If you just started learning about Bitcoin or are trying to understand why it is different from everything else, this is the place to be.
1. Bigger Picture of Bitcoin vs. Blockchain
Satoshi, the Japanese inventor of Bitcoin, is praised for overcoming the massive challenge of moving value online. Bitcoin certainly paved the way for the creation of new coins; but, more importantly, it opened our eyes to the new world of possibilities.
As a breakthrough invention, we can compare it to the first phone or aircraft. Still, as many Bitcoin connoisseurs like to point out, it is of vital importance that we don’t mix up the precursors and their more modern replacements. Who would like to use the brick phone nowadays anyway?
Therefore, when Bitcoin first appeared, it naturally shifted things quite a bit. We were presented with this new technology and decentralized digital currencies, which is one of its greatest benefits to this day.
What we now know as a decentralized distributed ledger allowed transactions to be made without any intermediary. This meant that banks finally no longer had to give their blessing for things to work, making Blockchain technology as important as the first car.
Now, the planes we use today differ greatly from the craft first designed by the Wayne brothers. We still appreciate the power of invention, but like with the software industry, we are inclined to use the newer versions which accommodate our current needs.
Some experts tend to stress these differences because they understand that new inventions may not always work out in the long term in their initial form. Sometimes we need to debug and fix issues before we can be fully satisfied with anything.
Bitcoin, which is essentially the first technology of its kind, definitely drew the attention of both people and institutions. Nonetheless, certain experts in the field still call for understanding what Blockchain entails and brings to the table in the long term aside from Bitcoin.
Ray Dalio, one of the most successful hedge fund managers in history, stated that he doesn’t really believe in Bitcoin, but he did say that he believes in the technology behind it. Although he received major backlash for his statements on Bitcoin, we cannot but notice similarities between the comments made by different individuals.
As Bitcoin remains the only market-proven use for Blockchain, those in favor of Bitcoin fervently disapprove of any separation between the cryptocurrency and the technology it is backed by. Some even say that favoring one over the other is the same as preferring the internet to HTTP. Still, it is crucial that we differentiate between Bitcoin cryptocurrency and Blockchain technology.
Blockchain, the first version of a decentralized distributed ledger, is a historically significant invention that introduced unprecedented changes in the world. As a first of its kind, Blockchain is sometimes criticized for the algorithm upon which it is built – proof of work (PoW). Twelve years after its creation, Blockchain’s performance is believed to be a far cry from what we should be having.
All critics aim to point out a need for a more sophisticated version of a decentralized distributed ledger that compensates for Blockchain’s limitations. While we still need the basic function of Blockchain, we also need much faster and efficient performance, thus calling for a replacement of the current PoW design.
Whereas traders certainly enjoy the option of earning a few extra tokens through staking (i.e. mining), the fact that the system requires this mechanism to function highlights its imperfections. Why do we need this feature in the first place? Why should any system’s security depend on this?
Luckily, we have seen some successful attempts to break this barrier in the recent past. A new distributed ledger, a permissioned distributed ledger, is able to process 10 times more transactions per second than any blockchain-based cryptocurrency. While Bitcoin still resides on Blockchain, XRP (previously called Ripple) cryptocurrency successfully uses the new system, which makes it surpass the limitations traders faced before.
Some people believe that the only reason we all rely on Blockchain is that no superior replacement has been found. So, are we still looking for a more efficient solution that can satisfy the basic requirements and speed up the process at the same time? Well, different companies have advertised their products in the past few years, claiming to have overcome challenges inherent to Blockchain.
Some financial professionals go as far as to say that this new distributed ledger finally leaves room for engineering scalable digital currency systems with the real potential to become, or even replace, major currencies in the global financial system.
The Blockchain-based cryptocurrency system may never be apt at achieving this, but we finally have the stage ready for digital currencies to compete with conventional currencies on the global level. Interestingly enough, some like to think that these new possibilities pose a threat to both Bitcoin and Blockchain.
