Bitcoin Blockchain Slowing, Fees Rising

During its early days, one of purported benefits of bitcoins were cheap transactions. Transfers between bitcoin users could be made peer to peer in a trustless system without transaction fees. The design of the bitcoin blockchain rewards miners who update the blockchain by giving them newly created bitcoins at a pre-determined rate. The idea of mining rewards supporting the blockchain assumed the newly minted bitcoins would provide enough incentive to miners who would contribute enough computing power to keep the blockchain live. However, as bitcoin has grown, and the volume of transactions has increased, transaction fees are having an increasing influence on processing bitcoin transactions.

4 days ago, I initiated a transfer of 0.50 bitcoins from one address to another. This used to be a quick and painless transaction. A few years ago, I didn’t even need to attach a fee to my transaction, and it would get processed in a timely manner. But this time, I chose a low fee and my transaction sat in digital purgatory for several days. Not only did the transaction sit on the blockchain unprocessed, but of course, I could call the address on a blockchain explorer and see the transaction sitting there. In many other payment networks, there is a standard lag of time between transaction initiation and final processing, so there is a window of time where a transaction could be initiated and then cancelled. If you write a paper cheque and give it to a service provider, if something goes wrong in the time the cheque is being delivered and processed by the payment network, you can instruct your back to “stop payment”. There is currently no easy to use “stop payment” mechanism with bitcoins. So for 4 days, I watched my transaction sit on the bitcoin blockchain without any confirmations, hoping, wishing, waiting.

The whole experience brings up questions about the changing role of transaction fees to newly minted coins as the miner reward for blockchain updating. How has the role of transaction fees changed over time, and what can we expect to change in the future?

One of the challenges with the way bitcoin was designed is the hard coded cap on block size. Bitcoin actually has a limit of 1MB block size. Miners can mine blocks up to the 1MB fixed limit, but any block larger than 1MB is invalid. This feature of bitcoin has become more important as volume has grown. The transaction processing lineup has got so big, that participants need to assign a large(er) reward to their transaction in order to incentivise miners to process their transaction in a timely manner. The limited bitcoin block size fuels calls for forks such as Bitcoin Unlimited and provides incentives for the creation of competing coins.

We can measure the transaction fee rate, and compare changes over time to understand how transaction fees are changing, how it is impacting volumes, and how this might change in the future. There are online services that provides us with information we can use to set fees.

Here is a page called Estimate Fee that estimates the fee required to process a bitcoin transaction within a number of blocks.

If you are running the bitcoin client, you can see the command used to call this data. According to this page, in order for your transaction to be processed in 25 blocks, you will need to assign a reward (fee) of 0.00198749 bitcoins. At the time of writing, with bitcoins worth $2,500 USD, that fee is worth $4.96. If there are 135 blocks per day being processed at the time of writing, a 25 block transaction can expect to be processed in about 4.5 hours.

I don’t necessarily think that the limited block size will mean the death of bitcoin. Making something expensive to move might mean bitcoin becomes (or has already become) impractical to use as a means of retail payment. But a high transaction fee might have some other benefits. The network and first mover advantages of bitcoins might mean they will increasingly be used as a clearing currency, and since each transaction is just a number (each transaction “number”, whether a large value one or a small value one) it might make sense to only process large value transactions in bitcoins, not retail transactions.

The blockchain is only updated once a transaction moves value from one address to another. If payments are being made within a network, no transaction fee needs to be applied. If you deposit bitcoins on an exchange, you send your bitcoins from their current address, to an address at the exchange. Once on the exchange address, the exchange operator can hold the bitcoins for you, and you can transfer the bitcoins within the exchange without interacting with the blockchain, between other exchange participants, until the money needs to leave the exchange again (in order to process a withdrawal perhaps).

At the outset, many bitcoin enthusiasts thought bitcoin would provide an alternative payment network, and it does, but this doesn’t mean payment networks won’t exist within the bitcoin blockchain. I believe that with the rise of bitcoin transaction fees, there will be a greater incentive for payment processors to emerge within the bitcoin blockchain in order to clear transactions quicker and cheaper without having to interact with the blockchain itself, thereby avoiding the associated fees. Such a system still supports the development of bitcoins, because the bitcoin blockchain will still fulfill a function of money as a unit of account since payment network (unless they are fraudulent themselves) will still need to net off balances.

