October 23, 2016

Bitfinex - Wolves and a sheep voting on what's for dinner

When Bitcoin first started up, although I have to say I admired the solution in an academic sense, I had two critiques. One is that PoW is not really a sustainable approach. Yes, I buy the argument that you have to pay for security, and it worked so it must be right. But that's only in a narrow sense - there's also an ecosystem approach to think about.

Which brings us to the second critique. The Bitcoin community has typically focussed on security of the chain, and less so on the security of the individual. There aren't easy tools to protect the user's value. There is excess of focus on technologically elegant inventions such as multisig, HD, cold storage, 51% attacks and the like, but there isn't much or enough focus in how the user survives in that desperate world.

Instead, there's a lot of blame the victim, saying they should have done X, or Y or used our favourite toy or this exchange not that one. Blaming the victim isn't security, it's cannibalism.

Unfortunately, you don't get out of this for free. If the Bitcoin community doesn't move to protect the user, two things will happen. Firstly, Bitcoin will earn a dirty reputation, so the community won't be able to move to the mainstream. E.g., all these people talking about banks using Bitcoin - fantasy. Moms and pops will be and remain safer with money in the bank, and that's a scary thought if you actually read the news.

Secondly, and worse, the system remains vulnerable to collapse. Let's say someone hacks Mt.Gox and makes a lot of money. They've now got a lot of money to invest in the next hack and the next and the next. And then we get to the present day:

Message to the individual responsible for the Bitfinex security incident of August 2, 2016

We would like to have the opportunity to securely communicate with you. It might be possible to reach a mutually agreeable arrangement in exchange for an enormous bug bounty (payable through a more privacy-centric and anonymous way).

So it turns out a hacker took a big lump of Bitfinex's funds. However, the hacker didn't take it all. Joseph VaughnPerling tells me:

"The bitfinex hack took just about exactly what bitfinex had in cold storage as business profit capital. Bitfinex could have immediately made all customers whole, but then would have left insufficient working capital. The hack was executed to do the maximal damage without hurting the ecosystem by putting bitfinex out of business. They were sure to still be around to be hacked again later.

It is like a good farmer, you don't cut down the tree to get the apples."

A carefully calculated amount, coincidentally about the same as Bitfinex's working capital! This is annoyingly smart of the hacker - the parasite doesn't want to kill the host. The hacker just wants enough to keep the company in business until the next mafiosa-style protection invoice is due.

So how does the company respond? By realising that it is owned. Pwn'd the cool kids say. But owned. Which means a negotiation is due, and better to convert the hacker into a more responsible shareholder or partner than to just had over the company funds, because there has to be some left over to keep the business running. The hacker is incentivised to back off and just take a little, and the company is incentivised to roll over and let the bigger dog be boss dog.

Everyone wins - in terms of game theory and economics, this is a stable solution. Although customers would have trouble describing this as a win for them, we're looking at it from an ecosystem approach - parasite versus host.

But, that stability only survives if there is precisely one hacker. What happens if there are two hackers? What happens when two hackers stare at the victim and each other?

Well, it's pretty easy to see that two attackers won't agree to divide the spoils. If the first one in takes an amount calculated to keep the host alive, and then the next hacker does the same, the host will die. Even if two hackers could convert themselves into one cartel and split the profits, a third or fourth or Nth hacker breaks the cartel.

The hackers don't even have to vote on this - like the old joke about democracy, when there are 2 wolves and 1 sheep, they eat the sheep immediately. The talk about voting is just the funny part for human consumption. Pardon the pun.

The only stability that exists in the market is if there is between zero and one attacker. So, barring the emergence of some new consensus protocol to turn all the individual attackers into one global mafiosa guild, a theme frequently celebrated in the James Bond movies, this market cannot survive.

To survive in the long run, the Bitcoin community have to do better than the banks - much better. If the Bitcoin community wants a future, they have to change course. They have to stop obsessing about the chain's security and start obsessing about the user's security.

The mantra should be, nobody loses money. If you want users, that's where you have to set the bar - nobody loses money. On the other hand, if you want to build an ecosystem of gamblers, speculators and hackers, by all means, obsess about consensus algorithms, multisig and cold storage.

ps; I first made this argument of ecosystem instability in "Bitcoin & Gresham's Law - the economic inevitability of Collapse," co-authored with Philipp Güring.

Posted by iang at October 23, 2016 12:35 PM
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