
Proof of stake is better, faster, far more efficient. No mining required or rewarded with newly
minted coins. Leadership can be dynamic, not static, by random choice or round robin, for
example. But a central point of failure can become a focus of attack, like DDoS attack.
PoS works by calling for nodes to stake a claim to be the forger or validator with their
existing coins. They can stake part or all they own. (In some systems, they can borrow from
other nodes, with shared rewards.) The winning node here proposes a new block as valid.
The network checks this claim. The staked coins are committed and frozen until PoS is
finished, a new block is formed, and the staked coins are returned. Stakers are compensated
with interest, which can be adjusted to provide incentive more or fewer stake claimers. No
mining, no newly minted coins as reward. Only transaction fees.
Forger or validator is chosen by some combination of size of stake, age of unused coins on
node, and a random component, or unbiased procedure like round robin.
Possible to value by looking at platform where such a system is running. Just look at the use
value of the tokens. Directly related to rate of turnover (money velocity).
PoW is naturally more secure, because so difficult and expensive to overwhelm the majority
of the network. PoS is more vulnerable, because a dynamically chosen leader can be
attacked. This is discouraged by forcing bad actors to give up whatever they staked if they
behave badly vis-à-vis other nodes or if they propose an invalid block. Trying to corner the
market in coins merely causes the price of a coin to rise sharply and checking the bad actor’s
attempt to buy all coins.
In spite of vulnerabilities, PoS is a promising avenue. More later.
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9. Tales from the Crypto:
Or, What I Saw at the Mania
https://www.wsj.com/articles/the-man-who-solved-bitcoins-most-notorious-heist-
1533917805
https://www.wsj.com/articles/the-crypto-crime-wave-is-here-1524753366
https://www.bloomberg.com/news/articles/2018-08-07/bitcoin-speculators-not-drug-
dealers-dominate-crypto-use-now
http://cfe.cboe.com/cfe-products/xbt-cboe-bitcoin-futures
https://coinmarketcap.com/
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12. → Distributed ledgers and other applications
• Server-less applications of blockchain and other distributed ledgers:
Financial transactions, smart contracts, medical and legal records, genomics,
file space and CPU rental, Internet of Things (IoT) that connects peer machines
• Steady growth in application of blockchain technologies by IBM,
Microsoft, GE, UBS, BBVA, and many others:
• Secure, transparent, time-stamped, distributed network-based applications
• Cloud-style services transacted on application platforms with cryptotokens.
Distributed public ledgers immutably record services and payments.
• Main venue: Ethereum and Solidity smart contract libraries. Rising rival: EOS.
• Several hundred applications now running such technologies
• My stack overfloweth: All over the Web … go see for yourself ….
https://www.forbes.com/sites/bernardmarr/2018/02/16/a-very-brief-history-of-
blockchain-technology-everyone-should-read/
https://medium.com/the-mission/a-brief-history-of-blockchain-an-investors-perspective-
e9b6605aad68
Popula (sent by Sarah Vallieres): https://popula.com/about-popula/
Getting into 1.x blockchain applications to support … journalism, in this case … see later:
micropayments.
Civil: civil.co. New micropayment journalism platform
West Virginia absentee voting: https://www.wsj.com/articles/blockchain-at-the-ballot-
booth-maybe-someday-1533132001
India digital legal identity for the millions who lack. Blockchain application some day?
http://blogs.worldbank.org/ic4d/using-digital-identities-fight-poverty
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14. Proliferation of crypto functions
Cryptocurrencies are breaking up into different functions:
• Cryptocurrency: Store of value, durable, but wildly volatile (BTC and
ETH/ether). Maybe not a store of value.
• Cryptotoken: Medium of exchange – Easy to transact with or exchange
in (ETH/gas, Ripple, EOS) – basis of application platforms
• Cryptoasset: Unique digital entity with value itself or acting as digital
cryptorecord for a real asset. … INFAMOUS: CRYPTOKITTIES.
More practical: Tokenization of small physical assets, often
connected with tracking of physical objects on the Internet of Things (IoT).
Such non-monetary uses includes tracking of ships and airplanes – which will
never be lost again!
Tokens & platforms doing well. Problem of speed and scale of transactions remains.
The problem of digital distributed consensus, in general, without a trustworthy
central authority in charge of a secret ledger. Bitcoin = distraction.
A general problem that needs to be solved in a networked, digital society.
Use versus buy and hold. Token is used, not held. Should have high money velocity.
