Decentralized Exchanges (DEX), are a hot topic in the bitcoin community, with many touting them as the ultimate solution to enable global hyperbitcoinization.

As we go through the purpose and history of exchanges, we shall see that a DEX that merely removes centralized custody and settlement is not enough. A true DEX is theoretically impossible even when assuming decentralized custody is completely solved. This is because decentralized liquidity, requires distributed matching engines and order books. Reality Arbitrage is presented as a possible solution that disrupts the current centralized exchanges, and is inspired by the invention of linked-timestamps, the precursor to the Bitcoin Blockchain.

With so many DEX projects coming on-line, lets first ask: What is an exchange?

Exchange

Say you are interested in buying Altcoin with ticker ALT. You interest is in owning ALT itself, either as an investor or a user. In contrast to a trader, who does not care about owning ALT, but is just trading to earn more profits in Bitcoin.

You are holding Bitcoin and want to purchase Altcoin; the price ticker is ALTBTC. To do this, you need to first find someone holding ALT, who wants bitcoin, and is willing to sell it to you. You can put adds on craigslist, ask friends, or post on social media. Better yet, what if there is a “central” place where everyone goes that wants to trade ALTBTC?

An Exchange, is like a marketplace, a physical or virtual place where like-minded people go to buy or sell financial assets.

One of the earliest “exchanges” was the Tontine Coffee House in New York City, in the late 1700s, which later became the New York Stock Exchange.

Even at a designated exchange place, finding a seller with the right quantity and price can take hours, days, weeks or months. Brokers saw a business opportunity, where for a commission, they will stay at the exchange all-day, watch the markets, and find sellers to match your buy price and quantity.

Bucket-Shops were are new kind of “exchange”, where you can bet on stock prices, but never actuality buy or sell any stocks at all. One of first traders and most successful speculators of all-time, Jesse Lauriston Livermore, began at bucket shops, before becoming a professional floor trader on Wall Street. The book, Reminiscences of a Stock Operator, is a fictional account of his life, and is a must read for anyone interested in the art of trading and speculation.

Advanced trading strategies emerged such as “short selling”, where a trader would borrow stock, and immediately sell it. He would hold onto the cash, and wait for the price to drop. Then use some of the cash to buy it back, and return the stock to the lender. The trader keeps the remaining cash, as profit!

Traders vs Investors

Traders, speculators, and market-makers will buy and sell any asset for the sole purpose of profiting by buying low and selling high. In one sense, traders get paid for providing liquidity to the true buyers, the investors or Altcoin users.

Investors give traders volatility with market orders, and traders give investors liquidity with limit orders.

Investors are seeking liquidity, and traders are seeking profit, and neither one wants to take on the risk that the other side of the trade will default or renege. Hence the modern financial markets were born.

Exchanges enable price-discovery by pooling buy and sell orders from investors, traders, and speculators, into a single “book” of liquidity. Orders are filled when bids and offers are matched at the desired price. When a trade is made, the exchange charges a fee, and broadcasts the price on a ticker feed.

In addition, exchanges remove counter-party credit-risk, by taking custody and guaranteeing settlement and clearing. They achieved this by only allowing pre-qualified members of the exchange to trade on the exchange. Members would consist of mostly two groups, investment brokers and floor “specialists” traders. Brokers are the agents of the investors and would work in their best interest, while floor traders are professionals seeking Alpha.

Alpha vs Beta

Beta is the returns from market movement of the underlying asset price itself, while Alpha is the excessive returns that are independent of the underlying market price. Alpha reflects your net profit and loss from trading. Beta reflects your profit and loss in relation to an underlying asset.

• An investor’s portfolio with 100% ALT, would have a Beta of 1 vs ALT.
• A floor trader seeks Alpha, by buying and selling ALT many times over but would always be flat the close of each trading session.
• A speculator seeks Alpha, by going long or short ALT Beta, and may hold for days, weeks or longer.

Exchange volumes have always been dominated by Alpha traders over Beta investors. By the 1980s and 90s, due to real-time computerized price feeds, and electronic broker networks, more volume was coming from traders and speculators than all investors combined. Then in 1998, when the SEC authorized electronic exchanges, High Frequency Trading (HFT) was born.

HFT, took automated trading to a whole other level. By 2017 over 90% of all trading volume will come from short term Alpha strategies! source

• Modern exchanges mostly rely on Alpha traders for profits, and cater to their needs.
• Alpha traders rely on the Beta investors for trading profits.
• Beta investors rely on the Alpha traders for liquidity.

At the center, and the core technology in this exchange ecosystem is the Central Limit Order Book.

Exchange order books create liquidity pools, and enable a fair and open efficient market for optimal price discovery. It contains all open orders, and is sorted first by price and then by time.

Modern exchanges provide:

• Liquidity: Matching and Execution of trades, through a single central limit order book, enabling best execution and price discovery.
• Custody: Settlement and Clearing of trades, plus transfer of assets. This removes the need for buyers and sellers to trust each other.

