A Farewell to Innocence: Crypto Pitfalls That Network States Should Avoid

An initial look at parallel challenges from the crypto movement that the network state movement should try to avoid or mitigate.

Introduction

First, let's start with an AI-generated haiku about the network state:

Data packets fly fast

Electric pulses crisscross space

Networks come alive

The Network State, A Haiku (AI Generated Image)

All right, that was fun. Now onto the actual essay. This essay is inspired by the first episode of the Network State podcast, in which Balaji Srinivasan and Vitalik Buterin talk about Ethereum's journey and challenges. Those interested can catch the Network State Podcast here.

The Network State Podcast (Source: The Network State Podcast)

A network state is, in one sentence:

A highly aligned online community with a capacity for collective action that crowdfunds territory around the world and eventually gains diplomatic recognition from pre-existing states.

-Balaji Srinivasan, The Network State

In some ways, we've see a “Satoshi Nakomoto moment” with Balaji's The Network State, in terms of it being a manifesto that has launched a global movement of enthusiasts hoping to build alternate paradigms to the nation state. For the crypto movement, it started with alternate forms of payments and tokens in hopes of eventually building new monetary systems on the cloud; for the budding network state movement, it is starting with alternative forms of unions and societies in hopes of eventually building new countries on the cloud.

In less than a decade, the crypto movement has gained tremendous traction in many parts of the world and has captured the imagination of millions. Yet, throughout its development arc, crypto has also experienced tremendous ups and downs, crises, and continued roadblocks projecting fear, uncertainty, and doubt. This essay makes an attempt to explore (in a non-exhaustive matter) some of the biggest pitfalls that have been experienced by the crypto movement, and how the network state movement could potentially avoid them — or at least in some way mitigate them — during its own developmental arc.

Bitcoin on the Network (AI Generated Image)

Inter-Network and Intra-Network Wars

Bitcoin maximalists believe that Bitcoin is the original and true cryptocurrency, and that all other cryptocurrencies are oftentimes inferior copies. Maximalists tend to view Bitcoin as a decentralized, censorship-resistant store of value and believe that its scarcity (limited supply of 21 million coins) and robust security measures make it the best option for a digital asset, and also that that Bitcoin's network effect, large community, and first-mover advantage give it a significant advantage over other cryptocurrencies.

On the other hand, many supporters of Ethereum, for example, believe that Ethereum's smart contract functionality, which enables developers to build decentralized applications on the network, gives it a significant advantage over Bitcoin. They also argue that Ethereum's more rapid pace of innovation, compared to Bitcoin, positions it well for future growth. These differences have led to various debates and arguments within the crypto community, with each side trying to promote its own views and beliefs.

Major crypto networks have experienced tumultuous civil wars. Notable civil wars include:

• The "Bitcoin Civil War," also known as the "Blocksize War," which was ignited due to disagreement in the Bitcoin community about how to scale the network to accommodate a growing number of users and transactions (and spawning multiple competing Bitcoin chains).

• The “Ethereum Civil War,” which split Ethereum community on how to respond to the DAO hack and gave birth to Ethereum Classic.

Wars between crypto networks have also been prevalent, and notable examples include efforts by Solana and Cardano to be “Ethereum killers” while different crypto influencers aligned to different chains would be pitted against each other. Constant civil wars within major crypto networks and wars between crypto networks have often diverted energies of the crypto movement: instead of networks and communities uniting against aggressive anti-crypto forces, of which there are many, significant amounts of energies have been spent toward internal squabbles and infighting.

Bitcoin Civil War (AI Generated Image)

Potential Implications for Network States

As network societies or states launch and grow, they would likely also hit points of disagreement between member factions, and civil wars within the network could erupt. Strong networks with core founding teams or core member communities may be able to weather though such divisions, but the process could be draining. Similar to how civil wars within a crypto chain network could result in forks, civil wars within a network society or state could produce mass exits that result in multiple new networked entities. Some of this process could be natural and healthy — to use Balajian terms, it would make little sense for an embattled network to maintain 51% consensus — but there also exist risks of excessive exit and splits that weaken the network ecosystem as a whole or extend the time it takes for a major network to recover.

As network societies or states become more prevalent, the idea of inter-network conflicts or wars is plausible. Different network societies may work against each other to compete for members and launch various media campaigns to outdo the other side. Some of the potential future competition between networks could be healthy — if we put an Adam Smith hat on — and in theory people could hold membership in multiple network states, but excessive competition could at times lead to bitter infighting within the network state movement as a whole and weaken the movement in the face of more external threats.

