Facebook Libra’s cold reception from Congress validates the need for Bitcoin

The hostile reception that Facebook’s Libra coin received from Congress should be viewed as a validation of the need for Bitcoin.

As a fiat currency pegged stablecoin, Libra offers little threat to the U.S. dollar’s monopoly. To Libra users, it would be little different from PayPal, Alipay, Apple Pay, Google Pay, WeChat, Zelle, or the dozens of other peer to peer payment platforms around the world.

Yet Libra threw the powers that be in such a panic that President Trump was pressured into tweeting a condemnation of Libra and a Congressional hearing was swiftly organized. Rep Brad Sherman compared Libra to the 9/11 attacks, which in case you forgot, killed several thousand Americans.

I certainly have my reserves about both Facebook and Libra, but a “blockchain-enhanced” payment network that competes with Paypal is hardly the terrorist event of the century.  It is highly unlikely that President Trump wrote his rant against Libra himself – his tweets were likely scripted for him as the party line against potential dollar competitors.

What’s crystal clear from this episode is that anything which is remotely a threat to the U.S. dollar’s dominance as the world’s reserve currency will be swiftly neutralized.

This is precisely why a peer to peer, decentralized network like Bitcoin is needed: any centralized challenge to the dollar’s dominance, by a company or nation-state, is likely to face swift retribution from the United States government. The U.S. economy relies on the dollar’s status as the world’s reserve currency to keep issuing new debt to sustain our unsustainable budget deficits.

Libra is currently little more than a vague white paper and a few lines of open source code, yet legislators like Rep. Carolyn Maloney and Maxine Waters are demanding that the project be shut down before the concept has even been fully flushed out.

It is clear that when U.S. dollar regime inevitably collapses – be it next year or decades from now, the U.S. government will not allow any organization within its reach to develop an alternative that can safeguard American’s assets. The government relies on its ability to collect (dollar-denominated) taxes to pay interest on its enormous debt and fund its unsustainable fiscal commitments.

This makes it all the more essential (for those of us who wish to safeguard our life savings and ensure an economic recovery based on sound money) to support decentralized, borderless, and censorship-resistant alternatives like Bitcoin. While Bitcoin is certainly not entirely immune from legislation, it is substantially more control as can be seen in countries such as VenezuelaChina, and India, where it is still widely used despite being banned.

Don’t dismiss Bitcoin just because of its wild price swings

There are valid reasons to criticize Bitcoin, but price volatility is not one of them. 

Why does the price of Bitcoin change so much from day to day? The answer is simple: the value of Bitcoin derives almost entirely from speculation on future adoption of Bitcoin rather than practical use. Bitcoin speculators are betting on the likelihood that Bitcoin will become offers a credible alternative to fiat paper money or commodities like gold.

No one knows the future, so many individual market participants speculate about the future using the information available to them. They will naturally disagree and change their opinions over time as new knowledge becomes available.  Good and bad news such as statements by governments, thefts from exchanges, or new startup ventures provide new information about the future and so influence the price.  Traders also react to the predictions of other traders. This is how price discovery works in any market. Those who make successful predictions earlier and more often will accumulate more Bitcoin, thus rewarding those with the best judgment. 

If you think that the Bitcoin trading is driven by too much hype, consider that the world’s economy currently hangs on the rants of President Trump’s reactions to the latest Fox News broadcast, and how the Federal Reserve reads the tea leaves of the market this week.

By contrast, crypto traders are ultimately responding to the long term success or failure of the Bitcoin ecosystem. This process of information discovery is always messy, but it is not any more arbitrary than the fake drama of the political news cycle.

Many critics of Bitcoin consider the fact that Bitcoin is a speculative asset as sufficient reason to dismiss it. But all entrepreneurial initiatives are speculative at the start. Bitcoin is like any early-stage startup. One investor claims a 10% stake for $1 million for a valuation $10 million, while a later round might value a $10% stake at $100 million. As a startup proves that its technology and businesses model is sound, and begins to make profits, it’s market cap grows. As profit transitions from potentiality to an actuality, the market capitalization becomes more stable. We are seeing a similar process with Bitcoin, except its ambition and potential is far larger than a startup, so the process takes far longer.   

