What to Consider When Investing in Bitcoin and Bitcoin Cash in 2017
Disclaimer: This article is not intended as investment advice, and only contains my personal opinions. Cryptocurrencies are risky. Never invest more than you can afford to lose. Always seek professional advice before making any investment.
Investing in Bitcoin and/or Bitcoin Cash presents both tremendous risks as well as tremendous opportunities.
In this article, I will explain what makes Bitcoin valuable and outline the history of the Bitcoin scaling debate as it relates to investing. We will look at both Bitcoin Cash and Bitcoin Core, as well as the upcoming SegWit2x, and analyze the various implications and dynamics in play.
It is a Confusing Time for Bitcoin Investors.
Some quick technical analysis:
Bitcoin has more than quadrupled in price since January, with a parabolic growth curve. This is a very tricky thing to handle for investors and traders.
Trends often go on for much longer than anyone expects, making it risky to sell. At the same time, these kinds of markets are often followed by major corrections that burn traders who chase the market.
IF Bitcoin wasn’t the historic opportunity that it is, the best thing to do would be to simply wait for clarity and a more tradable market.
Now let’s talk fundamentals. You may be wondering:
“Why has Bitcoin exploded in value?”
“Will it keep going up?”
“What is this new Bitcoin Cash all about?”
“What’s are these ‘SegWit’ and ‘SegWit-2X’ things I keep hearing about?”
The Initial Promise of Bitcoin
Bitcoin has many properties that make it one of the most ideal forms of money imaginable.
Overall, it is more scarce, durable, portable, storable, divisible, and fungible than fiat (government-issued) money, or precious metals like gold. It is also easier to verify its authenticity and harder to counterfeit than other forms of money.
The bitcoin currency is coupled with a payment system that is faster, cheaper, and more reliable than any traditional payment system. You could send any amount of money, anywhere in the world, almost for free.
Bitcoin’s biggest weakness is that it is not as widely used as other forms of money. Therefore, there is the risk that it may never achieve mainstream adoption. Yet, at the same time, there is the distinct potential that it may. This creates a high risk, high reward scenario and is the reason why early adopters have made a killing.
At this stage, there are still fortunes to be made and arguably it is the best time to invest because there is still a substantial upside while the risk is much smaller than it was 5 years ago. Cryptocurrencies are clearly here to stay. And this is precisely why main stream hedge funds and investors are starting to pile on.
The Bitcoin Scaling Debate
Unfortunately, the promise of Bitcoin (and its fundamental value) is threatened if Bitcoin cannot serve a growing number of users. This threat is already here as Bitcoin has gotten increasingly slow and expensive.
Largely unseen by those outside the inner circle community, Bitcoin has been at war with itself for the past 4 years over how to “scale the network” — in other words, how to increase the transaction capacity to accommodate more users.
While this may seem like old news to those in the know, its extremely important to understand if you’re an investor.
There have been 2 competing schools of thought. One is that aligned with the writings of Bitcoin’s creator Satoshi Nakamoto and his vision of Bitcoin as “peer to peer electronic cash”. This school of thought advocates scaling the network by simply increasing the size of Bitcoin’s “blocks” as needed.
The second school of thought, espoused by the so-called “Core” group of developers is that blockchains cannot scale effectively on their own. They argue that since Bitcoin cannot scale, it should instead become a settlement layer with second tier systems running on top.
Misinformation from the Bitcoin Core Developers
I don’t mean to be impolite, but sometimes the truth offends people.
Although it may be surprising to hear, the unfiltered truth is that the Bitcoin Core group of developers has been spreading misinformation for years and have been complicit in a massive censorship campaign to stop an open and honest discussion of the issues.
This may be controversial, but its highly relevant and I’m here to give you information you can use — not tiptoe around important topics. You can research it for yourself if you don’t believe me, or read some of my previous articles where I discuss this in more detail.
Anyway, one of the main themes of the “Core narrative” is that hard forks are dangerous. A hard fork is simply a system upgrade that is not backwards compatible to old network nodes.
As part of this myth that hard forks must be avoided, the Core group (“Core”) proposed a solution in 2015 called Segregated Witness (“SegWit”). SegWit is complex (5000+ lines of code), and introduces radical changes with dangerously shifted economic incentives.
Meanwhile, those who simply wanted bigger blocks proposed a solution increasing the blocks in a version of the software which is called Bitcoin Unlimited (“BU”).