DEX

The ultimate DEX: An exchange that provides price discovery by matching buyers and sellers from a deep pool of liquidity with transparency, immutability, and censorship resistance. Where buyers and sellers are open participants of the exchange, are always in custody of their own assets, and may remain pseudo-anonymous.

What does “Decentralized” mean in a DEX?

• Decentralized Liquidity: Matching and Execution of trades through a decentralized limit order book. This requires the matching engine to be distributed, and running on each users machine.
• Decentralized Custody: Settlement and clearing without a centralized custodian. Users control their own asset, via private-keys.

Decentralized Custody

Most DEX blockchain projects today are only trying to solve the problem of settlement and clearing without centralized custody. This makes sense, because the main bitcoin innovation was removing the need for a central authority, when transferring digital value. However, without pooling liquidity together, they are ignoring 90% of traditional exchange volume!

These DEX projects are really geared towards the individual investors and users, who are looking find peers to trade with. This is more similar to an Over-The-Counter (OTC) trading desks, than to an “exchange”! OTC desks match buyers and sellers, privately, at negotiated prices. These prices are independent of the current prices from the liquid exchanges.

Decentralized custody is an almost impossible problem to solve, yet projects like bisq (for bitcoin to fiat), or atomic swaps (for bitcoin to altcoin), are almost there. While there still maybe fundamental problems with these solutions, we are not going to delve into those here. Instead, we will be assuming that decentralize custody is already solved, and discuss an even bigger problem. Decentralized Liquidity!

The good news is, that decentralized custody, clearing, and settlement is already solved with blockchain.

The bad news is, that even when decentralized custody, clearing, and settlement is completely solved, decentralized exchanges are still impossible!

Custody solved “on-chain”

An account based blockchain with more than a single asset, can have a native on-chain “exchange” with a limit order book. Users place buy and sell orders by signing special blockchain transactions. Each node has a complete matching-engine and limit-order book built in, and processes the buy and sell orders from the block of transactions. After each trade execution, each node will automatically debit and credit funds and assets from the buyers and sellers.

In fact, many blockchains already have decentralized matching engines in production! Such as, XRP, Bitshares, Counterparty, Protoblock, Ethereum, and NXT, to name a few.

Of course this can only work with assets from inside the blockchain itself.

Decentralized Liquidity

DEX are only interesting if they can compete with centralized exchanges. For DEX to compete with centralized exchanges, they must provide deep liquidity for investors by attracting the short term Alpha traders, who account for 90% of traditional exchange volume.

Price discovery and liquidity are the main purpose of any exchange.

An exchange must provide a matching engine and order book to fill the needs, and attract Alpha traders. However decentralized limit-order books are impossible, due to Adverse Selection Risk also known as, front-running.

Adverse Selection Risk

The ability for miners to front-run orders, means that your orders only get filled when its not in your favor.

Your adversaries are selectively filling your orders, only when its profitable for them.

The problem is that matching-engines and order-books are path dependent. Meaning, the transaction ordering within a block matters. Bitcoin and Proof-of-Work solved double-spend, which only requires miners to decide which transaction to chose from in case of a double spend. Otherwise, miners are free to order the transaction in any way, since the order of transactions inside a block has no other side-effect. The same set of bitcoin transactions, in any order will create the same state data, or UTXO set.

The order of transactions is a fundamental property of exchange matching engines, since order-books are sorted by time and orders are filled first-in-first-out.

The term “Central Limit Order Book”, has been used since the 1980s, when early exchanges quickly discovered that matching engines cannot be distributed, and can only work when run on a single thread on a single server. In fact, the reason for this is same Byzantine Generals Problem, that was solved by Bitcoin!

Ordering of Transactions

Order Sequence A: These 7 orders should go though an exchange matching engine and produce the following fills and positions.

1. trader1: Buy  5 at 500 
2. trader1: Sell 5 at 1500 
3. trader2: Buy  1 at 950 
4. trader3: Sell 1 at 955 
5. trader4: Sell 2 at 500 
6. trader1: Sell 1 at 940 
7. trader5: Buy  2 at 950

Re-Ordering of Transactions

Order Sequence B: Now lets see what happens if we just reorder transaction 5 and 7.

1. trader1: Buy  5 at 500 
2. trader1: Sell 5 at 1500 
3. trader2: Buy  1 at 950 
4. trader3: Sell 1 at 955 
5. trader5: Buy  2 at 950 
6. trader1: Sell 1 at 940 
7. trader4: Sell 2 at 500 

Swapping the order of just 2 transaction dramatically changes the entire market and price action

• trader4 went from -$430 to breakeven, with avg price from 725 to 950, a 25% move!
• trader1 went from flat with +$445 profit to short 1 at 950 with $0 profit

Miner Front-Running

Order Sequence C: What if a miner inserted 2 new orders?

1. trader1: Buy  5 at 500 
2. trader1: Sell 5 at 1500 
3. trader3: Sell 1 at 955 
4. miner:   Buy  2 at 501 
5. miner:   Sell 2 at 940
6. trader4: Sell 2 at 500 
7. trader2: Buy  1 at 950 
8. trader1: Sell 1 at 940 
9. trader5: Buy  2 at 950

Miners can font-run every single time and earn free money, while everyone else suffers with loses and Adverse Selection risk!

