Today I read a disturbing post on /r/darknetmarkets called "Stop FEing"

[jehst]

http://www.reddit.com/r/DarkNetMarkets/comments/2rb4ai/stop_feing/

Reading the comments, you become aware of two things:

1) Almost every darknet market participant is FEing
2) Almost every darknet market participant has been taken advantage of because of the practice of FEing

What is FEing? FE stands for Finalize Early. It means that the buyer immediately releases his coins from escrow to the seller. The seller does not ship the product until he receives the payment. As you would expect, paying anonymous online drug dealers up front does not always turn out well. So why on Earth does anyone FE? Why do buyers and sellers not take advantage of multi-signature escrow. To put it simply, multi-sig escrow is simply a terrible, terrible idea from the perspective of the seller. Bitcoin's volatility is simply too high. If your profit margin is 20% and bitcoin declines by 20% in the 2-7 days that it's in escrow, then you've lost 100% of your profits. You can charge 10-20% more to make up for the volatility, but then your prices will be uncompetitive. Why? Because reputable vendors are offering normal prices and even discounts in exchange for FEing and buyers are agreeing. Why? A simple comparison of outcomes. Let's compare the two options:

Option 1) Three-party multi-sig escrow where the escrow is kept in BTC.
This is totally secure for the buyer, but the merchant takes a huge volatility risk. It's currently unpopular with bitcoin in darknet markets and will likely never become popular, hence my skepticism of OpenBazaar/FreeBazaar's adoption prospects.

Option 2) Centralized escrow + FE.  This is totally unsecure for the buyer, as he loses control of his coins immediately, but it is totally secure for the seller. The seller offers a competitive discount to entice buyers, which the buyer likes. Buyers can minimize their risk by choosing a seller with an established, honest reputation. However, this does not prevent scams because a seller with a established reputation is sometimes just building trust so that he can steal an even bigger sum of money in the end. This is currently the most popular style on darknet markets with bitcoin.

To try to quantify it:

Option 1. Seller Satisfaction: 2, Buyer Satisfaction: 10
Option 2: Seller Satisfaction: 10 , Buyer Satisfaction: 5

Option 1 just absolutely sucks for sellers, so they won't do it unless they are doing it temporarily to build a reputation. Buyers are forced to take Option 2 or refuse to participate. Seller offers a nice discount to entice them. Buyers aren't happy but they can live with it. Could there be a third option could achieve a higher aggregate satisfaction for everyone? What about a USD-stabilized escrow?

Have you  ever heard of nubits or bitUSD? Each are different, but both have mechanisms by which they maintain a value of $1. The idea of USD-stabilized escrow is to use a combination of a USD-stable currency (e.g. nubits/bitUSD and a free-floating anonymous currency (e.g. Monero/Boolberry/Darkcoin/etc.) to provide a USD-stable escrow with untraceable, unlinkable transactions. (I'm not interested in a pissing match over which USD-stable asset is better or which anonymous currency is better. You can do your own research and figure it out.)

Option 3) USD-stable centralized escrow: Instead of keeping the escrow in a free-floating currency, any deposits received in escrow are immediately exchanged for a USD-stable asset held by the marketplace administrator. Once the buyer receives the product and releases the escrow, the USD-stable asset is exchanged back into the free-floating cryptocurrency. The seller will receive, at the time of escrow release, the amount of free-floating currency equivalent to the seller's list price in USD. The seller then withdraws his anonymous, free-floating cryptocurrency. The transaction is totally untraceable and unlinkable. The seller never sees the USD-stable asset. He takes no volatility risk. He does absolutely 0 work.  