In early 2017, BU had about 40% of the mining support, while SegWit had about 30%. Neither side could achieve the majority required to force a system change.
The New York Agreement, UASF, and UAHF
After a long sustained deadlock between the competing scaling proposals, an agreement was made in May 2017 called “SegWit 2x”. It was intended as a compromise and consisted of activating SegWit first, followed by a hard fork increase of the blocksize from 1MB to 2MB within 6 months.
The agreement was made in New York City in a closed-doors meeting between many of the biggest industry players, and did not include the Core developers.
Here’s where things start to really get interesting:
As the “2x” deal was taking place, a (purportedly) grassroots effort to compel the miners to activate SegWit was getting a lot of attention. It was called the User Activated Soft Fork (“UASF”).
In response to the possibly disruptive UASF, the Bitmain mining company created yet another plan called the User Activated Hard Fork (“UAHF”)
UAHF was intended as merely a contingency if the SegWit2x agreement didn’t take place. However, the 2x agreement did move forward and Bitmain did not implement the plan.
But in a move that surprised many people, the UAHF plan was activated anyway (even though the 2x agreement happened) and implemented in a new software called “Bitcoin ABC”.
This effort got significant traction, and resulted in a hard fork of Bitcoin into a new currency called Bitcoin Cash, which increased the block size to 8MB, and does not use SegWit.
Bitcoin Core, Bitcoin Cash, and Bitcoin 2x
As of August 1st, 2017, Bitcoin Cash exists as its own currency: a fork of the Bitcoin ledger, meaning that all Bitcoin holders as of Aug 1st also became owners of Bitcoin Cash.
Bitcoin Cash is currently the fourth largest cryptocurrency with a market cap of 5 billion dollars and a price of $300.
93% of the mining power in Bitcoin is signaling their intention to honor the NY agreement, but the Bitcoin Core team was never a part of this agreement. Core doesn’t like the agreement, and in fact have modified their software to reject any network node signaling for SegWit 2x.
This could mean that in November, Bitcoin could split again and we could actually have 3 different versions of Bitcoin.
There are theories of why this actually will or will not happen, but we won’t go into that. Instead, let’s just look at the possible outcomes:
What are the Implications?
If Segwit2x does not activate, then there will only be Bitcoin Core and Bitcoin Cash. Arguably, this is good for Bitcoin Cash because there will be more differentiation between the two kinds of Bitcoin, with Bitcoin Cash having a distinct scalability advantage and lower fees.
If SegWit2x does activate (but there is no network split), it is arguably bad for Bitcoin Cash for the same reason, at least short term… and good for Bitcoin, since it will have hard forked and increased the size the blocks.
The third scenario (the network split where we have 3 kinds of Bitcoin) is more unpredictable. It may be good for current holders of Bitcoin since they will now have tokens on 2 chains, much like what happened during the Bitcoin Cash fork.
It is questionable whether all 3 versions would survive. Probably the least likely version to survive would be the pure SegWit version, since it would have nothing the SegWit2x chain wouldn’t have, and less hashpower.
However, the Core team could fork it again to a different Proof-of-Work algorithm with some surprises up their sleeve.
Hard Fork Fears
The market did not seem to be scared of the Bitcoin Cash split, and in fact the price rose to an all time high just prior to August 1st, as everyone wanted to receive their “free coins”. Perhaps for the same reason, the market will not fear the SegWit2x split.
It’s possible that too many splits will make investors lose confidence in the Bitcoin brand because it will be seen as an unstable fracturing. But I don’t think this will be the perception since many people know and can explain the history, and will provide clarity to protect their investment.
To me, Bitcoin would be obviously more competitive with Bitcoin Cash if it also had the 2x increase, but this does not fit into the Core team’s agenda.
Thus, there’s a strange alignment of interests for Bitcoin not to get the 2x upgrade, as many “small blockers” (Core supporters) and “big blockers” (Bitcoin Cash supporters) both believe 2x to be undesirable.
Bitcoin Maximalism and the Network Effect
The main reason Bitcoin has a bigger market cap than any other cryptocurrency is because it has had the first-mover advantage and therefore the biggest network.
The so-called network effect is self-perpetuating in that users (both new and existing) are naturally attracted to using the largest network since it holds the most benefits. It’s the same reason why Facebook doesn’t have much serious competition.
