Europe – a Clue about Bitcoin

The ECB did an investigation into the risks of crypto-currencies (pdf) (which they call virtual currencies — too broad a term in my opinion). FT Alphaville spotted it and pointed out this awesome table of seventy different risks (on page 22 in the pdf). Each one applies to a certain group of people involved or affected by cryptocurrencies. Some of these are exaggerated, some a bit understated, I think a couple are missing and a few are complete nonsense. Here’s my notes with the ‘threat levels’ I think they should be changed to:

Risks to VC users

  • User’s computing capacity is abused for the mining benefit of others (A07): Low –> High This really concerns not just ‘users of cryptocurrencies’ but Internet users in general. You don’t have to be a Bitcoin user to have this done to you.
  • User suffers loss due to changes made to the VC protocol and other core components (A08): High –> Medium Has this ever happened?
  • User is not in a position to identify and assess the risks arising from VCs (A09): Low –> High This chart sets out 35 different risks which VC users face (and I argue they have missed some). Do most users have a good overview of all of them?
  • Market participants suffer losses of VC units held in custody by others (A17): Medium –> High Medium? Really? This has happened dozens of times, and is the key complaint by disillusioned cryptocurrency users.
  • User suffers loss when VC payment they have made to purchase a good is incorrectly debited from their e-wallet (A24): High –> Medium? I’m not sure what mechanism they are talking about here? Fat-finger by the user? (quite possible but avoidable with some basic precautions) Software failure of wallets?
  • User suffers loss as a result of VC prices being manipulated (A41): High –> Low? Is this really a big problem for the average user (except for pump-and-dump in minor altcoins – so-called ‘scamcoins’)? Is it different from or more prevalent than penny stock manipulation? How exactly are prices being or subject to be manipulated?
  • User investing in regulated financial instruments (eg derivatives, SPS, CIS) using unregulated VCs suffers unexpected loss (A42): Medium –> ? Why do people use cryptocurrencies to invest in regulated instruments? Regulatory arbitrage, or a misunderstanding of how they are transacting? Does this affect what level of protection they should have? I’m not sure exactly what the ‘unexpected loss’ here is, or how it differs from other investment risks.
  • User suffers loss when investing in fraudulent VC investment schemes (A44): Medium –> High Arguably caveat emptor applies to people using cryptocurrencies to gamble and do other forms of speculation that they can’t do lawfully using fiat. However, this has been and will be a big problem – there is an ecosystem of VC-denominated shares (ie in mining ventures) and derivatives (mainly but not exclusively against cryptocurrency prices) which is pretty lawless.
  • User suffers loss when investing in fraudulent VC investment schemes (A45): Medium –> High Is this considered Medium because it doesn’t happen much, or because it is considered part of the risk-reward profile of VCs?
  • User is exploited by a VC Ponzi scheme (A47): Medium –> Spurious Not sure how this is different from A44?
  • Key guessing : Missing –> Medium This does happen when ‘brain wallets’ are used with weak passphrases, or wallet generators have weak random number generation. Worth mentioning as it is different to A11 and often unexpected by users.
  • Users are unable to understand the difference between VC held in custody for them by third parties, and personally held by them using a key : Missing –> High This is massively prevalent, and it leads to people making bad decisions about where and how to store their money. Tbf can apply to fiat too (users of money are unable to understand the difference between cash, bank money, and other financial assets).

Risks to VC market participants

  • Exchange is operationally unable to fulfil payment obligations denominated in VCs or FCs. (B11): Medium –> High This has been known to happen, to say the least.
  • Exchange is not in control of its operation (B11): Medium –> High This too has been known to happen.
  • E-wallet provider faces loss should their refund policy be adused to hedge transactions (B13): Medium –> I think they are talking about people getting a ‘free option’ by being able to reverse transactions. I don’t know what it has to do with ‘hedging’ but it is real and basically unavoidable for some providers. A balancing act being being picked off, and alienating newbies by having very strict/onerous refund policies.
  • After accepting VC for payment, merchant is not reimbursed (B21): Medium –> Low Basically the counterparty risk of BitPay or similar. I don’t think this is a big deal – BitPay are regulated and have a lot to lose. Similar to the risk of doing business with eBay, PayPal, etc.
  • Merchant faces compensation claims from customers if transactions have been wrongly debited (B24): Medium –> Low Like A24 it is a bit nebulous how exactly this is supposed to happen. Besides, ‘facing a claim’ isn’t the same as facing a loss – anyone can claim anything really.
  • Scheme governance authority is subject to unexpected civil/criminal liability that brings the VC scheme to a halt (B33): Medium –> High This is massive and has happened several times.