An asset just sits there. You can count it, you can stroke it. [Gollum]
Tracking in space and time requires a blend of GPS and Irridium satellite phone network.
Things will never get lost over water or in remote areas again.
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15. Role and nature of money
• A polarity in the meaning of money:
BTC ← ETH →
• Functions of money:
Unit of account … Store of value … Medium of exchange
• Properties of money:
Durable … scarce … recognizable … portable … divisible … fungible
• Modern fiat currency systems have split off durability and scarcity in favor of
token aspects of money: portability and divisibility above all.
Essentially a way to liquefy credit creation, the main lubricant of modern economic
activity and growth. Cryptocredit?
Money as commodity Money as token
Money as scarce and durable
store of value
Money as useful intermediary to
transact for real goods and services
Cryptocredit gets into a sensitive area: the creation of “broad money” (M2) by commercial
banks and others, starting with the central bank monetary base (M1).
Will this cartel be toppled by distributed credit systems? Profound political, social, and
economic implications.
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16. Valuing cryptocurrencies
• Equation of exchange:
• MV = PT: money supply x rate of turnover = price level x transactions per time
• Distinguish:
• Using cryptocurrency and holding cryptocurrency.
• Purchasing cryptocurrency as a long-term store of value from
short-term speculative holding in relation to conventional currencies
What’s the value of BTC, say, in terms of USD?
What’s the value of some good or service in terms of BTC?
Is there easy substitution from the USD economy?
Or is it unique to cryptocurrency?
Basic conflict: Is a crypto a security, a commodity, or a currency?
True cryptocurrencies will be easily available application tokens and NOT tradable
on public exchanges. What’s on “real-world” exchanges, in turn …
… will not be treated as currencies.
Application
platform ↓
For example, smuggling drugs or contracting murder-for-hire can just as easily be done in
cash 
Crucial role of application platforms and tokens. Application platforms require use of the
special tokens—have to convert from USD or other national currencies.
Money supply [$ or whatever]
Rate of turnover often called money velocity [1/yr]
Price level [$]
Transactions [1/yr]
Widespread confusion: ICOs = IPOs? Really? “Market cap”? Or “money supply”?
Attempts to stabilize cryptos (Tether, stablecoins) treated as illegal market manipulation.
Sounds like a security ….
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17. Rising to full problem of distributed consensus
• Doesn’t have to be anonymous or about money. Could be:
• Sharing social applications like an online game
• Voting
• Securing and sharing medical or legal records
• Can be:
• Public, private, or secret
• Anonymous, pseudonymous, or named
• Permissioned or permissionless
• Has to be:
• Distributed
• Acyclic and directed
• Unambiguously ordered
• Immutable once committed
General system should provide affordance for all possibilities.
Permissionless Permissioned
Access Open read/write Restricted read/write
Speed Slower Faster
Security Distributed proof Preapproved auth
Identity Ano/pseudonymous Known to all
Asset Native to network Any
Cost More Less
Unfortunate in the case of BTC that consensus problem was first solved in this context. BTC
was built from the beginning as a “difficult” system – no leadership or central server, no
network state, large burden on each miner. Born and grew up in the shadow of the Great
Financial Crisis of 2008 and growing mistrust of commercial and central banks.
Better, comprehensive solutions possible and practical.
General implementation of distributed consensus that is much faster, more secure, much
more flexible, one that supports applications in general,
not just the narrow case of BTC: anonymous, permissionless, peer-to-peer with no state
and no proof of irrevocability.
Private: existence known, but activities closed to non-users. Permissioned = existence and
identity of users known. BTC permissionless.
Want a system not subject to economies of scale and tendency toward a few miners –
increases chance of 1/3 rule being violated or a 51% malicious attack.
PoS fits this much better. Weight of probability assigned randomly, but weighted by stake of
each node.
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18. Cyclic graph Acyclic graph
Directed acyclic graph
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19. Micropayments …
Transaction fees > impractical. Blockchain platforms too slow and expensive.
Fast, cheap, secure consensus cryptotoken system > practical micropayments
Distributed consensus: Major applications
Social networks … without advertising or data harvesting or distractions
Virtual voting – No actual voting – Gossip-based protocol metadata
determines what your vote would have been had you actually voted –
Much more secure than sending a vote.
Powerful alternative to common existing models: subscriptions …
or “FREE” model based on advertising ….
… Inevitably leads to spying on users.
Powerful template for online “shared worlds,” like gaming …
… After all, isn’t everything online a game anyway?
