Bitcoin Maximalism is Rubbish

bitcoin

Ever since the the launch of the first altcoin (alternative coin, as in alternative to Bitcoin), prior to the invention of the label “Bitcoin Maximalist,” there have been people opposed to the idea of multiple blockchains. At first they claimed that there can only be one blockchain. Their argument usually was that the invention of the Bitcoin protocol was analogous to the invention of the TCP/IP protocol which is the backbone of the internet. Therefore, just as TCP/IP was the first and only protocol to be used in what later became the internet, despite there being superior protocols invented afterwards, bitcoin will be the only protocol that will be used because, like TCP/IP, it had first mover advantage.

The first mover advantage would help the Bitcoin protocol achieve such a large network effect that it would make other blockchain projects redundant. If someone had to use a blockchain, that someone would use Bitcoin because it was the most widely used blockchain and blockchains are only meaningful if other people use them. It does not matter that competing blockchains may offer superior technological innovations because those innovations could be incorporated into the Bitcoin protocol thus rendering the competing project redundant.

The problem with this argument is that it’s based on an incorrect analogy. The Bitcoin protocol does not provide a service analogous to the TCP/IP protocol. The TCP/IP protocol is generic and trivial to use. Meaning that it can be used to transfer any type of information and no single transfer of information is significant to the network, thus not having any value. The cost of changing to a new protocol is higher than the cost of developing better hardware and software to work with the current protocol. On the other hand the Bitcoin protocol is very specific and its use nontrivial. One can only transfer bitcoins through the network and each transfer is significant enough that it requires other users to validate that network event (the bitcoin transaction). Thus every event is costly to the network and it may be cheaper to use a different protocol. In addition the fact that Bitcoin’s protocol is specific opens Bitcoin to competing projects with different protocols that satisfy users’ needs that Bitcoin cannot satisfy.

Although, there have been efforts to make the Bitcoin protocol more generic, such as the Mastercoin project and the Counterparty project, the Bitcoin protocol has been proven to be highly inefficient in performing the types of transactions a more generic project could offer. On the other hand were a more generic protocol be created to serve primarily to transfer tokens, as Bitcoin does, it would pale in comparison to Bitcoin. The network would be clogged with the amount of information having to be processed with every transaction, not to mention the rapid growth its blockchain would experience in terms of memory, i.e. Ethereum. For this reason it is not sensible for Bitcoin to adopt features offered in other blockchains, as Bitcoin’s performance limitations are not an accident but intentional by design.

When encountered with these facts some of the proponents of Bitcoin Maximalism argue that some of the features offered by other blockchains should not even be used by any blockchains at all. Their argument is that if a feature cannot be adopted by the Bitcoin protocol, it does not make sense at all in the realm of blockchain technology. Therefore, it cannot be considered an improvement on blockchain technology. The problem with this argument is that it assumes knowledge of the full impact of blockchain technology on society. It assumes full knowledge of the future, something no one is capable of. Prior to the creation of Google, searching the internet was considered a solved problem. In the 1990s no one had envisioned the rise of online social networks or the sharing economy. Microsoft was expected to rule the world. Therefore, while someone can make educated guesses on what is or what isn’t an improvement on blockchain technology, no one really knows what it is. Only the market will tell which features of new blockchains are improvements because they fulfill a need among the people that use them. This is evident in Ethereum’s rise as the default funding platform for new blockchain projects, overtaking Bitcoin’s place through the Counterparty and Mastercoin platforms back 2014.

Although no one can really tell what the future will be like, given the large potential impact blockchain technology can have on society, one thing is certain, Bitcoin will not be the only widely used blockchain in existence. In addition it is most likely that Bitcoin will not be the most widely used protocol given the limitations of its design. At this point in time Bitcoin is ancient technology with even Litecoin (a long time competitor) being significantly ahead of Bitcoin technologically, having already implemented Segregated Witness, something that may or may not happen for Bitcoin. A most likely future scenario is one of multiple blockchains specializing on different services with some competing against each other in the same service space and some dominating their service space. Bitcoin, however will no doubt remain as one of the most well known blockchains in existence for being the first of its kind, and therefore may still be widely used.

