3/Tale of Three Coins

The relationship between hashrate, community, and price

Most of us know the Bitcoin story: the shutdown of Silk Road, the price boom of late 2013, and the fall of Bitcoin’s largest exchange, Mt. Gox. But what about years one through four? I believe that the best way to understand the contributing factors to bitcoin’s growth in price and user adoption is by looking at the short histories of alternative cryptocurrencies.

In my previous post, I posed some questions about the nature of miners and their relationship with cryptocurrencies as well as the prices of the coins. To answer these questions, we look at three cases in particular: Litecoin, Auroracoin, and Dogecoin.

Litecoin

Litecoin is often referred to as “…the silver to Bitcoin’s gold.” As the second largest coin in terms of market cap that certainly holds true. In fact, as an investment it performed much better during (and as a result of) Bitcoin’s run going from around 7¢/LTC to a high of about $40/LTC in December of last year. But even before this 500%+ price increase, a community was building around the coin with anywhere from 1% to 20% of the coin being transacted or traded per day.

Figure 1: Early transaction activity among Litecoin users. Litecoin has been a popular option for traders as it is accepted on most exchanges.

So what happened when Bitcoin tanked from $1000/BTC to under $450/BTC at the beginning of 2014? As one would expect, Litecoin was dragged down along with it.

Figure 2: Litecoin’s price is largely tied to Bitcoin’s, although after the price drop in early 2014, Bitcoin has recovered somewhat whereas Litecoin has continued to decline.

It’s what has happened afterwards that shows the nature of the cryptocurrency and its prospects for the future. Litecoin is at an advantage in its: 1) community of users, 2) previously strong price performance, and 3) a strong contingent of miners. The exponential growth of hashrate amidst an 80% drop in market cap indicates a strong community of miners supporting the coin.

Figure 3: Litecoin’s price change and hashrate change over time. We see tremendous growth in hashrate during a time of Litecoin’s poorest price performance.

During Bitcoin’s and consequently Litecoin’s price fall, hashrate actually increased. With the introduction of Scrypt ASICs to the public at the beginning of Q2 2014, Litecoin’s hashrate has begun to grow exponentially.

Although the price for Litecoin has not recovered as well as Bitcoin’s, one can have reasonable confidence (due to the support of miners) in the longevity of the coin. Users + miners + price performance = health of a coin. In the absence of strong price performance, a coin’s miners can maintain the strength of a coin.

Auroracoin

Auroracoin launched in February as an alternative to the Icelandic Króna. Its creators planned to distribute half of all coins mined to the 330,000 people listed in Iceland’s national ID database. It was created to circumvent restrictions on the movement of the Icelandic Króna outside of the country.

Regardless of Auroracoin’s intentions (or stated intentions), there is no denying that the coin has failed. After reaching a high of about 0.1 BTC, the coin has fallen over 400% in just four months. During that time, the coin’s use has dropped off significantly as well.

Figure 4: Auroracoin’s users are seemingly non-existent in the aftermath of the price falloff. This is an indicator of a potential “pump-and-dump” scheme.

One can see that after the initial price drop there was a frenzy of transaction activity (most likely by the creators and largest stakeholders) as traders tried to unload the coin. Most troubling perhaps is the precipitous drop off of hashrate since the coin’s inception, down to virtually nothing at the present date.

Figure 5: With price goes mining hashrate. At the present Auroracoin’s hashrate has dropped to almost nothing, spelling doom for the coin.

Without miners, a mined coin simply does not exist. What’s interesting to note is that during the steady price decline, there were several instances where hashrate spiked. This may best be explained as “value mining.” In other words, at little cost, a miner may mine a certain number of coins of a cryptocurrency that has fallen in price and difficulty in the off chance that the coin appreciates in value dramatically.

In the end we see that even miners have lost all faith in the future of Auroracoin. When that happens, a coin is assuredly a failure. We return to our equation users + miners + price performance = health of a coin. In this instance the users never really took off despite being available to the entire population of Iceland. The price performance was poor and as a result the miners fled. This is the formula for the death of a coin.

Dogecoin

It admittedly began as a joke cryptocurrency. But, its community has gone on to do some amazing things like help provide clean water to Kenyans, to sending the Jamaican bobsled team to Sochi, to sponsoring their own Nascar driver. What was started as a joke has become a serious subject amongst cryptocurrency enthusiasts, with coin ranking sites placing Dogecoin right behind Bitcoin in terms of rankings.

So where did it all begin? From the outset, Dogecoin has been very easy to obtain. The block rewards were initially quite generous albeit random (between 0 and 1M coins/block, 1 block/min) which deployed around 50 billion coins within the first couple months. While the laws of supply and demand would dictate that such huge supply would negatively impact the price of a coin, this launch strategy (combined of course with a cute shiba inu as a mascot) served to maximize the user community component of our equation.

Along with several viral marketing stunts (see above) the online community of Dogecoin die-hards (shibes) has grown to over 87,000 strong. The historically low value of the coin encourages a culture of “tipping” where social media users will tip coins to other users for their comments, content, and feedback with the aid of tools such as /u/dogetipbot for Reddit or @tipdoge on Twitter. As a result much of the transaction activity occurs “off the blockchain.” Still, during price slips, the strong user activity among Dogecoin users cannot be denied.

Figure 6: Dogecoin’s users are passionate about the coin and trade, tip and use it during price downturns.

In the case of Dogecoin, the coin itself has become its own greatest marketing asset. Some have even said that Dogecoin has been the best marketing to ever happen to Bitcoin, as Dogecoin has evangelized atypical cryptocurrency users and eased them into other currencies like Bitcoin and Litecoin.

That said, Dogecoin’s price performance has been less than stellar. Since it’s price peak in early January, Dogecoin has lost over 85% in value. Most interesting however, is how the community of users and miners has behaved over this down trend.

Figure 7: Dogecoin hashrate came down with price initially, but recently has been surging.

As price declined, so did hashrate to an extent. Since May, Dogecoin’s hashrate has begun to rebound ahead of the price of the coin, almost returning to levels seen last during the price boom. This is attributable to either miners seeing future value and profit in the coin, or Dogecoin community members mining the coin altruistically. In either instance, the true value driver of the coin is the community. Again we return to our formula users + miners + price performance = health of a coin. With Dogecoin, in the absence of price performance and miners, a strong user community can bring back the miners and sustain the coin.

Bitcoin

So what does this tell us about the king of crypto, Bitcoin? Bitcoin needed all three: users, miners, and price performance in order to get to where it is today.

With early marketplaces like The Silk Road to recent onboards like overstock.com, the opportunity to use and spend Bitcoin has always been there. With the introduction of ASICs to SHA-256 coins as early as 2012, Bitcoin’s hashrate far eclipses that of any other cryptocurrency. And with one of the most storied price booms in history, Bitcoin has returned a lot to some of its early believers.

So what’s next? As of today, only Bitcoin can lay claim to institutional investment and the number of venture-backed startups that are helping to build out the its ecosystem. From Andreeseen Horowitz’s investment in Bitcoin startups to Fortress Capital buying Bitcoin, it is plays like these that will propel the technology to greater levels of adoption and use in the future. It is an exciting time for Bitcoin users regardless of the price of Bitcoin.