Recognizing that some forms of divisions within a network state or competition between network states may be inevitable some time down the line, there may still exist ways to at least mitigate some of the most negative impacts of division, competition, and conflict. Below is a non-exhaustive list of ideas:

1. Building strong core communities that could weather through exits and splits.

2. Building robust intra-network consensus building and decision making protocols.

3. Building comprehensive set of inter-network “diplomatic” protocols agreed upon by multiple network states (like a “United Nations charter” for the network state system).

Shitcoins

As of November 2022, there are approximately 22,000 different cryptocurrencies (this number may have changed by the time of this essay's publication). One could make an argument that, beyond strong networks such as Bitcoin, Ethereum, Polygon, Cardano, Polkadot, and Solana, and outside the top 200 cryptos on Coinmarketcap, over 90% of cryptos offer fairly little tangible value or utility to the majority of users. The majority of cryptocurrencies are, to use a crypto industry word, shitcoins.

To illustrate a sample lifecycle of a shitcoin, let's look at one that is, well, conveniently called Shitcoin (yup, there is a cryptocurrency named Shitcoin!):

1. Initial coin offering (ICO): A company or group will launch an ICO to raise funds for their proposed project by selling their tokens to investors. A website and a white paper is sometimes shown for a project with a nice vision. The ICO may promise high returns and hype up the potential of their project.

2. Pump: Once the ICO is complete, the price of the token may be artificially raised through market manipulation or hype.

3. Dump: After the price has been artificially inflated, large holdings of the token may be sold, causing the price to plummet. This often leads to significant losses for investors who bought the token at a high price.

4. Flatline: For a long period of time, the project makes no tangible progress on delivering product or value.

5. Meme: Some billionaire or social media influencer hypes up the coin as a joke, and suddenly there is a momentary interest in the project and token, followed by downwards dump and flatline again.

6. Abandonment: At some point, the project team may abandon the project altogether, leaving the token with zero real value or use case. The token may continue to trade for a while, but eventually, the price will likely decline to zero or close to it.

Shitcoin Chart (Source: Coinmarketcap)

Potential Implications for Network States

The point here is not to associate network society projects with shitcoin projects — many emerging network society projects have strong mission, teams, and goals, and unlike crypto, startup society projects are not likely to be subject to market manipulation. Yet, early stage network society projects would need to avoid the pitfalls of becoming nice-to-have “online clubs” that raise a lot of hype but then fizzle and flatline as time goes on. Maybe the Discord channel becomes empty. Maybe the meetups have fewer and fewer people showing up.

Building and sustaining a network society will take significantly more effort, conviction, and engagement. Founding teams and core architects of a startup network society will find ways to convince members that the society offers real tangible value that is worth continued membership and engagement. In broad strokes, here are some potential examples (not an exhaustive list) of efforts:

1. As Balaji has pointed out, aligning network society members with a strong moral commandment (to use Balajian terms) and purpose.

2. Enabling strong engagement metrics to make sure the community is constantly engaged meaningfully.

3. Solving for a basic citizenship need or societal need that existing institutions cannot do as well or as efficiently.

Hijacked Narrative

Bitcoin launched a movement that opened up new possibilities for billions of unbanked around the globe. A peer-to-peer system via a decentralized ledger in which secure, fast, and low-cost transactions could be verified directly by the users on the network would eliminate the need for intermediaries. Yet, for millions of “normies” around the world, the first time they learned about Bitcoin was through major newspapers and media outlets running pieces on Mt. Gox and Silk Road.

Mt. Gox was once the largest bitcoin exchange platform, handling over 70% of all Bitcoin transactions at its peak. However, in 2014, Mt. Gox announced that it had lost 850,000 Bitcoins, worth hundreds of millions of dollars at the time, due to a security breach. This was one of the largest cryptocurrency thefts in history, and it raised concerns about the security and stability of Bitcoin exchanges and the crypto industry as a whole.

Silk Road was an online black market that operated on the dark web and used Bitcoin as its primary currency. It was used to buy and sell illegal goods and services, and was eventually shut down by law enforcement in 2013. The connection of Bitcoin to illegal activities reinforced the negative stigma surrounding crypto, and led many in the public to view crypto as a tool for criminal activity.

Events such as the Mt. Gox hack and Silk Road scandal had major negative impacts on the emerging crypto movement and its narrative. For a very long time, much of the general public would associate Bitcoin with fraud, abuse, and illegal activities, and anti-crypto proponents would be quick to use Silk Road to paint negative portrayals of crypto. Many early adopters of Bitcoin and crypto who once served as advocates for the movement had lost significant assets on Mt. Gox, Bitcoin price subsequently crashed, and crypto lost a significant following during its early days. Although crypto has since recovered from the initial hits to its narrative to become more mainstream, hacks and scandals — as evidenced by the FTX saga in 2022 and the surrounding contagion — continue to plague its ecosystem.

