Transaction tech can’t compete with savings tech, pt 2
I n Part 1 of this two-part article series, we discussed how different forms of money compete and win. Using thought experiment, economic theory, and history, we concluded that the ultimate deciding factor is a money’s attributes conducive to holding trade value over time—its effectiveness as a medium of exchange. Attributes conducive to participation in exchange itself are much less important, despite what many might assume. Next, we will apply this conclusion to the idea of investing in new forms of money, particularly in the current environment of thousands of new cryptocurrencies.
Investing in a new form of money
When someone invests in a new form of money, they are speculating that the value of the money will increase, especially relative to the currently dominant form. Assuming a fairly stable monetary supply—which is likely a prerequisite for any rational speculation of this nature—an increase in value must come from increased demand for the new money.
Demand for the money in what sense? Demand for transacting with it? Demand for using the money in active exchange?
No!
Demand for holding it, as a medium of exchange. The value of a money is supported entirely by its holders—by people who want to use it as a savings mechanism to preserve trade value over time.
Pandering to the savers
It doesn’t matter how great the features are for transacting, if nobody wants to hold a form of money, then it will be worth absolutely nothing.
Consider a hypothetical money that nobody wants to hold. A customer trying to spend this money would need to find a merchant who already knew about another trade partner to pass it off to, and that trade partner would need to already know another person to pass it off to, who would need to already know the next person, and so on. The chain of predetermined transactions would need to be infinite if it never ended in someone who wanted to actually hold the money, and thus a chain like this could never come to exist in the first place. Despite the great features for transacting, a transaction could never even occur.
“The initial price of bitcoin was caused by people who wanted to hold it, not people who wanted to spend it. Furthermore, each subsequent step in Bitcoin’s advance must begin with more holders, not more spenders. [… Bitcoin] can only achieve [a higher value] if the peoples’ desire to hold bitcoins continues to increase faster than their desire to spend them.”
— Daniel Krawisz, I’m Hoarding Bitcoins, and No You Can’t Have Any
Therefore, it should be clear that anyone considering investing in a new form of money should be spending their time and focus on whether or not the money offers the most desirable features for those holding it, not necessarily those transacting with it. If it can surpass all alternatives in terms of pandering to holders and savers, it should eventually win the monetary competition and become the most dominant form of money.
This isn’t to say that developers should make no effort to improve the technology for facilitating transactions. However, the focus of these developers ought to be on improving transactions for the money that people want to hold. Not for a proposed form of money that is less desirable to hold, because that money will fail to win in the end.
Transaction technology can’t compete with savings technology, it can only complement it.
Why altcoins don’t surpass bitcoin
Bitcoin is, and has always been, the cryptocurrency with the most desirable attributes for preserving value across time. It protects holders from dilution via a fixed supply that is enforced by a global network of tens of thousands of computers, and it secures transactions with over 100 terawatt-hours of energy. Whereas every alternative cryptocurrency (also called an altcoin) has a smaller, weaker network of participants and energy. This results in lower levels of decentralization, less resistance to fundamental changes being made to the protocol infrastructure, and more susceptibility to potential attacks. From the perspective of savers, these risks attached to altcoins are frankly unattractive, whilst bitcoin exists as an option that offers them a far more credible array of protective attributes.
Promoters of altcoins have no choice but to deflect attention away from saving and toward spending. They will scoff about bitcoin being inconvenient for transactions, a problem which happens to be solved by some particular altcoin. You will hear “my altcoin has faster transaction speeds than bitcoin” or “my altcoin can do more advanced smart contracts than bitcoin.” They will even try to frame a disadvantage as an advantage: “my altcoin uses less energy than bitcoin.”
"Psst, hey sonny, come here. You wanna buy an altcoin? This one here will be like bitcoin, and make ya rich."