• Miner is up $878, made 46% in the trade, with no risk!
• Every other traders positions has changed too, its as if they are all trading blind!

Even if the miners won’t do this themselves, they would eventually be bribed by hedge-funds to front-run for them. This changes the entire economic incentives of mining, where front-running could be worth more than block-rewards!

Flash Crash

The above is an example of front-running during a flash-crash. However, even in more benign markets, the same opportunity for risk-free profits by miners front running exists. As we shall see below, flash crashes are thought to be caused by high-frequency-trading bots.

Reality Arbitrage

A Possible Solution

The approach to solving the Decentralized Liquidity problem requires a new kind of exchange. This exchange, must create new matching engine technology, that:

1. Is better than current exchanges, in a way that attracts liquidity from Alpha traders.
2. Is able to reach consensus in way that gives all traders an equal opportunity to profit.

HFT creates Flash Crashes

Although investors and exchanges have always relied on Alpha traders for price discovery and liquidity, the current HFT bots seem to be causing more harm than good. HFT is thought to be the main cause of flash crashes to begin with. Regulators, investors and governments have been trying to come up with solutions to curb the practice, to no avail.

A new decentralized exchange that eliminates HFT, thus removing the flash crash epidemic, while still retaining the longer term Alpha Trade, is a tall order!

Inspiration

We take inspiration from the inventors of linked-timestamping, the precursor to the blockchain. In 1991, Scott Stornetta and Steward Habor found it impossible to solve the problem of creating immutable digital records, because anyone who had access could always change them. And even when you put a group of people in-charge of watching over the data, they can ultimately collude! The solution was a “conspiracy so large that every one in the world must be in on it”. By making the data widely distributed and public, the problem is inverted!

Inverting the problem

Distributed limit order books are impossible, since there is no way to reach consensus on the ordering of the transactions within a block. This gives each miner the ability to front-run, and take free money, causing adverse selection risk to all traders at the exchange, which would kill liquidity and ruin the ability of a DEX to compete with a centralized counterpart.

What if we look at this “front-running” as a block-reward? In normal blockchains, miners need to be incentivized with block-rewards. However, here you get free profit from signing blocks and re-ordering the transactions.

What if we make a new blockchain, where “miners” would have to pay to sign blocks? What are they paying for? They are paying for the rights to re-order the transactions and front-run!

We invert the problem of front-running, by explicitly letting anyone pay to front-run. Re-ordering of the transactions is a feature, and awarded to the highest bidder for each block!

From the example above:

How much would trader4 pay to go from losing $430 with Order Sequence A, to Order Sequence B where he loses nothing?

• In theory he would pay up to $430, to stop his $430 loss!

How much would trader1 pay to keep his $440 profit with Order Sequence A, verses switching to Order Sequence B with no profit?

• In theory he would pay up to $440, to keep his $440 profit!

The price flash crashed from $950 to $500 and back up to $940, this makes the move $440 per share. Now with this bidding process between trader1 and trader4, that exact amount is now recoverable!

We called this Reality Arbitrage, since you can change the immediate past, and go back in time to a new reality!

As an Alpha trader, knowing the rules of this new exchange, how would you trade differently? Would there even be a point to placing low bids in an attempt to catch a quick drop?

Could it be, that this approach would remove the profitability of High-Frequency-Trading, solve flash-crashes, and solve DEX liquidity, all at the same time? Only doing the research work, can answer that!

If we are going to solve the DEX issues, it will have to be done the Bitcoin way. By a total disruption of the centralized alternatives. A completely new paradigm for financial markets and exchanges. A new blockchain where you pay to sign blocks, and the highest bidder gets to re-order the transactions, with the longest chain being the total cost of the chain.

Does this seem like something that should be explored in more details? I think so! Please contact me via email or @jaybny on twitter to explore this idea farther.

Happy 2019!

Originally published at protoblock.github.io on January 2, 2019.

I listen to a popular weekly fantasy football podcast, and the same question is asked to each guest, who are some of the most skilled and experienced High Stakes Fantasy Football players on the planet! They ask:

“When not playing fantasy football, what do you do for a living”?

I cringe when I hear this. Shouldn’t the top players in a 27-billion-dollar fantasy football economy be playing fantasy football professionally for a living?

As veteran fantasy football players, we know how hard it is to win. Even the best players can go years without a championship team. Playing season-long Fantasy Football professionally full-time is just not possible. For a deep dive into why this is the case, see my 2016 paper — ProtoblockOpportunity

Imagine Barry Sanders in his prime, being asked:

“When not playing NFL football, what do you do for a living?”

We love Fantasy Football, it’s a unique game of skill with a social component. You can keep in touch with old friends and make new ones. Fantasy twitter is alive with heated debate, yet it remains civil. In Fantasy Football, most debates are settled one way or another with each week’s games and each season’s totals. In contrast to my other community, Crypto Twitter, where the debates are continuous and have become nasty and personal.