Risks to financial integrity

  • Criminals are able to launder the proceeds of crime because the can deposit/transfer VCs anonymously (C01): High –> High
  • Criminals are able to launder the proceeds of crime because they can deposit/transfer VCs globally, rapidly and irrevocably (C02): High –> Spurious This is exactly the same as C01.
  • Criminals/terrorists use the VC remittance systems and accounts for financing purposes (C03): High –> Spurious This is basically the same as C01 and C02 – criminals can pay each other secretly. Not sure why the fact that it’s ‘financing’ makes a difference.
  • Criminals/terrorists disguise the origins of criminal proceeds, undermining the ability of enforcement to obtain evidence and recover criminal assets. (C04): High –> Spurious Ok. Central banks and governments would like to know where everyone’s money is going. Fair enough. This is why the crime of ‘money laundering’, which might be considered a victimless crime, part of other crime but not a crime in itself, or lawful behavior functionally indistinguishable from completely innocuous acts, exists. Now, cryptocurrencies endanger that to a certain extent. This could be a very bad thing, especially for some online crime like child pornography or extortion where the money is the weak link in concealing the identities of the perpetrators. Nonetheless, it is somewhat exaggerated to have 4 very very similar risks, all ‘High’. Note that the inclusion of terrorists in this risk is pretty sketchy – terrorists don’t usually have ‘proceeds’, and aren’t often subject to asset recoveries.
  • Market participants are controlled by criminals, terrorists or related organizations (C05): High –> High This is a real risk. If organized crime aren’t already involved in Bitcoin enterprises then they should be. (Undoubtedly the same mythical terrorists who allegedly fund themselves through DVD piracy and cigarette smuggling are also involved in this stuff. [hmm])
  • Criminal uses VC exchanges to trade illegal commodities and abuse regulated financial sector at point of entry (C11): High –> Spurious A bit like C01, C02, C03 and C04. Criminals can pay each other secretly. When they change the crypto into fiat, no-one knows where it might have come from. This isn’t a threat to the financial system, it’s a threat to AML.
  • Restorative justice of victims of crime is hindered by criminal using VCs to avoid seizure of assets, confiscation and financial sanctions (C12): High –> Spurious Those pesky criminals! Not only do they steal and cheat, afterwards they try to conceal the money they got rather than hand it back.
  • Criminal can use VCs for anonymous extortions (C13 ): High –> High This is massive. It will enable lots and lots of extortion which was previously hard to do undetected, from corporate DDoS to blackmail of individuals over stolen or blagged intimate photos etc. Cryptocurrencies are the final link in a chain that includes email, TOR, etc. Basically there are two parts to VC payments for criminals – criminals paying each other, essentially ‘digi-cash’, and criminals being able to receive payments from non-criminals anonymously, which is a game-changer.
  • Criminal organisations can use VCs to settle internal or inter-organizational payments (C14): High –> Spurious ‘Criminals can pay each other secretly.’
  • Hacking of VC software, wallets or exchanges allows a criminal to implicate others in the criminal activity they commit. (C16): Medium –> Low Not really different to botnets/rootkits, hacking email accounts or stealing WiFi, and arguably more difficult.
  • Criminals, terrorist financiers and even entire jurisdictions are able to avoid seizure of assets, confiscation, embargoes and financial sanctions (incl. those imposed by IGOs) (C17): Medium –> ? A redundant part (criminals can pay each other secretly!) and a sinister part (we should be able to outlaw whole countries from the money system). Only one country ever tries to do this, and whether or not it’s a good idea is debatable.
  • Tax evaders are able to obtain income in VCs, outside monitored FC payment systems (C19): Medium –> High This is a massive use case of cryptocurrencies as a cash substitute.

Risks to fiat currency payment system providers

  • FC payment systems which don’t use VC face competition from VC systems because users don’t understand the drawbacks of unregulated VC. : Missing –> High This might sound sarcastic, but I think it’s the biggest risk for FC payment systems. It could be easy for people to start using Bitcoin instead of Western Union, without having a good notion of what support/guarantees they are getting from WU that might justify a higher fee. Of course fiat-based payment systems also fear disruption because they want to collect monopoly rents, so perhaps they need to make those benefits more obvious and better value.

Risks to regulatory authorities

  • Should VCs gain widespread acceptance, central bank as issuer or FC can no longer steer the economy, as the impact of its monetary measure becomes difficult to predict. (E31): Low –> Ha ha, not funny Joseph Cotterill spotted this one. Perhaps this is a low (rather than existential) risk for the ECB because it’s not considered very likely to happen? The Portugese youth unemployment rate will remain safely steered to an optimal 58%. Joking aside, this is pretty spurious – it applies equally to all other forms of private balance sheet creation such as most derivatives, and bubbles in housing and other assets. CBs don’t have to control all of these – they just have to be able to measure them to understand the relationship with those things they do control. Cryptocurrencies are in fact surprisingly easy to measure – confidence in the system relies on knowning exactly how many coin there are.

