Speaker 1: Hello everyone, and welcome to the latest episode from the
Speaker 1: midweek edition of the coin bureau podcast. Every week, I
Speaker 1: pick out two of my favorite videos from coin bureaus
Speaker 1: YouTube channel to present to you in podcast form. The
Speaker 1: audio you're about to hear is from those videos I've
Speaker 1: chosen this week. Many of you have been in touch
Speaker 1: to ask whether it's possible to listen to our videos
Speaker 1: in podcast format, and so your wish is my command.
Speaker 1: This week, I've selected our videos on the proof of
Speaker 1: work versus Proof of steak debate and the recent sanctioning
Speaker 1: of the Tornado cash mixing protocol by the US Treasury Department.
Speaker 1: As ethereums merge approaches and the network prepares to switch
Speaker 1: to proof of steak, many will be wondering about what
Speaker 1: differentiates proof of steak from the famous proof of work
Speaker 1: consensus mechanism that powers Bitcoin and has everyone in the
Speaker 1: mainstream media up in arms about its energy usage. Well,
Speaker 1: the good folks at the Crack and Cryptocurrency Exchange have
Speaker 1: written a brilliant report on the differences between the two,
Speaker 1: and in the first part of today's episode you'll hear
Speaker 1: our summary of that report and a few of my
Speaker 1: thoughts on the matter. Then, in the second part, we
Speaker 1: take a look at the controversial sanctioning of a well
Speaker 1: known crypto privacy tool that has sent shock waves through
Speaker 1: the industry. Tornado Cash may have been used by North
Speaker 1: Korean hackers to launder at stolen crypto, but it was
Speaker 1: mainly used by law abiding citizens to maintain some degree
Speaker 1: of financial privacy. So for a detailed explanation of what happened,
Speaker 1: what it means, and what could come next, keep listening
Speaker 1: to get the full low down. I hope you enjoy
Speaker 1: listening to these videos, which were, as always a pleasure
Speaker 1: to make. I'll be back talking crypto with Mike very soon,
Speaker 1: so be sure to stay tuned, and if you want
Speaker 1: even more content from coin Bureau, be sure to subscribe
Speaker 1: to our YouTube channel and visit us on social media too.
Speaker 1: M h as ethereums merge approaches, more and more people
Speaker 1: are asking the obvious questions, what exactly are the differences
Speaker 1: between proof of work and proof of steak and which
Speaker 1: of the two is better? As it so happens, Kraken
Speaker 1: recently released an incredible report which compares these two consensus
Speaker 1: mechanisms and answers almost all the questions that crypto holders
Speaker 1: are asking about them. That's why today I'm going to
Speaker 1: give you a bit of background about the report, summarize
Speaker 1: what it says in simple terms, and tell you what
Speaker 1: it could mean for e once the merge is complete.
Speaker 1: The report I'll be summarizing today was written by the
Speaker 1: Kraken cryptocurrency exchange. Kraken is based in the United States,
Speaker 1: and it was founded by entrepreneur Jesse Powell Inn. Kraken
Speaker 1: has since become one of the top ten largest cryptocurrency
Speaker 1: exchanges by training volume, and has come to support over
Speaker 1: one and ten coins and tokens and counting. Fun fact in,
Speaker 1: Kraken became the first cryptocurrency exchange to receive a crypto
Speaker 1: banking license from the state of Wyoming, making it possible
Speaker 1: for the exchange to offer traditional theat services alongside its
Speaker 1: crypto services all in house. Shortly afterwards, the first krack
Speaker 1: and Bank branch was established in Wyoming's capital of Cheyenne,
Speaker 1: and Kraken is working towards extending its crypto banking services
Speaker 1: to the rest of the country in accordance with the
Speaker 1: exchange's explicit goal of accelerating crypto adoption. Krakens focus on
Speaker 1: crypto adoption is also why the Exchange has put a
Speaker 1: huge emphasis on crypto education, and in addition to having
Speaker 1: some of the best articles about crypto projects, the Exchange
Speaker 1: also has some of the best crypto reports the industry
Speaker 1: has to offer. Now. Today's report is titled quote proof
Speaker 1: of Work versus Proof of Stake Securing the Chain and
Speaker 1: I'll leave a link to the full document in the description,
Speaker 1: along with a link to micrack and tutorial if you're
Speaker 1: interested in learning more about the Exchange Now. The report
Speaker 1: begins with a brief introduction and the first sentence is
Speaker 1: too good not to repeat. Quote At the heart of
Speaker 1: every blockchain lies a protocol that defines how pseudonymous individuals
Speaker 1: reach consensus in a globally distributed network. Now, if you
Speaker 1: watched our video about crypto consensus mechanisms, you'll know that
Speaker 1: consensus in crypto is no different from consensus, say between
Speaker 1: you and a group of friends deciding where to go
Speaker 1: for dinner. The only difference is that crypto consensus is
Speaker 1: digital and you're deciding on which transactions are valid. The
Speaker 1: authors then explain the importance of civil resistance in cryptocurrency.
