If you’ve been paying attention, you’ll have noticed that I recommended buying cryptocurrency a few years ago. I bought my first Bitcoins in March 2013 and sold them again in June 2017 at 2700 dollar. What I hadn’t expected back in June 2017 was the absurd bubble that would follow. The bubble seems to have been entirely unjustified, the product of cryptocurrency exchanges using the deposits of their customers as collateral to print fake dollars (Tethers), to serve as buyers of last resort whenever the price sought to correct. That’s not something I anticipated because I was a bit of a true believer, until reality hit me in the face and I figured out that cryptocurrency is primarily useful for scammers. I started warning people to stay out of Bitcoin when it hit 6000 dollar back in late 2017. In fact, not so long ago I recommended short-selling Litecoin. Its value has dropped by two thirds since then.
It’s easy to make fun of us early adopters, but most of us were genuinely interested in what was emerging spontaneously on the internet. A form of digital money that could be used to donate to organizations like Wikileaks, that were cut off from the international banking system. Most fascinating perhaps was the fact that you could send money around the world, for a fraction of a cent. People were able to trade drugs on the internet and studies showed that prohibiting the drug dealers from knowing each other reduced violence, while drug users received higher quality supplies with fewer contaminants.
Because we tried to look at this from a rational perspective, most of us sold before the bubble began. Mike Hearn sold years ago when he figured out that the system would not scale because of ideological objections. I sold when I figured out that the market cap of Bitcoin was starting to exceed the market cap of Paypal, which I considered a good comparison for a similar service. I also figured out that the days of huge growth were over. Bitcoin was using 0.3% of the world’s electricity supply, it can’t go up in value another tenfold if it had such a resource impact.
I felt done with Bitcoin, just about a few months before the crowd began to discover Bitcoin. People began buying bitcoins with money they borrowed, some people sold their house to buy bitcoin, others used credit card loans and student debt to buy their bitcoins with. Most of these people had no real clue how the system functioned, but that was not relevant to them, they heard people in the news say it could go up in value and they could draw lines on a chart and predict what would happen. I knew this was not sustainable, but I felt comfortable staying out of the market because I figured it could collapse dramatically any moment. It took one and a half year for the project to end up back where I stepped out of it.
In hindsight it’s now quite clear that Bitcoin has failed. Mike Hearn figured it out years ahead of most other people, but the writing is now on the wall. The Bitcoin community split in late 2017, between those who want to have a method of cheap payments and those who see Bitcoin as the equivalent of digital gold. The latter group was primarily concerned with ensuring the price would continue to go up, thus they rejected any dramatic changes to the protocol that might be messy and scare off newcomers. The prior group split off with their own protocol (BCH), but this failed too. As a minority community it attracted various people who sought to make a name for themselves, a clash of egos that ultimately split the project in two. The project also depended for its success on the demand for cryptocurrency. In practice there was no more demand for cryptocurrency transactions when cryptocurrency stopped going up in value at an absurd pace.
The end of Bitcoin
I’m quite comfortable today in stating that Bitcoin is going the way of the dodo. This is caused by a number of factors. To start with, Bitcoin’s biggest problem is the dogmatism and stubbornness of its greatest enthusiasts. When it became apparent in late 2017 that Bitcoin was beginning to use absurd amounts of electricity, Bitcoin developers and other participants in the phenomenon could have looked for ways to reduce the electricity consumption of Bitcoin. What they did instead was to look for ways to justify Bitcoin’s enormous energy consumption.
Of course they could not come up with any credible argument that would serve to convince anyone who was not a die-hard believer in the phenomenon in the first place. As a consequence, institutional investors had relatively little interest in participating in the phenomenon. Analysts from banks looked at the phenomenon, observed its huge energy use and correctly concluded that Bitcoin would be a passing fad, that would economically ruin a few people but never evolve into a mature functional digital currency.
What the big bitcoin cultists seem to forget is that if bitcoin uses a huge amount of electricity, someone will need to pay for all of that electricity. An average Bitcoin transaction consumed around 50 dollar worth of electricity last time I did the math. Someone needs to pay for that, right now all users pay for it through massive inflation. If Bitcoin miners need to spend a lot of money to mine a bitcoin, they’ll need to pay their electricity bill by selling their coins on the market. Millions of coins were lost when the system just started out, so the practical rate of inflation is somewhat higher than the technical rate. This is one of the reasons why the value of bitcoin keeps crashing.