The current game evolved from the early internet days, with Commissioner.com, RotoWire, RotoWorld, WCOFF, FSTA, Podcasts, ScottFish, and Pros-vs-Joes. Experts have found new ways to monetize their skill and knowledge, by providing content: Articles, projections, YouTube, twitter, and paid subscriptions.

Then came DFS — but will leave that for another day

Just as we evolved from Newspapers to the Internet, I believe the next evolution will be from the Internet to the Blockchain

PROTOBLOCK — Professional Rotisserie Blockchain, is a system with a set of rules. Each user runs software locally on their computer and connects to each-other in a peer-to-peer distributed network.

• Protoblock will NOT kill the expert’s business models
• Protoblock will NOT replace data providers
• Protoblock does NOT compete with season-long or DFS game providers
• Protoblock is NOT Fantasy Football
• No Teams
• No Leagues
• No Luck
• No Off-Season
• Protoblock has no business model

Protoblock, founded in 2014, is The Original Football Blockchain, and has the potential to double the Fantasy Football economy!

• Protoblock IS a public utility for the fantasy football player
• Protoblock IS controlled by fantasy football players
• Protoblock IS a system designed to create new value

Protoblock is the beginning of an evolution, a revolution that puts Fantasy Football back into the control of the community itself. With no central point-of-failure, it has the potential to solve many fantasy companies legal and payment processing issues. It can also eliminate problems of DFS insider information.

Protoblock can generate free, accurate, real-time, last-minute, start/sit advice. As well as accurately price dynasty trade values and enable Fantasy Football players to monetize all their skills, including predicting busts. Protoblock can democratize fantasy football celebrity.

Protoblock has the potential enable hundreds of thousands of season-long veterans to become full-time professionals, earning a living doing what they love!

Protoblock is 100% free. Protoblock users may remain anonymous. Protoblock is a self-fulfilling prophecy.

There is no free lunch — you already paid with 20+ years acquiring Fantasy Football Skill!

• Protoblock DOES requires individual action, responsibility, and attention.
• Protoblock DOES requires community and consensus.
• Protoblock DOES requires early-adopters to trust the process before its obvious, while climbing a steep learning curve, with potential rewards of fantasy fame and fortune at the end.

We WON’T ask for money, we WON’T ask for your name, we WON’T ask for your email address. We WILL pay you for your attention to football. We WILL provide Windows and Mac Fantasy Desktop Wallet Software with schedules, player info, projections, and results, as well as Android and iOS companion Apps. We are the decentralized Protoblock developers!

Who’s in?

Welcome to the first decentralized fantasy football community. Its currently week 9 of 2018 NFL Season. There are 7 weeks left and there will be around 22,000 PPR points scored through week 16. This means that 2,200,000 Fantasybit coins are up for grabs, valued at around $200,000! (will explain below, but first let’s get you some coins!)

Projections Game

This is not really a competition with your fellow fantasy experts, since all your projections are instantly public. Rather it’s a community effort to widely distribute coins among all NFL knowledge and Fantasy Football skill.

Come back after each game to see how many coins you earned. Projections are open through week 16 and startup again after 53-man-rosters for 2019 Week 1 projections.

Rule #1 each PPR point scored in the NFL from Week 1 to Week 16 generates 100 Fantasybit

1 Fantasy Point = 100 Fantasybit

Rule #2 all Fantasybit are split among users with qualifying accurate projections. The more accurate your projection the more Fantasybit awarded.

Fantasybit — The PPR Coin — Is a token of fantasy football Skill!

Each user’s software independently keeps a ledger of all other users projections, runs the numbers, follows the rules, and keeps score.

Example: Tom Brady scored 20 Fantasy Points, this equals 2000 Fantasybits — if 50 users projected 20, then each user gets 40 Fantasybit

Let’s use a thought experiment to try and explain blockchain in Fantasy Football.
Imagine a 12-team high-stakes league, where each team downloads open-source desktop software that connects to each other. All draft picks, waiver moves, and lineups, are sent to the other 11 teams’ computers. Each team “brings his own” NFL stats data.

Now, since your computer knows the league settings and scoring rules, it can independently score each matchup, each week, and crown a Champion at end of the fantasy season.

For everyone to reach the same conclusion, the stats data must be exactly the same. Consensus must be reached on the NFL data. (As we will see below, this consensus is the core of the Protoblock system.)

Now, all that is left is to payout the winners…

Question: Why can’t we currently have 100% payouts? What do current fantasy game companies give us in return for fees?

Answer: Companies provide safekeeping of funds through escrow and provide payouts to winners.

Bitcoin and Blockchain are the final piece to the internet puzzle — a trustless way to transfer value without the need for escrow or a central authority!

So instead of using a Company for payouts, we can created a virtual currency that is native to our little 12 node network. As soon as the season is over, each machine will automatically update a ledger and assign the winnings accordingly.

This idea can be applied to all industries, companies, banks, casinos, etc. Take away any fees, or revenue from almost any product or service, and instead create a virtual currency that is required to be used as payment for the product or service.