Bitcoin will achieve price stability when a large portion of Bitcoin’s market cap is used for practical purposes rather than speculation. The practical value of Bitcoin is as a means of exchange and store of value.  

Can we track the adoption of Bitcoin as practical money? Yes. When Bitcoin was invented, only a few highly technical users had the skill to make Bitcoin transactions. Over the last 10 years, the cryptocurrency ecosystem has grown and evolved. Bitcoin is now easier to use, safer to store, and the number of businesses who accept it is in the tens of thousands.

Still, in all but a few narrow use cases, it is still more convenient to use more traditional payment networks. That’s normal — monopolies are broken not by assaulting their business model head-on, but within narrow edge cases where it is easier to build a superior alternative. In the case of Bitcoin, it is already a viable option for cross-border money transfers from nations with currency controls, trade in black and grey market goods, funding of politically incorrect institutions, and of course, criminal operations. In developed countries with robust financial networks, Bitcoin is only used by its most devoted followers, as the traditional financial system is still far easier to use.

That doesn’t mean that we will not see a sudden and unpredictable shift in which Bitcoin suddenly overtakes traditional financial networks. The Western banking system suffers from major and intractable structural faults and is ripe for disruption.  By contrast, here is a single Bitcoin transaction worth $670 million dollars with a total fee of $7.82.  Imagine how much more effort and due diligence a banking transaction of this size would take. A transaction to buy your morning coffee with Bitcoin comes with the same level of security.

We’ve seen how countries like China evolved from a cash-only society to one entirely dominated by mobile payment apps for practically all applications in just a few years.  With Whole Foods, Home Depot, and other major stores now accepting Bitcoin, virtually all millennials using smartphones, and growing instability in the global fiat money regime, the currency marketplace could be ready for disruption. Or not. The “flippening” between the dollar and Bitcoin could be decades away. The point is that there is nothing fundamentally wrong with speculating on the possibility of a Bitcoin-based economy and global monetary standard if you believe (as I do) that the technology is fundamentally sound and capable of evolving to handle the business of 7 billion people.

Why does the price of Bitcoin change so much from day to day? The answer is simple: the value of Bitcoin derives almost entirely from speculation on future adoption of Bitcoin rather than practical use. Bitcoin speculators are betting on the likelihood that Bitcoin will become offers a credible alternative to fiat paper money or commodities like gold.

No one knows the future, so many individual market participants speculate about the future using the information available to them. They will naturally disagree and change their opinions over time as new knowledge becomes available.  Good and bad news such as statements by governments, thefts from exchanges, or new startup ventures provide new information about the future and so influence the price.  Traders also react to the predictions of other traders. This is how price discovery works in any market. Those who make successful predictions earlier and more often will accumulate more Bitcoin, thus rewarding those with the best judgment.

If you think that the Bitcoin trading is driven by too much hype, consider that the world’s economy currently hangs on the rants of President Trump’s reactions to the latest Fox News broadcast, and how the Federal Reserve reads the tea leaves of the market this week.

By contrast, crypto traders are ultimately responding to the long term success or failure of the Bitcoin ecosystem. This process of information discovery is always messy, but it is not any more arbitrary than the fake drama of the political news cycle.

Many critics of Bitcoin consider the fact that Bitcoin is a speculative asset as sufficient reason to dismiss it. But all entrepreneurial initiatives are speculative at the start. Bitcoin is like any early-stage startup. One investor claims a 10% stake for $1 million for a valuation $10 million, while a later round might value a $10% stake at $100 million. As a startup proves that its technology and businesses model is sound, and begins to make profits, it’s market cap grows. As profit transitions from potentiality to an actuality, the market capitalization becomes more stable. We are seeing a similar process with Bitcoin, except its ambition and potential is far larger than a startup, so the process takes far longer.

Bitcoin will achieve price stability when a large portion of Bitcoin’s market cap is used for practical purposes rather than speculation. The practical value if Bitcoin’s is as a means of exchange and store of value.

Can we track the adoption of Bitcoin as practical money? Yes. When Bitcoin was invented, only a few highly technical users had the skill to make Bitcoin transactions. Over the last 10 years, the cryptocurrency ecosystem has grown and evolved. Bitcoin is now easier to use, safer to store, and the number of businesses who accept it is in the tens of thousands.