Speaker 1: This is a fancy term for potential attacks on a
Speaker 1: cryptocurrency blockchain, such as convincing consensus participants that an invalid
Speaker 1: transaction is valid, or spamming transactions so that no real
Speaker 1: transactions can be processed. Civil resistance is why proof of
Speaker 1: work and proof of steak exists at all. They are
Speaker 1: fundamentally a means of making it very difficult to corrupt
Speaker 1: a cryptocurrency blockchain by incentivizing minors or validators to process
Speaker 1: transactions correctly, and in some cases punishing them for not
Speaker 1: doing so. The authors go on to make it clear
Speaker 1: that neither of these two consensus mechanisms is perfect. Each
Speaker 1: one comes with its own trade offs regarding decentralization, scalability, security,
Speaker 1: and of course sustainability, which has been an especially hot
Speaker 1: topic among proof of work critics. The authors argue that
Speaker 1: the correct consensus mechanism ultimately depends on what the cryptocurrency
Speaker 1: in question is trying to do, as this will determine
Speaker 1: which trade offs need to be made naturally. These trade
Speaker 1: offs are what the report examines in detail. The second
Speaker 1: part the report gives a bird's eye view of the
Speaker 1: quote anatomy of blockchain protocols. This includes things like how
Speaker 1: minors or validators are selected, how frequently blocks are produced,
Speaker 1: and when transaction finality is achieved. The authors reiterate that
Speaker 1: the purpose of a crypto consensus mechanism is to deter
Speaker 1: cibil attacks, and they provide a detailed definition of this
Speaker 1: term quote. A sibil attack is an exploit against an
Speaker 1: online network whereby a small number of entities as few
Speaker 1: as one, attempt to take control of the whole network
Speaker 1: by leveraging multiple accounts, nodes, or computers. The author's point
Speaker 1: to one of the most popular civil attacks in cryptocurrency,
Speaker 1: and that's a fifty attack. Without getting too technical, a
Speaker 1: fifty attack involves contributing or more of the computing power
Speaker 1: to a proof of work cryptocurrency so that transactions on
Speaker 1: its blockchain can be manipulated. The authors then exp lane
Speaker 1: that every crypto consensus mechanism requires some sort of skin
Speaker 1: in the game from miners or validators to ensure they
Speaker 1: remain honest i e. Process transactions correctly, and that this
Speaker 1: honesty is typically achieved in three ways. The first way
Speaker 1: is by quote encouraging participants to reach a consensus on
Speaker 1: the state of the blockchain through a competitive process such
Speaker 1: as mining or staking the second way is by quote
Speaker 1: punishing bad actors that try to stall the network from
Speaker 1: reaching a consensus, and the third way is by quote
Speaker 1: rewarding some or all participants for behaving honestly and coming
Speaker 1: to a consensus, be it through transaction fees, block rewards,
Speaker 1: or both. The authors go on to provide this incredible
Speaker 1: infographic which shows you half a dozen different crypto consensus
Speaker 1: mechanisms and how they ensure network participants process transactions correctly.
Speaker 1: I definitely suggest pulling up this page and having a
Speaker 1: closer read if you have the time. What's awesome is
Speaker 1: the authors provide a breakdown of how much of the
Speaker 1: crypto market cap is being secured by each consensus mechanism.
Speaker 1: For those who can't see or are just listening, around
Speaker 1: six of the crypto market is secured by proof of work,
Speaker 1: twelve percent by proof of steak, and thirty percent by
Speaker 1: other consensus mechanisms. This will obviously change once Ethereum transitions
Speaker 1: to proof of steak, as the author's count tokens as
Speaker 1: part of this calculation, and most of the largest tokens
Speaker 1: by market cap are e r C twenty tokens circulating
Speaker 1: primarily on ethereum namely stable coins. You can find out
Speaker 1: more about what Ethereum will look like post merge using
Speaker 1: the link in the description. Next, the author's turn to
Speaker 1: consensus methods, which are slightly different from consensus mechanisms. Whereas
Speaker 1: consensus mechanisms describe always to prevent attacks on transactions, consensus
Speaker 1: methods refer to how minors, validators, or nodes actually agree
Speaker 1: on the accuracy of transactions. Cryptocurrencies like Bitcoin and Cardano
Speaker 1: used the longest chain consensus method, meaning that minors and
Speaker 1: validators assume the longest version of the blockchain is the
Speaker 1: most accurate. In the case of proof of work, this
Speaker 1: is because the longest blockchain took the most energy to create,
Speaker 1: and in the case of proof of steak, this is
Speaker 1: because the longest blockchain received the most votes. Meanwhile, cryptocurrencies
Speaker 1: like Ethereum and conflux use the heaviest chain consensus method,
Speaker 1: which is like the longest chain consensus method, except that
Speaker 1: it includes orphaned blocks valid blocks which were rejected because
Speaker 1: they were proposed at the same time as another valid block.
Speaker 1: The authors underscore the significance of these so called Nakamoto
Speaker 1: style consensus methods because they make it possible to increase
Speaker 1: the threshold of corruption for a distributed system from thirty
Speaker 1: to while simultaneously removing the trust that's often required for
Speaker 1: a distributed system to function. The tradeoff of Nakamoto style
Speaker 1: consensus methods is that transaction are never truly final. Instead,
Speaker 1: transactions are probabilistic, meaning the likelihood of a transaction being
Speaker 1: final increases with every block that's added to the blockchain,
Speaker 1: but that likelihood never actually reaches If you watched our
Speaker 1: video about the fastest cryptocurrencies, you'll know that what counts
Speaker 1: as a final transaction varies from coin to coin and
Speaker 1: depends on the number of confirmations, which can be simply
Speaker 1: understood as the number of blocks that have been added
Speaker 1: to the chain since the transaction occurred. For reference, a
Speaker 1: BTC transaction on Bitcoin is considered final after six confirmations
Speaker 1: i e. Six blocks. Since it takes around ten minutes
Speaker 1: to add a block to the Bitcoin blockchain, this means
Speaker 1: it takes around one hour for the average BTC transaction
Speaker 1: to be considered final i e. Irreversible, even though it's
Speaker 1: technically not. The authors then provide another incredible infographic which
Speaker 1: breaks down all the different types of crypto consense as methods,
Speaker 1: and even gives an overview of the consensus methods and
Speaker 1: consensus mechanisms used by Cardano Ethereum, Ethereums, beacon chain, and Selana.
Speaker 1: The authors end the section by emphasizing the importance of
Speaker 1: knowing the difference between a consensus method and a consensus
Speaker 1: mechanism when discussing proof of work versus proof of steak.
Speaker 1: This ties into the third part of the report, and
Speaker 1: that's the tradeoffs of proof of work and proof of steak.
Speaker 1: The authors start by giving one of the best explanations
Speaker 1: of proof of work that I've ever read, so quote.