How does Option 3 stack up? Well, the buyer's risk is much, much improved compared to Option 2, where the buyer loses control of his coins immediately and risks immediate total loss. From the seller's perspective, the seller's risk is slightly worse because he must now trust the marketplace for 2-7 days (until delivery is complete) rather than a few minutes or hours. However, the seller will not need to add any FE discount or bonus, which he will like. I believe buyers and sellers will both be relatively happy with Option 3, and I'd quantify it as follows:

Option 3: Seller Satisfaction: 8 , Buyer Satisfaction: 8

Although the seller isn't as happy with Option 3 as he is with Option 2, the buyer is much happier with Option 3 as he won't face constant exit scams and bait-and-switch scams.
Notably, Option 3 allows buyers more flexibility in choosing new, unestablished sellers. It allows non-established sellers to begin selling for a normal price instead of being forced to sell cheaply or assume volatility risks with escrow in order to build a reputation. The buyers and sellers need only trust the marketplace for the duration of the shipping time.

Thoughts on Option 3? Would the market continue using Option 2 if Option 3 were available? Would marketplaces be willing to float the necessary amount of USD-stable assets to facilitate the USD-stable escrow?

(Why do I post this in the altcoin section? Because if you haven't noticed, bitcoin isn't involved in this. It's only a matter of time before people realize that altcoins can be more than speculative assets. Altcoins can do things bitcoin can't, and it's time that we put them to use.)

[gatra]

what would be a USD-stable asset? let me guess: bitshares' bitusd?

[jehst]

what would be a USD-stable asset? let me guess: bitshares' bitusd?

I gave two examples. I know it's long, but please read before responding.

[Yurizhai]

It's been clear to me that a stable cryptocurrency like NuBits is a much better match for the Dark Net than Bitcoin.

[generalizethis]

The only problem that I see is that now you've shifted trust to the market instead of the seller and given the market more incentive to steal funds. If you've worked-out a way to make this aspect trustless, you'd have a great solution.

[jehst]

The only problem that I see is that now you've shifted trust to the market instead of the seller and given the market more incentive to steal funds. If you've worked away to make this aspect trustless, you'd have a great solution.

The only way not to trust anyone is through multi-sig, which the market has already rejected. Relatively, is there a disadvantage compared to trusting the market instead of the seller? Admittedly, it's not a 10-10 solution, but the question is whether it's better than a 10-5 solution. We can add Open Transactions/Monetas voting pools to the scheme to provide distributed trust and real-time auditing for escrowed funds, but then convenience is sacrificed and things become slower and more complicated.

[generalizethis]

"Relatively, is there a disadvantage compared to trusting the market instead of the seller?"

Yes, the market has more money involved and therefore more incentive to steal. Also, it paints a bigger target for hackers.  And finally, a seller only rips off those buying from them at the time of the theft, whereas a market rips off everyone who has money in the market at the time of the theft.

[aminorex]

tracking

[generalizethis]

tracking

For escrow release? Or for government agencies? Something else?

[jehst]

"Relatively, is there a disadvantage compared to trusting the market instead of the seller?"

Yes, the market has more money involved and therefore more incentive to steal. Also, it paints a bigger target for hackers.  And finally, a seller only rips off those buying from them at the time of the theft, whereas a market rips off everyone who has money in the market at the time of the theft.

The market has more money to steal but it takes much longer to build a reputation and gain volume whereas fraudulent sellers can start up new accounts and get them ready for more frequent (although smaller) scams. Most markets never become popular. The darknet is usually dominated by 2 or 3 of them. So there's a significant opportunity cost to giving up a #1 through #3 ranking. You can earn 100k+ bitcoins running a market honestly, as we can see from Ulbricht's personal stash.

re: a bigger target for hackers. Yes, it is. But if the market keeps the majority of funds in cold storage, and only keeps enough in a hot wallet keep up with withdrawals, then the hacker's take is limited.

I think we always must return to the fact that the market is not interested in perfect security. Participants could have near-perfect security with multi-sig, but participants would rather be scammed every so often than have constant inconvenience and volatility. Maybe Option 3 is 7-7 and still wouldn't be as popular as Option 2 (10-5), but I think it's still worth thinking about.

[generalizethis]

"Relatively, is there a disadvantage compared to trusting the market instead of the seller?"