But as we’ve covered, none of these marketing tactics are relevant in the grand scheme of things. An advanced smart contract sounds great, but not if the contract is denominated in inferior monetary units. A faster transaction sounds great, but not if the money received is of a more precarious quality.
If we grant that some random altcoin is better than bitcoin at transacting, but recognize that it is worse than bitcoin at being held over time, we run into the same problem as “the hypothetical money that nobody wants to hold” described in the previous section. There is an opportunity cost for all of the time spent holding the altcoin instead of bitcoin, and therefore all rational actors should want to hold the altcoin for as little time as possible. If the altcoin were received in a transaction, the recipient would want to trade it to someone else as soon as possible so that they can be holding bitcoin instead. In a world full of rational actors and devoid of gullible folk, the value of this altcoin (and all other altcoins) would drop to zero against bitcoin, so long as bitcoin remains the best option for holders and savers. In the real world, this should also be expected to happen, but less immediately.
Krawisz’s assessment of altcoins
Much of what needs to be said about altcoins has already been written ten years ago by Daniel Krawisz. Three articles in particular serve as a comprehensive smackdown of any notion that altcoins are a sound investment, that altcoins can coexist with bitcoin long-term, or that altcoins are morally acceptable. I consider them essential reading material—while the details may be imperfect, the main point has been vindicated in the decade following. Bitcoin remains the top cryptocurrency by a substantial margin, and the mortality rate of altcoins created between then and now exceeds 99%.
The following are some select quotes from these articles. First, from The Problem with Altcoins published on August 22, 2013:
“What is a cryptocurrency actually for? I say that its purpose is to become money. It is obvious that creating altcoins impedes that purpose. Altcoins can only be explained if we believe the purpose of cryptocurrencies is to make money rather than to become money. If you can trick people into investing in your new altcoin, then you can make a profit trading it or mining and selling it. All the arguments of the altcoin promoters serve as misdirection from that basic purpose.”
— Daniel Krawisz
Next, from The Coming Demise of the Altcoins (And What You Can Do to Hasten It) published on March 14, 2014. I’ve applied color to the quotes within the quote, hopefully making it a bit easier to parse.
“As investors look at a new altcoin that has come out, they might think to themselves, ‘This cryptocurrency network is innovative, perhaps this means it will do well.’ They might buy in at that point, or they might think a little harder and continue, ‘But wait. Bitcoin has the much larger network and is therefore objectively more useful as a currency than this new altcoin, despite its innovative features. […] No reasonable person would expect this coin to have any but a small chance of success. But since it can only succeed if lots of people really believe in it, this ensures that it cannot be successful because if no one buys more than a small gamble, then its failure is virtually guaranteed.’ If they stop thinking there, they will stick with Bitcoin.
However, they might also think something along the lines of, ‘It’s quite possible that this altcoin will have an extra jolt in price during the next Bitcoin mania because some people may buy it either because they were not intelligent enough to follow the same train of thought as me or because they too, like me, realize that it may attract people who can be preyed upon. However, that is a risky proposition because it will be hard to know if I am the one preying upon suckers or if I am a sucker myself.’ They will then either buy it or not depending on their own confidence in their ability to predict the behavior of foolish people.
Thus, altcoin investment ends up as a dynamic interplay between people who have not thought very far ahead, and people who think they are taking advantage of other people.”
— Daniel Krawisz
And another section of the same article:
“I don’t object to altcoins in themselves. What I object to are the lies. […] If you tell me this altcoin implements some cool new idea, then very well. But if you tell me it’s going to be the next big thing and that it’s a great investment, you’re lying. And if you believe it yourself, you’re lying to yourself.
The only reason that an altcoin should have any value at all is as an extreme speculation on the death of Bitcoin. Although it is impossible for an altcoin to beat Bitcoin on its own merits, it is theoretically possible that the Bitcoin community could destroy Bitcoin through its own foolishness. If that possibility should loom, then altcoins can do a valuable service by going up in value, thus alerting the Bitcoin community to reverse whatever it is doing.”