Mt. Gox Impact on Bitcoin Price (Source: Bitcoincharts.com)

Potential Implications for Network States

As major paradigm-changing movements aim for eventual embrace by millions, a sustained positive narrative is crucial to momentum. A hijack in narrative that sours global public perception could be devastating and hold back adoption for years.

Like crypto, the network state movement also starts with noble missions to connect millions around the world and facilitate more borderless interactions. The network state movement should be careful not to accidentally witness fringe extreme groups hijacking the narrative. It would be devastating if, for example, a terrorist group applies network state principles to build a terrorist digital state, or if a racist group uses network state ideas to expand its foothold globally. To go beyond communities of early enthusiasts, the network state movement will need to sustain a positive narrative and offer compelling evidence of positive impact to people around the world.

Bad Actors

Since inception, hacks to crypto exchanges, wallets, and funds by bad actors have not stopped. Here is a non-exhaustive sample list of major hacks to crypto networks and exchanges since Mt. Gox:

1. The DAO hack - In June 2016, an unknown attacker exploited a vulnerability in The DAO (Decentralized Autonomous Organization), a smart contract running on the Ethereum blockchain, and stole 3.6 million ETH (worth approximately $50 million at the time).

2. Bitfinex hack - In August 2016, Bitfinex, a cryptocurrency exchange, suffered a security breach and lost approximately 120,000 Bitcoins (worth around $72 million at the time)

3. Coincheck hack - In January 2018, Coincheck, a Japanese cryptocurrency exchange, lost approximately $534 million worth of NEM tokens in a hack.

4. BitGrail hack - In February 2018, Italian cryptocurrency exchange BitGrail lost approximately 17 million Nano tokens (worth around $195 million at the time).

5. Cryptopia hack - In January 2019, New Zealand-based cryptocurrency exchange Cryptopia suffered a security breach and lost an undisclosed amount of cryptocurrency.

6. QuadrigaCX hack - In January 2019, Canadian cryptocurrency exchange QuadrigaCX filed for bankruptcy after its CEO, Gerald Cotten, died and it was discovered that he was the only person with access to the exchange's cold wallets, which contained an estimated $145 million worth of cryptocurrency.

7. Binance hack - In May 2019, Binance, one of the largest cryptocurrency exchanges, suffered a security breach and lost approximately 7,000 Bitcoins (worth around $40 million at the time).

The list goes on, and it also includes instances of crypto founders disappearing with loot, leaving investors and customers in the dark. In 2022, the crypto world witnessed some of its biggest seismic events, from the Luna/Terra collapse to bankruptcies to Three Arrows Capital and Celsius, to Sam Bankman-Fried's arrest for defrauding billions worth of funds from customers. The Contagion, as it has been often named, has revealed countless more bad actors in the crypto ecosystem, shaken the confidence of investors and users, and invited more heavy-handed regulatory scrutiny from governments.

FTX Scam (AI Generated Image)

Potential Implications for Network States

As network states launch, grow, and expand, they should also be on the defensive against arrays of bad actors. Hacker groups that target nation state level financial institutions may also turn to target network states’ treasuries and other key asset stores. Hostile nation state actors may decide to infiltrate and persecute members of network states. And possibility, network state versions of Sam Bankman-Fried may exist in the future.

Finding various ways to defend against bad actors would be tricky but critical. Balaji had talked extensively about digital defense as a way to mitigate risks. There may also be ways for network states to form alliances in order to make the entire ecosystem more robust. As Balaji and others have pointed out, network states may also collaborate with friendly physical nation states and cities. Finally, network states may decide to build more robust mechanisms and protocols so that any deranged founder or internal actor intending to defraud the community would be deterred.

Conclusion

As network states launch, grow, and expand, builders, architects, leaders, and members should make best attempts to avoid pitfalls experienced by crypto networks:

1. Resolve intra-network conflicts and internetwork conflicts with agreed-upon protocols so that the network state movement would not be long divided.

2. Build for value, utility, engagement, and purpose; avoid becoming nice-to-haves.

3. Demonstrate positive narratives and avoid negative narratives arising from hijacking by extremist groups.

4. Mitigate risks posed by potential external and internal bad actors.

Crypto, despite all its pitfalls, is here to stay and change the world ultimately for the better. Network states will also inject more dynamism to the world and ultimately make the world more safe, more free, more open, more collaborative, more innovative, and more sustainable. We are only at the beginning of the network state movement's developmental arc, and an exciting journey awaits!

This is essay 2 of 4 essays for The Network State (TNS) Creators Cohort #3 (by 1729 Writers). 1729 Writers is a group that writes to reflect on the network state movement, AI, trans-humanism, and other techno-socio topics.

Disclaimer: This post is academic in nature, and it does not constitute any formal political, scientific, legal, financial, social, religious, or ethical advocacy. For earlier posts and musings, please visit whatifwhatif.substack.com.