Still, in all but a few narrow use cases, it is still more convenient to use more traditional payment networks. That’s normal — monopolies are broken not by assaulting their business model head-on, but within narrow edge cases where it is easier to build a superior alternative. In the case of Bitcoin, it is already a viable option for cross-border money transfers from nations with currency controls, trade in black and grey market goods, funding of politically incorrect institutions, and of course, criminal operations. In developed countries with robust financial networks, Bitcoin is only used by its most devoted followers, as the traditional financial system is still far easier to use.

That doesn’t mean that we will not see a sudden and unpredictable shift in which Bitcoin suddenly overtakes traditional financial networks. The Western banking system suffers from major and intractable structural faults and is ripe for disruption.  Here is a single Bitcoin transaction worth $670 million dollars with a total fee of $7.82.

Imagine how much more effort and due diligence a banking transaction of this size would take. A transaction to buy your morning coffee with Bitcoin comes with the same level of security.

We’ve seen how countries like China evolved from a cash-only society to one entirely dominated by mobile payment apps for practically all applications in just a few years.

With Whole Foods, Home Depot, and other major stores now accepting Bitcoin, virtually all millennial using smartphones, and growing instability in the global fiat money regime, and the currency marketplace could be ready for disruption. Or not. The “flippening” between the dollar and Bitcoin could be decades away. The point is that there is nothing fundamentally wrong with speculating on the possibility of a Bitcoin-based economy and global monetary standard if you believe (as I do) that the technology is fundamentally sound and capable of evolving to handle the business of 7 billion people.

Three Key Differences Between Traditional and Crypto Markets

What is the real market value of cryptocurrencies like Bitcoin?

The numbers used to explain the performance of Bitcoin and other cryptocurrencies are less meaningful than most assume.

Cryptocurrencies are not exactly like stocks, and cryptocurrency exchanges do not work like traditional securities markets. As a result, many crypto-asset investment strategies based on conventional definitions of market share, capitalization, volatility, and trading volume are deeply flawed. Misleading numbers mean that cryptocurrency valuation and adoption is poorly understood, which creates a false perception by the media and investors about cryptocurrencies such as Bitcoin.  One implication of this analysis is that Bitcoin has captured the vast majority of the long-term upside in the cryptocurrency market despite having about half the nominal market share.

Most cryptocurrencies and crypto exchanges manipulate numbers in ways that publicly traded companies and traditional exchanges like NASDAQ and NYSE wouldn’t dream of.  As a result, “market capitalization” and “trading volume” are at best rough and relative measures of cryptocurrency adoption. Even when intentional manipulation is not involved, crypto-asset markets fundamentally just do not function like securities markets. It’s important to understand these differences to asses the state of cryptocurrency and crypto asset adoption.

Let’s look at three important differences between how cryptocurrencies and traditional securities markets work:

Will Bitcoin burn the planet to ashes? Not so fast.

Environmentalists have recently become concerned about the impact Bitcoin mining has on global warming. Headlines such as “Bitcoin Will Burn the Planet Down. The Question: How Fast?” and “Bitcoin Mining Alone Could Raise Global Temperatures Above Critical Limit By 2033” suggest that Bitcoin is an unfolding environmental disaster.

However, those panicking about crypto make three fundamental errors. First, they do not understand how Bitcoin works, second, they do not understand what mass adoption would look like, and third, they do not understand the problem Bitcoin is intended to solve.

Regardless of your opinion on the danger of global warming, Bitcoin does not use nearly as much energy as claimed, will become far more efficient as it grows, and most importantly, solves one of the greatest causes of resource inefficiency, corruption, and human suffering.

Bitcoin mining is a market-based process that taps underutilized energy sources

When Bitcoin critics focus on the raw energy usage of Bitcoin mining, they miss the bigger picture: cryptocurrency production is a competitive market process.

Because the cost of Bitcoin mining comes mostly from electricity consumption, Bitcoin mining is concentrated in places with cheap or surplus energy. Industrial-scale mining facilities are located in far-flung locations with cheap hydro-electric, nuclear, geothermal power, or undeveloped industrial regions with excess production. Energy costs money, and miners will always look for the world’s best sources of cheap and efficient energy. Cryptocurrency mining is a means to tap underutilized energy resources for a valuable purpose—the maintenance of a monetary system. No other industry can rapidly move into an industrial ghost town and create value the way Bitcoin mining firms do.