The hard part would be using this made-up virtual currency to buy groceries! For it to have real value, it must become “hard money”. It must be scarce, censorship resistant, have an immutable ledger, and real utility.

• Bitcoin with Proof-of-Work (POW) was the first real “hard money” Cryptocurrency.
• Fantasybit with Proof-of-Skill has a similar potential!

As difficult as it is to understand bitcoin and blockchain. Trust me when I tell you, it’s just as hard for bitcoiners trying to understand fantasy football!

Bitcoin is a system of aligning economic incentives — every 10 minutes a bitcoin miner, usually located in China, is awarded $100,000 just for finding a virtual needle in a virtual haystack. The one who finds this needle becomes central authority for this “Block”. Every 10 minutes a new random authority is chosen. This creates the censorship resistance property and enables bitcoin to reach consensus and prevent double-spend.

Why are billions of dollars spent finding needles in haystacks? Because they are being paid for it. Incentives are economically aligned between miners and users.

Bitcoin POW miners are searching for a single number, that when combines with the Block and put through a one-way SHA256 hash function, solve a difficult random problem. Each bitcoin node runs their own SHA256 on the block to confirm it. This is how the bitcoin creates a distributed ledger.

POW is slow, and some say it not environmentally friendly. However, until now, there was no other way of independently agreeing on random data.

We may be sitting on a gold mine!

Professional Sports is human phenomenon where major sporting events, like NFL football, are watched by 100s of millions of people at the same time. After the game this data is published in every newspaper and broadcasted online.

Billions of dollars in bets are settled, all without a central authority! In fact, major sporting event data already has decentralized consensus!

We now have a second kind of random data, that “everyone” can independently agree on, we can replace POW with Proof-of-Skill!.

Fantasy points data from each NFL game already has consensus. Users running Protoblock act collectively to turn Fantasy points into Fantasybit coins. They then distribute all coins to the football community, for Skilled Projections. Now, every 40 seconds we have a lottery, where one random Skilled user with the “winning ticket” becomes the central authority and gets to create a block of transactions!

Why would anyone pay us $200,000 for Fantasybit created out of thin air?

Fantasybit has value from its “hard money” properties. They are scarce, hard to obtain, immutable, and has real utility.

• Scarcity comes from the limited number of NFL games each season. Around 50,000 fantasy points are scored, generating 5 million Fantasybit each season.
• Hard to obtain — right now, it’s easy to obtain, but at some point “mining” Fantasybit with Projections, will become a specialized endeavor for real knowledgeable NFL fans and skilled Fantasy Football players. As we all know, Fantasy Football skill is hard to obtain.
• Immutability — comes from the fact that your balance cannot be changed. As long as you can independently verify that the NFL stats are correct, you can be sure that no cheating is possible.
• Utility — Protoblock Trading Game is the current utility. However, one can imagine a Protoblock Casino charging 0% vigorish on spread bets, or Protoblock Season-Long or Protoblock DFS with 100% payouts. The only requirement would be all entry fees, bets, and payouts are made in Fantasybit. These utilities create the fundamental demand for the token,

Now that Fantasybit takes on properties of “Hard Money”. Some investors may buy Fantasybit as a “Store of value” to hedge their stock portfolio. Other investors would buy to speculate on Fantasybit price rise due to demand.

These buyers will pay bitcoin or even dollars for Fantasybit. Now guess who gets paid? The community of Fantasy Football Skill will get to sell their coins that they mined for free! It’s a WIN WIN!

10 years ago, today, Satoshi Nakamoto released bitcoin software, anyone who downloaded the software would be earning 100s of coins a day. Now it takes a huge multi-million-dollar operation to mine a single bitcoin. The price of bitcoin went from $0 to a high of $19,900 and is now trading at $6500

Trading Game

The first utility for Fantasybit is currently live.

Decentralized Fantasy Forwards Market

Protoblock is a financial market for hedging and speculating on individual players Fantasy point results. Player contracts are available for a single game, rest-of-season, or next season.

• Solves a real-world problem with a $12 billion-dollar untapped market.
• Hedge Early Round Draft Picks
• Short Season-Long Busts
• Hedge DFS Fades
• Generates Real-Time Efficient market-based sit/start decisions @Prototicker

Want to become an early adopter? If and when your 2018 Fantasy teams are out, take a couple of minutes of your time, download Protoblock and make projections. There is even an “easy button” where you can copy other players projections. Then, after each game, see how many Fantasybits you have. It’s not a competition between Fantasy Football players, rather its meant to be equally distributed among all Fantasy Football players — the more real fantasy players with coins the more robust the system would be.

Protofund, has allocated 1 million coins for any and all Fantasy Players — just create an account and send a tweet. Bonuses available for Scott Fish players or Fantasypros experts, and more.

Thank You and good luck! Jay Berg October 31, 2018

Originally published at protoblock.github.io on October 31, 2018.

Thus far, all proposed alternatives to Proof-of-Work have failed to live up to expectations. Leaving many in the bitcoin community convinced that this is a fools errand, and react to any mention of Proof-of-Stake with a roll-of-eyes and loss of attention.