Another issue they seem to forget is that this competition to waste electricity is not a sustainable way to operate a currency. Right now 12.5 new bitcoins are created per block of transactions. The people who want to send bitcoins to other people pay around 0.125 bitcoin in transaction fees. If the system needs to keep functioning at the current rate of electricity consumption, you’ll need to make people pay 100 times more in fees to keep the system functional. Why would people ever decide to go along with that, if there are cheaper alternatives available to them? If on the other hand, the system can safely function with less electricity usage, how do you justify the huge environmental impact it currently has?
One other problem that’s overlooked is that Bitcoin’s way of validating a transaction is rather risky, in the sense that anyone willing to spend a lot of money can double-spend a transaction. There have been a large number of cryptocurrencies so far that have been double-spent through a 51% attack. The proponents of Bitcoin don’t see this as evidence of a flaw in Bitcoin’s proof of work system, they see it as evidence that anything that is not Bitcoin is a “shitcoin”. In reality, the continual decline in value of bitcoin and its declining rate of inflation ensure that bitcoin will eventually suffer the same fate, if the protocol is not radically improved.
The massive bitcoin bubble ensures that numerous mining devices are now stationed around the world that can be bought up or rented at a low price to mess with the protocol. This is a self-fulfilling prophecy, because the decline in mining that happens today generates the (correct) impression that the system is becoming less safe. This causes people to sell Bitcoins, which makes them less valuable, which makes mining even less economically viable and exacerbates the problem. The reason this hasn’t caused problems in the past yet is because bitcoin mining was not the global industrial scale activity it is today and because there were relatively few actors who had a motive to target bitcoin. The fact that mining cartels can’t break even on their activities any longer, creates a massive incentive for them to screw with the protocol in one way or another. A 51% attack is the most obvious way to go about this, but the mining pools can also target each other, create spam transactions to boost transaction fees and engage in various other shenanigans.
Perhaps most importantly, as Mike Hearn predicted, the promise of Bitcoin has been lost. Bitcoin can no longer be thought of by users as a system that provides safe, fast and cheap transactions. There have been cases of people who had to wait for months before they had access to their money again, because they sent out their coins with a very low fee. You can’t know in advance when a transaction is going to be confirmed anymore, it can take hours and various technical tricks may need to be carried out to ensure your transaction goes through. At a price of 20 cent per transaction, you can’t use the system for micropayments. If you want to pay 20 cent to read an article online, you can’t reliably use Bitcoin for that.
The solution proposed to this problem is to create a “second layer” on top of Bitcoin, known as the lightning network. You make a regular bitcoin transaction to open a channel, this channel then allows you to make small transactions with other people. The big problem this faces is the complexity. Nobody who isn’t emotionally invested in Bitcoin wants to use the lightning network. To start with, why would I want to use two different payment systems, one to send small amounts of money and one to send large amounts? Second, the lightning network requires me to fund my channel with a Bitcoin balance. I need to buy large amounts of bitcoin in advance, to make it worthwhile to participate. Bitcoin has always suffered from problems in regards to user-friendliness, the idea of a second layer just made this whole problem worse. There are various technical problems with the system that I won’t bore you with, the bigger issue is that nerds designed a system so complex that no regular person would ever choose to use it, except out of ideological considerations.
Normal people don’t want to use Bitcoin
In general, the biggest problem Bitcoin has faced is its lack of user friendliness. Bitcoin is a rare example of a technology that became less user-friendly as its adoption began to grow. People were willing to buy huge amounts of bitcoins, because they expected them to go up in value. Without this promise of a huge rise in value, I wouldn’t want to hold onto any bitcoins, because the risk of losing them is enormous for non-experts. Bitcoin is permissionless, but most people don’t want to be their own bank any more than they want to be their own baker, dentist, or financial planner. We like taking small responsibilities ourselves. The big responsibilities in life, are responsibilities we’d rather leave to professionals. If my bank has issues, there’s someone who can be held responsible. The main reason I use a bank is the promise that if I follow a series of relatively simple rules, nobody can steal my money from me and no accidents can lead me to lose my money.
