Learning from Satoshi Nakamoto’s ideas to regulate cryptocurrencies well (part 1)

Sam Bankman-Fried’s FTX exchange ranks second among cryptocurrency exchanges. Because of his boldness, he caused great trouble and caused shock in the mainstream financial field. If the Federal Reserve fails to rescue banks in time, it will cause another financial tsunami. He finally brought cryptocurrencies into the mainstream ignominiously and received a beating from the mainstream. In the past, the mainstream could ignore the existence of cryptocurrency, but now it is found that it is no longer possible.

As the mainstream, it is the elites who call the shots. They do not beat cryptocurrencies to death with a stick, and the methods they adopt are thoughtful. The nobility also recognizes that cryptocurrencies are the future. As a blessing and a curse, the mainstream is beginning to discuss regulatory approaches to cryptocurrencies, a significant boon for the market. Considering the elite’s background, I’m still unsure whether they can manage it well.

Cryptocurrency in this article is a general term for cryptocurrencies, crypto-securities, and crypto-commodities. The elite want to do well, but their thinking is still relatively traditional. Traditional craftsmanship can make cryptocurrencies into crypto buns, not cakes because the chef’s specialty is steaming steamed buns. The technology of steaming steamed buns is still used, but new guiding ideas and recipes are needed to make cakes.

What is the thinking behind the regulation of cryptocurrency? We must be based on reality and face the future. This kind of supervision should use the thought of Web3 and the successful experience of the current blockchain as a template. I advocate using Satoshi Nakamoto’s ideas and formulas because his ideas have withstood the test of 14 years, with minor flaws but no major mistakes, and his methods can exist as de facto standards.

Artificial intelligence can improve productivity. The Bitcoin system is a comprehensive innovation of contemporary multi-field technologies and can enhance productivity like artificial intelligence. However, artificial intelligence cannot keep up with the creation of production relations. In other words, the supervision of all cryptocurrencies is to adjust production relations. To avoid detours, it must be consistent with and refer to Satoshi Nakamoto’s innovations in production relations. Regulation should be based on the characteristics of Bitcoin and cryptocurrencies rather than simply restricting it using traditional frameworks. It is the correct approach.

There are two concepts here: ideas and formulas. Formulas are the embodiment of ideas, that is, standards. First of all, we need to understand what Satoshi Nakamoto thought.

First, does Bitcoin need to be regulated?

Should gold be regulated? Historically, a specific country once issued a law prohibiting private holdings of gold. How ridiculous it seems now. Likewise, Bitcoin has such a ban. It is a crude form of “regulation.” It is wrong for future generations to laugh at their predecessors because the cognitive level of the predecessors was not enough. How will gold be regulated after it is lifted from the ban? Gold now has a very mature regulatory approach. Bitcoin is called digital gold, so it is reasonable to compare Bitcoin with gold.

Gold has custody regulations and verification methods, but Bitcoin does not and does not need them.

Profits are taxed. It is the same for gold and Bitcoin.

Gold holdings are not taxable.

Gold can be held anonymously.

Gold is traded privately in cash and is challenging to regulate.

How to manage anonymous assets is one of the essential things for regulators to study. It is a challenge to the current regulatory system. Unfortunately, I searched on Google using the keyword “regulation of cryptocurrency.” Although there are 16 pages of article titles indexed, none of them talked about how to regulate anonymity, and no one compared Bitcoin with gold. Not to mention handling with reference to Bitcoin.

Anonymity is one of Bitcoin’s great strengths but also a drawback. The anonymous Bitcoin you own contains a tax component. Taxation is the country’s interest, and paying taxes is the obligation of citizens. Tax issues are not complex to solve.

Bitcoin is a “private” asset. Bitcoin anonymity is unrelated to the Bitcoin system and belongs to two fields. If the supervision of Bitcoin is the same as that of gold, it should be acceptable, thus simplifying the supervision of Bitcoin. Whoever manages the goods can control Bitcoin. By the way, cryptocurrencies are not necessarily all commodities. The Monetary Authority regulates them if they are currencies, and the Securities Regulatory Commission regulates them if they are securities. Unfortunately, if a cryptocurrency has multiple properties, multiple big bosses will have regulatory authority.

Second, does the Bitcoin system need supervision?

The Bitcoin system completes two tasks: “mining” and “accounting.” There are no rules for both functions about who can and cannot participate. It is a purely competitive and market-oriented behavior that achieves optimal efficiency. Any further supervision will be a waste of costs. In other words, if a cryptocurrency system’s design can reach the Bitcoin system’s level, it will be an ideal state without supervision.