Speaker 1: In proof of work blockchains, miners must gather information and
Speaker 1: try to guess a solution to a cryptographic puzzle. Once
Speaker 1: minus solve the puzzle, they share their results with other
Speaker 1: nodes to verify their work before adding the block to
Speaker 1: the chain. Because miners must consume energy in the proof
Speaker 1: of work process and nodes can easily verify any blocks validity,
Speaker 1: malicious miners who try to add an invalid block waste time,
Speaker 1: energy and resources. Conversely, the protocol rewards honest miners that
Speaker 1: successfully mine a valid block. And for some extra clarity,
Speaker 1: I'll add that each block contains BTC transactions. Now. As
Speaker 1: far as benefits go, the author's note that proof of
Speaker 1: work cryptocurrencies have been battle tested at scale, though they
Speaker 1: acknowledge that there have been a few attacks on smaller
Speaker 1: proof of work cryptos, notably Ethereum Classic. You can learn
Speaker 1: more about Ethereum Classic using the link in the description
Speaker 1: I digress now. The authors add that at this point
Speaker 1: in time, purchasing the computing power required to conduct a
Speaker 1: fifty attack against a cryptocurrency like Bitcoin would be so
Speaker 1: expensive that it would make no sense to do unless
Speaker 1: you're a government trying to protect your national currency against BTC.
Speaker 1: Of course, what's crazy is that the authors actually took
Speaker 1: the time to calculate how much it would cost to
Speaker 1: corrupt Bitcoin and other major proof of work cryptocurrencies. For Bitcoin,
Speaker 1: it would cost over eight point six billion dollars in
Speaker 1: hardware costs plus twenty million dollars in energy costs per day.
Speaker 1: The authors then touch on the infamous New York Agreement
Speaker 1: of seventeen, wherein fifty companies, including cryptocurrency exchanges, tried to
Speaker 1: convince the crypto community to double Bitcoin's block size. Their
Speaker 1: initiative failed because bitcoin nodes refused to implement the change
Speaker 1: the institutions wanted to see. Now, the authors note that
Speaker 1: this resistance to institutional influence would have been difficult, if
Speaker 1: not impossible, if bitcoin had been proof of stake, because
Speaker 1: the institutions would have been able to simply buy up
Speaker 1: the stake they needed to implement changes they wanted at
Speaker 1: the blockchain level. Another pro proof of work argument the
Speaker 1: authors identify is the huge incentive for geographical decentralization due
Speaker 1: to crypto minors trying to find the cheapest electricity sources,
Speaker 1: which are often located in remote areas. The authors acknowledge
Speaker 1: that this geographical decentralization is less apparent in practice, as
Speaker 1: China did in fact become a crypto mining hub. However,
Speaker 1: the authors also note that bitcoin mining operations were beginning
Speaker 1: to migrate out of China even before the country's famous
Speaker 1: crypto ban last spring. Today, bitcoin's hash power is much
Speaker 1: more decentralized, though if you ask me, it looks like
Speaker 1: the United States could soon become the new point of centralization,
Speaker 1: and something tells me that the US government will be
Speaker 1: more thorough in its surveillance of the crypto mining sector
Speaker 1: than the CCP. The last two advantages of proof of work.
Speaker 1: The author's cover are the natural resistance to blockchain forks
Speaker 1: due to the high costs of forking and the fact
Speaker 1: that it's much harder to bribe minors than it is validators,
Speaker 1: at least on paper. As far as drawbacks to proof
Speaker 1: of work go, the authors note that there are any
Speaker 1: concerns about the carbon footprint associated with proof of work cryptocurrencies,
Speaker 1: but if you watched our video about coin Shares crypto
Speaker 1: mining report, you'll know the bitcoin mining accounts for less
Speaker 1: than zero point one percent of global carbon emissions. The
Speaker 1: second drawback is similarly straightforward, and that's the inability of
Speaker 1: smaller proof of work cryptocurrencies to effectively protect themselves from attacks.
Speaker 1: The third drawback is one that I alluded to earlier,
Speaker 1: and that's the possibility that mining could become centralized among
Speaker 1: the most well capitalized entities, who could then work together
Speaker 1: to change the blockchain to their benefit. Note that the
Speaker 1: three largest bitcoin mining pools have of the hash power.
Speaker 1: The fourth drawback is a little bit funny, and that's
Speaker 1: the quote. Since nodes can operate anonymously, blocking a malicious
Speaker 1: miner from participating in the network is impossible, and there's
Speaker 1: no way to confiscate their mining equipment for misbehaving. This
Speaker 1: is obviously meant to be in contrast to proof of steak,
Speaker 1: where misbehaving validators sand to lose some of their steak,
Speaker 1: but it's still funny to imply that it would be
Speaker 1: ideal if malicious miners could have their mining equipment confiscated.
Speaker 1: The fifth drawback is the possibility of a so called
Speaker 1: selfish mining attack, which was apparently discovered by Avalanche founder
Speaker 1: Emin Gun Sarah and another Cornell University professor. Back in,
Speaker 1: a selfish mining attack involves secretly creating a longer chain
Speaker 1: and introducing it late to steal crypto. The final drawback
Speaker 1: is also peculiar, as it has to do with transaction fees,
Speaker 1: which are often higher for proof of work cryptocurrencies. The
Speaker 1: authors point out that higher fees aren't always a bad thing,
Speaker 1: as they protect against spam, something that's plagued low cost
Speaker 1: cryptocurrencies like Nano and Salana. On that note, you can
Speaker 1: find out what Salana has been up to using the
Speaker 1: link in the description. Anyways, when it comes to proof
Speaker 1: of steak, the authors don't provide an elaborate explanation of
Speaker 1: how this consensus mechanism works because it really is quite simple.
