Today’s post attempts to answer the question of what properties should an ideal cryptocurrency have? These properties should be derived from the problem(s) that cryptocurrencies are attempting to solve. Over the past decade we have had the opportunity to observe a multitude of different technological attempts to solve the problem(s) of currency. One thing has become clear, the best technology cannot compete with the best network effect and better technology doesn’t automatically build network effect.
As a result of this, the first move advantage of Bitcoin and Ethereum have given them network effects that far outweigh the technical shortcomings of their relatively primitive, low performance, designs. These network effects are fueled by the self fulfilling pursuit of capital gains and liquidity. People adopt Bitcoin because it is growing in popularity and “everyone else is doing it”, not because it is “better” or even because it actually solves the problem(s) it set out to solve. Capital gains creates fear of missing out which creates a positive feedback loop… until everyone has adopted it or governments co-opt it.
What Problems does Bitcoin Solve?
So what problems did Bitcoin set out to solve and did it actually solve them? In the broadest sense, I believe Bitcoin set out to create “free market money” that cannot be controlled and abused by governments. Decentralization is the general approach to preventing governments from shutting it down.
We have all observed how centralization of power in banking leaves everyone at the mercy of unlimited government spending and complete government control over their economic lives. Attempts to use gold as money failed because digital gold notes depend upon trust in a centralized issuer. Governments first took over control of gold notes, then removed the gold backing, and finally utilize their power to shut down via “regulation” or military intervention any institution or small government that attempts to issue 100% reserve gold notes.
Decentralization is guerrilla economic warfare against economic empires. These technologies enable people to collaborate outside the government’s control grid and escape the government manipulation in gold, silver, and fiat money. They enable people to communicate without censorship and reach a new consensus.
So the question of the ideal crypocurrency is a question of the ideal technologies and social arrangements that defend against regulatory capture and monopolistic abuse. Physical gold and silver were the ideal currencies in a world without electronic communications. Without instantaneous long distance communication physical gold and silver and information could move at the same speed. In the information age, money must move at the speed of communication.
Banking under a gold standard is an attempt to replace physical gold and silver with digital IOUs which can be transferred at the speed of light. This introduced a dependency on a third party to both protect the gold and facilitate the transfers. This dependency created an irresistible opportunity for institutionalized fraud and regulatory capture. Gold and silver notes were a Trojan horse to unbacked and unaccountable fiat money.
An ideal cryptocurrency should have the properties of physical gold and silver coins circulating among the population at the speed of light. It should be rare, relatively easy to verify, hard to counterfeit, private, and infinitely scalable. No one should be able to stop two parties from transacting privately in the currency any more than two people trading gold for bread behind closed doors.
Bitcoin started out decentralized where anyone could transfer to anyone at almost no cost. If no one else would include your valid transaction in the ledger, then you could mine your own block on your home computer in hours. This didn’t last. Gradually the cost of transactional autonomy grew to the point where all Bitcoin transactions must be approved by a handful of mining pool operators. The lack of scalability means the typical transaction fee fluctuates between $2 and $14 and takes from 15 minutes to hours to confirm. This makes it on par with wire transfers and not credit cards. This is a far cry from a replacement for physical money.
Bitcoin is rapidly being captured in the same way that gold and silver coins were captured. Financial institutions are slowly gaining control of the majority of the supply and eventually the majority of Bitcoin payments will occur off chain. These institutions are too big and visible to escape government regulation which means Bitcoin will not escape regulation any better than gold or silver did.
Over time 100% reserve Bitcoin banks will turn into fractional reserve Bitcoin banks and government regulations will declare unbacked Bitcoin IOUs to be legal tender as payment of debts denominated in Bitcoin. It may take a generation or two, but the ultimate destination of Bitcoin is a reset to the multi-generational, government backed, fractional reserve, central bank ponzi scheme. Can you make money by buying Bitcoin under this scenario? Yes. Will you create multi-generational economic freedom for the masses by using Bitcoin? No.
Bitcoin, like gold, is not infinitely divisible. Sure you could, in theory, divide gold down to a single atom. But the cost of transacting in an atom of gold is greater than the value of gold itself. Bitcoin may be divisible down to 8 decimal places, but it can only be transacted on chain in quantities of $500 or more assuming people are willing to pay a 1% transfer fee. As Bitcoin grows in value it will end up being far less divisible than gold. This will force everyone interested in using bitcoin for payments to use an intermediary IOU.
The only way to increase the divisibility of Bitcoin is to increase the scale of the Bitcoin blockchain to enable more than a handful of transactions per second. This increase in scale would lower the cost to transact on chain and therefore increase the divisibility of the currency. It would also result in centralizing control of the blockchain due to the network, storage, and computational costs of operating a full node.
An Ideal cryptocurrency would be able to circulate at the speed of light with the privacy, divisibility, and transaction fee of trading in physical copper coins. Transaction fees are evidence of ability to censor and lack of divisibility which leads to government control.
Is the Ideal cryptocurrency possible? Maybe, maybe not. Would such a solution be widely adopted? Would it be persecuted by governments attacking individuals and exchanges? Likely. Would it win at the end of the day. Eventually. One thing is certain, I think we can get much closer to solving the problem of an ideal currency than we have with Bitcoin.