Third, is the Bitcoin system managed?

Why does the Bitcoin system not require regulation? There are two reasons: the system already has a market-oriented check and balance mechanism and a community decision-making mechanism, forming the self-management of the system itself. The Bitcoin system itself already has a management mechanism.

The Bitcoin system only involves two people: miners and programmers. There are checks and balances between these two groups of people. For programs developed by programmers, miners do not need to download them. Therefore, when program development only benefits programmers, for example, only transaction fees are left for programmers, and miners’ interests are harmed, miners do not need to download these programs. Broad checks and balances also involve the participation of Bitcoin holders. If the Bitcoin system goes the wrong way, users will abandon it. Mutual checks and balances among all participants are a necessary condition without supervision. Once a decisive “one dominant force” exists in a system, supervision must play a role and provide a new check and balance mechanism. The “one dominant force” of the blockchain system is summarized as centralization or a risk point, which requires a new check and balance mechanism.

Centralization is a very vague concept in blockchain and is also a source of systemic risks. Examining whether there is centralization can be carried out from the following 10 aspects:

Management, decision-making, control, development, calculation, verification, accounting, storage, ledger and system structure. In these 10 aspects, every blockchain project is different. For detailed discussions, please refer to the author’s 2020 article “Hey! Please get out of the misunderstandings of blockchain” (chainless.hk). Why does Gary, the chairman of the US SEC, have questions about Ethereum? Because Ethereum has destroyed the original checks and balances of miners and programmers, making Ethereum closer to the Internet system in terms of central control. Of course, the managers of Ethereum have a thorough and profound understanding of the blockchain, which is reflected in their foundation’s transparency, respect for the community, and usage skills.

Programmers manage projects through the community. The use of the community is the secret to the development and growth of Bitcoin and cryptocurrency. It is very different from the current thinking and is something the existing regulatory authorities need to learn and understand. We will write more about the community.

Fourth, the widespread adoption of community trial networks

Cryptocurrencies generally adopt technical communities, and everyone can participate in programming. Is the effect good? Through the community trial network experiment, this is a successful experience that has gradually developed. Internet projects generally do not have a test network. For example, Apple’s iterative version does not have a test network and no roadmap. The community characteristics of cryptocurrency can be summarized as everyone contributing resources, sharing benefits, and participating in governance. Which of the two costs more? Make a judgment.

In this regard, Ethereum’s practice is commendable. It switched from 1.0 to 2.0, a project worth hundreds of billions of dollars, and the system changed without any shock. The solution to all problems lies in the experimental network. The Ethereum Foundation here is just the organizer, and the community will evaluate the quality of the improvements. Everyone in the community can express their opinions on an equal footing, fans can get up close and personal with their idols, and contributions can be answered immediately. The community selects the active members of the community. The community mechanism determines that talents can be automatically selected worldwide, and skills can be freely combined. There is no human resources department (H.R.) or a leader. Everyone discusses and solves problems in the community. This kind of community has many similarities with WeChat groups, but WeChat groups have too many restrictions.

The idea of the test network is the development of the community by latecomers such as Vitalik of Ethereum. Vilalik was also a member of the Bitcoin community at the beginning and was influenced by the community. Satoshi Nakamoto complied with the opinions of the Bitcoin forum community and left a precious manuscript of less than 80,000 words. He also left the Bitcoin system to the community and then disappeared invisibly. Communities represent advanced production relations. If supervisors do not understand communities and use their inherent viewpoints to manage them, they will do a job too small to fit the shoes.

All policies need to be experimented with. Sandbox experiments seem good, but there is a lack of community discussion. What regulators come up with may fail. Everyone is experimenting with new things. Are you sure you are better than me? You have the right to make rules, and I have the right not to participate.

Fifth, community and association are two different ideas

We have seen the establishment of the Web3 Association in Hong Kong, and many people have titles. Titles only tell history; it’s a power structure. Check out the association’s website. Is it different from any other Web1 website? First, there is a lack of transparency, such as who pays? I haven’t seen their web3 community or the problems they must discuss and solve. Is using a big name to call people to join the team different from traditional gameplay? Comparing it with Bitcoin and Ethereum, this is not how blockchain works. Apart from the name Web3, I can’t see what else is Web3. Use web1 ideas to serve Web3. An ancient man travels to modern times, making people laugh out loud.

