What the nani are Fedimints?

Part education, part musings

This is a post about developments in Bitcoin. If you want a less technical entry-point, please head here. If you want to read a story, please head here.

By DAWIT ABEBE

When transacting using cryptocurrencies like bitcoin, people tend to encounter two key problems.

The first is losing their “secret key” which is essentially a password using which you can access your bitcoins from any place in the world. It’s not uncommon to see people lose their secret keys. Once you lose your secret key, all the wealth stored in that particular account is gone forever. So the idea of “safekeeping and remembering that ONE “password” is daunting for many. This post will not cover this point in further detail and will instead expound the next point.

The second problem is with regards to transacting privately. Cryptocurrencies like Bitcoin are decentralized. What this means is that the “Bitcoin database” (aka a “blockchain”) is stored in numerous computers located all around the world. So anyone can go and search up this database and look at the historical record of transactions. For example, someone could look up the Bitcoin blockchain and with a little bit of effort, find out that you’d sent me 0.1 BTC one hour ago.

So does that mean that Bitcoin is doomed because private transactions aren’t possible? Of course not! It’s all relative. For example, while transacting in bitcoin usually won’t equal the privacy of transacting using physical cash, it’s superior to transacting digitally via your commercial banks.

However, as with any innovation, we’re always trying to make Bitcoin better. Sure, transacting using bitcoins is superior to transacting digitally via commercial banks… but can we make it as good (or even superior?!) to transacting in physical cash?

Possibly — and that’s where Fedimints come in. In simple terms, here’s how they work:

Essentially, you and a group of folks you trust form a group. Let’s say it’s you, your mum, and your dad. Within this group, you can send and receive bitcoin IOUs. Since these are bitcoin IOUs and not actual bitcoins, nothing is recorded on the blockchain and transactions are completely private.

In this manner, all transactions within the group become completely private.

But of course, this complete privacy presents new trade-offs. There are certain things you’re giving up when you decide to transact privately within this group of yours.

Perhaps the most significant trade-off is that your bitcoins are no longer completely yours. If your mum and dad decided one day that you were a bad kid and decided to abruptly spend all your bitcoin on fruit, they could do so (they hold 66.7% of the vote in your three-man group, remember?). Hence to mitigate this trade-off, it’s important to form groups only with people you trust in real life — and Fedimints happily allow that.

Another such point is with regards to the bounds of this privacy: once you want to send currency outside this group, transactions are no longer completely private. When you join a new Fedimint, you pass your bitcoins to the Fedimint treasury, and in return, you get an equivalent number of bitcoin IOUs. These aren’t digital equivalents of actual bitcoins and therefore aren’t recorded in the blockchain. However, once you want to transact outside the Fedimint, you’ll have to swap your IOUs back for your bitcoins stored in the Fedimint’s treasury. And those transactions, by virtue of now being in bitcoin-terms, are less private. There are pros and cons to reduced privacy in this form. One pro is that privacy-solutions like Fedimints don’t automatically become the go-to for fellas engaging in illegal activities — criminals probably aren’t merely playing around with a fixed amount of cash within themselves.

By TILLY STRAUSS

Nonetheless, as with any privacy solution, Fedimints raise a natural question: how are regulators going to react? We don’t know yet. The Fedimint code is still being worked on and is expected to launch next year.

However, some form of regulation should be expected to come. Cryptocurrencies like Bitcoin have been innately unpopular with governments and even if Fedimints make it marginally easier for bad actors to transact, regulators will hit back. I’m not exactly pro-regulation, but on that note, I’ll over some thoughts on regulation and Fedimints in a future article.

For now, I hope this piece was a good primer on Fedimints and their functions. Cheers!

You can find me on Twitter @ramwithouthorns.

Some ideas in this post have been simplified. Head here if you’re interested in a more thorough read.