Furthermore, the total energy usage of Bitcoin is limited by economics: crypto-miners will only keep mining when their profit is higher than the cost of electricity. The Bitcoin network automatically adjusts the difficulty of mining new blocks in response to the “hash rate” or the net mining capacity of the network. This means that Bitcoin has a built-in cap on energy use, and can dynamically adjust in response to energy prices and innovation in computational hardware.  Currently, humanity consumes around 17.7 Terawatts per year. The Economist estimates that Bitcoin uses 2.55 gigawatts or .014% of that. Some estimate the total use of cryptocurrencies at 7.7 gigawatts, but it’s likely that a single cryptocurrency will dominate after the current shakeout period.

How I Built a Bitcoin Exchange: Design Principles & Risk Management

In 2013, I designed and built a cryptocurrency exchange for the China market.  The basic concept & architecture only took a few days, but the full implementation required several years.   I shared the basic architecture in 2013, and with the recent spike in interest in Bitcoin and Ethereum, I thought I would share additional details on the concept.

I wrote the trading engine for the exchange over a long weekend in Shanghai.  It turns out that building a large-scale cryptocurrency exchange is quite complex, and it finally (and successfully) launched in 2016.  The notes below describe my design vision from 2013 – the implementation followed this specification fairly closely.  There is a lot of detail and documentation to many of the sections below – some of which I will elaborate in future posts.  If you want more detail on something specific, comment below or find me on LinkedIn.

Happy 10th birthday to Bitcoin!

Happy birthday to Bitcoin! 10 years ago, Satoshi Nakamoto published a white paper for “a Peer-to-Peer Electronic Cash System” which would “allow online payments to be sent directly from one party to another without going through a financial institution.” Just a few short months later, the Bitcoin network launched on 3 January 2009.

Bitcoin is the culmination of thousands of years in the evolution in money. It is durable, portable, divisible, uniform, and limited by design. Over the span of human history, money has taken the form of shells, salt, coins, banknotes, and fiat bills. While money serves a crucial role in facilitating trade and wealth creation in society, it has often suffered from hidden inflation, outright confiscation, or the exclusion of unpopular groups from the economy. In the 100 years, the inherent flaws in fiat paper money have been used by governments to fund wars, corruption, and cronyism through the hidden tax of inflation.

Bitcoin is the first credible alternative to fiat currency and offers real, sound money made for the information age. The decentralized nature of Bitcoin has revolutionary potential for both the global economic order and billions of people who suffer from lack of access to financial institutions and corrupt governments and corporations. The concept of a distributed ledger stored on the blockchain has applications well beyond money, with the promise of creating a durable and credible record of property ownership, which has the potential to transform how we record property deeds, corporate shares, insurance claims, business contracts, and many more applications.

After the basic concepts of Bitcoin and the blockchain were discovered in 2009-2013, Bitcoin and the blockchain space entered the infrastructure stage. We are now building the ecosystem of tools, vendors, and relationships to make Bitcoin as easy or easier to use than products of legacy financial institutions. Once a mature infrastructure is in place for cryptocurrencies, the stage will be set mass adoption. Billions of people will have the devices, services, and vendor networks to use Bitcoin for everyday transactions, meeting the final requirement for money: widespread acceptability.

The mass adoption of cryptocurrencies will not create a utopia – it is more likely to be hugely disruptive to the economic-political order. However, genuine sound money is what humanity desperately needs to build a harmonious, robust, and integrated global digital economy on the backbone of the Internet.

Is Bitcoin a help or a hindrance to criminals?

Reposted from my Quora answer:

The way this question is phrased is problematic.

Are pencils useful to criminals? They can be used to write down schemes for robbing banks, kidnapping letters, etc.

What about guns? Weapons give criminals an edge in committing crimes.

Of course, pencils and guns can be used against criminals as well. Most people would agree that it’s a good idea that weapons exist (even if you think that only the policy and military should have them) — otherwise, the strongest bullies could force their will on everyone else, and society would collapse.

So what you should really ask is – will Bitcoin lead to more crime or less?

Arguments for more crime:

  • The quasi-anonymous nature of Bitcoin makes it very convenient for extortion payments, bribes, etc.
  • Stealing Bitcoin can be easier than stealing cash given that it is portable, easy to transfer, the transactions are irreversible, etc.

