Is cryptocurrency here for good?

<These notes assume you understand Bitcoin, Public/Private & Permissioned/Permissionless & federated blockchains, consensus concepts, side chains, ICO/STO, stable-coins, utility/app-payment/security tokens and smart contracts.  If you don’t please review the following notes (1) and (2).>

It’s hard to argue that the cryptocurrency world is not here to stay when you see…

  • Tech luminaries (Andreessen, Dixon) come out and say “[Crypto tokens] will soon be seen as a breakthrough in the design and development of open networks, combining the societal benefits of open protocols with the financial and architectural benefits of proprietary networks.” I listen and want to participate. (more)
  • a crypto-market cap of $194 Billion dollars (8/14/2018)
  • big finance (Goldman Sachs, JPMorgan, Morgan Stanley, HSBC, Citigroup, Barclays, Credit Suisse, Deutsche Bank, UBS, Fidelity Investments, BlackRock) getting on board (more).
  • countries (To date Senegal, Tunisia, Marshall Islands, Venezuela and many others testing the concept more) and central banks (Caribbean) issuing or considering their own cryptocurrencies.
  • regulators stepping in (more and more)
  • Intercontinental Exchange (ICE) and Starbucks getting involved (Bakkt)
  • Coinbase having more users than Charles Schwab (more) – “Charles Schwab reported 10.6 million active brokerage accounts for October, in contrast with 11.7 million users in October for Coinbase, the leading U.S. platform for buying and selling bitcoin.”

…but this market it difficult (complex tech + complex economics + the science of network effects) with many overlapping layers (Coins such as Bitcoin & Ether, Stable-coins, Utility tokens, Security tokens etc..) and too many speculators (Tim Draper).

Putting private permissioned blockchains aside for the moment (this will be a follow-on note) I tried below to outline all the basic arguments for and against cryptocurrencies such at Bitcoin & Ether AS WELL AS the tokens that rely on the success of currencies such as Bitcoin & Ether.  I will eventually use this as a rough way to determine if this is a fad or a true economic tidal wave…

  • Pro #1: A cryptocurrency such as Bitcoin or Ether is a more effective/efficient currency than FIAT (it’s scarce (Bitcoin has 21M ceiling yet fiat is easily printed), easily divisible, durable (a ledger entry that exists on computers around the world versus fiat that slowly loses value due to inflation over time), fungible, recognizable, can’t be counterfeited, highly portable (without a need for a bank), permissionless (versus fiat where you need permission to send dollars to some nations like Russia), decentralized (versus fiat that is controlled centrally) and most importantly programmable (which fiat is not)).
    • Con: Speed: Public permissionless blockchain networks are slow and currently do not scale to yield transaction throughput on the scale of Visa (1700 tps)—Bitcoin is ~7 tps and Eth is ~10 tps (more)
    • Con: Proof of Work Consensus systems use enormous resources: Public permissionless blockchain networks (especially those that use PoW consensus) require enormous resources (bandwidth, memory, and CPU). The ledger is shared and maintained by every node of the network. To be a node in the network, one needs to download the whole ledger/blockchain and keep it on their system. Distributing a ledger potentially consumes over a hundred times the energy of single databases. Scaling up from relatively niche use could be impossible.  Also, for cryptocurrencies that using proof of work (mining) as their consensus mechanism–If the market value of the reward for mining drops below the cost of mining, then miners will stop mining, and nobody will process transactions.
      • Rebuttal: Proof of Stake consensus systems and Layer 2 solutions
        • Con-Rebuttal: Proof of Stake may be more expensive than Proof of Work—see this.
    • Con: Cryptocurrencies are not a “stable” store of value. They operate less like a “currency” and more like a “stock” whose price fluctuates. What % of today’s BTC is being used to purchase services? Less than 1%?  With crypto there is no certainty of its future value–in order to be money, you need to be able to price products & contracts in it… but none of these things can be done with crypto when its price is so volatile. Artificial scarcity is essential to cryptocurrency’s value but works against making it a viable medium of exchange.  Why would you buy a soda with Bitcoin if one day it’s $1, the next $5, and the day after that $10?
      • Rebuttal: In economics, something has value if it checks the following two boxes: scarcity and utility. Scarcity means that something has a finite supply. In the case of bitcoin, the cryptocurrency has a set cap of 21 million bitcoins. Cryptocurrency’s utility lies in the fact that no government, bank or single person has control over it hence it can’t be toppled by corruption at the top.  Gold has underlying utility value in applications such as semiconductors and jewelry. Real estate has underlying value for building, farming, and mining, among others.  Cryptoassets have an enormous amount of potential underlying utility value, promising to disrupt just about everything, including payments, record keeping, legal contracts and many other industries.
        • Con-Rebuttal: Crypto is not scarce–it can be forked off. There are 1500 current currencies and new ones every day.   Maybe the network is scarce today much like MySpace was many years ago, but bigger/better networks will constantly be created.  Yet there is only 1 gold.
      • Rebuttal: Volatility is currently high, but volatility is what happens when a market is trying to figure out what the price should be–it will eventually flatten out. Stability is earned with time. The volatility issue is self-correcting.
    • Con: Deflation is bad. Bitcoin caps out at 21 million total BTC in circulation; Litecoin at 84 million LTC. These fixed supply mechanisms give them deflationary characteristics over the long term.
      • Rebuttal: Ethereum (ETH) chose to uncap the total supply of their coins and opt for long-term, pre-determined issuance schedules. No-cap cryptocurrencies are thus inflationary in nature. The risk with inflationary crypto assets is that new, future coins entering the market will reduce the value of existing coins by increasing the supply relative to demand.
      • Rebuttal: A crypto asset with deflationary characteristics could theoretically be a better store of value because existing coins are protected from future supply-based dilution.
    • Con: Cryptocurrency is not ‘required’ for anything other than ransomware payments or illicit dark-web purchases! With fiat—governments require it for citizens to pay taxes.  Who requires crypto?  Without the requirement of use you will never know the demand (i.e. supply/demand) hence you will never have a stable price given speculators currently drive the demand not use of the currency.
      • Rebuttal: Crypto may not be required but is a necessity in the developing world (more)
    • Con: Country-specific monetary policy is required for a stable society, to offer benefits (Social Security, Medicaid, Medicare) to its population and to finance wars
      • Rebuttal: Cryptocurrency and monetary policy are not mutually exclusive. (more, more, more)