Speaker 1: Validators must lock up a certain amount of a cryptocurrency
Speaker 1: coin for a certain amount of time to get selected
Speaker 1: to produce a block. This selection is pseudo random based
Speaker 1: on stake, and if the validator tries to cheat the
Speaker 1: selection or try and manipulate transactions, some or all of
Speaker 1: their steak is slashed I destroyed. Note that not all
Speaker 1: proof of state cryptocurrencies have slashing enabled, nor do they
Speaker 1: all have lock up times for validators. As far as
Speaker 1: benefits go, the author's note that proof of state consensus
Speaker 1: mechanisms require next to no energy to protect against CIBIL attacks,
Speaker 1: with Ethereum's post merge energy use estimated to be nine
Speaker 1: percent less than what it is now. The second benefit
Speaker 1: is that validators do not need to constantly upgrade their hardware,
Speaker 1: as miners often do. The third benefit is that misbehaving
Speaker 1: validators can be punished via slashing. The fourth benefit it
Speaker 1: is that proof of state cryptocurrencies are much faster, and
Speaker 1: the fifth benefit is that participating as a validator on
Speaker 1: a proof of state cryptocurrency is much easier than becoming
Speaker 1: a minor, as it requires less capital and less specialized hardware,
Speaker 1: though it's important to note that this is not the
Speaker 1: case for all proof of stake cryptocurrencies. As far as
Speaker 1: drawbacks go, the author's note that proof of state cryptocurrencies
Speaker 1: are not nearly as battle tested as proof of work cryptos,
Speaker 1: and are also not secured with nearly the same amount
Speaker 1: of capital. The second drawback is one that's unfortunately quite
Speaker 1: common among proof of state cryptocurrencies, and that's that the
Speaker 1: initial distribution of the crypto coin can cause the concentration
Speaker 1: of stake among a handful of participants. The third drawback
Speaker 1: relates to the crypto consensus methods I mentioned earlier, and
Speaker 1: that's that many proof of state cryptocurrencies do not use
Speaker 1: Nakamoto style consensus mechanisms and can therefore be corrupted if
Speaker 1: malicious validators control a third of the total stake. A
Speaker 1: much lower threshold than the fourth drawback relates to the second,
Speaker 1: and that's that proof of state cryptocurrencies are more vulnerable
Speaker 1: to centralization because quote, those with large amounts of coins,
Speaker 1: such as earlier adopters, exchanges, and custodians, can overwhelmingly influence
Speaker 1: the rules of the network. Moreover, quote, they can also
Speaker 1: accumulate more of the coin via staking, causing a positive
Speaker 1: feedback loop that can increase centralization. Now it's safe to
Speaker 1: say that this is becoming a bigger and bigger concern
Speaker 1: as large asset managers like black Rock enter the crypto space.
Speaker 1: The fifth drawback is that validators could easily process incorrect transactions,
Speaker 1: particularly for proof of state cryptocurrencies that don't have strong
Speaker 1: deterrence mechanisms like slashing enabled. The sixth drawback is something
Speaker 1: that I mentioned a few moments ago, and that's that
Speaker 1: staking requirements can still be prohibitively high, particularly on the
Speaker 1: hardware side it. To accompany their point, the authors give
Speaker 1: an infographic about the hardware requirements to run a validator
Speaker 1: node on popular proof of stake cryptocurrencies, and you can
Speaker 1: see that Salana is an outlier, extremely difficult to run
Speaker 1: a validator node there. The seventh drawback is a bit odd,
Speaker 1: and that's that staking presents an opportunity cost for validators
Speaker 1: because their money is locked up and can't be used.
Speaker 1: This is odd because there are many liquid staking protocols,
Speaker 1: such as Lido finance that make it possible to freely
Speaker 1: trade your staked coins. Some crypto projects like Phantom also
Speaker 1: have liquid staking at the layer one level, meaning there's
Speaker 1: no need to trust a third party protocol. The eighth
Speaker 1: drawback is that proof of steak doesn't protect as well
Speaker 1: against blockchain forks, and cryptocurrencies leveraging this consensus mechanism without
Speaker 1: slashing risks are again vulnerable. I'm surprised the authors didn't
Speaker 1: add another evident drawback, and that's that it's incredibly difficult
Speaker 1: to get a proof of state cryptocurrency off the ground
Speaker 1: without lots of centralization. That's because any fairly launched proof
Speaker 1: of state cryptocurrency would be easy to corrupt, as the
Speaker 1: value of its coin would be close to nothing, and
Speaker 1: that would make it easy for a malicious actor to
Speaker 1: acquire a third of the stake and manipulate transactions. As such,
Speaker 1: the only option would be to conduct an i c
Speaker 1: O to create a baseline value for the coin, potentially
Speaker 1: support its price with the capital raised, and ensure that
Speaker 1: enough of its supply is held by and ideally staked
Speaker 1: by the team and early investors so that it's next
Speaker 1: to impossible to acquire the stake required to corrupt it.
Speaker 1: Besides the centralization this would create would also attract the
Speaker 1: attention of regulators like the SEC who would almost certainly
Speaker 1: consider this kind of cryptocurrency to be a security and
Speaker 1: you can find out what criteria the SEC is using
Speaker 1: to crack down on cryptocurrencies using the link in the
Speaker 1: description any who. In terms of which of these two
Speaker 1: consensus mechanisms is better, the authors frame their conclusion in
Speaker 1: the context of the blockchain trilemma and state the following quote,
Speaker 1: It is our take that proof of work tends to
Speaker 1: offer better security and decentralization guarantees, sacrificing scalability in the process.
