May 11, 2019

$40 Million Binance Hack Sparks Bitcoin Reorg Controversy

Talks of a reorg on the Bitcoin blockchain take centre stage after Binance were hacked for 7,000 bitcoin. Data from Diar show Bitcoin on-chain transactions approach record levels while fees paid to miners remain drastically lower. Crypto conference season is upon us and Bitfinex issue the whitepaper for their proposed $1 billion IEO.

Quick Take;

  • Considerations of a reorg on the Bitcoin network to tackle the Binance hack sparks intense debate in the crypto community
  • Consensus kicks off on Monday but ticket sales are reported to be 50% lower
  • The Diar newsletter shows the number of transactions taking place on Bitcoin approaching record levels while the fees remain far lower than peak levels

Controversy kicked off during the week when the idea to reorg the Bitcoin blockchain to reverse the Binance hack of 7,000 bitcoin was considered. Changpeng Zhao (CZ), the CEO of Binance, aborted the idea and acknowledged its difficulty after some discussions.

A reorg is simply a reorganization of the blockchain. These happen all the time on a small scale as miners build on different chains before they know which one is the longest. This is why six-block confirmations are recommended on Bitcoin for large payments.

However, a deep reorg is another matter entirely. A deep reorganization of the ledger coordinated by an entity would raise serious questions over the immutability and the decentralization of the Bitcoin network.

The fact that the idea was even considered sparked outrage. The various tribes that comprise crypto twitter all quickly voiced their opinions with their 280-character podiums.

The initial idea originated from bitcoin contributor Jeremy Ruben.

The idea is simple. By posting a transaction which double spends the hacked coins that has a huge transaction fee, miners would be incentivised to reorganise the blockchain, allowing them to process the transaction with the huge fee and work on the new chain until it becomes the longest chain.

At the time the idea was proposed, 50 confirmations had already happened on the chain. The longer the time that passes, the more complex it becomes to execute a reorg.

When a reorg happens, an alternative chain is created and this chain competes with the original chain to become the longest chain. To overtake the original chain, the reorg chain requires at least 51% of the hash power.

The more hash power the reorg chain has, the quicker it can overtake the original chain. For every incremental piece of hash power that remains on the original chain, the reorg becomes more expensive to execute.

Jimmy Song did some rough calculations assuming a reorg was attempted when the hack was 58 blocks deep.

With research showing that over 50% of the hash power is concentrated in four mining pools, it is plausible to think that they could be coordinated if the decision was based purely on numbers alone. However, many other complexities come into the decision.

Bitcoin miners are highly exposed to the value of bitcoin and their ASIC miners. This highly incentives them to always mine on the longest chain which would be the original chain in the case of a reorg.

The balance sheet of miners is extremely exposed to the value of bitcoin and the value of their ASIC hardware. Anything which undermines the immutability of the Bitcoin blockchain poses a high risk of depreciating the value of the currency which operates on the network.

Analyst Ari Paul notes that the social media outcry played a key role in communicating to miners that a reorg would jeopardize the value of the network and bitcoin.

Jimmy Song also did a post-scenario analysis of the proposed reorg. From a user standpoint, the game theory also extremely favours the longest original chain.

Let’s say the reorg was coordinated successfully with >51% of hash power. In the case that the reorg chain was catching up to the original, users on the original chain would be highly incentivised to raise fees to an extent that attracts a majority hash rate back to the original chain.

It would be a huge headache for major users such as custodians, exchanges, and merchants to have a deep reorg take place. This acts as a strong incentive to drastically raise fees.

Let’s not forget the thief also. The thief would be another user incentivised to stake anything less than the stolen funds as fees to incentivise miners back to the original chain from the reorg chain.

The incentives driving a deep reorg get very complex very quickly. What is interesting is that it is theoretically possible. What is also interesting is that the incentives for a reorg make much more sense when a hack is large in size and the reorg is coordinated quickly after the hack has taken place.

