The second part is about the bitcoin network itself.

Today, if you look at where transactions are going on bitcoin, and the throughput, it’s mostly going between large exchanges. It’s settling flows between large exchanges, especially between many fiat on-ramps. Bitcoin is the global clearinghouse for that system. I think many of us would like it to be a functioning payment system, but there’s only a few million dollars worth of payments flowing per day for actual merchant services. But the vast majority of volume is between exchanges. Now a lot of people would say that means bitcoin is just for speculation. I would say bitcoin is a really efficient clearinghouse for value, and it doesn’t matter what it’s used for, all that matters is that it’s being used.

How do I know that bitcoin is mostly transmitted between exchanges?

We can look at batching and see where coins are being sent and how. You can look at batching figures on p2sh.info. It’s typically exchanges that batch multiple inputs together into a single transaction. You can see that 30–40% of all on-chain transaction volume is batched. You can also tag a bunch of exchange addresses and see that about 18% of all bitcoins is held within those exchanges’ hot wallets. So the exchanges typically do dominate.

I also spot-checked the batching figures. If you look at the last week of transactions, there are many kind of exotic “many-inputs/many-outputs” transactions which are the hallmarks of exchanges. So the exchanges do really dominate, for better or worse, and I would argue that we probably need to accept that. A lot of people say “not your keys — not your bitcoin”; it’s definitely true but it’s hard to convince everyone else of that fact.

This is my model of how bitcoin is likely to look like in the future.

I don’t endorse intermediation in bitcoin and I strongly support all measures to give users autonomy and ownership over their keys, especially using non-custodial methods. But the reality of the situation is that bitcoin is highly intermediated today. Most people only touch it through Xapo or through Coinbase or through any of the numerous exchanges. It’s our responsibility to police those intermedaries. We have banks, fiat off-ramps, custodians, lightning custodians, merchant solutions, and obviously there is still direct access and many still do transact with the base layer, but as transaction fees get more expensive, it’s likely that it continues to become more and more intermediated. This is a challenge that we all have to take on as the stewards of bitcoin.

I would like to briefly talk about a couple of measures to determine how well those large intermedaries are taking care of this commons which is the bitcoin block space.

This is the average transaction size in bytes.

It’s creeping up, which is interesting. In my ideal world, we’d get better and better compressing that. But it’s creeping up and some people say this is because of batching and compressing many payments into single transactions. This doesn’t necessarily seem to be the case right now. We haven’t had too much success with batching.

I would like to propose a measure to really determine how efficient bitcoin transactions are, which is the “economic density”.

This is the total economic throughput divided by the bytes that are being throughput on bitcoin. So what this tells you is that a single byte on bitcoin today represents about $15 in transfer activity. That figure might not mean a lot to everyone, but that tells us that we have natural constraints on the system, because we can only transmit so many bytes per units of time. Ideally we want this value be as large as possible, so with limited throughput (so we can keep running full nodes really cheap) we can transmit a huge amount of economic activity. We have to get better and better at this efficiency if we want the system to work long-term.

Returning to that “bitcoin is an intermediated chain” idea.

The criticism of that is: are we not meant to be dis-intermediating economic activity? Obviously we are, but we just have natural constraints. We have the problem that the UX of using bitcoin at the base layer is in many cases worse than using it through an intermediary. Many people much prefer using it through intermediaries, whether that is custodial exchanges of some sort, or payment processors, rather than using BTCPay server or something.

My argument here is that Hal Finney was actually right about this “bitcoin banking” idea, it’s just that today we call banks “exchanges”. There are huge amounts of bitcoin held on exchanges and they’re essentially operating as full reserve custodial banks. Right now the exchanges aren’t doing fractional reserve (I hope), but people do treat them as banks. People treat Coinbase as a bank. In many cases, this is a better UX for users even though I would encourage people to hold their own bitcoin.

The question here is: how do we cope with this reality? I would prefer that we don’t plug fingers in our ears and ignore the reality of the intermediated chain today. My argument is that we should be trying to reason with these intermediaries and ensure that they are behaving appropriately.