Speaker 1: On the other hand, proof of steake typically offers better
Speaker 1: scalability in exchange for security and decentralization. However, the authors
Speaker 1: immediately repeat that quote, the optimal choice ultimately depends on
Speaker 1: a given block chain's use case and how developers implement
Speaker 1: its civil resistance mechanism. Some blockchains are better suited for
Speaker 1: proof of steak, while others should use proof of work naturally,
Speaker 1: the authors argue that for cryptocurrencies which are meant to
Speaker 1: be hard money, such as bitcoins BTC, proof of work
Speaker 1: is preferable because security and decentralization are paramount for such
Speaker 1: use cases. By contrast, cryptocurrencies that are aiming to become
Speaker 1: the next generation of payment rails such as Salana are
Speaker 1: better off using proof of steak, since scalability is paramount
Speaker 1: for such a use case. What's interesting is that the
Speaker 1: authors provide a few infographics showing the number of daily
Speaker 1: transactions for popular proof of state cryptocurrencies, and I say
Speaker 1: it's interesting because it reveals just how much and how
Speaker 1: little use some of these cryptocurrencies are seeing. Not naming
Speaker 1: names at the end of this section, the author's caution
Speaker 1: that quote every blockchain still requires a deep understanding of
Speaker 1: the protocol's measures to defend against civil attacks, achieve a
Speaker 1: consensus on the state of the network and how its
Speaker 1: measures balanced the trade offs within the blockchain trilemma. Now,
Speaker 1: the final part of the report is the conclusion, wherein
Speaker 1: the authors basically repeat everything they wrote, but with a
Speaker 1: bit more punch. For example, quote, blockchains should adhere to
Speaker 1: a proof of work mechanism if they want to retain
Speaker 1: the ethos of crypto assets, decentralization, and security. Logically, this
Speaker 1: implies that blockchains which use proof of state consensus mechanisms
Speaker 1: will not retain the ethos of cryptocurrency, something that the
Speaker 1: author's tacitly confirm in the next paragraph where they say
Speaker 1: proof of steak is most appropriate for cryptocurrencies focused on
Speaker 1: payments and smart contracts. This makes me wonder what consensus
Speaker 1: mechanisms are appropriate for different types of crypto niches, and
Speaker 1: you can learn more about those using the link in
Speaker 1: the description. So this brings me to the big question,
Speaker 1: and that's what the findings of this report mean for
Speaker 1: Ethereum once it transitions to proof of steake. Well, I'll
Speaker 1: start by saying that the authors hit the nail on
Speaker 1: the head with their assessment that the appropriate consensus mechanism
Speaker 1: depends on a cryptocurrency's use case. This is where things
Speaker 1: get a bit complicated, because Ethereum's use case is probably
Speaker 1: a bit different depending on who you ask. Ethereum was
Speaker 1: initially pitched as the world's computer, but following the e
Speaker 1: I P fifty nine upgrade last August, some have started
Speaker 1: referring to EAT as ultrasound money. This and other developments
Speaker 1: have led many to label Ethereum as a payments network,
Speaker 1: which is objectively the case even if you don't buy
Speaker 1: the ultrasound money narrative. And that's because Ethereum has become
Speaker 1: the de facto base layer of the largest stable coins.
Speaker 1: At the same time, Ethereum is home to not only
Speaker 1: the largest defied protocols, but also other decentralized applications, the
Speaker 1: largest n f T projects, and all the new ecosystems
Speaker 1: that are being built on Layer two's that derive their
Speaker 1: security from the Ethereum blockchain. This makes it incredibly hard
Speaker 1: to say what the correct consensus mechanism for Ethereum should be,
Speaker 1: and though proof of steak seems like a no brainer,
Speaker 1: it's important to remember that the reason why Ethereum's ecosystem
Speaker 1: got so big is precisely because of the security and
Speaker 1: decentralization that came from its proof of work consensus mechanism.
Speaker 1: It's certainly true that Ethereum was losing Ground two competitors
Speaker 1: because of its lack of scalability, but this is something
Speaker 1: that was and still is being solved by scaling solutions
Speaker 1: and side chains such as Polygon. It's also clear that
Speaker 1: the obsession around scalability coming from crypto projects like Slana
Speaker 1: has done serious damage to their security, and it's only
Speaker 1: a matter of time before what's left of their decentralization
Speaker 1: starts to suffer too. So in some what made Ethereum
Speaker 1: stand out from its competitors was its decentralization and security,
Speaker 1: and though this decentralization and security is likely to carry
Speaker 1: over when it transitions to proof of steak, I find
Speaker 1: it hard to see how these levels of decentralization can
Speaker 1: be maintained indefinitely given the nature of this consensus mechanism.
Speaker 1: It's also no secret that institutions are itching to get
Speaker 1: their hands on EATH so that they can stake it,
Speaker 1: and with asset managers like black Rock entering the ring,
Speaker 1: it's only a matter of time before institutions are staking
Speaker 1: enough to have the power to decide what happens at
Speaker 1: the protocol level. What happens at that point is anyone's guess,
Speaker 1: but the recent incident with Tornado Cash gives us some
Speaker 1: insight into just how much it could change Ethereum's ecosystem.
Speaker 1: More about that using the link in the description. Now,
Speaker 1: for what it's worth, I know that Vitallic and other
Speaker 1: Ethereum o g s are hyper aware of these risks,
Speaker 1: and I have no doubt that they will do everything
Speaker 1: in their power to ensure that Ethereum remains secure and
Speaker 1: decentralized after it transitions to proof of steak. Let's just
Speaker 1: hope they succeed. Last week, we witnessed one of the
Speaker 1: biggest attacks to date on crypto privacy that came in
Speaker 1: the form of the US tread juries sanctioning of Tornado Cash. Now.
Speaker 1: This led to protocol's blocking addresses, funds being seized, and
Speaker 1: one of the Tornado Cash developers being arrested. But this
Speaker 1: story is far from over and its implications for the
Speaker 1: broader crypto industry cannot be overstated. Today, I'm going to
Speaker 1: give you everything you need to know about the situation
Speaker 1: and what it could mean for you. On the eighth
Speaker 1: of August, we learned that the Treasury's Office of Foreign
Speaker 1: Assets Control o FAK had sanctioned the Tornado Cash mixing protocol.
Speaker 1: A number of addresses associated with the mixer, containing around
Speaker 1: four hundred and twenty four million dollars worth of crypto,
Speaker 1: were also sanctioned. Now, for those unfamiliar, Tornado Cash has
Speaker 1: long been one of the most well known mixing protocols
Speaker 1: on ethereum, and what it would essentially do is obsfor
Speaker 1: skate transaction history. This means that it would anonymize transactions
Speaker 1: and remove all traces of where funds had originated from.