Vols and volleys

FT Alphaville showed us a chart by Goldman of SPX realized volatility every year since 1929 (which had high vol). The volatility of the first half of 2014 is on the far side of the chart.

No doubt the six months of vol are annualized to give a rate which can be accurately compared to the other years. If volatility were constant, the completely standard way of doing this would be completely accurate. We know what 10.9% vol looks like over half a year and over a year. But volatility is not constant – this is the whole point of the chart. Now, some years with high vol have low vol in half the year and high vol in the other half of the year (like 1987, or 2008). The variation between high and low vol halves is bigger than the variation between high and low vol years, because combining two halves into a year smoothes the ups and downs of vol out a bit.

When we look at the chart, the temptation is to compare 2014H1 to other measurements, to see just how low it is. Such a comparison has absolutely no validity unless we can quantify just how the distribution of half year vols relates to the distribution of year vols. But there is no easy way (and not really any reliable but difficult way) of doing this. You need a model of stochastic volatility which has held up over the last 85 years. Stochastic vol models are quite hard if you want to price index options two and a half years out, but no-one even tries to calibrate them back further than the ’80s.

Putting the vol levels for each of the half-years in the chart would make the bars a little narrow, but it would also make some sense.

Now for a slightly silly article on the FT Data blog – apparently England were unluckier than any other team in the group stages of the World Cup. This is based on a measure called PDO, “how many of a team’s shots on target are scored, combined with the number of its opponents’ shots on target that are saved”. England’s was very low, and this is said to be unlucky, because PDO is usually ‘quite random’. FT Data have a little bit of justification for this, and various commenters have questioned it. (The biggest objection is that PDO mostly measures how crap your goalkeeper is and how good the other one is. PDO comes from hockey, and perhaps goalkeeping in hockey, which seems to involve a man standing in front of a goal which is much smaller than him, getting ready to put one or other knee on the floor, has a different statistical importance).

Let’s look at one thing they said though:

Regressing the PDO in one season on the value for the next season, using data from the Premier League, gives an R-squared statistic of 0.3724. This essentially means only 37 per cent of the extent to which a team’s PDO is above or below 1.0 can be explained by talent.

Aren’t PDO in one season and PDO in the following both dependent on a third variable ‘talent’? If so, should we expect the correlation between the two to be much less than either of their regressions onto talent (if we could observe it)? I don’t remember what the relationship between the 37% and an estimate of the ‘amount that can be explained by talent’ is, or how it depends on n or whatever, but it is certainly straightforward and in a textbook, and definitely isn’t that they are the same.

Nitpicking I know, but it is the FT Data blog (and Goldman are Goldman).


The fourth wall

Five large-scale photographs make up ‘Architecture of Density’ by Michael Wolf at the Flowers Gallery:

These are amazing. If you can go and see them IRL I advise you not to click through and look at the online images. No price tags or price list were visible.

Only Kafka understood the full horror of the new bargain: the bargain by which in exchange for sustenance a man forgoes the right to have his existence noticed. No god invented by man has ever had the power to exact such punishment. [John Berger, The Success and Failure of Picasso]


a poem is a naked person . . . some people say that I am a poet

Apparently Bob Dylan

“has welded for 40 years as a form of catharsis”.

That is, he

“welds like you would play golf,”

in case you know what golf is, but not catharsis.

During these 40 years, he has made quite a collection of gates and railings by welding together various old tools and pieces of machinery. These are on display, and on sale – low six figures for a gate – ‘for the first time‘ at a gallery on New Bond Street. Along with the gates there are ‘wall hangings’ – something like 40 scythes, 20 cogs and 60 pairs of pliers, arranged into a circle (and why not). And along with these are some paintings, which the gallery sensibly put downstairs. These are the sort of thing Paul McCartney does, whereas the ironmongery is the sort of thing high-functioning schizophrenic men who live in tents in suburban woodland do, along with sculptures made with a chainsaw from a single tree trunk.

First of all, the gates are actually functioning gates, or at least look like they are, with real connectors and hinges down one side of them. So you can buy then and actually hang them between gate posts to keep people out of your garden. It isn’t clear if Bob Dylan comes with his welding equipment and adjusts them himself if you want say, the hinges on the other side. Nor was I sure how you drop Bob Dylan’s authorship of your gate into conversation when it is being admired, especially if it’s by people who aren’t aware of his welded oeuvre.

What really got me about the steel sculpture was the finish though. Rather than leave them naked, the working-class rust of his native Winnesota ore, or whatever, like the schizophrenic men would tastefully have done, they were powder-finished to be shiny metal color, and one scythe or rawl or crowbar or each gate was painted shiny red or yellow or blue. This made them look like fictional artefacts from bondage-themed steampunk, as rendered lovingly in digital 3d on deviantart, only in real life.