— Daniel Krawisz
And finally, from Appcoins Are Snake Oil published on May 24, 2014. For your reference, an “appcoin” is an altcoin that alleges value by being the only acceptable payment for an associated application. Similar to an arcade token, or a gift card for a store that only accepts gift cards.
“Not everyone buys [an] appcoin to interact with the [application], of course. Some buy it as an investment. However, after understanding the economics described in this article, investors will no longer be so innocent as to see value in an appcoin. An investor could not ultimately expect to make a return on an appcoin given that there is an incentive to disconnect the coin from the app. Once that happens, the appcoin is simply another altcoin.
[…] The only reason they can be used now is that the [issuances] are not yet generally understood to be a scam. However, that is precisely what they are. It is grossly unethical to sell something which adds no value and which can be expected, always, to become worthless in the end.”
— Daniel Krawisz
Unfortunately, a few years after writing these pieces Krawisz fell on the wrong side of some splits in the bitcoin community, also called forks, which we will discuss more a few sections below. For reasons unclear to me, he has never repented, and I can’t recommend readers toward his more recent ideas.
Altcoins are not friends of bitcoin
Altcoins can’t end well, and therefore their timelines are plagued with inevitable misfortunes. When these occur, the bitcoin maximalists (bitcoin advocates who understand why altcoins are bad investments) will sometimes react in a celebratory manner. In turn, the altcoin enthusiasts tend to recoil in bewilderment. They will ask: “how can you celebrate? Can’t you see we’re all on the same team? We are cryptographers and cypherpunks, trying to put an end to the fiat monetary system. How can you be so narrowly partisan, tunnel-visioned, and heartless to delight in our misery?”
The fact is, we are not all on the same team. This can be proven by the very nature of the game being played. Investors in cryptocurrency cannot acquire both an altcoin and a bitcoin with the same capital. They must choose to use each portion of their capital for one or the other. Every time someone chooses to acquire and hold an altcoin, they are missing an opportunity for holding bitcoin instead. This serves as a distraction that delays bitcoin’s progress.
Even worse, holding altcoins is not only failing to have a positive effect on bitcoin, but it can actually cause setbacks. As each altcoin inevitably fails, sometimes in spectacular fashion, it promotes the idea that cryptocurrency is inherently risky, scammy, shady, desperate, and immoral. While this notion is fairly accurate outside of bitcoin, most people don’t know to separate the two concepts. Onlookers will tend to become skeptical of bitcoin through false association. The victims of altcoin collapses can also become disillusioned, and think that their error was getting involved in cryptocurrency, rather than the true error of getting involved in altcoins. This then leads to a secondary mistake of avoiding bitcoin.
The whitepaper is problematic
The bitcoin whitepaper changed the world forever. It’s a sacred document, and yet in my opinion, it does a remarkably poor job of highlighting the true importance of bitcoin for curious learners, freshly entering into the subject of cryptocurrency.
The title of the paper is “Bitcoin: A Peer-to-Peer Electronic Cash System.” The main point of the paper was to propose a solution to the double-spending problem, so that digital money could trade hands without trusting a third party. Certainly, this was a revolutionary breakthrough, and a necessary building block for what was to come.
However, for many readers, the title and content of the paper emphasizes bitcoin’s role in payments and transacting. It can lead to the interpretation that bitcoin serves humanity by making transactions smooth and convenient, navigating around traditional credit and banking systems. To this very day, altcoiners point to the bitcoin whitepaper as a way to justify their altcoin, claiming that their altcoin better fulfills this promise and the original intentions of Satoshi Nakamoto.
A fixed supply savings system
As we’ve covered extensively in this article and previously in Part 1, a form of money cannot possibly catch on and survive, simply because it’s convenient to transact with. It must cater to the savers, those who want to hold the money for lengths of time. If bitcoin failed to do this, it would likely be dead by now. It is my view that one of the most important, yet often glossed-over sentences within the whitepaper is the final one:
“Any needed rules and incentives can be enforced with this consensus mechanism.”