Subscription model makes it harder to sample and skip around. Less than optimal for
consumers, dampens competition.
Alternative: “FREE” model based on advertising, which is worse. Inevitably leads to spying
on users. You are the product, as they say.
Not only can replace or migrate current models, but opens up new possibilities for online
and offline services.
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20. Distributed consensus: Serving the unbanked
• Leapfrog beyond banking in poor countries and in poorer parts of the
developed world. A world that is heavily unbanked and often lacks legal ID.
• Not worth it for banks – with high cost structures and heavy regulatory
requirements – to provide banking services here.
• Older cryptocurrency systems (BTC, ETH) can’t serve this market.
• Key alternative platforms …
… cell phones, cellular service, and money transfer apps
• Already happening: US: Apple, Google, PayPal, Venmo, BitPay –
China: WeChat, Alipay –Argentina: Ripio (BitPagos) – Kenya: M-Pesa –
Somalia: Telesom, Somtel …
Need greater speed, security, and reliability, with
no bottlenecks or high transaction fees …
… These will be early places to test and develop distributed
consensus systems. Next logical step: CRYPTOCREDIT!
Shady alternatives to banks, like payday lenders and pawn shops, flourish there. But
paternalistic regulation to restrict such activities just makes it harder for poorer people to
make a living.
In poor countries, people have to rely on the kindness of strangers or on expensive services
like Western Union. Costly and inefficient.
Cost structures include heavy regulation of “know your customer” and many middlemen in
the chain of money transfers and transactions.
For example, the Hedera consensus system requires that your public key be bound to a
verified, “real-world” identity for full use with national currencies.
In the developing world, the costs of transfer of largely borne by customers. In the
developed world, it’s the businesses that bear the cost, which then shows up in higher
prices indirectly.
WeChat (Tencent) – Alipay (Alibaba)
Somalia:
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21. https://www.wsj.com/articles/SB10001424052748704608104575220570113266984
M-Pesa: https://blogs.wsj.com/tech-europe/2012/10/29/more-to-african-mobile-payments-
than-m-pesa/
New Kenyan service M-Kesho includes credit and interest. One-third of Kenyan GDP flows
through M-Pesa!
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22. Resources
Classics
1977: R. Rivest, A. Shamir, L. Adleman, US patent #4405829A. “A Method for Obtaining Digital Signatures and Public-Key
Cryptosystems,” Comm. Assoc. Comput. Mach. 21(2) (1978)
1980: M. Pease, R. Shostak, L. Lamport, “Reaching Agreement in the Presence of Faults,“ J. Assoc. Comput. Mach. 27(2) ● 2005
Edsger W. Dijkstra Prize in Distributed Computing
1982: L. Lamport, R. Shostak, M. Pease, “The Byzantine Generals Problem,“ ACM Trans. Prog. Lang. Sys., Vol. 4(3)
1983: L. Lamport, “The Weak Byzantine Generals Problem,“ J. Assoc. Comp. Mach., Vol. 30(3)
1991: S. Haber & W. S. Stornetta, “How to Time-Stamp a Digital Document,” J. Cryptography, Vol. 3(2)
1993: C. Dwork & M. Naor, “Pricing via Processing, Or, Combatting Junk Mail,” CRYPTO’92 (Springer, 1993) (proof of work)
Moderns
White papers (2008 – now): Bitcoin, Ethereum, Hashgraph, Hedera. See https://lopp.net/bitcoin.html.
Books
The Mathematical Theory of Epidemics. N. T. J. Bailey, Griffin, 1957. (Gossip protocol)
The Wisdom of Crowds. J. Surowiecki, Doubleday, 2004.
The Age of Cryptocurrency. P. Vigna & M. J. Casey, Picador, 2015.
Blockchain Basics: A Non-Technical Introduction in 25 Steps. D. Drescher, Apress, 2017.
https://www.microsoft.com/en-us/research/publication/reaching-agreement-presence-
faults/
https://www.microsoft.com/en-us/research/publication/byzantine-generals-problem/
https://www.microsoft.com/en-us/research/publication/weak-byzantine-generals-
problem/
https://tools.ietf.org/html/rfc4998
More technical: Mastering Blockchain: Distributed ledger technology, decentralization, and
smart contracts explained, 2nd Edition. I. Bashir, Packt Publishing, 2018 (e-book).
Font and origin of all modern social aggregation and coordination discussion:
F. A. Hayek, “The Use of Knowledge in Society,” Am. Econ. Rev. 35(4), September 1945
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