Again, I probably agree with Saifedean on this, that we can retain the “hard money” and the scarcity properties that make bitcoin so great, even if there are intermediaries that are serving the chain for us. And we can probably still retain trust minimization because not all intermedaries are the same.

I would say it is on us as bitcoiners to encourage large operating companies that use the bitcoin chain in some manner to behave appropriately. We’ve actually seen a lot of this in December 2017, people were really hounding exchanges to use SegWit, to batch, and to some degree that worked pretty well, and many exchanges adopted it. But many still don’t use SegWit, and it is completely and utterly irresponsible of them to not include the latest efficiencies, if they have the operational capacity to do so. In many cases it just comes down to laziness or not caring too much about the on-chain impact.

I would argue that they are the stewards of the chain, and if we don’t police them, we’ll have a “tragedy of the commons” situation developing. If you look at Ethereum, there has been absolutely no stewardship or policing of that chain. The outcome is that it is just packed full with spam and being abused. And now you have Ethereum devs asking users to stop running dApps and so on. That’s not an ideal situation. It’s better to get ahead of that and just encourage the large industrial users who have large chain impacts to behave appropriately and right now that means SegWit and batching. But more generally it means respecting the p2p network governance process which was demonstrated with the UASF last year, and not supporting hostile forks. If these intermedaries are supporting hostile forks to bitcoin, then they are overtly hostile to bitcoin and we should make them aware of that and treat them accordingly.

I would argue that bitcoin activism with regards to intermedaries is tremendously important. We have been successful so far but there are many operating businesses that rely on bitcoin but are totally deaf to bitcoiners and it’s up to us to actually make our voices heard.

As far as allocators go, it’s important to support businesses that retain bitcoin’s trust-minimization properties, so HodlHodl is a really great example for that, as it is a functional, operating business but also a p2p exchange which doesn’t involve full custody or intermediation.

Then, I would say lastly, it’s very very important to maintain the focus on the verification costs, so that if people want to exit from that intermediated world and run their own nodes and become fully sovereign, they should still have the ability to do that. I’m very pleased to see a lot of people talking about maintaining an own full node as cheaply as possible.

So the takeaways from this talk are:

I critiqued market cap and I urge you all to be very critical, especially of the supply figures which are quoted on websites like Coinmarketcap, which are total nonsense in my opinion, and very uncritical in terms of listening to the data claims of altcoin promoters. We should be much more critical and we should actually look at the chain to determine what the real float of these things is and what the real supply is, because you have multi-billion market caps for many altcoins, and effective (or realized) caps in the low millions. It’s completely unacceptable to just listen to folks who have a huge incentive to get that glamorous spot on Coinmarketcap. What we should be doing instead is inspecting the chain, or at least adjusting the supply accordingly.

With bitcoin, the problem is not as extreme, but you probably should be making an about 15% adjustment for the lost coins, and one way to do that is with the “realized cap” methodology, which I publish an explainer about soon.

I think our preferred measure of bitcoin’s success should not be transaction count, because that’s capped in a variety of ways, but economic throughput and “economic density”. We should be trying to make bitcoin transactions as efficient and as large as possible. We’ve had a lot of success doing that so far and I’m very optimistic about that. I think we definitely should be trying to maximize the throughput of bitcoin, which we’ve had great success with so far, and I’m certain that in the next five years or so, we’ll be surpassing Visa and that will be an extremely exciting day.

Let me return back to this slide here:

I think it’s also important to be realistic about the nature of bitcoin’s economy today. To the extent that we have intermediation, that’s ok, and not all intermediaries are hostile to bitcoin. Many of them are attempting to be a good steward of the chain but unfortunately, some of them are hostile, or at least careless. So at that point it’s on bitcoiners to try and force them to behave appropriately.

But I would argue that we cannot hide from intermediaries. There are many operational businesses that are being built on bitcoin, and many many millions of users are using those instead of running their own full node, or using Electrum server, or custodying their coins themselves. To the degree that there is intermediation, I think that’s ok, we should be aware of that and encourage them to be as responsible as possible.

Nic Carter (Twitter)

Transcript by RainDogDance (Twitter), with help of Brian Bishop’s (Kanzure) transcript