Arguments for less crime:

How many cryptocurrencies will survive the infancy period?

Reposted from Quora:

The best way to estimate how many cryptocurrencies will survive the infancy period is to look at other markets.

For example, how many social networks survived the infancy period?

Facebook has 63% market share:

If you use a stricter definition of “social network” to mean “feed-based platforms based around personal profiles” Facebook has over 99.8% market share. Google+ and Diaspora are well under 1%.

What about Search Engines? Google has 87% market share.

What about Desktop Operating Systems? Windows has 82%.

What emerges from looking at these and other markets is that network effects lead to a dominant player, a secondary minor player, and about three competitors with marginal market share.

However, if you expand the definition of the market, the picture can change dramatically. For example, if you include mobile device in the “operating systems” market, Android is #1 at 41. Likewise, Facebook’s dominance varies from 60% to 99.8% based on how strictly you define “social network.”

Let’s apply these insights to cryptocurrencies:

A single dominant cryptocurrency is likely to emerge with 90%+ market share. Given the strong network effect of money and the probable lack of nation-state restrictions on adoption (unlike the USD), the dominance may be over 99%.

However, if we expand the market definition to “cryptographic assets” or “digital assets” then we need to include tokens and securities such as Ethereum and ERC20 tokens. This expanded definition may see the leader’s share drop to 60–70%.

Is Bitcoin being used to spread “child abuse imagery”? Not really.

Yesterday, the Guardian wrote that “researchers have discovered unknown persons are using bitcoin’s blockchain to store and link to child abuse imagery, potentially putting the cryptocurrency in jeopardy.”

Is that true? This is a serious allegation. Unfortunately, both the Guardian story and a Bitcoin.com article which rejects these claims make grossly inaccurate statements. Furthermore, the cited study makes false statements about Bitcoin in its abstract. Aside from the sensational claims in the abstract, and the even more sensational claims in mainstream media articles about it, the paper is fairly thorough and accurate – but contains no new insights or discoveries, and duplicates prior work without credit. This is a common pattern: researchers make modest claims about something, an editor exaggerates them in the abstract to get attention, and then allows ignorant journalists to make an even more dramatic exaggeration in the press.

So does the Bitcoin blockchain contain illegal content? Not really.

While the media and the public like simple and definitive answers, getting to the truth of this claim requires understanding something about how Bitcoin works.

Bitcoin is a payment network. For the most part, the network itself only records the destination addresses of payments and the amount sent. There is no need for the network to store any arbitrary information which is not specific to a transaction. For example, unlike bank wires, there is not “memo” field in Bitcoin for adding “for pizza, love mom.” Aside from an 80 character field available for miners who sign blocks, the primary way to store non-payment information in the blockchain to use fake destination addresses for transactions. It’s kind of like one of the crank calls in The Simpsons:

Moe: Hello, Moe’s Tavern. Birthplace of the Rob Roy.
Bart: Is Seymour there? Last name Butz.
Moe: Just a sec. Hey, is there a Butz here? Seymour Butz? Hey, everybody! I want a Seymour Butz! [the entire bar laughs; realizes] Wait a minute… Listen, you little scum-sucking pus-bucket! When I get my hands on you, I’m gonna pull out your eyeballs with a corkscrew!

As you might imagine, this is a very inefficient way to store information. Bitcoin transactions have size limitations, so one can either send very small files or split files among many transactions. Since the Bitcoin network charges senders based on transaction size, sending large files is expensive, and much more so with the increase in the price of Bitcoin. The more popular Bitcoin becomes, the more expensive it becomes to insert non-trivial amounts of information.