The community has only two critical factors: the big V and the group owner. Big V sells knowledge, and group owners sell relationships. From this point of view, the Hong Kong Web3 Association has attracted many well-known companies and wants them to be big Vs. The criterion for measuring big V is the activity of the community. The idea of attracting people to the platform is the same as the ICO (Initial Coin Offering) back then. The blockchain has long abandoned it. It is not a community idea. When production relations are not advanced, the same productivity cannot form an advantage in competition, and there is no chance of winning.

The exhibition is a forum structure but not a permanent institution and, therefore, not a community. What we see more is the promotion of centralized projects. The core of the community is consensus and communication of hearts. Only leeks need authority as an object of worship.

Does Bitcoin have an association? Does Ethereum have an association? Is there a government-run Web3 association in the United States? I have no idea.

I logged into the Financial Secretary of Hong Kong website and found it is also Web1. I didn’t see the director or deputy director who could communicate with everyone. Our opinions can be sent to them, and we can get a “received” response, but we don’t know whether they have carefully read our thoughts or opinions. If the Financial Secretary wants to engage in Web3, he must first turn his website into a community website. Hong Kong Financial Secretary Paul Chan Mo-po has the consciousness of an Internet celebrity. Trump has only reached the level of governing the country through Twitter; Trump has reached Web2. Everyone has to learn about Web3 on youngsters. There is no other way but to accept the brainwashing of youngsters. The regulation of Web3 must first have a regulatory discussion community rather than the traditional opinion solicitation model. The conventional method of collecting everyone’s opinions and then making decisions lags. Satoshi Nakamoto does customer service “personally.” A layman leading an expert is a joke. Hong Kong wants to lead the world. If it does not update its thinking and organization, it will not be able to surpass the achievements of the U.S. regulatory authorities.

Sixth, the community is the democratic decision-making mechanism developed by the Bitcoin system

The decision-making process of the Bitcoin community follows the BIP proposal (Bitcoin Improvement Proposal), and Ethereum is an EIP proposal. How should supervision be done? The level cannot be lower than theirs. The community proposal process is transparent, discussions are transparent, and voting is transparent. Only by adopting this mechanism can our supervision be worthy of Web3 supervision and be easily accepted by supervision targets. The current supervision has no community or test network. It is equivalent to going directly to the main network with no fork mechanism. What should I do if something goes wrong? We are all white mice; we have to hold our noses and eat the shit we are given.

Seventh, same risks, same regulatory principles

It is theoretically sound for Hong Kong regulators to apply the original Securities and Futures Ordinance to supervise digital currency exchanges based on the principle of “same business, same risks, same rules,” but even for the same business, the structure may be different. For example, if no bank exists in the blockchain, how can currency transactions be separated from user assets? The business surface is the same, but the regulatory risk points may differ.

We have discussed a lot about the regulation of Bitcoin. Cryptocurrency regulation should learn from the rules and automation of the Bitcoin system and write the rules into the program. Otherwise, the program will not work. It is efficient and cost-effective. It is not just about formulating a rule for companies to implement but clarifying procedural issues and publishing procedural requirements to solve problems in the community. Everyone handles everyone’s affairs, and everyone supervises them. Why Bitcoin has 6 block verifications is an example of participant supervision.

The Bitcoin system is a self-regulatory model from the perspective that problems may occur. We still need to compare cryptocurrencies with Bitcoin and their systems before we can know where the risks are and strive to achieve the management efficiency of the Bitcoin system, that is, machine supervision.

“Same risks, same regulatory rules” is a good idea, but how to implement it? You cannot use Web1 thinking to manage Web3 affairs. Please don’t say that it surpasses the Bitcoin system; the same is OK. But you cannot turn web3 into Web1.

Eighth, the Bitcoin system requires trust

The Bitcoin system does not require trusting a third party but still requires trust. Trust the programmers and miners. The trusted party is often the center, and the modification decision-making power of the Bitcoin system rests with maintenance programmers. Although they have no equity, they have control. Although there is little control, at least there is the power to upload programs. Miners are free to come and go as they please, and there is no power in freedom. Dissatisfied miners are similar to small shareholders and can choose to vote with their feet. At the same time, the miner can choose not to download. Even the largest Bitcoin Core development team cannot control 100% of the program. The Bitcoin program they developed achieved 96% market share. Apple’s version download is not 100% downloadable. Can you say Apple is decentralized? Therefore, corresponding supervision must be designed based on the power of the controlling party. We saw the Ethereum Foundation’s annual report. They are ahead of the curve in regulation and provide a template for regulatory controllers.