This post will first breakdown blockchain consensus algorithms and come up with properties and a framework needed for reaching decentralized consensus. With a key finding being the need for data from outside the blockchain to be known inside.

Then Proof-of-Skill is described as a new consensus algorithm that works by using external data that already has decentralized consensus. This data, derived from major sporting events, is used to generate coins which are then distributed to users based on the skill of predicting said sporting events. These skill coins combined with Nxt Forging is then used to reach distributed decentralized consensus.

Double Spend Problem

Blockchain based digital currency are transferred when a sender digitally signs a transaction. The transaction is then broadcasted and propagates through the entire network. However, since it takes time to propagate, how can the receiver know that the sender didn’t “double spend” the same coins? When a double spend is attempted, half the network thinks receiver-A gets the coins, and the other half thinks receiver-B gets the coins.

Solving the double-spend problem, while maintaining censorship resistance, requires a decentralized distributed consensus algorithm. Every N minutes, a pseudo-random node on the network becomes the oracle and gets to decide which receiver gets the money. He does this by packing the transactions into a block with “Proof” that he is the oracle and broadcasting the block to the network.

For this system to work, all the nodes need to independently verify this “Proof.” For the block signer to be pseudo-random, the “Proof” has to be a result of a pseudo-random process.

Consensus Algorithm Properties

Based on findings above, we can deduce two properties required of a consensus algorithm:

Property #1: A problem must be independently derived by all nodes, using only the information contained in the blockchain.

Property #2: The solution must be independently verifiable by each node.

Proof-of-Work algorithm:

1. The block hash must contain N leading 0’s.
2. Nodes can independently verify the solution by running the SHA256(block) — and counting the number of leading 0’s

Proof-of-Work can be thought of as finding a needle in a haystack. In order to find the solution, a miner would run SHA256(block) over and over again with just a small change to the block header. This is done by incrementing a counter, also known as a ‘nonce’.

Proof-of-Stake algorithm(Nxt):

1. ‘Public-key of block-signer’ plus ‘previous block-signer’ must hash to a value less than X times the ‘block-signers balance’ times ‘the number of seconds since last block’
2. Nodes can independently verify the hash by running: SHA256(pk(block-signer) + pk(prev-block-signer)) < X * balance(block-signer) * seconds-since(prev-block)

Proof-of-Stake can be thought of as a lottery. Each coin holder has a different lottery ticket. The number of coins held determines the probability of winning. The more coins one has, the higher the chance of winning the lottery.

Stress testing consensus algorithms

Blockchain consensus algorithms only work if they cannot be manipulated in such a way that a single entity has the ability to sign a majority of blocks. Lets stress test…

PoW: The block hash must contain N leading 0’s.

Proof-of-Work consists of finding a block with N leading 0's. This can only be done in brute-force by incrementing the nonce with many parallel computers. However, the block difficulty increases each time a block is found faster than 10 minutes, requiring more processing power. It turns out that the energy cost of processing POW makes it an even playing field. Consensus verified!

PoStake: SHA256(pk(block-signer) + pk(prev-block-signer) ) < X * balance(block-signer) * seconds-since(prev-block)

Proof-of-Stake can be stress tested on the right or left side of the inequality. On right side, we can try buying more stake. But that is prohibitive because of the costs and as you buy more stake you incentive to be honest increases. So far so good…

On the left side - we have pk(block-signer) — which is our public-key. Since we generated this key our-self, we can just try to generate many keys over and over, until we win the lottery. We can do this block after block after block! It turns out that PoStake degenerates into PoW, making PoStake irrelevant. Consensus failed!

A Third Property of Consensus Algorithms

Both PoW and PoStake fulfill the two properties discussed above. However, PoW reaches consensus while PoStake does not. So what is PoStake missing? Looking carefully at PoW, we see the nonce is the one piece of data from the real world, outside the blockchain.

Property #3: External effort must be implicitly tied to the block signer through Proof.

Jay Berg on Twitter

Fundamental theory of Bitcoin: Distributed consensus can be reached on the condition, 1) nodes continuously and indpendently derived the same random variables 2) outcome is independently verifiable 3) real world effort implicitly tied to digital signatures

Scope limited to “just” solving Consensus

Scope of this post is limited to describing an algorithm that reaches distributed decentralized consensus, for purpose of blockchain synchronization and double-spend avoidance.

Goal of Proof-of-Skill is to be the second true consensus algorithm after Proof-of-Work, and ultimately rely on Bitcoin for fiat liquidity. With Bitcoin as a backstop, the scope is farther limited to reaching consensus in the context of utility. For bitcoin, the utility is the worlds electronic cash. For Protoblock, the utility of Fantasybits is monetizing the skill of predicting sporting events and hedging external sports gambling risks. Utility comes into play when looking at incentives of attacking ones own stake.

Theoretical attack surfaces meant to counter-act economic incentive structures are not addressed in the post. These includes things like:

• Selfish mining “economic attacks” in POW, where a miner loses money in the short term, for the purpose of sabotaging his competition, to force him to join his coalition to 51% attack the network.
• Stealing stake in POStake, to counter-act the cost of buying enough stake to mount an attack.
• Taking a large short position on a coin, to counter-act the cost of mounting an attack.