Speaker 1: This was a privacy tool that was used by thousands
Speaker 1: of people in the DeFi space. Unfortunately, it was also
Speaker 1: used for laundering the proceeds of cybercrime, and that is
Speaker 1: the use case that the Treasury honed in on. It
Speaker 1: stated that Tornado was a favorite tool of North Korean
Speaker 1: hackers and had been used to laund up more than
Speaker 1: seven billion dollars. Now, on a side note, that number
Speaker 1: is highly inflated for reasons I'll get into later. Anyways,
Speaker 1: the moment Tornado was sanctioned, its website was taken down
Speaker 1: and the code disappeared from git ub. Not only that,
Speaker 1: but one of the contributors had his git hub account.
Speaker 1: Band Circle blacklisted any USDC that was in the affected wallets,
Speaker 1: and RPC providers such as Infuror and Alchemy started blocking
Speaker 1: calls to the Tornado Cash smart contracts. And if that
Speaker 1: wasn't bad enough, a number of decentralized applications also began
Speaker 1: to restrict access to their front ends for wallets which
Speaker 1: had interacted with the Tornado Cash smart contract. For example,
Speaker 1: both are they and d y d X reported that
Speaker 1: they were blocking access from those wallets which had interacted
Speaker 1: with tornado Cash, and even those that had received funds
Speaker 1: from it. In the case of d y d X,
Speaker 1: users who had immaterial amounts but who had associated with
Speaker 1: Tornado Cash in the past were also blocked. Things were
Speaker 1: further complicated by the fact that someone in the community
Speaker 1: decided to start dusting a number of public ether addresses
Speaker 1: of celebrities in the space. In other words, they sent
Speaker 1: a number of small transactions to hundreds of known wallets
Speaker 1: associated with E E N S addresses. The likes of
Speaker 1: Brian Armstrong, Jimmy Fallon, and Steve Aoki were potentially committing
Speaker 1: sanctions violations by appearing to be doing business with a
Speaker 1: sanctioned protocol. What's even crazier than that is that some
Speaker 1: of those users who were hit with the dust found
Speaker 1: that they were not able to interact with our vey's
Speaker 1: front end. These included the likes of Anthony Sassano and
Speaker 1: Justin Son. But perhaps the most chilling development, at least
Speaker 1: so far, was the arrest by Dutch police of one
Speaker 1: of Tornado Cash's developers, Alexei Pertzev. Was picked up by
Speaker 1: the Dutch Fiscal Information and Investigation Service f i o
Speaker 1: D two days after Tornado Cash was sanctioned. Now, the
Speaker 1: exact reasons for his arrest and what he is actually
Speaker 1: being accused of remain unknown. But if it's just because
Speaker 1: he wrote some code, then this is a dangerous precedent
Speaker 1: for a number of reasons, which I'll explore a little
Speaker 1: later on. The first thing that we need to be
Speaker 1: asking ourselves, however, is whether these actions by the Treasury
Speaker 1: were legal. Allow me to explain. This is the first
Speaker 1: time that the Treasury has effectively sanctioned a tool, a
Speaker 1: piece of open source code that exists on the Ethereum
Speaker 1: blockchain and which can be used by anyone for any purpose,
Speaker 1: be it good or bad. Given that it is open source,
Speaker 1: that means it is akin to the likes of a
Speaker 1: public good. So that could be analogous to a road
Speaker 1: or a park. So it would be as if o
Speaker 1: FAC were to sanction the use of an interstate highway
Speaker 1: because drug dealers drive on it, Or if you wanted
Speaker 1: a more relevant example, it would be like the Treasury
Speaker 1: sanctioning the t c P I P protocol because hackers
Speaker 1: use the Internet for hacking, it's impractical. Moreover, just because
Speaker 1: a tool is sanctioned does not mean that the criminals
Speaker 1: are not going to use it. That's because criminals, by
Speaker 1: definition have zero consideration for the law. They're likely to
Speaker 1: continue using the smart contract as they see fit. Then
Speaker 1: there is the very important question of whether sanctioning a
Speaker 1: piece of code violates the First and men mint allow
Speaker 1: me to explain. You see, thanks to a case Bernstein
Speaker 1: versus the d o J, it's been established that code
Speaker 1: should be considered speech, and if it is indeed speech,
Speaker 1: then it should be protected by the First Amendment. By
Speaker 1: sanctioning this tool, the Treasury is effectively saying that the
Speaker 1: speech itself is illegal. Now there is a very real
Speaker 1: possibility that should someone want to challenge these sanctions, they
Speaker 1: could have a strong case in court. The Coin Center
Speaker 1: lobbying group has stated that it plans to Moreover, if
Speaker 1: indeed the only thing the developer did was right code,
Speaker 1: then that could also be seen as a violation of
Speaker 1: free speech. Now, I'm sure that more astute legal minds
Speaker 1: than mine are going to have a field day with
Speaker 1: this case. But if there are any legal challenges mounted,
Speaker 1: it will take a long time for them to be settled.
Speaker 1: Until that time, the sanctions will have to be enforced,
Speaker 1: and that means that all those defied projects and protocols
Speaker 1: will hinue blacklisting the smart contract less the teams behind
Speaker 1: them fancy a date with a prison cell. Apart from
Speaker 1: the legal aspect, there is the practical consideration for how
Speaker 1: this will be enforced. To remember, criminals are criminals, and
Speaker 1: they will continue to use it. The code is open
Speaker 1: source and free to fork. Should that happen, the Treasury
Speaker 1: will end up playing whack a mole with a bunch
Speaker 1: of newly deployed smart contracts. Not only that, but those
Speaker 1: other crypto projects and protocols are also going to have
Speaker 1: to monitor not only the funds that are coming from
Speaker 1: the original Tornado Cash smart contract, but also from all
Speaker 1: the forked ones. This could quickly become a logistical impossibility,
Speaker 1: and projects will always have to worry whether any ether
Speaker 1: they handle has gone through a forked version of the
Speaker 1: original Tornado Cash. And speaking of which, there's also the
Speaker 1: broader question around who, as a result of these sanctions
Speaker 1: could technically find themselves in violation of oh fact rules.
Speaker 1: If someone say from the Tornado contract to you, does
Speaker 1: that mean you are in violation? I mean it's not
Speaker 1: like you can refuse to receive it. As we saw
Speaker 1: with those dusting attacks. Protocols themselves have started blocking some
Speaker 1: of these dusted addresses. Could the Feds start going after
Speaker 1: any of those wallets that have received tornado tainted eath?
