Why Bitcoin is Different than other Cryptocurrencies
In my last article, I discussed how the market cap of many altcoins is deceiving as recently, there’s been a large run-up in the prices of a lot of altcoins. In this article, I seek to show how and why Bitcoin is different than all the other altcoins that exist.
How People Progress in Bitcoin
Having been involved in Bitcoin for a long time, I’ve noticed that there’s a pattern to how people think about Bitcoins as they discover more and more of the ecosystem surrounding it. Usually, the thoughts go something like this:
- Wow, Bitcoin is amazing! There’s a limit to how many will ever exist and significant control over my own money. How do I get some?
- Mining sounds really cool. That sounds like where the money is going to get made. How do I get miners and start making some Bitcoin?
- Mining looks really hard and difficult. I guess it’s better if I just buy it. Now where can I go buy some?
- Awesome, now I own some Bitcoin, but what are all these other coins? Are they going to take over sometime?
- I want to hedge against Bitcoin self destructing somehow. Maybe I should buy some of these altcoins.
- I can’t possibly look into every altcoin there is, there’s just too many of them. How do I choose?
- I know, I’ll just buy the most popular ones since they’re probably the most likely to have any chance at all of beating Bitcoin anyway.
- Hmm, but the popular ones look pretty expensive. Maybe I’ll buy some of these other ones that are just starting.
Many people stop and stay at a particular step. For example, I know many people that have never bought Bitcoin but have simply mined all the Bitcoins they own. They’ll gladly spend thousands on mining equipment but would never actually buy Bitcoin on the market. There are others that stay on the Bitcoin step and never proceed to look into altcoins. There are still others that hedge with pretty much every altcoin out there. Point is, that this pattern of looking for the best way to take advantage of this new innovation progresses in a predictable way, but different people are convinced by different things.
Why People Buy Altcoins
Mostly, people get into altcoins as a way to hedge against Bitcoin. Here are some common reasons for someone to hedge with altcoins:
- Bitcoin may have some catastrophic failing that the altcoin is not subject to.
- An altcoin may have some future utility that is significantly better than Bitcoin allowing the altcoin to overtake Bitcoin.
- Even if Bitcoin continues to be the most valuable cryptocurrency, there may be room for altcoins to serve some other niche and hence may not be bad bets in their own right.
Let’s examine each reason.
There are several ways in which Bitcoin could die catastrophically. The first would be a technical flaw (for example, a bug that would allow someone to steal coins). The second would be an economic flaw (for example, a code change that would instantly give 10 million coins to some entity for some reason). The third would be a consensus flaw (for example, Bitcoin splits into two roughly even coins).
A technical flaw would be something like a vulnerability in the cryptography used by Bitcoin or some security vulnerability in the consensus code that could be exploited. A cryptographic vulnerability (such as a clever attack against the particular elliptical curve used in Bitcoin) would naturally extend to a lot of other coins as many use the same exact same crypto libraries. A security vulnerability would again naturally extend to a lot of other coins as many use a lot of the same code.
Regardless, it’s worth asking the question of what would be the consequences if something like this were to happen? First, if the vulnerability is caught early enough, most likely Bitcoin would patch and perhaps fork very quickly to reduce exposure to the vulnerability. Indeed something like this has happened before and a fork was exactly the reaction of the community.
The more interesting question is what happens if the vulnerability is caught much later. Very likely, this will cause a huge drop in price, not just of Bitcoin but pretty much every other altcoin out there as confidence that cryptocurrencies in general can be trusted would be shaken. After all, how can we know an undetected vulnerability isn’t in every altcoin as well?
An economic flaw would be changes to the economic rules of Bitcoin itself. This has never been done nor discussed in Bitcoin. What we do know is that Bitcoin requires strong consensus for changes and changes of this nature cannot be done without support of almost all of the community as the recent scaling debate has shown. Such catastrophes are generally prevented a priori.
That said, preventing technical and economic flaws requires a talented, dedicated and trustworthy development team and the risk being hedged against. Of course, the same risk exists in altcoins and it’s worth pointing out that Bitcoin is one of the few cryptocurrencies that has a natural hedge against degraded development in the form of alternative clients.
The final flaw is perhaps the real reason to actually hedge. The scaling debate has shown that there is at least some appetite in the community for a permanent split. There have been suggestions of doing a User-Activated Soft Fork or a consensus-busting feature being activated. Both are symptoms of the fact that Bitcoin really doesn’t have a leader and isn’t authoritarian. Most altcoins have a creator who acts as the de-facto benevolent dictator for their altcoin. The fact that Bitcoin doesn’t is the risk. Of course, not having a benevolent dictator for life is a feature as well since there’s less economic flaw risk.
Most altcoins have some technical difference compared to Bitcoin and that is often the reason given for why people invest in them. The reasoning is that since these altcoins have much of the same utility of Bitcoin plus something else, the altcoin can be more useful than Bitcoin and thus take over.
In one sense they’re right. If you have a lot of the same technical properties, of course an altcoin existing in a vacuum would do about as well as or maybe even better than Bitcoin existing in a vacuum. Even if the code bases are substantially different but the economics very similar, they likely have the same effect in a vacuum.