This is why most images stored in the Blockchain so far were placed there when Bitcoin was cheaper and are tiny, low-resolution images (sample embedded “image” follows):

---BEGIN TRIBUTE---
#./BitLen
:::::::::::::::::::
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:.:'' ,,xiW,"4x, ''
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::TTXWWi,_  Xll :..
=-=-=-=-=-=-=-=-=-=
LEN "rabbi" SASSAMA
     1980-2011
Len was our friend.
A brilliant mind,
a kind soul, and
a devious schemer;
husband to Meredith
brother to Calvin,
son to Jim and
Dana Hartshorn,
coauthor and
cofounder and
Shmoo and so much
more.  We dedicate
this silly hack to
Len, who would have
found it absolutely
hilarious.
--Dan Kaminsky,
Travis Goodspeed
P.S.  My apologies,
BitCoin people.  He
also would have
LOL'd at BitCoin's
new dependency upon
   ASCII BERNANKE
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----END TRIBUTE----

Here’s the address for the above tribute. It cost 1 BTC to send or $8500 at the current price of Bitcoin. Not a very cost-effective way to share illicit files, is it?

Still, based on the above, it seems like it would be possible to store illegal information on the Blockchain if one were able to make it very compact and spend enough money on it. Even if there is nothing illegal in the Blockchain yet (and the study presents no evidence of such information, despite articles which state otherwise), it could always be added in the future.

However, here is an important point: arbitrary information in Bitcoin can only be included by steganography, and cannot be read without tools which have nothing to do with the primary function of Bitcoin. Steganography is “hiding data in plain sight” – in other words, using information flows in ways other than they were intended to and that are not visible to normal users without special tools. Steganography has been known since 440 BC when Herodotus mentioned two examples in his Histories.

There is no way to prevent information from being hidden in any communications channel. For example, two criminals could conduct a series of bank transfers where the monetary amount itself encodes a message with illegal content. There is no way to detect or prevent such a message. However —  the payment network itself has no capability to decode such a message and is not designed for such a use. It’s actively hostile to such a use since all transactions (whether we’re talking about Bitcoin or bank transfers) incur a cost and can store very limited data.

Here is a screenshot I took of a Bitcoin transaction which contains the entire whitepaper where Satoshi Nakamoto presented Bitcoin:

As you can see, the output (aka destination) field contains a hex-encoded alpha-numeric string, which no Bitcoin client can convert into a human-readable message – because that is not their purpose. Furthermore, using Bitcoin to share secrets is a terrible idea. Not only is the amount of information that can be stored very limited, but the information is public for the world to see. Worse, Bitcoin transactions require spending Bitcoin and have the potential to trace back the transaction to a real-world Bitcoin purchase.

A final note: a major inaccuracy is the paper’s claim that “clearly objectionable content such as links to child pornography, which is distributed to all Bitcoin participants.”  The paper provides no such evidence, and only mentions that it found unspecified “nudity of a young woman.”  More importantly,  99.9% of Bitcoin users use a “light” client, which does not contain the full blockchain. Light clients defer blockchain validation to online servers which store the full node.

Here is an earlier and more accurate paper which contains a more fair analysis of the possibilities for data insertion on the Bitcoin blockchain.

 

Can DAG-based cryptocurrencies like IOTA scale better than the blockchain?

Some people claim that DAG (directed acyclic graph) technologies like the IOTA’s Tangle or Byteball will be able to scale (process large transaction volumes) better than blockchain-based technologies like Bitcoin and Ethereum.

Let me start by saying that only a few people in the world are qualified to offer an expert opinion on the question of whether a blockchain or DAG perform better. They make a great deal of money, and their time is generally too valuable to comment on Internet forums. This is why you see a lot of DAG advocates claim that it is superior without informed counterpoints.

I will admit that I’m not qualified to offer an expert opinion on this either.

However, the claim that a DAG scales better than Blockchain should not be accepted at face value. A number of people smarter than I have said that validating a DAG is far more labor intensive than a block.

There no magic solution to the problem of keeping thousands or millions of nodes synchronized, and DAG based networks like IOTA actually rely on a single Coordinator node which keeps the network from fragmenting. This is the very thing that cryptocurrencies were created to avoid!

While some see the need to put transactions in a block as a negative, the blockchain is actually a very efficient, market-driven way for the users of a network to bid on processing capacity. Transaction fees ensure that the network is always capable of processing the most valuable transactions, whereas a DAG-based network may be overwhelmed and fail if load gets too high. Centralized “coordinator” nodes may solve this problem, but if so, DAG advocates cannot claim that they are necessarily more distributed and scalable than Bitcoin.

Furthermore, with second-layer technologies like Lightning Network, Bitcoin has explicit and unlimited scaling options. The scaling potential of coordinator/master node model in DAG-based currencies is far less clear.