Speaker 1: Could we soon see Jimmy Fallon dragged away in cuffs?
Speaker 1: It's not even about addresses that have received funds. What
Speaker 1: about liquidity providers on the decks? What happens if they
Speaker 1: unknowingly convert eth that has been through Tornado Cash into
Speaker 1: some other cryptocurrency? Are they thus engaging with sanctioned entities?
Speaker 1: What about ethereum miners? What liability do they have if
Speaker 1: they were to propagate a block that included a Tornado
Speaker 1: cash transaction? Does that mean that they could also be
Speaker 1: flirting with illegality? Or how about that eth that's sent
Speaker 1: to the eath to steaking contract? What would that mean
Speaker 1: for proof of steak ethereum? What happens once the transition
Speaker 1: to proof of steak is completed? Will validators have to
Speaker 1: decide to censor certain transactions that their jurisdiction deems as illegal?
Speaker 1: Could they get slashed? So you can see how quickly
Speaker 1: this grows out of control. The crypto space has just
Speaker 1: seen a massive can of worms opened up right in
Speaker 1: front of it. Now. Of course, there will be some
Speaker 1: who claim that these actions are justified. Swiped funds from
Speaker 1: some of the most high profile crypto hacks of the
Speaker 1: past two years have gone through Tornado. This was seen
Speaker 1: in the wake of the one million dollar Harmony hack
Speaker 1: that took place a few weeks ago. There are plenty
Speaker 1: of people who have been asking whether there are really
Speaker 1: any legitimate use cases for Tornado cash, a tool designed
Speaker 1: specifically for privacy. Essentially, this all comes down to the
Speaker 1: broader question of why someone would want to have financial
Speaker 1: privacy in the first place. As the old saying goes,
Speaker 1: if you have nothing to hide, why do you worry? Well,
Speaker 1: for plenty of reasons as it happens. Firstly, because blockchains
Speaker 1: are public and transparent, everyone can see exactly what your
Speaker 1: wallets are doing and what you could be buying or
Speaker 1: investing in. This is not the case with trad fi,
Speaker 1: where your bank account balances and spending habits aren't public.
Speaker 1: The moment they are public and someone can attach it
Speaker 1: to your I r L identity, it opens you up
Speaker 1: to potential physical harm if criminals ever wanted to get
Speaker 1: access to your crypto, or perhaps you wanted to donate
Speaker 1: crypto to a cause, which may get you into some
Speaker 1: serious trouble in your country. For example, what happens if
Speaker 1: you were a citizen of Iran or Venezuela who wanted
Speaker 1: to donate to a journalist or newspaper that the government
Speaker 1: didn't like. Blockchain is immutable, you'd live in constant fear
Speaker 1: of being placed on a list of some kind. Or
Speaker 1: how about if you were a Russian who wanted to
Speaker 1: donate to Ukraine, not something that you would like the
Speaker 1: FSB to know about. On the flip side, you could
Speaker 1: be a Ukrainian refugee wanting to hide where you were
Speaker 1: getting your donations from. This is something that Fatalik himself
Speaker 1: highlighted earlier this year when he donated to the country.
Speaker 1: Beyond such high stakes implications, it could also just be
Speaker 1: a situation in which you don't want people you interact
Speaker 1: with on chain to know what you do with your money.
Speaker 1: For example, let's assume that you get paid in crypto.
Speaker 1: That means that your employer will be able to see
Speaker 1: exactly what you do with that money and what you're buying.
Speaker 1: Or perhaps you're buying something from an online merchant and
Speaker 1: you don't want them to know what else you've been
Speaker 1: spending the money on or how much you have Just
Speaker 1: imagine the targeted advertising. Ironically, this would be a lot
Speaker 1: easier to achieve when paying with a completely open and
Speaker 1: permissionless form of money. Now, these are all reasons as
Speaker 1: to why someone would want to anonymize their transaction history. Now,
Speaker 1: some might say you could just use a centralized exchange. However,
Speaker 1: the whole point of de centralized and censorship resistant currency
Speaker 1: is that you don't have to rely on a centralized gatekeeper. Moreover,
Speaker 1: some people are just not comfortable having others holding their
Speaker 1: private keys, and can you blame them? It was also
Speaker 1: pretty disingenuous for the Treasury to claim in its press
Speaker 1: release that seven billion dollars was laundered through Tornado Cash.
Speaker 1: That was the total volume of transactions, many of which
Speaker 1: would have been for such perfectly legitimate reasons as I
Speaker 1: have just talked about. In fact, according to stats from
Speaker 1: the blockchain sleuths over at Chain Analysis, only about sevent
Speaker 1: of the funds that flowed through the protocol were tied
Speaker 1: to sanctioned activity. The vast majority was related to defy activities.
Speaker 1: That means that these users were thrown into the laundering
Speaker 1: bucket by the Treasury when all they were really doing
Speaker 1: was trying to anonymize their funds. So this raises the
Speaker 1: of what all this means for crypto privacy and heck,
Speaker 1: privacy in general. Well, it's quite clear that privacy is
Speaker 1: under attack. Yes, this move by the Treasury was prompted
Speaker 1: by concerns around North Korean hacking, but the tool used
Speaker 1: is so blunt for the effect it's trying to achieve
Speaker 1: that you have to wonder whether the folks at oh
Speaker 1: FAK gave any thought to collateral damage. Many have drawn
Speaker 1: parallels with the early crypto wars. For example, for those unfamiliar,
Speaker 1: this was when the US government arrested Phil Zimmerman, a
Speaker 1: developer who distributed PGP cryptography online. They accused him of
Speaker 1: quote munitions export without a license, Yes, that's right. They
Speaker 1: contended that his p GP encryption system was a weapon
Speaker 1: that could be used by adversaries. I mean, heck, while
Speaker 1: on Earth would someone want privacy online, only criminals and
Speaker 1: enemy governments would want to encrypt their communications. Well, it
Speaker 1: turned out that there were many many practical uses for
Speaker 1: encryption online and various encryption standards have helped power the
Speaker 1: multibillion dollar e commerce revolution that we've experienced over the
Speaker 1: last twenty years. What was initially considered a way to
Speaker 1: hide state secrets has in fact allowed legal commerce to thrive.