Bitcoin absolutely needed incentives—for people to want to hold the coins. It achieved this by implementing a fixed supply of 21 million, which is not even mentioned in the whitepaper! Yet the credibility of this fixed supply is the driving force entirely responsible for bitcoin’s success.
It was the first time in history that humanity could access a reliably fixed supply of interchangeable units for the purposes of money. By far this is the most significant breakthrough that bitcoin offers us. It means we now have objectively the best savings mechanism in existence when it comes to protecting savers from dilution. Combine that with bitcoin’s defense systems of cryptography, distributed nodes, and devoted electric power, and it becomes the best savings mechanism in existence, period. And therefore, also the best form of money, and the form which will ultimately win against all other forms.
If the bitcoin whitepaper could be re-written today as a marketing tool, I would suggest something quite different. People are attracted to scarcity, not peer-to-peer electronic cash. A better title might be “Bitcoin: A Fixed Supply Savings System” with an abstract and body that explains why all other methods of saving wealth are clearly inferior.
It’s possible that if this were the original title, bitcoin would have been noticed by adversaries and attacked much earlier on, at a time when the system was far more vulnerable. Satoshi Nakamoto has repeatedly demonstrated impeccable levels of foresight, and this could be one more example. After all, the fixed supply attribute of bitcoin never needed to be said—it spoke for itself, by sparking an initial demand for the coins, and increases to their value ever since.
Upgrade debates and fork wars
Several times in bitcoin’s history, there have been debates on whether the community should agree to change something about the protocol, or in what way something should be changed. This will likely continue in perpetuity, as proposed changes could benefit certain people.
It has the tendency to become quite contentious, with lots of money on the line. Even minor changes could allow for new business models and services within the bitcoin economy, or destroy existing ones. Tradeoffs must be weighed. If we see bitcoin as one of the most important tools for improving the world, how we treat it can prompt very strong wills and emotions. In the case of a hard-fork, where bitcoin splits into two coins, people committed to one of those coins will eventually lose everything.
In 2015-2017, a clash known as The Blocksize War occurred, culminating in a hard-fork split between Bitcoin Core and Bitcoin Cash. The winner was Bitcoin Core, which is what we just call “bitcoin” today. Bitcoin Cash is worth much less, and continues to fall in value against bitcoin. It was Bitcoin Cash enthusiasts that incorrectly understood bitcoin’s primary purpose to be a convenient transaction tool, citing the whitepaper. Advocates of Bitcoin Cash were willing to improve bitcoin transactions at the expense of weakening bitcoin’s properties of decentralization. Because decentralization is what makes bitcoin’s fixed supply credible, this tradeoff was seen as a negative for savers. Since savers determine the victor in a monetary competition, the final result makes sense.
I believe the lesson here is that any suggested change to bitcoin should be judged on the basis of what it will do for savers. Not necessarily because we should be more fond of savers, but because of the reality that savers are the deciding factor for the implementation of the idea. If a group begins advocating for a change to bitcoin that improves one aspect but is in some way a net-negative to savers, then they should realize that they are wasting their time. The change either will never happen, or the group will split off and create their own form of money which will be doomed to fail.
Conclusion
We now live in a world where money can be transparently engineered, rather than choosing items from the natural world that are not aligned with our needs. Since this field of engineering is novel, it is likewise under-explored, and many people attempting designs have not yet realized basic truths. As demonstrated in these articles, I believe one such truth is this: monetary technology benefiting savers must always take precedence over technology benefiting transactors.
Sometimes a feature may benefit both the acts of saving and transacting, in which case it is clearly a good thing. But if a decision must be made between two opposing paths, the path that better serves savers will always be victorious, and the path that prioritizes to the contrary shall always perish.