It is difficult for miners to unite due to different interests. China controlled 70% of the computing power then and had never beaten Bitcoin Core. Explain that the control center is always on the Bitcoin Core side. Centralized trust is always a problem. Satoshi Nakamoto is anonymous. Everyone can trust him, but they may not trust others. Due to concerns about centralization risks, the Bitcoin Core team evolved to a real name. They are Hennadii Stepanov, Michael Ford, Andrew Chow, and Gloria Zhao. The Bitcoin core team has no salary, which actually constitutes a risk point for the Bitcoin system. Ethereum has seen the shortcomings of Bitcoin, and its foundation has made up for Bitcoin’s flaws. Bitcoin still has some hiccups left.

Although Bitcoin and Ethereum have central control points, they are both community negotiation control mechanisms. Code is law, and code modifications must be based on rules. Their trust has been experienced for a long time and gradually accumulated trust. And the ledger is transparent.

Based on this, if a centralized exchange in the blockchain fails to achieve ledger transparency and Bitcoin-level community governance, the risk of such an exchange will be higher than that of a traditional financial exchange because it has the function of banks, securities firms, and traders. Therefore, they should be regulated more strictly than financial exchanges. My proposal is on-site supervision, with supervisory procedures embedded in such exchanges, at least so that the exchange cannot touch users’ money. The regulatory authorities already have very mature experience in supervising the financial industry.

Ninth, Smart contracts are centralized

Many blockchain people will disagree. Listen to me. Your past perception may be wrong.

If you read Satoshi Nakamoto’s 80,000-word customer service record, you will know that Satoshi Nakamoto didn’t think about smart contracts. Why didn’t he do it? As soon as smart contracts are made, Bitcoin becomes a platform. When smart contracts go wrong, people will blame the platform. It is the foresight of Satoshi Nakamoto. A smart contract error in Ethereum caused a fork in the Ethereum community because Vitalik insisted on modifications. Someone Insisting on forking, ETC tokens were produced.

In order to solve the problems of smart contracts, smart contract audit companies have emerged. However, the audit company only reviews the code and cannot check the code developers. In fact, code developers are generally a tiny centralized team, and users often authorize the software when using their programs. Although smart contracts cannot be modified once they are published online, rogue developers can use users’ assets due to the existence of authorization. Two issues currently not covered in the audit are the adequacy of program testing and the anonymity of developers. Compared with Bitcoin and Ethereum, although a new smart contract has been audited, it still needs at least the same testing time as Ethereum before it can be launched. Otherwise, users should not participate.

People with the right to modify programs in the Bitcoin system have real names, and an anonymous smart contract is not worthy of trust. The center doesn’t have to be one person; it could be a team. For the supervision of smart contracts, it is obvious that the regulatory authorities must organize discussions, formulate guidance or procedures, and expand the audit scope of audit companies to comply with the guidance and procedural requirements of the regulatory authorities.

The principle here is that any centralized point in the system must be transparent if it is opaque. If it cannot be fully transparent, it must be supervised. The shortcomings of Bitcoin system programmer anonymity were corrected when Gavin Andresen became the chief maintainer, but smart contracts inherited the defects. Whenever something goes wrong with a cryptocurrency, it must first be compared with similar parts of the Bitcoin system, which is an unregulated system. If it cannot reach the level of the Bitcoin system, it will need supervision, even manual supervision.

Tenth, Classified supervision based on different risk points

Stablecoins and distributed exchanges (DeFi) are smart contracts; centralized parts should be regulated.

The cryptocurrency field can be divided into these 7 categories, and supervision can also be classified as follows:

Token issuance refers to Bitcoin, BCH, etc., characterized by POW tokens. The Bitcoin system does not require supervision.

Platform: refers to public chains such as Ethereum and ADA. No supervision is required.

The smart contract refers to DeFi projects such as Uniswap and Cake. Establish supervisory guidance or procedures to expand audit scope and audit responsibilities.

Community: There is currently a phenomenon of excessive power of the controlling party. This problem was not solved, and there was no mature template. Satoshi Nakamoto could not bear the abuse, so he walked away without choosing to ban someone’s account. And the bad habit of blocking accounts is also contagious. The Bitcoin forum has banned accounts, too.

Exchanges: Binance, Coinbase, etc. It is a crucial subject of supervision, and the supervision method is an automated version of the more stringent traditional financial supervision method.