2. New coins to potentially harm Bitcoin
Ray Dalio believes how another cryptocurrency could disrupt Bitcoin, offering the impact iPhone had on Blackberry as an example. While changes are happening in the world of cryptocurrencies, avid Bitcoin enthusiasts believe that this scenario is highly unlikely.
The power of Bitcoin lies in its path dependence. This one-time invention is not just any product we will toss away after it serves its purpose. Now, why is that so?
The invention of Bitcoin was a critical breakthrough that can only happen once in a lifetime. Many argue how it was the way in which events unfolded that rendered Bitcoin the uniqueness it has.
For example, if this new cryptocurrency was launched today, its chain security would be extremely weak at first, as it would require everything to be done afresh. As everyone is nowadays already familiar with Bitcoin, it is likely that the new cryptocurrency (which we will call Bitcoin 2.0) with weaker chain security would probably have to fight opposition in the form of banks and governments, among others.
Therefore, Bitcoin’s importance does not only lie in what it brought to humankind but the organic sequence of events that led to its release. The order of events can hardly be replicated, which leaves little room for Bitcoin 2.0 ever being created.
What is more, Bitcoin’s money supply is scarce, which makes people want to hold it. Traders would always go for more liquidity, greater network effects, and stronger chain security, making Bitcoin 2.0 look rather pale in comparison.
Even if Bitcoin 2.0 was devised in a way to feature negative scarcity (i.e. a deflationary monetary policy), it would be practically impossible to determine its rate, not to mention the mechanism of money supply decay.
Fighting for the best market position, impending and unavoidable chain forks would reduce Bitcoin 2.0’s liquidity and chain security, essentially making traders opt for the original Bitcoin.
3. Bitcoin’s Expiration Date
As we mentioned above, Bitcoin’s money supply is scarce. When Bitcoin was invented, it was issued on a predictable supply curve. We know that after the mid-22nd century, there would be no more Bitcoin made.
We additionally know that there is a point after which you literally can’t split the coin in half anymore and it also goes to zero (i.e. exponential decay that approaches zero). This means that, while in 2020 we had approximately 1800 coins produced per day, the production is going to fall below 1 by 2100. This is one of the things that make Bitcoin exceptionally unique.
4. Bitcoin similar to gold
As the scarcest monetary metal, gold came to dominate the world. Owing to it being the most inflation-resistant, governments across the world built their monetary systems on this metal. Gold has several determining qualities that allowed it to serve as a medium of exchange:
- durability, allowing it to persist through time without deteriorating
- visibility, reflected in gold’s changeability and transformative power that makes it more tradable
- portability, making gold easily moved from one place to another
- recognizability, making it easy for people to differentiate between gold and anything else
- scarcity or limited supply creating its value
Gold essentially became money because its supply was both scarce and predictable. People’s efforts to increase the production of gold could barely affect its supply. Because of this, gold turned into a preferred means of pricing and payment.
Now, how can Bitcoin compare to that?
The absolute scarcity of Bitcoin, which we discussed in Part 1 of this series, makes it the ultimate pricing mechanism. This trait allows people to easily express their needs through trade, safely hold their capital, and compete at scale.
There are two main characteristics of gold that are essentially comparative to Bitcoin:
- production difficulty
- new supply predictability
History taught us how these played out with gold. However, Bitcoin may be even harder to obtain than this precious metal. Even if everyone focused on the production, we could still hardly generate more Bitcoin.
Bitcoin is based on a mechanism called difficulty adjustment, which makes it increasingly hard to forcefully obtain greater quantities of this cryptocurrency. While we can calculate with mathematical precision how many coins will be issued by the mid-22nd century (see the previous article for more information), it is unlike any asset or commodity we’ve heard of.
It is important to understand that this mechanism functions in both directions – if more resources are directed at mining, other market participants will face difficulty in getting their share; similarly, if a percentage of production is stopped, others will enjoy easier access.