Yes, the market has more money involved and therefore more incentive to steal. Also, it paints a bigger target for hackers.  And finally, a seller only rips off those buying from them at the time of the theft, whereas a market rips off everyone who has money in the market at the time of the theft.

The market has more money to steal but it takes much longer to build a reputation and gain volume whereas fraudulent sellers can start up new accounts and get them ready for more frequent (although smaller) scams. Most markets never become popular. The darknet is usually dominated by 2 or 3 of them. So there's a significant opportunity cost to giving up a #1 through #3 ranking. You can earn 100k+ bitcoins running a market honestly, as we can see from Ulbricht's personal stash.

re: a bigger target for hackers. Yes, it is. But if the market keeps the majority of funds in cold storage, and only keeps enough in a hot wallet keep up with withdrawals, then the hacker's take is limited.

I think we always must return to the fact that the market is not interested in perfect security. Participants could have near-perfect security with multi-sig, but participants would rather be scammed every so often than have constant inconvenience and volatility. Maybe Option 3 is 7-7 and still wouldn't be as popular as Option 2 (10-5), but I think it's still worth thinking about.

I think any option is worth discussing. Hashing out what are the risks versus the rewards is part of any healthy vetting process.

[ArticMine]

There is a very simple solution to this. The seller can simple hedge her exchange risk say USD/XBT using derivatives. This is an issue common to many markets no just just "dark" markets or even currency markets. It is the reason the futures markets were initially developed for agriculture. Furthermore the hedging does not have to take place in the same market as the transaction.

By the way hedging with derivatives is one reason why proof of stake coins can very easily fail.

[altcoin hitler]

or use a coin less volatile than horribly volatile bitcoin.

[jehst]

There is a very simple solution to this. The seller can simple hedge her exchange risk say USD/XBT using derivatives.

I've considered this possibility in my post re: OpenBazaar/FreeBazaar

With bitcoin, there are well-developed margin trading and options trading platforms now. If a merchant is selling 2 BTC worth of merchandise on Freebazaar, and 2 BTC is put in escrow, he can immediately borrow 2 BTC on Bitfinex and sell them for his desired currency. If bitcoin's price plummets, he takes no risk. When the 2 BTC are released from escrow, he uses those BTC to cover the short. Of course, this may be complicated and time consuming from the merchant's perspective. First, it requires the merchant to keep some USD on Bitfinex as collateral in order to borrow the BTC. Money that will be sitting there doing nothing, which is an opportunity cost. Second, borrowing the BTC comes at a cost in the form of interest. Third, selling the BTC incurs fees. Fourth, there is counter-party risk in leaving funds on BitFinex. So hedging comes at a cost.

So, yes, the seller technically can hedge, but in practice, he doesn't (because it's a PITA).  Constantly hedging on Bitfinex outside of the market is probably a Buyer 10, Seller 3 solution. It's as if the seller has to run two separate businesses concurrently: a finance firm and a merchant firm. What we see in reality today is that the seller prefers simplicity. He would rather just give a discount in exchange for FEing. So FE remains the most popular.

It is the reason the futures markets were initially developed for agriculture.

(re: farmers. Farmers usually have one or two big harvests per year and thus only need to hedge several times per year. The negatives of hedging are greatly, greatly reduced when you only have to think about it once per crop per year rather than every day or week. Hedging is also much, much more necessary for farmers. Only a limited percentage of a merchants bankroll should be locked up in escrow at any given moment, whereas the farmers entire year's earnings are "locked up" in his uncertain yields. So with farmers, we see much greater incentive and much less of a drawback to shopping around on the futures markets.)

Furthermore the hedging does not have to take place in the same market as the transaction.

The idea of having the market do the hedging is because:

1) It offloads the initial investment requirement to the exchange. The exchange is more likely to benefit from investing in an automatic hedging system than an individual merchant. The individual merchant may just want to make a few sales on the market, or even a few hundred sales. If he hedges, he will do it manually, frequently, and will incur various costs (discussed above). He is not going to pay a developer to build a hedging engine. The market is the long-term actor, and is the party best suited to do do this work.