Stablecoins, USDT, USDC, etc., are critical regulatory targets. Stablecoins are very special and will be described in another section.

Users: Supervise during the monetization process.

The “Cryptocurrency Act of 2020,” proposed by the U.S. Senate, divides cryptocurrencies into three major categories – encrypted commodities, cryptocurrencies, and encrypted securities, regulated by the Futures Trading Commission, the Financial Enforcement Network, and the Securities and Exchange Commission. Looking at their methods, they cannot cover the 7 aspects I mentioned.

Eleventh, The global nature of cryptocurrency brings regulatory difficulties

The global nature of cryptocurrency, peer-to-peer payment, anonymity, and innovation, as systems and products belong to different fields. For example, payment belongs to the scope of banking supervision, and tokens representing the system’s value belong to the area of securities. Traditional regulatory tools are insufficient to regulate cryptocurrencies well. Taking a prohibitive approach is too simplistic; imposing regulations too early and using traditional rules may stifle innovation.

Supervision is now divided into three ideas. Most countries divide supervision into securities and non-securities, including the United States, Japan, Singapore, Hong Kong, etc. There are differences between them in detail. The second is the E.U.’s behavioral supervision, divided into payment, non-payment, and money laundering. The three are those prohibited include China and others.

This division is based on traditional regulatory thinking. Is there another angle?

In Section 10, we analyzed it from the functional perspective, and in this section, we analyze it from the entity perspective.

For example, the Bitcoin system has no controlling entity and cannot find a regulatory target, so Bitcoin should not be regulated.

Ethereum has a foundation, and the foundation should be regulated. The actual controller should be subject to supervision.

Same reason. Although some exchanges claim to have no headquarters and no entity, their systems are profitable and should be incorporated into the management model of global multinational companies. “Same risks, same rules” should apply. If there is no entity, the actual controller has ultimate liability, tax liability, and, therefore, unlimited liability.

The same goes for smart contracts. Without an entity, there is unlimited personal liability, so a real name is required.

Anonymous Bitcoin accounts belong to individuals, and individuals have tax obligations. In the next 20 years, the Bitcoin standard is not yet realistic, so we should seize the conversion channels between cryptocurrency and legal currency to implement supervision. These are all traditional financial channels, and sorting out tax payments and money laundering is easy. When taxpayers cannot prove their costs, the channel should withhold and pay the total amount of tax. In other words, money is not taxed unless it enters the legal tender system. Just like cash transactions cannot be taxed in a fiat currency system.

There is now a view that it is challenging to reach a consensus on the global introduction of unified policies for supervision. Under a decentralized global system, it is necessary to classify and sub-category supervision. According to the current perspective of securities classification by regulatory authorities, it only manages the owners of securities rather than the management of various risk points in the entire ecosystem.

To manage Web3, you must first use Web3 ideas and methods and understand the community at the height of community civilization.

Twelfth, What is the best supervision?

The Bitcoin system implements a machine-trusted approach and does not require the supervision of regulatory agencies, so it is an efficient system. Comparing the Bitcoin system and Bitcoin to find risk points, rather than starting from the traditional regulatory approach, maybe a correct regulatory approach. If the project can reach the level of the Bitcoin system, the regulatory cost will be almost zero. The Bitcoin system represents the best regulatory model- no regulation.

How does Bitcoin do it? The characteristics of the Bitcoin system can be summarized as follows:

Data characteristics: Data sovereignty lies with the people, and data is transparent and trustworthy.

Community characteristics: everyone contributes resources, everyone shares benefits, and everyone participates in governance.

Control characteristics: The trusted party has automatic checks and balances. The system itself has a negative feedback design.

Negotiable Features: Code is the law. Modify the code according to the rules.

Characteristics of machine trust: The fewer people you trust, the better, and the longer the trust has been experienced, the better; that is, credit must be accumulated over time. The ledger is open, transparent, and cannot be tampered with.

Automatic operation feature: the system does not go down.

Please refer to the relevant articles in the chainless community (chainless.hk) for a detailed explanation.

Thirteenth, written on the back

Because stablecoins span cryptocurrency and traditional finance, they have complete currency attributes and can be directly used for cross-border payments and settlements. Bitcoin cannot directly replace fiat currencies, but stablecoins can. Stablecoins have peer-to-peer payment capabilities and can easily achieve global circulation. Stablecoins are the second most mature application of cryptocurrency after Bitcoin. It is discussed in detail in the next section.

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