Scarcity of money affects its utility, which is why a zero growth terminal money supply represents perfect scarcity and makes Bitcoin a perfect monetary technology. We can say that there has only been one analog gold and Bitcoin, due to its uniqueness, is probably going to remain the only digital gold. Similarly, as gold’s value is undeniable, the market recognized Bitcoin’s worth. The more liquidity there is in the market, the more network effects and value it has as well.
It is also interesting to note how Bitcoin followed the same monetization path as gold did. No one used gold at first until they slowly started to recognize its value and importance. People started to barter gold and it slowly turned into an invaluable asset. Because of its stable value, gold penetrated all spheres of life over time, and we are already seeing how cryptocurrencies are taking over the world in a similar fashion.
When people finally understood what gold was worth, it turned into a currency. Not only did people exchange gold for goods but gold also turned into money. That is how we had the gold standard and gold paper money as well. When people thought they were using banknotes, they were actually trading the value of gold. Now, currencies are no longer pegged to gold but think about Bitcoin here. Bitcoin serves the same purpose today.
Bitcoin is slowly but surely gaining a track record in reliability, predictability, cost-effectiveness, and manipulation resistance, which puts it in the same position as gold. More and more individuals and public personas predict that Bitcoin will be the next reserve currency, which after this comparison with gold is far from surprising.
5. Bitcoin supreme to CBDCs
Ray Dalio, who we first mentioned in the first article of this series, saw Bitcoin as inferior to central bank digital currencies (CBDCs) or cryptocurrencies such as Libra (i.e. Diem). Bitcoin is viewed as a less stable and more unpredictable medium of exchange. Naturally, this is a predictable statement because any currency in hands of large corporations such as banking institutions is prone to manipulation and external control.
Monetary policies serve to enrich those whom these policies favor, and, as Bitcoin opened new doors that were previously unimaginable, we’ve seen more and more announcements on the issuance of new cryptocurrencies lately. There are many terms in which we can define this decision, but certainly, it is a wise move for those who recognized the movement Bitcoin set forth.
Still, as Bitcoin is undeniably a scarce money supply, it can only further appreciate in terms of exchange ratio against fiat currencies. It is a well-known fact that today’s currencies are printed freely, without any real value backing up these decisions. Over time, these activities can cause fiat currencies to become entirely worthless, as many have noticed already.
Now, comparison with fiat currencies is a standard approach for determining the value of any emerging asset such as Bitcoin is. This price discovery is based on volatility assessment, which we have seen many times before. However, this mechanism in which we assign value may not be as functional as one may think.
In 1999, when Amazon crashed 94% from 85 USD to only 5 USD, no one expected a massive comeback. However, when Amazon started conquering the digital sphere, its value impressively grew by over 33,000%. This is an excellent example of how gaining control over the digital world entails gaining space driven by scarcity. Like with gold, Amazon ascended to market dominance owing to finite distribution channels and winner-take-all dynamics previously seen with gold.
Now, many would say that this is a highly volatile stock and they would be correct. However, volatility goes both ways or, more precisely, its function is two-fold. We need volatility to go both up and down. There can be no superiority in performance without undergoing volatility. And, the same is true for Bitcoin despite it not being a stock. There needs to be some volatility between zero and the top. What we have been seeing in the cryptocurrency market lately is demonstrative of this mechanism. So, we only need to power through.
Now, contrary to popular belief, money is not a government creation although governments evidently want their piece of cake. Any trading society will require a medium, which money serves since it is simply the most tradable thing. People will always conduct trading to get to the things they need. Before they exchanged goods and now we exchange other things. So, as this dynamic unfolds, something necessarily becomes more tradable than anything else does. We mentioned at the beginning of this article which traits propelled gold to its globally recognized position, so you can compare for yourself where Bitcoin stands in terms of durability, visibility, portability, recognizability, and most importantly scarcity in comparison to emerging cryptocurrencies. All based on the information we provided in the first and the second article of this series.
Would you bet on Bitcoin’s superior monetary traits?