In Bitcoin, I have no such promises. In fact, I need to do everything myself. A bug in the protocol, a flaw in my own security or any other issue can lead me to lose all my money. I can’t let a professional set it all up for me, because that means exposing myself to the risk of theft. Worse, occasionally forks in the protocol happen, that suddenly divide the value of my investment between two or three different coins, requiring me to carry out all sorts of vague technical procedures that allow me to keep whatever coin I expect will stay valuable. Imagine I had 20,000 Euro in my bank account and overnight a conflict in the EU led to Ireland crediting my bank account with 20,000 Irish Euros valued at 10,000 Euro, but everyone warns me that these euros will soon lose their value as everyone is trying to get rid of them. This would be a stressful experience, but in Bitcoin this is just another regular day.
For most people, the only use for Bitcoin is the fact that it sometimes gives rise to a speculative bubble that allows them to become rich fast. There are a few other niche uses, but those hardly justify the high valuation we saw in late 2017, especially when considering the fact that most of the alternatives to Bitcoin are better suited to such niches. As an example, there are some people who want to trade drugs on the internet without anyone knowing about it. Why would they want to use Bitcoin for this, if they can use Monero? In Bitcoin the blockchain is transparent, whereas in Monero at least an attempt is made to obscure the movement of funds.
Similarly, Bitcoin can be used to scam people. It’s easier for people to pay for ransomware or blackmail through Bitcoin, because Bitcoin can be bought through more sites than Monero. However, scamming people is hardly a sustainable use case for a technology. The only real use case for assault rifles is to attack people with, so 99% of governments don’t allow their citizens to own assault rifles. If Bitcoin’s main use is for various get-rich quick schemes and other frauds, governments will probably take steps to shut down the off and on-ramps for Bitcoin. This might not destroy Bitcoin, but for 99% of people there won’t be a reason to own Bitcoin, any more than they have a reason to use Tor or Tails.
How Bitcoin will probably die
Everyone now knows about Bitcoin according to surveys, so there are no real greater fools left. Those fools who would be willing to buy Bitcoin did so in late 2017 and paid a heavy price as a consequence. If Bitcoin dramatically went up in value in the future, they would not interpret it as another opportunity to make money. If I’m somehow wrong and people would indeed be willing to step into Bitcoin, they would simply face the same issue they faced in late 2017: The system can handle about five transactions per second. During a genuine speculative mania, the excessive use of the network would drive transaction fees up towards around 30 dollar per transaction again and the system would come crashing to a halt again as a consequence, as transaction capacity on the network has only increased by around 50 to 100 percent.
The biggest problem Bitcoin will face to adoption is the fact that various other currencies emerged in the meantime that can do what bitcoin does, but better. If you want to build Ponzi schemes on top of cryptocurrency, you don’t use Bitcoin for that anymore, you now use Ethereum. If you want to trade drugs you use Monero. If you actually want to make somewhat legitimate financial transactions at low cost, you will probably want to use a stablecoin, a digital currency guaranteed to be worth one dollar. People who want to get rich quick will similarly comprehend that alternative currencies that haven’t faced scalability issues the way Bitcoin has are a better opportunity than Bitcoin is today. People always talk about the network effect of Bitcoin, but there’s a much more important principle at work here: Fear of being the greatest fool. Nobody wants to be the last guy to step into a bubble. With Bitcoin this fear is much more legitimate than with some obscure cryptocurrency, because everyone now realizes that Bitcoin is no longer a secret.
So Bitcoin probably won’t rise to its former heights again. What will happen instead is that the system will continue to decline in value, with a big dump somewhere in early 2019 when the victims of Mt Gox receive the remnant of their own coins, that have now dramatically increased in value. The system will continue to be plagued with flaws and poor user experience. The true believers continue to cling onto it due to the promises of the lightning network, but they’ll eventually begin to understand that the lightning network is not really a game-changing technology that somehow makes Bitcoin of any relevance to normal people who are not looking for a get-rich quick scheme. When this happens Bitcoin will reach a crisis moment, as people begin to abandon the system in droves. Other cryptocurrencies will rise in value, as people start wondering why they haven’t decoupled from Bitcoin yet.