Speaker 1: I'll leave some resources in the description for you where
Speaker 1: you can get some more information on the crypto wars.
Speaker 1: It is a fascinating subject. Back to cryptocurrency though, and
Speaker 1: many have also been wondering why Tornado Cash got hit
Speaker 1: and not other well known crypto projects like Manero for example. Well,
Speaker 1: my assumption is that mixers are viewed with a lot
Speaker 1: more suspicion than privacy. By default, cryptocurrencies people could see
Speaker 1: on chain how the Lazarus group was laundering its funds
Speaker 1: through the tool. This isn't something that you can easily
Speaker 1: observe with Manero. Moreover, the mere volume of funds that
Speaker 1: were running through Tornado Cash made it a prime target.
Speaker 1: But this doesn't mean that Manero isn't being studied and tracked.
Speaker 1: I can only imagine that there is a strong state
Speaker 1: backed effort to crack the ring signature technology it's famous for.
Speaker 1: This is perhaps one of the reasons why the Manero
Speaker 1: devs push some new upgrades to the protocol only a
Speaker 1: few days ago. Now some are advancing another argument, and
Speaker 1: that's that this could be a good thing for crypto
Speaker 1: in the long term. These include the likes of Kevin O'Leary,
Speaker 1: a k A. Mr Wonderful. He said in a recent
Speaker 1: YouTube video that cracking down on quote crypto cowboy culture
Speaker 1: was needed if we wanted to see widespread institutional adoption,
Speaker 1: that we needed a quote rules based environment in order
Speaker 1: to attract real institutional capital into the digital asset industry.
Speaker 1: These seem to be fair points. Institutions do want a
Speaker 1: more transparent and well regulated crypto space before they all
Speaker 1: feel comfortable throwing large sums of money into it. For them,
Speaker 1: privacy isn't a major concern money is. Financial freedom isn't.
Speaker 1: Why so many so called decentralized Web three projects are
Speaker 1: getting multiple billions in VC funding. If the name of
Speaker 1: the game is mass adoption through the paths of least resistance,
Speaker 1: then a more centralized and controllable defy is the way. However,
Speaker 1: is that the defy we want? Do we want to
Speaker 1: trad fi lapping is defied to achieve our goals of
Speaker 1: mass adoption? Not me personally, but you may have a
Speaker 1: different perspective. Okay, Time for some of my closing thoughts
Speaker 1: on the matter. Now. Firstly, I think we can all
Speaker 1: agree that those who engage in criminality should be brought down.
Speaker 1: The laundering of ill gotten gains, be it through a
Speaker 1: bank account or a defied protocol, should be prosecuted to
Speaker 1: the full extent of the law. Those wallets identified as
Speaker 1: being linked to criminal activity should also be sanctioned and flagged.
Speaker 1: This is exactly what the Treasury had been doing prior
Speaker 1: to the Tornado Cash sanctions being imposed, and it's not
Speaker 1: as though this approach wasn't enjoying some success. Thanks to
Speaker 1: some pretty advanced tools and tracking services, law enforcement is
Speaker 1: able to catch such miscreants more effectively than they could
Speaker 1: in the past. They also have the power of subpoenas
Speaker 1: and search warrants. Quite simply, they didn't need to take
Speaker 1: this action against Tornado Cash. As I've pointed out, the
Speaker 1: net result is a loss of privacy for some and
Speaker 1: a massive mess up for all in the DeFi space.
Speaker 1: As for those North Korean hackers, they'll just switch to
Speaker 1: one of the other one hundred or so laundering techniques
Speaker 1: that they were using long before Tornado came about. Moreover,
Speaker 1: given that Tornado cash is nothing but code, it will
Speaker 1: be hard to permanently outlaw. It will be a game
Speaker 1: of whack a mole, It won't have the desired effect,
Speaker 1: and the collateral damage is already permeating through the crypto industry.
Speaker 1: There are also all the legal questions raised by these actions.
Speaker 1: Is this a breach of the First Amendment? And what
Speaker 1: happens to any of those citizens who have used it
Speaker 1: in the past or anyone that interacts with it. It's
Speaker 1: a legal quagmire, no doubt about it. There may be
Speaker 1: legal challenges, and perhaps this could turn into a new
Speaker 1: crypto war, one with a net positive long term impact
Speaker 1: as we saw with the first crypto war. Or perhaps
Speaker 1: the large centralized institutions will conform and will have a
Speaker 1: more amenable, but less free crypto space. One thing this
Speaker 1: does show us, however, is how centralized the crypto space
Speaker 1: has become and how dependent we are on certain services
Speaker 1: and depths. It also demonstrates how willing certain developers are
Speaker 1: to really embrace decentralization. I mean, when you have the
Speaker 1: threat of sanctions violation over your head, it changes your
Speaker 1: risk calculus. I don't know how many dept developers would
Speaker 1: be ideally stick enough to want to risk thirty years
Speaker 1: in prison. One thing is for certain, those Tornado Cash
Speaker 1: sanctions could have significant implications for the crypto industry, some
Speaker 1: of which will only become apparent further down the line.
Speaker 1: Whatever happens, though, it's a story we will be keeping
Speaker 1: a very close eye on and will be updating you
Speaker 1: folks every step of the way. Thank you so much
Speaker 1: for listening to the coin Bureau podcast. If you'd like
Speaker 1: to learn more about cryptocurrency, you can visit our YouTube
Speaker 1: channel at YouTube dot com forward slash coin Bureau. You
Speaker 1: can also go to coin bureau dot com for loads
Speaker 1: more information about all things crypto. You can follow me
Speaker 1: on Twitter at at coin bureau or one word, and
Speaker 1: I'm also active on TikTok and Instagram too,