Before I scare everyone off, I do not mean to say that Bitcoin itself is doomed to fail. What I am referring to is that I believe the implementation of blockchain solely as a currency is destined to be far less successful than the world believes it to be. This includes the likes of Litecoin and Dash, and less so privacy based ones like Monero and Zcash. The reason I believe this lies in the value proposition of blockchain itself. To start, let’s breakdown what a blockchain really is.
Data Structure > Consensus Layer> Incentive Model
At its core, blockchain is nothing more than a novel structure for storing and interacting with data. The incentive layer is merely a mechanism designed to keep the consensus layer and data structure intact. Its potential to transform the world lies only marginally in its ability to store value, and far more in its ability to link together computers. Let’s look at the tradeoffs of bitcoin vs. a traditional currency.
- Inflation — Many proponents of bitcoin cite its deflationary component as a strong advantage, but it also has significant downsides. Bitcoin inflation cannot be controlled and as such is lower than other currencies. However, it still has inflation, it is simply lower. At some point this means that bitcoin will appreciate in value due to the growth of value created on the platform outpacing its inflation rate (assuming that bitcoin has already fully penetrated its use case, obviously bitcoin is a speculative asset today and has blown up despite virtually no mainstream payment use). This, however, has never been the purpose of an actual currency. Currency is a base layer of the economy, we don’t put our money in it expecting returns, we put our money in it so that it can be easily spent. If we want to gain a return on our assets, we put it in other financial instruments. Is bitcoin supposed to be the ultimate be all end all financial instrument that just creates unlimited wealth for everyone? Regardless maybe it is a slight value add that you gain money by keeping it in an appreciating version of cash, it simply is not enough of a disruptive force to gain widespread adoption because we have other versions of this that achieve the same goal already. This aspect of bitcoin also has significant drawbacks. In a world run on bitcoin, government bailouts cannot exist. The 2008 recession would have turned into a depression without the US government’s ability to essentially cover the losses of large financial firms by taking a little value out of each dollar in circulation. Increasing the money supply may not be a perfect system, but it does allow a certain amount of liquidity in crisis events that would not exist with Bitcoin. Even in a world where the US Government would have thought of using its own stash of Bitcoin to prop us AIG, it has significant disincentives to do this because unlike the US Dollar, it appreciates in value, thus making the losses not only immediate but also spread out over the future.
- Lack of central control — Proponents of bitcoin also say that the lack of central control empowers the individual to own his own money. No entity has the ability to seize control over her or his assets for any reason, which makes it much safer to own. First of all, this is a myth. As John Locke put it, we have entered a social contract with our government and endowed it with dominion over us in exchange for enforcement of individual rights. Aside from theory, what this means in practice is that governments can do whatever the hell they want to. In some respects they can’t actually take it from you without your ultimate consent, but they can apply virtually unlimited amounts of pressure to get you to do so for them. The limits of this pressure are exclusively bound by the brutality of the country you happen to be a part of, ergo **this is least effective in the places that need it the most.**The lack of central authority also has significant downsides to the legal ramifications of money. In the event of a death where the will is written out to someone’s children, but nobody has the private key, what do you do? In the event of a Bernie Madoff scandal where Bernie instead took all of his thefts and put them into bitcoin, how do you recover that? If there is a lending platform on bitcoin that faces uncertainty, how will it handle a bank run without FDIC insurance? The lawlessness of bitcoin can be seen as a good thing, but it also has a hint of anarchy in that it almost seems like it despises the governments we’ve created. Obviously this makes sense in corrupt countries, but in countries where the rule of law is sound and successful the technology already exists to perform every function that bitcoin performs. I can make feeless transactions with Venmo, I can invest in stocks to earn a return, and why would I do any of this without the ultimate fallback of the US court system to protect my money?