At this point a lot of cryptocurrencies will have declined significantly in value, to the degree where they became irrelevant. This is known as the consolidation phase, as the number of potential competitors to Bitcoin is reduced and one or two prominent contenders rise to the forefront. One of these will begin to eclipse Bitcoin. At some point its market capitalization exceeds the valuation of Bitcoin and a dramatic shift happens, as everyone jumps on board of the new phenomenon. I expect this to happen somewhere in late 2019 or early 2020. My money would be on Ethereum, because most of the new developments are still being built on top of Ethereum.
Once this happens Bitcoin is in big trouble, as it finds itself losing its main purpose, as a lingua franca in the world of cryptocurrencies. Cryptocurrencies are 90% hot air, but people want to purchase some of them for genuine purposes. As an example, prediction markets allow people to bet on events in a reliable manner, while stablecoins and the currencies underlying stablecoins are of tremendous use in prediction markets. Other people want to buy currencies that pay out dividends from the fees generated by exchanges.
Around this time, Litecoin will start to suffer serious consequences from its low valuation. It will be relatively simple for nefarious actors to carry out 51% attacks against Litecoin. This will prove to be a serious wake up call for Bitcoin investors, as Litecoin essentially functions with the same technological specifications as Bitcoin. They will ask themselves how to proceed from here. The problem is that it’s impossible to arrive at a genuine consensus in regards to how Bitcoin will have to be upgraded. Some might wish to transition to a proof of stake algorithm, but if a hardfork needs to be implemented anyway, bigger blocks will be discussed again too. Others will insist on simply changing the mining algorithm. Other issues like the difficulty reward halving will similarly cause enormous controversy. It won’t be possible to arrive at a consensus on any of these issues.
At this point, Bitcoin will not have died yet, but various competing currencies will emerge, all of which have a somewhat viable claim to being the legitimate successor of Bitcoin. The community will tear itself apart, most competent developers will distance themselves from Bitcoin and the entire phenomenon will increasingly be seen as a bad joke. Bitcoin will be thought of as the Myspace of cryptocurrencies, home to people who reminiscence about the “good old days” and various cultists who treat the phenomenon as a digital religion.
What comes after Bitcoin
Cryptocurrency is a fascinating experiment, in the sense that small communities can now set up their own means of exchange at a low cost without the ability for any government to intervene and shut the whole thing down. Handing out investment advice is a good way to embarrass yourself, but I do feel comfortable in saying that cryptocurrency won’t disappear.
I’ll go a step further and argue that cryptocurrency is one of the few economic sectors that will see significant growth in the years ahead, along with biotechnology, asteroid mining, and renewable energy companies not specialized in solar and wind. The difference between cryptocurrency and most other economic sectors is that individuals are able to invest in small promising cryptocurrency projects, but not in small biotech startups. It remains the case however that the only real genuine chance normal people have to get rich quick is by breaking the law.
Most importantly, there are various use cases for cryptocurrency that haven’t quite matured yet. People have a desire for drug markets that can’t exit scam, shut down or be infiltrated by three letter agencies. It’s perfectly possible to set up decentralized drug markets, just as it’s perfectly possible to set up decentralized cryptocurrency exchanges. It takes a while for such phenomena to become user-friendly and attract sufficient users.
I’m not about to claim that most use cases of cryptocurrency are ethical. The ethical concerns around assassination markets or fentanyl sales on the darkweb are insufficient however to lead to a global ban on cryptocurrency and the complete implosion of the industry in 2018 is sufficient to eliminate any strong desire for legal prohibition that would be difficult to enforce to begin with. The depths of disillusionment tend to be the best times to invest in a nascent technology. I don’t think we have reached those depths quite yet, as I think it will take until 2019, but I might be wrong in that regard.
Ironically perhaps, the best cryptocurrencies to invest in are the ones that are generally not treated as investments. After all, if people own the currency just to see it rise in value, the valuation is based on hot air. My own recommendation remains to have a stake in Gridcoin. One reason for this is because the currency is simply not treated as a speculative investment. The correct way to judge the value of a cryptocurrency is to look at its current market capitalization and to ask yourself what a fair valuation would be if the project became a success. Although I consider the chance that Gridcoin will function well relatively low, the payoff would be enormous.
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