 

Flexepin Vouchers to Buy Bitcoins/Ethereum in Canada

Recently, I purchased some bitcoins using Flexepin and this post describes my experience. I’ve tried a bunch of methods to buy bitcoins over the past few years, I’ve used Coinbase when they had a Canadian payments processor, but now I mostly use QuadricaCX. Since nobody can predict how regulations and payment methods might change in the future, its smart to continue developing alternative channels, so I decided to try using the Flexepin payment method on bitaccess.co.

I learned about Flexepin when I noticed it was being offered as a payment method for other Canadian bitcoin dealers such as QuickBT. As I reviewed the bitcoin ATM at Delloite’s offices in Toronto, I noticed the Bitaccess machine also accepted Flexepin vouchers as a payment method. I then explored Bitaccess.co website and found that registered users could use Flexepin to purchase bitcoins directly on the Bitaccess.co website.

So I took $500 Canadian cash to a cheque cashing store down the block from my apartment and exchanged the cash for a Flexepin voucher. Flexepin vouchers are offered at many gas stations and convenience stores in Canada, but I chose a cheque cashing store because I figured they might be more knowledgeable of the product and understand the rules a bit better, such as not charging HST on money cards.

I took my $500 to the counter and after I told the cashier what I’d like, she logged into a program on her desktop to process the transaction. I was provided with a receipt that contained my Flexepin pin number and other transaction details. The cost of the transaction was $15.95, which represents a purchasing fee of 3.19%.  The fee is tiered to the amount purchased, and so smaller purchases will be charged a different fee. However, the smaller the purchase, the greater the fee as a percentage of the overall amount.

Now I had a Flexepin voucher. The voucher is like cash, if I lose the voucher, its gone. I did’t provide ID to the merchant, although I was captured on the store camera, there was no other documentation required. If someone got the voucher pin, the value would be theirs. So I went home and logged into my account at bitaccess.co.  I chose the Flexepin method to purchase bitcoins and was presented with a price of $3,858.25, which compared to the current offer on QuadrigaCX of $3,600, representing a spread of 7.17%.

I purchased the bitcoins on bitaccess.co, but then I received an e-mail from bitaccess.co asking to confirm some details. They asked me to write a confirmation number on the physical Flexepin receipt, take a picture of it, and e-mail it back to them. I did this promptly, and then my bitcoins arrived within the next transaction block. I monitored the transaction using a blockchain scanner, so I could see my transaction was processing.

For my $515.95 Canadian dollars, I managed to purchase 0.1295921 bitcoins, which translates into a rate of $3,981.33 btc/cad. This compares to a price of $3,672 on QuadrigaCX after factoring in the fees related to that method. We can say that purchasing bitcoins using the Flexepin / bitaccess.co method costs 8.42% more than QuadrigaCX.

Most of the costs of purchasing bitcoins using Flexepins happened at the point of the transaction with bitaccess.co. The price quoted by bitaccess.co was quite a bit higher than what could be obtained on other exchanges.

So from a purely cost perspective, QuadrigaCX is cheaper than using Flexepins on bitaccess.co, but there are some advantages to using Flexepins. If you are trying to avoid using a bank account or you don’t have a bank account, then Flexepins will allow you to stay anonymously in cash. Otherwise, registering with QuadrigaCX and following the AML process is the best method for Canadians to buy bitcoins.

Price Fallout of DAO Theft

It has been another exciting day in digital currency markets.  Today, a hacker attacked a vulnerability to the DAO, which is a decentralized autonomous organization that was initiated on the Ethereum blockchain. The DAO was worth about $150 million USD of Ethereum before today’s hack. The hack itself looks set to drain the DAO of Ethereum.  The market knows the address of the stolen ether, but nobody seems able to stop the attack.

The reaction of markets to this news has been a dramatic fall in the price of DAO shares.  DAO traded on Poloniex are down by almost 50% today.  Poloniex itself even crashed at one point today because of increased traffic.

It seems like at this time, Ethereum itself is intact, but DAO has been fatally wounded. The Ethereum community is debating weather to hard fork the Ethereum that been stolen so that it cannot be moved, or do nothing and plan on hunting down the entity that stole the Ethereum.