Yet, the network effect isn’t absolute. If a network becomes unreliable or disadvantageous, it will start losing its users. And if another network comes along that is notably better, it will begin to siphon off usage from the older, larger network, until the new network becomes king.
This is exactly what happened when Facebook replaced MySpace as the main social media website. The user experience in Facebook was much better.
Despite their different approaches, Bitcoin Cash is very much a direct competitor to Bitcoin, and probably only one kind of Bitcoin is going to have the lion’s share of users, merchants, investors, and miners.
Right now that is ‘Bitcoin’.
But remember, the network effect can be eroded and challenged. And if Bitcoin cannot soon offer competitive fee rates, it will continue to lose users and merchants to Bitcoin Cash. Investors will follow, and then the miners.
Institutional Investors Are Not Necessarily the Smartest Money in Bitcoin
Usually, institutional investors are professionals that are considered the “smart money” because they invest and trade for a living.
Yet, Bitcoin is part of such a new asset class, that many hedge funds do not even know enough to participate in the game. Many of the professional investors that are not investing have stated “I don’t know enough about it”.
Is Bitcoin In a Bubble?
Market bubbles pop and crash when there’s an absence of real (non-speculative) demand. In this case: when a coin is not actually used as the payment system it was meant to be and on which it built its reputation.
Some of the mainstream money has bought into the promise that SegWit is a good scaling solution when in reality, it is not. Also, many incorrectly assume that SegWit2x is a done deal.
Until now I have not considered any of Bitcoin’s price action to be a “bubble” because fundamentally, it is a superior payment system and form of money.
However, if investments continue to flow into a version of Bitcoin that is actually not a useful payment system (because it is expensive and slow), then a true bubble will form with a potentially terrible outcome for investors.
A Winning Investment Strategy
The Bitcoin Core roadmap is to build second layers, but those layers are unproven at best, both technologically and demand-wise, and probably inferior to traditional on-chain Bitcoin.
This is why some people are saying that Bitcoin Cash is the true Bitcoin, since it will continue functioning the way Bitcoin has always functioned, while Bitcoin Core wants to make radical changes.
Bitcoin Cash has better fundamentals but a smaller network. In a way, Bitcoin Cash vs Bitcoin is somewhat comparable to Bitcoin vs Fiat when Bitcoin first appeared on the scene.
The difference is that Bitcoin could swallow up Bitcoin Cash’s value proposition by also providing big blocks. But, this seems unlikely since the entire reason for Bitcoin Cash’s existence is that there has been a contingent that seems like their life depends on preventing this.
Holding both Bitcoin and Bitcoin Cash seems like a winning strategy because at least one chain is likely to continue to provide the peer to peer electronic cash that put Bitcoin on the map in the first place.
In this way, Bitcoin Cash is like a constant watchdog, and may be here to stay no matter what.
Making all of this even more complicated is the fact that Bitcoin Cash uses the same SHA-256 proof-of-work algorithm as Bitcoin, which means that miners who have invested in ASIC rigs can mine either chain.
If we assume that miners are generally rationally selfish and profit driven, they will mine on the chain that is the most profitable.
Bitcoin Cash began with the same mining difficulty as Bitcoin when it forked, but adjusted downwards quickly due to a new algorithm.
If Bitcoin Cash becomes as profitable or more profitable to mine than Bitcoin for an extended period of time, it could cause a significant number of miners to switch chains.
If miners defect from Bitcoin and move over to Bitcoin Cash, it could have devastating consequences, because Bitcoin is only able to adjust every 2016 blocks. Worst case scenario for the Bitcoin chain is that it gets stuck and is forced to hard fork to a new PoW algo.
If that happened, Bitcoin Cash would explode in value in a very short period of time, while Bitcoin would crash equally hard.
This may be part of the reason that Bitcoin is priced so high right now. Perhaps it is being pumped in an attempt to prevent the mining profitability from reaching parity.
Given all of these factors, an investment in Bitcoin Cash has a favorable risk to reward ratio at the current time (in my opinion).
But we also need to acknowledge that Bitcoin has shown impressive resilience and global demand, so it is wise to exercise caution when considering liquidating any positions.
It is a complicated time in Bitcoin. I encourage you to do your own research and critical thinking. Personally, I am holding my Bitcoin while continuing to accumulate Bitcoin Cash.
If I was a brand new investor today, I would consider buying small amounts of both on an ongoing basis using a dollar cost averaging strategy.