2) It makes it a one-click solution for the seller.
"I want a USD-stable escrow."
Click it. Done.

3) The exchange can avoid the costs of exchange fees by maintaining its own floats in crypto (which it probably does anyway). Let's say that the market administrator can't keep all of his earnings in government fiat currency because it isn't easily laundered. So, like Ulbricht and others, let's say he's long on BTC and he keeps a large amount of earnings in BTC along with USD. He can incorporate this into the hedging system by making his stash into a float:

a) The admin converts his BTC-stash into USD-stable crypto.
b) Whenever a buyer escrows BTC, the administrator does the exchange internally. He takes ownership of the BTC and converts the escrowed amounts into USD-stable crypto. This is all on paper.

If BTC goes up during the escrow period, he ends up giving less BTC to the seller and keeps the rest as profit. If BTC goes down, he ends up giving more BTC to the seller and losing some of his bankroll. But the admin wanted to be long on this amount of bitcoins anyway. At the same time, the administrator avoids the counter-party risk and exchange fees that would arise from sending the buyer's escrowed coins off-site for exchange.

This is an issue common to many markets no just just "dark" markets or even currency markets.

In non-"dark" markets, we see specialized actors arise to handle these kinds of risks. Bitpay and Coinbase specialize in hedging against bitcoin's volatility so that merchants don't have to. Because merchants don't want to. They just want to do their business, not become part-time actuaries. On darknet markets, the market, not the customer or merchant, is the best-placed actor to do the hedging.

[noelmal]

I have a simple solution  Don't do drugs  Problem solved 

[jehst]

I have a simple solution  Don't do drugs  Problem solved 

That actually does solve the problem of getting scammed by drug merchants 100%.

[jehst]

It's been clear to me that a stable cryptocurrency like NuBits is a much better match for the Dark Net than Bitcoin.

Upon reflection, my preference for anonymous currency shines through here and complicates my idea. There's another option here.

Option 4: Three-party multisig with USD-stable currency.

No exchange volatility.
No risk of market scam.
No risk of seller scam.
The seller can exchange his USD-stable currency for whatever he wants afterwards, including bitcoin or an anonymous crypto.

The only risk is that the entire USD-stable currency fails during delivery time.

Buyer 10 , Seller 9.5 (the seller would still prefer to get his money completely upfront)

Checkmate.

/thread

I just solved everything. Everybody can go home.

[fran2k]

It's been clear to me that a stable cryptocurrency like NuBits is a much better match for the Dark Net than Bitcoin.

Upon reflection, my preference for anonymous currency shines through here and complicates my idea. There's another option here.

Option 4: Three-party multisig with USD-stable currency.

No exchange volatility.
No risk of market scam.
No risk of seller scam.
The seller can exchange his USD-stable currency for whatever he wants afterwards, including bitcoin or an anonymous crypto.

The only risk is that the entire USD-stable currency fails during delivery time.

Buyer 10 , Seller 9.5 (the seller would still prefer to get his money completely upfront)

Checkmate.

/thread

I just solved everything. Everybody can go home.

Clearly FIAT-stable currencies like nubits, bitUSD or bitCNY could be a great game changer in next-gen markets.

In the case of bitASSETS, they are already anonymous because of TITAN protocol.

Most of current TOR markets seem already using 2of3 multisig escrow.

[Nxtblg]

tracking

For escrow release? Or for government agencies? Something else?

I think he means tracking this thread: keeping an eye on the responses.

[Nxtblg]

I have a simple solution  Don't do drugs  Problem solved 

That actually does solve the problem of getting scammed by drug merchants 100%.

And it reminds me of an old Andy Capp cartoon. His wife, Florrie, is looking at a dress shop with a sign "Save 25%!" And Andy pulls her away form the store, barking "I'll show you how to save 100%!"