The funding rate of Ether on Bitfinex was fairly steady at just below 7.5% APR in the days leading up to this hack, but then spiked up 86% a few hours ago. I’m currently putting out Ether loans at 0.06%/22% APR.

Thoughts on The DAO Hack

We just lived through the nightmare scenario we were worried about as we called for a moratorium on The DAO: someone exploited a weakness in the code of The DAO to empty out more than 2M ($40M USD) ether. The exploit seems to have targeted the ‘unchecked-send’ problem in the ‘splitDAO’ function.

Will Ethereum Hard Fork? – CoinDesk

Key stakeholders behind the alternative blockchain platform ethereum are debating changes to the platform’s code after millions of dollars in ether were diverted from a major project by an alleged attacker.

Comparing Crypto Margin Lending Sites

As the digital currency financial system develops, a new type of investment is emerging: margin lending. Currency exchanges have created platforms for their users to take out margin loans in order to make leveraged currency trades and the margin funding itself is also provided by users. This goes against the traditional system of brokers providing margin. This development makes sense because it takes the exchanges out of the credit side of the transaction, and focuses their role on maintaining a market and processing transactions. The exchange still needs to work on providing users with a margin exchange that promotes liquidity by offering participants a fair marketplace. The relative success of each exchange will depend on the rules accompanying their own system.

The table below shows the simple APR for various margin lending platforms for various currencies. The way I calculated the rates in the table was to take the midpoint of the bid/ask in the current market at the time of writing then multiply this midpoint price by 365 to arrive at an annual rate.  I understand this calculation doesn’t take into consideration such factors as compounding, but the table below still gives us an idea of relative rates of return.

  USD BTC ETH
Bitfinex 17.53% 1.57% 7.14%
Poloniex N/A 6.28% 1.99%
OKCoin 31.02% 27.37% N/A
BitVC N/A 0.37% N/A

The first thing I noticed from this table is the widely divergent rates between each platform and between currencies. Each of the markets listed in the table provides bitcoin margin lending markets and the rates that can be obtained from each site are widely different. The rate on Bitfinex for BTC is so low as to compare with the rates offered by regulated banks in the fiat economies of North America, whereas the rate for BTC at OKCoin is at a massive 27.37%.

The best rate for both USD & BTC can be found at OKCoin, and OKCoin also offers CNY margin lending markets as well. So let’s look at the mechanics, liquidity, and rules of OKCoin in particular to see why this might be the case. OKCoin is based in mainland China and does not allow US based customers. This might partially explain the high rates for USD as there might be a lack of supply for these types of margin loans, but not the high rates for BTC. The mechanics at OKCoin for the margin lending market are pretty straight forward, with an open market of bids and offers and an auto-renew feature. The exchange states the margin rules call for forced liquidation in the event a trader’s margin falls below 10%. Without much experience on this platform or data at my fingertips, its impossible for me to say whether the risk of default is large. Judging by the high rates at OKCoin, default sounds like a real possibility. The exchange offers a service called “insurance” which costs 10% of the value of the interest earned. Whether this is a good or bad deal, or the details of coverage don’t seem to be disclosed. The fact that insurance costs a nice round number like 10% makes me think the exchange is up-selling coke & fries with margin orders.

Bitfinex is the largest crypto currency exchange and provides the platform with the most usability and an ecosystem of data from BFXData that publishes useful information from the exchange. Although Poloniex trades the most currency pairs and also has the most currencies listed for margin lending, Bitfinex is the most liquid and the market at Bitfinex is currently offering higher rates on Ether.

I wonder how these markets will develop? In terms of regulation, these exchanges will be in a constant negotiation/battle with regulators, particularly in the US & China. It might be beneficial to be located in a 3rd party country in order to fly under the radar of the shifting regulatory landscape. Another factor to keep in mind as these platforms develop is liquidity. A lack of liquidity might be a bad thing in terms of getting orders filled and keeping money invested, but a lack of liquidity could also offer opportunities for higher rates (being compensated for the lack of liquidity) and also arbitrage and hedging between platforms. I think as more margin lending groups start using APIs to move faster between platoforms, the rates of returns between platforms should converge. But maybe not, if the margin rules between exchanges are different, those different rules will mean different risks, which means different rates.