So, this might be where ‘stablecoins’ get interesting and bypass most of the issues outlined above…  

    • Con: Credit and cryptocurrencies play poorly together.
      • Rebuttal: Cryptocurrency and credit are not mutually exclusive as seen with the announcement of Bakkt.
        • ConRebuttal: “it’s also a double-edged sword because it’s likely the beginning of Wall Street creating financial claims to bitcoin out of thin air (and not backed by actual bitcoins), which could offset some of Bitcoin’s algorithmically-enforced scarcity.”-Caitlin Long
    • Con: Fragmentation: like Linux, many cryptocurrencies are open-source causing new currencies to appear quickly. There are 1500 current currencies and new ones every day.
      • Rebuttal: The network is the value not the currency/code.
        • Con-Rebuttal: Maybe the network is scarce today much like MySpace was many years ago, but bigger/better networks will constantly be created.
    • Con: Lost keys: Cryptocurrency stored in a public permissionless blockchain can be lost forever if someone loses their key. Hence, most people won’t want to maintain their own private keys, and if you don’t maintain your own private keys, cryptocurrencies are essentially no different from fiat money held in banks.
    • Con: Quantum computing: The entire blockchain assumes that hash problems take a constant time to solve. If someone can solve a hash problem even slightly faster, then the whole blockchain system fails to work.
      • Rebuttal: This is fear-mongering-any potential security risks are solvable (more and more and more)

 

Maybe there is enough value in the Pros below to bypass all the Cons above…

 

  • Pro #2: A coin such as Bitcoin or Ether can be used for low-cost international money transfers: The current system is a multibillion-dollar industry that exploits immigrants with fees (Western Union skimming a %). With cryptocurrency, the transfer fees are negligible, and the transfer times are near-instant.
  • Pro #3: A coin such as Bitcoin or Ether can minimize government intervention: Allows citizens to not have their capital tracked by governments as a means of control in the case of 1) Seizure resistance by badly acting governments and 2) Ease of transport of currencies across international boundaries (cryptocurrencies allow you to cross a border with literally a billion dollars in your pocket)
    • Con: Won’t pass regulatory scrutiny: Governments won’t tolerate the loss of monetary control. The US government specifically is not going to allow wide-scale movement of money within the United States in which it can’t identify the sources and uses.  Governments also won’t tolerate illegal commerce (especially if used for terrorism).   Eventually, societal pressure to regulate cryptocurrency will increase as more fraud (example: market manipulation) is discovered. Most people want strong governments, and strong governments want to control their own currencies.  Net: Governments can make the use of cryptocurrency illegal (much like what the Saudi’s did with Bitcoin more).
    • Con: Requires Pro #1
  • Pro #4: A token based on a coin can be a better way to fund an open source network to allow it to compete with a proprietary network (Facebook, Google, Amazon, Microsoft, Apple, Netflix etc.). A token can 1. fund the operating expenses required to host the network (Bitcoin and Ethereum have tens of thousands of servers around the world that run their networks) 2. provide shared computing resources (including databases, compute, and file storage) 3. incent network participants (developers, users of the network and investors)
    • Con: Requires Pro #1
  • Pro #5: A cryptocurrency (coin or token based on a coin) can provide for the ability to sell digital goods: For example Music & Photography
    • Con: Requires Pro #1
  • Pro #6: A token (based on a coin) can be used to replace the need for a central bank:
    • Con: Well-run central banks succeed in stabilizing the domestic value of their sovereign currency by adjusting the supply of the means of payment in line with transaction demand.
    • Con: Requires Pro #1
    • Con: Bank of International Settlement’s very negative view

 

 

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