- Single point of failure — Another theoretical benefit of bitcoin is its lack of a ‘single point of failure’ allowing it in theory to be more secure than holding your money in a traditional bank. This is a facade and it envisions some kind of apocalyptic scenario in which all bank data is erased or someone goes in and manually changes your dollar figures. First of all, most large banks are supported as SIFIs by the government, which have already proven to be too big to fail. Make whatever value assessments you need to about this, but also remember it is likely that the government would have the exact same responsibility regardless of the type of currency used in the economy. In terms of the manually changing dollar figures, I have no statistics on the matter so I can’t argue too strongly that it doesn’t happen. All I can say is I’ve never heard of anything like it and any bank participating in practices such as these would most likely lose their entire customer base.
All this being said, the ‘disruptive potential’ of bitcoin is slim to none. Today, it is essentially operating on a wave of mass hype due to the ridiculous gains it has seen as an asset class, and has been struggling to perform the exact activities it was designed to perform. Once it can actually execute feeless transactions and contains a more complete scripting language, then maybe we can talk, but for now it is emphatically a worse economic system than the one we have today. So then the question becomes, if not currency, what is blockchain good for? My main thesis in this respect boils down to a couple arguments.
- The incentive layer should be restricted to incentivizing correct participation in the network — This means that the dollar values ascribed to the value of the token are exclusively valued to a particular asset which you need to purchase. In Ethereum, Ether is worth the purchase of computing power on the network, in Filecoin the asset is tied to the value of the network storage hardware, etc. Bitcoin trying to be the be all end all store of value is cool in principle but has no disruptive potential i.e. reason that people would want to use it. It is this circular logic that says as more people use bitcoin it is more likely to become a widely used currency and will appreciate in value because more people are using it, but if there is no reason to use it in the first place then all the value accumulated from people joining the network to get profit is a sham. What tying the incentive layer of a blockchain to an asset does is a) give a more clear picture of the valuation structure of a blockchain and thus decreases volatility of the asset and b) improves the performance of the protocol itself as developers are incentivized to make the protocol as production ready as possible so that the most possible people use it and it has the most disruptive potential. In bitcoin this has been a significant problem as we have seen core developers neglect proper performance of the network in order to profit off of their personal scaling solutions (lightning network / blockstream conflict of interest) instead of profiting from the increase in value due to the widespread use of the network. Were bitcoin tied to say the net cost savings of using the network over alternative money transfer mechanisms, the developers would have had no problem increasing the block size (obviously this ignores the decentralization aspect, but it would have been far less contentious).
- Blockchain will commoditize everything— When you have this network of computers all correctly incentivized to perform specific tasks, what this gives you is a computing platform in which nobody has pricing power. This is a beautiful thing, because all the tech companies today have pricing power and they use it mercilessly. The blockchain essentially drops all price of computing to commodity levels, but only for applications that you can program into a blockchain, which I suppose is theoretically all of them. The core innovation of blockchain is that previously when we created these peer-to-peer networks we had no way of telling who was cheating and who wasn’t, which means you couldn’t put money on top of it which means you can’t incentivize correct participation. The blockchain says these are the rules of participation, this is how you check if people are participating properly, and this is how you take advantage of other people who are not participating correctly and take their money. By following this line of logic, those who create the most efficient rules of participating properly and target the markets with the highest amount of pricing power will create the most value in the future. This doesn’t just apply computing resources like bandwidth, file storage, and CPU time. This also applies to physical assets that can be ‘proven’ in the blockchain. As an example of this take Power Ledger, a token trying to create an economy of energy. If Power Ledger can create a way to prove that energy was transferred from account A to account B, then they can commoditize energy. It’s much more difficult than computing power, however, because the internet does not exist for power transfer in the same way it does for information. We do not have the ability to send anyone power, and create our own power that we can sell off if we have excess the way we do with computing resources. This is where the future of blockchain exists, and the algorithms and infrastructure requirements behind it are going to blow our minds.
Conclusion
Bitcoin is the most primitive implementation of the blockchain, which follows logically from the fact that it was the original. This does not by any means imply that it can’t evolve to be a successful currency, it only means that it utilizes the key innovations of blockchain in the most rudimentary fashion. Blockchains are networks in which an unlimited number of people can participate and correct participation can be efficiently measured. This can be applied to currency, but it simply does not differentiate itself enough as a product. What will truly be the key value creator of blockchain is its ability to inject massive supply into markets that currently are dominated by players with pricing power.