Decentralization vs Centralization

decentralization

One of the main arguments in favor of bitcoin has been its decentralized architecture. The fact that no single entity can have control over the network was a feature that was celebrated by supporters of bitcoin and used as an attack against the current monetary system and blockchain projects that were not fully decentralized such as Ripple.

While decentralization certainly has its benefits, such as an increment in network resilience because there’s no single point of failure, it also comes with the drawback of longer transaction confirmation times. It is much easier to get one hundred nodes to agree on the state of the network than one million nodes. This drawback is becoming more evident in Bitcoin with the amount of time it takes now to confirm a block (a group of transactions) having at times more than doubled compared to a few years ago despite transaction rates remaining mostly under 10 per second, a far cry of the 2,000 transactions per second Visa handles on average. A solution to this problem used by most miners supporting the network is to increase the transaction fees. However, this is not a real solution to the problem of network scalability since it does not address the problem of handling much more than 10 transactions per second, since higher fees lead to a lower number of transactions being processed. In addition, the higher transaction fees make bitcoin less competitive against traditional online transaction methods especially during times of rapid appreciation in the value of bitcoin. Therefore, unfortunately the full decentralization feature of bitcoin renders the project’s goal of becoming a global currency unfeasible.

That decentralization increases the time a network takes to reach consensus is a well known fact that extends beyond the subject of technology. Most modern democracies use a representative system in their legislative process where a citizen is assigned to represent the interest of a large group of citizens instead of having every single citizen participate in the legislative process. While a complete dictatorship would be the most efficient way to create new laws, it fails to protect the state in the event of a less than capable dictator. A democracy on the other hand diminishes the risk of bad actors in the legislative process, but also increases the time it takes to create new laws. Therefore, a representative democracy serves as a compromise between the two extremes. That compromise is seen in different parts of the organization of modern societies. For example, instead of every participant in society specializing in every single field of value to society we rely on different people that specialize in a single field (medical doctors, lawyers, engineers, bankers, etc.) to help us achieve our goals. Supporters of full decentralization would have us believe that this is terrible for society, yet society has progressed in every way imaginable under the current system. Having every single member of society become an expert in every single field would be unfeasible and highly inefficient. No one can be an expert in everything and it is better to be an expert in something than a mediocre in everything.

Therefore, blockchain projects that do not fully decentralize their transaction confirmation processes like Ripple are not counter to the revolution being brought on by blockchain technology. Instead, they are the future of the blockchain industry if it is to extend beyond its niche number of users. The benefit of blockchain technology is not full decentralization but the lower barriers to entry to provide certain services. Its self regulation through algorithms renders much of the legal framework in existence for the systems it tries to supplant obsolete, thus generating big savings for society.

What Kind of Assets are Cryptocurrencies?

cryptocurrencies

In the previous post I claimed that cryptocurrencies, at least most of them (including bitcoin), are not currencies although they are assets. Therefore, from now on I will stop referring to them as cryptocurrencies and call them cryptotokens, since I think the word token describes better not only their utility but also their properties as an asset class and does not exclude other projects that can actually perform as currrency.