Suspending Beliefs

Distributed decentralized consensus is mathematically impossible. Satoshi took a practical approach and gave us Bitcoin with PoW, a probabilistic solution to the impossible. Nocoiners are still refusing to suspend their intuitive belief that bitcoin is impossible.

Bitcoiners are now falling into that same trap. Yes, PoS is impossible. No, we have not seen a real non-currency use case that requires a separate public blockchain. But suspending our beliefs is what got us all here!

Professional Sports: Consensus in a Human Phenomenon

Major public professional sporting events are considered a phenomenon, where up to 1.5 billion people watch the same thing at the same time. And after the game, billions of dollars in bets are settled based on the final score. On top of that, thousands of statistics are compiled and normalized into ‘Fantasy Points’ and billions of more dollars are awarded to winners of fantasy sports contests. All this without any central authority! In fact, humans have been reaching decentralized consensus on major public sporting events since the Roman times.

The 2015 Cricket World Cup was watched by 20% of the worlds population. A true phenomenon.

In theory, there already is consensus on major sports data, but how does the data get into the blockchain without a centralized oracle? The actual implementation requires 66% of stake to sign, but users can appoint Data Agents for practicality. Full details are found in the 2014 white paper: Distributed Engineered Autonomous Agents : Satoshi Fantasy.

Outside data that already has decentralized consensus can now be brought into the blockchain without an oracle

Full Consensus is Consensus

If “everyone” agrees on something, you already have consensus. What is often misunderstood about blockchain, is that from the point of view of each individual node, they are always in consensus rules. Even when rules are changed, and your node hard-forked off the main chain, all your node knows is its current consensus rules. Since you will only connect to nodes that are on the same chain, it follows that you and your peers will always be running the same consensus rules. This is exactly how UASF accomplished its goal of forcing segwit adoption. By only listening to miners who were signaling for segwit, the result will always be that 100% of the “network” is signaling.

Long Range — Nothing at Stake

Proof-of-Stake is a class of algorithms that only use data from the blockchain to chose the next block-signer. The major issues with PoS are:

1. Nothing at stake (N@S) — when you are presented with a natural fork in the blockchain you are forced to choose one to work on in POW, with POS there is nothing stopping you from signing blocks on top of both heads, just in-case the other one survives. N@S has a known Slasher solution, where punitive rules put your stake at stake, to dis-incentivize extending multiple chains.
2. Long-Range Attacks (Stake Grinding) — As described above, you can “grind” through the historical data that was used to choose the block-signers, and rewrite history so that you version of the blockchain is stronger and better then the “real” version. A new node, has no way to tell the difference.

PoS just doesn’t work, it’s a logical tautology. It expects you to use the content of the blockchain to decide the content of the blockchain. Gregory Maxwell

As we looked for a solution to stake-grinding, we see a glimmer of hope in the classic 2014 post On Stake by Vitalik Buterin

The idea is simple, to stop stake grinding, we make the set of block-signers and their public-keys static. We use the Nxt algorithm, which does not use the contents of the block to choose the next signer. So now there is nothing to grind! Delegated-Proof-of-Stake (DPOS), used in bitshares, steem, and EOS, has a similar concept, where there is a known list of 21 static “validators” signing all the blocks.

This idea may work, provided we have a known list of decentralized pseudo-randomly chosen block signers. It would almost be like having all the POW miners find the lowest hash all at once and then use them as the static list moving forward.

However, this problem of creating a list of decentralized block-signers is precisely the problem we are trying to solve in the first place, only from another angle. Since there is no way a list can be generated from the blockchain itself, there must be some real-world effort or information, just like Property #3 from above.

If you can Zero-Premine, you can create a static list of signers

Not only does PoW secure Bitcoin, it is also used to distribute new coins. Taking a step back, we could argue, that any blockchain that claims to reach decentralized consensus should be able to start with a Zero-Premine. In fact, the reason PoStake coins all have a 100% premine is that, otherwise, whomever gets the first coins will get all the coins. Again, this is all comes back to the same issue, where the only information available is what is contained inside the blockchain.

Show me a coin with a Zero-Premine and I will show you decentralized consensus

Protoblock is the first non-PoW chain with a Zero-Premined token. This is made possible by bringing sports data that already has consensus into the blockchain, via a continuous UASF like process.

