Predicting the path for Bitcoin
In my last post, we discussed the characteristics that make money useful and explored whether Bitcoin has the potential to function as a form of money. My hypothesis is that bitcoin needs to be widely adopted to work effectively as a form of money. In this post, we’ll discuss a few reasons that I believe we should be paying attention, even if bitcoin doesn’t work as money in its current form.
Bitcoin has some problems. The chief arguments against its use as money include:
Bitcoin transactions are slow –the network can only validate a limited set of transactions (a block) every 10 minutes
Validating bitcoin transactions is expensive — It takes an inordinate amount of power to mine bitcoin
The economics of bitcoin encourages saving— it’s in limited supply, meaning that in a stable environment the price of bitcoin should increase slowly. A logical user would be careful to hold on to their bitcoin if it can buy more tomorrow than it buys today
If bitcoin isn’t acceptable to most people as money, then what? Will it fade into non-existence? There are some good reasons to be sceptical, but there are also reasons that we should continue to pay attention.
There are 3 factors that I want to explore with you here; we’ll discuss our ability to predict use cases, the power of a network and the concept of exponential growth.
We are bad at predicting the best uses for what we create.
When Thomas Edison invented the phonograph, he provided the world with the opportunity to record and share sound. When Edison wrote down what he expected were the best uses for his invention, top of his list was the ability to play Christian sermons in the evening. The phonograph would go on to be the catalyst for unlocking a world of music and radio, allowing these to become billion-dollar industries.
Edison couldn’t see into the future. What was clear was that he created an instrument that had uses beyond what he could predict. This allowed other minds to build on his work and create new and surprising results. If I may apply this to the bitcoin situation:
- Bitcoin was originally proposed as a decentralised cash system that could be used to move money
- The original version of bitcoin was not perfect and a community of developers have worked for almost a decade on updates and improvements, mostly with the aim of making bitcoin a viable money system
- The bitcoin of today is still not perfect; transaction costs are too high and transaction speed is too slow
It’s important to emphasise that Bitcoin is orders of magnitude away from taking over from Visa (which processes ~2’000 transactions per second). It’s also possible that moving money around isn’t the best use case for bitcoin because we’re incentivised to save our coins rather than spend them. However, a set of intelligent people are working on many other use cases for bitcoin (and other cryptocurrencies). In my view, it is short sighted to dismiss bitcoin out of hand simply because there are hurdles that appear to invalidate one use case, especially for a technology that has the potential to be used in many ways.
In the world of social technology, strong networks are winners. The same applies to cryptocurrencies, but there is an interesting catch.
It is very difficult to compete with Facebook, Instagram and other tech leaders in part because they have extremely strong network effects. Imagine the first day that Instagram was launched, do you think that it would be a particularly exciting app to visit? Your feed would be empty and it may feel strange to upload a photo that none of your human network (who don’t yet have Instagram) would even look at. Contrast this with the Instagram of today, where over 95mn pieces of content are shared each day.
This is how network effects work on the web, there is a circular problem. When there are few users, there is a poor user experience and the risk that the network will not grow. Only if the user base does grow, will the experience of each user improve. The network creator also gains more feedback, which allows them to improve the user experience further, drawing in even more users.
More users > bigger network > better feedback > better experience > more users:
This is a one reason why strong internet networks become monopolies. We generally wouldn’t swap our Facebook accounts for Myspace accounts because (1) we wouldn’t find all our friends on Myspace and (2) the user interface on Facebook is much better.
This applies to cryptocurrencies. As the community grows, evidence suggests that the growth becomes exponential as we can all use the cryptocurrency to transact with each other. However, there is another interesting twist with cryptocurrencies.
I mentioned above that networks that don’t gain strength lose out to the strongest network. This isn’t necessarily the case with cryptocurrencies because the early adopters gain an important advantage. The early user gets a financial reward. If you “got in to bitcoin” early, you made some money.
If we put these two concepts together, the early user gains financial reward while the late user gains an improved user experience.
These network effects are powerful, because they incentivise early adopters to stay on a network for financial reward, solving the circular problem with traditional networks we showed above. Users are incentivised to get in early and stick around to make the network more useful. The potential implication is that cryptocurrency networks with proper use cases are hard to kill (more so than traditional networks that are owned by a couple of founders and to whom all the financial benefits flow).
Applying this to bitcoin, we have people joining for both greed and need. Some purely want to get rich, others simply find bitcoin useful and many users have mixed intentions. it’s likely that many recent users are only here because the price is going up (greed). I argue that (1) the user group isn’t static and the mix will change over time and (2) It’s important to have both types of users for the network to grow.
We find it difficult to identify exponential growth.
There is a principle called “the deception of linear and exponential growth” which explores the idea that when we look back at a growing technology in the early stages of exponential growth, the growth rate looks linear. Revisiting our Instagram example, here is a graph showing the growth in Instagram users between Feb 2013 and September 2015:
The growth rate looks linear (the line is pretty straight). Let’s extend this graph out further:
It took Instagram 9 month intervals to go from 200mn to 300mn to 400mn users. It took them only 4 months to go from 600mn to 700mn. Industries that have the capacity for exponential growth can become important a lot more quickly than any of us are able to predict.
In the case of bitcoin, adoption rates have been picking up pace. The implication being that widespread adoption of bitcoin could be closer than any of us expect and that the number of users holding and/or using bitcoin will drive further adoption and develop new use cases.
Tying this together
The rate at which the price of bitcoin has risen in 2017, with the concurrent media attention, gives us all pause to wonder whether everyone has simply lost their marbles. The sceptics warn that:
1. Bitcoin isn’t useful as money right now because it’s too expensive to transact and too slow to process transactions
2. It’s a bubble driven by greedy fools that don’t understand what they are buying
3. This bubble will burst and bitcoin disappear
My opinion is that:
1. Bitcoin might not work as a currency but this doesn’t make it useless for another purpose that is being worked on
2. The bitcoin protocol is an open piece of software that could be moulded into a new and different use case that is even more exciting and some of the options are quite interesting
3. We do have a high proportion of greedy users, but these users are helping to grow the network and the demographic is likely to change over time
4. The strength of network effects makes it unlikely that bitcoin will ultimately fail
5. Adoption is probably closer than we think
I give credit to @MarcusSwanepoel, @FEhrsam and @pmarca for shaping my thinking on this topic