Many people have pointed out how bitcoin, ethereum, ripple, etc. have equity like properties. For example, if bitcoin gains mass adoption, the price is expected to go up to match the price required to satisfy its utility with its user base. This is analogous to the price of a stock going up as a company’s earnings increase which usually require an increase in their customer base. However, the flaw in this analogy is that ownership of a cryptotoken does not provide any of the legal rights that are often afforded to the owners of equity in a company. To make matters worse for investors concerned on the legal ramifications of their investments, cryptotokens exist outside of any regulatory environment. While there have been efforts by several countries to pass laws to limit their citizens’ use of cryptotokens to avoid currency controls, such as in China, the fact that there is no actual legal entity standing behind cryptotokens other than the entire user base makes cryptotokens impossible to regulate without the state cracking down on its population in a manner reminiscent of a dystopian novel. While an argument can be made for the development teams behind a project as holding legal accountability for investors in their projects, once the project is live and the cryptotokens are being traded, the development team is not as relevant anymore, a different development team can fork the project and take the development of the cryptotoken in a different direction as it happened with Bitcoin Unlimited and Ethereum Classic. It is really up to the user base to decide which blockchain they will support. Therefore, the user base is the ultimate holder of leverage in the life of a cryptotoken and for that reason the user base is the ultimate holder of legal accountability regarding the value of a cryptotoken. Although, there may be in the future regulations introduced that afford some legal rights to owners of cryptotokens issued by a company where such company exists outside of the blockchain where the cryptotoken exists and those rights make the company legally accountable for the investments of cryptotoken owners thereby turning said cryptotokens into securities, until then most cryptotokens in existence are not securities and for that reason cannot be considered equity.

Detractors of cryptotokens have often pointed out the fact that cryptotokens lack legal backing despite performing like equity in a company as evidence that they are a scam since as the user base grows they become more valuable solely for the sake that there are more users. However, this type of thinking is due to a failure to understand what cryptotokens really are and the utility they provide. A better description of what cryptotokens represent are rewards points like those issued by credit cards or the loyalty programs of some businesses that can be used to pay for products or services offered by a business. In the case of cryptotokens however the business is not a brick and mortar entity but the network on which the cryptotokens exist whose service is provided through the algorithm within its blockchain. This company does not have any legal persons working in it and therefore it is considered a Decentralized Autonomous Corporation/Organization (DAC or DAO for short). The value of the service that this DAO provides to the public is measured in the value of its cryptotokens which go up in value as its services become more valuable to the public at large since you need the cryptotokens to access the DAO’s services just like rewards points offered by a small business would also become more valuable if the value of their services increases in US dollar terms but not in terms of their rewards points. Therefore, according to this terminology Bitcoin is the first DAO ever created with its service being the most basic of services possible with a blockchain, that is transferring information securely and with guarantees that it is not forged without the need of a middleman. Effectively solving the Byzantine’s General Problem.

While blockchain technology can be used to represent national currencies, or other well known assets like stocks, real estate, commodities, etc. it is currently being used to represent rewards points used to purchase the services of DAOs which are not much different than using rewards points to purchase products or services at your favorite shop. As a matter of fact rewards points of existing companies themselves are arising as a new asset class independently of the advances of blockchain technology with an expected value of $500 billion by 2019. There are even institutional investors such as hedge funds seeking exposure to them through new exchanges like the Affinity Capital Exchange (ACE). ACE is even planning to use blockchain technology to trade the products listed in its exchange. However, the difference between the majority of cryptotokens such as Ethereum or Bitcoin and the rewards points of loyalty programs of existing companies is that the companies behind the majority of cryptotokens are supranational decentralized entities called DAOs, that are virtually impossible to regulate. Therefore if one wants to classify cryptotokens as an investment vehicle, that investment vehicle is rewards points which has been in existence prior to the invention of Bitcoin, although not previously available to retail investors. However, the technology behind cryptotokens has actually created a new asset class, the DAO. One can seek exposure to DAOs, through cryptotokens that function as loyalty programs or mining equipment that verifies transactions in a DAO’s network, the latter being similar to fixed income products like preferred shares that pay out in the loyalty program tokens of the DAO while given the owner control over the network proportional to his ability to verify transactions.

Therefore, despite there being new blockchain projects every day, it is important to distinguish whether the cryptotoken being offered is giving exposure to a new DAO or the services of an existing physical company or companies (i.e. potcoin), because the latter would just offer exposure to loyalty programs of old fashioned companies, an asset that has already been in existence, whereas the former is giving exposure to a completely new asset class that has only been possible thanks to the internet.