The replace by fee (RBF) feature of the bitcoin protocol was a method noted after the fact that could have been used to prevent the hack taking place at the time the theft was carried out. Also noted by Jeremy Rubin, RBF would have allowed Binance to replace the transaction with their own by posting a transaction with a higher fee.

The proposals served to spark some interesting discussions. In the end, Binance users will be compensated from the SAFU (“secured asset fund for users”) which is a fund that Binance has contributed towards so that users do not lose their funds in an event such as this.

The hack itself took place on Binance’s hot wallet account. It is estimated that Binance has another $2 billion worth of bitcoin in cold storage.

Kudos to Binance for remaining transparent throughout the security breach. They will easily weather the storm.  Although the hack is the sixth largest in the history of cryptocurrency exchanges, it is estimated that Binance can recover the lost funds in revenue in less than two months.

Quick bits (and bitcoins)

Cryptocurrency Conference Season Kicks Off

Crypto conference season is upon us and the bellwether of crypto conferences Consensus kicks off on Monday. It is reported that the event is expecting a 50% drop in attendance.

Here’s a list of all the events taking place around New York over the next week:

  • Ethereal (Friday 10th and Saturday 11th)
  • Magical Crypto Conference (Saturday 11th and Sunday 12th)
  • Consensus (Monday 13th to Wednesday 15th)
  • Digital Asset Summit (Wednesday 15th)
  • Token Summit (Thursday 16th)

Bitfinex Robs Peter to Pay Paul

The Bitfinex IEO is going ahead. The exchange plans to raise $1 billion to cover funds frozen by the Portuguese, Polish, and US governments. Panamanian-based payment processing company Crypto Capital lost access to the Bitfinex deposits. Bitfinex was forced to use Crypto Capital after losing a number of different banking partners. It is reported that $650 million has been raised through private investment and that the investment will be open to the public on May 10th if any issuance is left. The IEO whitepaper was released during the week. This all takes place a week after the New York Attorney General’s Office pursued legal action against the company behind Tether and Bitfinex.

Joseph Stiglitz talks cryptocurrencies

Nobel-prize winning economist Joseph Stiglitz believes cryptocurrency should be shut down. The neat thing about the Bitcoin network is it is not an easy task to shut it down. If it were, governments would have called an end to this party a long, long time ago. Prior attempts at digital currencies failed because they were centralized and easy to bend to the wishes of the state. Did you know PayPal started with the idea of issuing a digital currency? Bitcoin is antifragile in nature. You attack it from one vector, it will grow stronger in another. Stiglitz believes that we would have a better economy if we had an electronic spending system that provided surveillance on “all the data in real-time knowing what people are spending.” 1984 anyone?

Interesting Insights

Diar Data Shows Bitcoin On-Chain Activity Approaching Record Levels

Data presented in the Diar newsletter published this week show bitcoin on-chain activity levels recorded in April approaching record levels seen in December of 2017. Despite the transactions approaching record levels, the value transferred in USD terms remains far below record levels due to current prices being significantly below those observed in late 2017 to early 2018.

The first quarter of 2019 was the lowest amount of USD value transferred on the bitcoin network since the first quarter of 2017. However, the start of Q2 is already showing a significant improvement.

Another interesting observation from the Diar newsletter was that the number of satoshis paid in fees per byte transferred was drastically lower than peak times. The evidence indicates that increased levels of SegWit adoption are driving the lower fees.

The data indicates the current adoption of SegWit is 35% with the average block size being 1.2 Mb. The recent Bitcoin Core upgrade release is also pushing to make it easier for miners to update their software to support native SegWit addresses.

One Final Note

Bitcoin recorded new 2019 highs this week. It has also managed to surpass a price point which provided significant amounts of buying pressure on numerous occasions in 2018 before eventually breaking sharply below in November. As price continues to increase, the general consensus becomes increasingly bullish for price prospects.