Of course, we don’t live in a vacuum and the existence of Bitcoin affects the future utility. A feature shown to be useful is very likely to be adopted into Bitcoin itself in one form or another. Thus far, most features that differentiate altcoins haven’t been proven to be that useful and thus haven’t been added to Bitcoin.
Should an altcoin show usefulness, there are a couple of ways that Bitcoin can add the same utility. First is that Bitcoin can add the feature itself if found useful enough. An example is confidential transactions which is being proposed in a sidechain to Bitcoin. Certain features, however, may conflict with Bitcoin’s current use-cases. For example, Bitcoin is an excellent store of value and features that add a larger attack surface are likely not to be added without really good justification. This is where the second way to add utility to Bitcoin comes in. Entrepreneurs can add similar functionality while making a profit themselves. Given that consensus is very hard to change, the latter seems a much more likely path by which useful innovations will find their way to Bitcoin.
In other words, not only do altcoins have to compete with Bitcoin itself, but they have to compete with all the entrepreneurs looking to build something on Bitcoin. Hence while hedging may make sense in some aspects, the more likely outcome is that Bitcoin in one form or another will consume other use cases nullifying any advantage than an altcoin might have.
Certainly, many altcoins have tried to carve out niches for usage. Dogecoin, for example was built on tipping each other and transferring value, often just for the sake of transferring value. Ripple was originally conceived as a way for banks and large institutions to transfer value.
The main way a niche coin makes sense is if it can do something that Bitcoin can’t or won’t do. What Dogecoin quickly found out is that Bitcoin tipping is just as easy. You may argue that this will be a problem again due to tx fees in Bitcoin and perhaps Dogecoin has a role to play going forward, but Dogecoin tipping was never really on-chain to begin with and neither was Bitcoin tipping (changetip was a centralized service). Should tipping come back into fashion, this is something that the Bitcoin ecosystem can easily do. Banks transferring value to each other can do that with Bitcoin.
Niche usage is similar to the future utility argument except on a smaller scale and the same argument applies. Entrepreneurs have every incentive to bring similar, profitable innovations to Bitcoin given the larger user base to work with.
What Makes Bitcoin Different
The main advantages of Bitcoin are network effect and proven security. Both are nearly insurmountable advantages.
Bitcoin has a proven usage case as a store of value. It’s instructive that most coins try to carve out some differentiation based on much smaller use cases, such as prediction markets, buying things completely anonymously or adding a decentralized name server.
Bitcoin has a large lead as a store of value over every altcoin in having existed 8 years without failure. The security of Bitcoin has been proven far more than its much younger counterparts with usage by almost every metric exceeding that of altcoins.
Further, Bitcoin is more accessible, with more exchanges, more merchants, more software and more hardware that support it. Bitcoin is far more liquid, with much larger volumes than every altcoin. Bitcoin has the largest developer ecosystem with more software and more implementations than any altcoin. Bitcoin has the most entrepreneurs creating companies around it with a lot of intellect, dedication and creativity going toward making it more useful.
When you compete with Bitcoin, not only are you competing with its much larger user base, development team and mining operation, but you’re also competing against the very large ecosystem of startups, open source projects and entrepreneurs.
To make this clearer, imagine I create a coin for email spam filtering. Let’s call this altcoin SpamCoin. It’s an altcoin that lets you message someone only if you pay them some SpamCoin. Suppose this actually turns out to be very useful and lots of people start using it, making SpamCoin more valuable. What would happen?
It’s unlikely that Bitcoin would add SpamCoin’s features in directly (though with sidechains, I suppose you can’t even rule that out). But there is a strong possibility that some entrepreneur would create a similar service based on Bitcoin. They would have a much larger potential user base to start from and you wouldn’t need SpamCoin to use it. The barrier of entry would be less, the user base more, so in the end, the new Bitcoin service would have built in network effect advantages that SpamCoin wouldn’t have.
That’s not to say SpamCoin can’t win, but it does face longer odds.
This is not to say that altcoin investment is bad. Each investor needs to evaluate their own risk vs. reward ratio and decide whether that’s a good fit for their goals. What is clear is that altcoins are actually not a great hedge against Bitcoin. Much of the same risk exists in the altcoin and much of the potential rewards consumable by Bitcoin.
It’s possible for an altcoin to take over Bitcoin, but it would have to show far more (present, not future) utility first and be able to grow itself to be competitive with Bitcoin’s network before the Bitcoin ecosystem has a chance to add the same feature.
As Bitcoin evolves, we can expect Bitcoin to grow in unexpected ways as new utility is found. Bitcoin owners can expect that its usefulness will only increase over time. In contrast, altcoin owners have substantially more risk of the coin falling into disuse.
In other words, Bitcoin has already lapped the field and has the ecosystem and the resources to compete with significant advantages. Bitcoin has two things going for it that help significantly in this respect. Stability and entrepreneurship. Both far exceed that of altcoins thus far and will make catching up very challenging.