Bob Dylan is largely famous for not being able to sing or play the guitar particularly well, and writing lyrics which make these deficiencies unimportant. It would obviously be unfair to suggest that he shouldn’t make things out of pieces of iron, unless there was some kind of reciprocal agreement that welders would no longer attempt to bang out ‘Blowin’ in the Wind’ in their own leisure time. But if he could do something with ferrous metal which was nearly as surprising as hearing his songs for the first time, you wouldn’t be buying it in W1, even for £165,000. You would be able to see it from space.

I Am Become Death, Shatterer of Worlds Paperweight

Monopoly bored

‘Street artist’ Alec Monopoly is showing at Mead Carney Gallery on Dover Street until 11 January. A selection of the works on show.

The title of the show is ‘Luxury tax’, a feature of US, but not British Monopoly. (Monopoly is a trademark of some games company who have a tendency to sue people for creating games called things like Alcoholopoly, Lake Distropoly, or Stop Global Wopoly) Most of Mr Monopoly’s pictures feature the running man in a bowler hat who is the mascot of the Monopoly game. Presumably he is hoping that he gets sued by the Monopoly company so that he can start some kind of viral backlash as a publicity stunt.  There are also various dollar signs and other things like 1950s gas station comics children holding dollar bills up and so on. These are usually done spray paint with some stencils and then a tag of the artist’s tag ALEC and some other painted bits in acrylic, on top of a collage either of old comics, or of newspaper clippings about the global financial crisis, or something else.

It’s not really clear if Mr Monopoly is commenting on money itself, or the practice of making some out of putting street art on a canvas in a gallery and selling it, or if he just wants to get some money without necessarily commenting on anything. Of course, you can put a lot of thought into an ethical question and then still behave in a way which you know to be clearly unethical. You only have to lie to yourself once. The people that buy this are presumably all rich, and they either think it’s a jolly jape to have a painting hanging up which ‘satirises’ how rich and stupid they are, or they are so rich and stupid they don’t really care. The final possibility is that both Mr Monopoly and his rich customers are gleeful about how much money they both have that they want to celebrate it with tacky, crass art which glorifies money without any pretence of depth. But then why would they do this in full public view rather than behind closed doors??

In any case this is quite possible, given the motif of pretty much the only memorable one – Monopoly man (he actually has a stupid trademarked name) crucified on a ‘Wall St’ sign. Are we supposed to be happy about this crucifixion? It seems more likely that this is an attempt to gain sympathy for round bowler-hatted men, sacrified on an altar of whatever it’s supposed to be, people with iPhones in Zucotti park. Mr Monopoly was probably taking designer drugs and reading about art history on Wikipedia the day he thought of this one, and there are very few crucifixions in art history which are not intended to evoke sympathy for the victim.

The simple answer is probably that Mr Monopoly is not making art for either the rich or those who require facile cartoons to express their disapproval of the rich for them. He is making it for both – for anyone who EITHER thinks his stuff is worth money OR that it has some other merit.

The good thing about bad art is that it establishes that good art is really real, since that which is present but usually invisible in good art is blatantly absent from bad art. Damien Hirst’s art is the world’s biggest advert for conceptual art, since looking at conceptual art which lacks any ideas, reminds one of how many ideas are present in even quite abstruse or poorly executed conceptual art done by proper conceptual artists who are not Damien Hirst. Looking at Mr Monopoly’s work is similar – it reminds us that there are quite a few ideas are present in Banksy’s work, since otherwise it would look like this. His stuff does contain ideas, just not as many as one per picture. There should be at least one per picture, some artists have many more than one per picture. If there is less than one per picture, by the pigeonhole principle at some point the artist must have started painted a work from start to finish without ever once using thought.

There was a nice exception, a painting of Bob Dylan with spray paint drips that went up instead of down. Bob Dylan has sheet music collaged behind his face, slightly inappropriately since he doesn’t read music or write his compositions down on staves. It looked like this, but I don’t think it IS this one, just a self-plagiarism of it.Imagee:

There were also various combinations of Bob Dylan, Jack Nicholson and other cool people of that ilk who probably have lots of money. There was also another ‘straight’ portrait, probably of Robert Kennedy, Roman Polanski or Ben Stiller, which looked quite good from far away.

Outlook: SELL the bowler hat stuff. Target price: 5 bitcoin.

An economic experiment

  1. Find a three-year-old.
  2. Measure the emotional state of the three-year-old.
  3. Give the three-year-old an icecream.
  4. Re-measure the emotional state.
  5. Snatch away the icecream before they have had a chance to start eating it.
  6. Re-measure the emotional state – is it equal to that measured at (2.)?
  7. Give the three-year-old its icecream back.
  8. Re-measure the emotional state – is it equal to that measured at (4.)?