• Before the inaugural season of 2014, there were in-fact 0 Fantasybits in circulation.
• After the first NFL game, and after every NFL game since, all nodes deterministically generated 100 Fantasybits for each Fantasy Point scored in the NFL.
• All coins, 100% of coins, are then deterministically awarded, by all the nodes, independently, to known users wallets based on the accuracy of their projections.
• Before each games anyone can create a wallet and sign a projectionTransaction

signed_transactions {
    trans {
        version: 1
        type: PROJECTION
        [fantasybit.ProjectionTrans.proj_trans] {
            season: 2016
            week: 1
            playerid: "1321"
            points: 12
         }
    }
    id: "e682b5e001882b0336c1ed46913bf5c09bd6d768c6446a050a510c1e7217d261"
    sig: "5dzQN1XuMd5vkJoqBcGk3H5bZ3oXb9BAZJeNe1qKqzpgGbMC2R1ziNguahydqXJpMtXmPG2oY7Eao3VUJk6L53zE"
    fantasy_name: "@SpreadSheetFF"
}

Example signed projection transaction by @SpreadSheetFF, for 2016 Week 1, playerid “1321” — projecting 12 Fantasy Points

Marquise Lee scored 4.2 fantasy points from 2 Receptions and 22 Receiving yards. @SpreadSheetFF predicted 12 points. According to the distribution algorithm, he gets 0 coins. The 9 users who projected 5 points will split those 420 virgin coins.

Schedules, player data, gametime, and game results are all external data brought into the blockchain, which already reach decentralized consensus on the outside, and does not need a centralized oracle.

Fantasybit are a token of the skill of predicting NFL statistics.

FantasySkill as the decentralized static signer list

• All virgin FantasyBits generated and distributed actually have two parts. FantasySkill (Skill) and FantasyBit (Stake).
• Skill is tied to your public-keys forever and is non-transferable
• Stake is the typical cryptocurrency counterpart. So when you first transfer your virgin coins, the Skill remains and you only trasfered away the Stake
• Now we have FantasySkill, a static list of public-keys that were generated from a Pseudo-Random decentralized process of predicting NFL statistics!

FantasySkill is used to determine block-signers in Proof-of-Skill

Proof-of-Skill — putting it all together to reach consensus

Property #1: Known problems are the thousands of random data points from the upcoming games which comes from the Schedule data that has consensus

Property #2: Results are independently verifiable by each node operator by bringing his own feeds or ultimately re-watching the games and scoring the results

Property #3: Efforts of obtaining the skill of predicting NFL FantasyPoints over the past 1–30 years, is implicitly tied to the key of the block-signers

The actual Protoblock Proof-of-Skill algorithm is straight forward

1. Nxt Forging algorithm is used over the static set of FantasySkill holders

SHA256(pk(block-signer) + pk(prev-block-signer)) < X * FantasySkill(block-signer) * seconds-since(prev-block)

1. Slasher is used for N@S, where if you are caught signing multiple chains, your will lose some of your Skill. So now your Skill,and block-signing rights IS at stake.
2. The list of FantasySkill holders is static, which solves the Long-Range-Stake-Grinding attacks. Approx 5 million skill coins are added to the static pool each year, keeping it fresh with new incentivised stake holders.
3. There is real world effort required to obtain Skill in predicting NFL data, which comes from outside the blockchain, so it cannot be easily gamed.

Joe Public Friendly Verification

For a user to verify that the blockchain is in a good state, all he would need to do, is confirm that the NFL schedule and the results are correct. Everything else falls into place with the assumption that Skilled predictors are sufficiently distributed among the masses.

Compare this to PoW. How can one verify that in fact the work is correct? You would have to check the code, make sure its correct, compile the code, then test the code. But in reality, you are just trusting your bitcoin core software, and relying on a small group of specialized bitcoin coders, to sound the alarm if something was wrong.

Sybil Attack Mitigation

Sybil attacks are a real threat and are mitigated by requiring a small amount of coins in an account in order to make projections. However, even without this mitigation, the threat is manageable. There are 40⁶⁵⁰ total possible projection combinations for each week. Attackers would need to create 40⁶⁵⁰ accounts, and would finish with a perfect week 1. However, for week 2, there is no way to have the same account score perfect. So he would end up with lots of Fantasybit stake, with uncountable many accounts with low Skill value. All we need to do, to mitigate his block signing, is to put more weight on higher Skill balances, which would force the attacker to ensure the same accounts win each week, and this can only be done with real skill. In the end, those will real skill, will always be at least equal to the attacker. Either way, the attack would be evident and we would/could consensus fork, or just charge a small fee for each projections.

Fantasybit Utility

Protoblock is a distributed decentralized futures/forwards exchange for hedging and speculating in the $50B fantasy sports markets. FantasyBit, the stake part, is used for margin when trading on the exchange. We have up to 1200 contract available to trade now, live, and in production. Our blockchain was written from scratch over the past 4 years in C++/QT and currently runs on Windows and OSX. There are also light clients for iOS and Android.

Utility is similar to Augur, but only for our specific NFL data that already has consensus, and is in the blockchain. No oracles needed.

The code is now open source and there there was no ICO nor preMine. We have been “live” since 2014, so there around 20 million coins are in circulation (based on 200,000 Fantasypoints scored by NFL players).

Each year from September through December, there will be around 5 million more coins up for grabs, and in 2018 almost every early adopter will earn coins. Actual expert skill would come into play in the future when blocks start reaching capacity.

Protoblock

• Jay Berg (@jaybny) | Twitter
• Protoblock (@protoblock) | Twitter
• "Fantasy 🏈 Ticker" (@Prototicker) | Twitter