Two reasons bitcoin is doomed and one reason it isn’t
Rationality says bitcoin is doomed. But rationality says a lot of things.
- There are rational arguments as to why bitcoin is doomed.
- There are emotional arguments as to why it's not.
- In many cases, emotion is a better driver of value than rationality.
In a guest piece for CoinDesk, Kevin Dowd, professor of finance and economics in the Business School at Durham University has laid out two clear reasons why bitcoin will die.
The two reasons are relatively straightforward:
- The economics of proof-of-work cryptocurrency mining inevitably lead to monopolisation, which undermines bitcoin's key value proposition of decentralisation.
- Without regulatory barriers, a functionally inferior product will not survive in the long run.
At the same time, crypto venture capitalist Tim Draper wrote a guest piece arguing that bitcoin will still take over, and that it's just getting started. His reasons are also fairly clear and can be summarised as "because it's bitcoin."
Two reasons bitcoin will die
Dowd's first point, that proof-of-work mining inevitably leads to centralisation, is not really contested in the cryptocurrency world.
The gist as Dowd argues it is that manufacturing cryptocurrency mining hardware is complex and expensive, and that the biggest entities will always have economies of scale on their side. Over time, this will see one big producer crowd all the others out of the market.
"This player will become a point of failure for the system as a whole, so the "no single point of failure" feature of the system will also disappear. Then pseudo-anonymity will go, as the dominant player will be forced to impose the usual anti-anonymity regulations justified as a means to stop money laundering and such like, but which are really intended to destroy financial privacy," Dowd writes. "Even the bitcoin protocol, the constitution of the system, will eventually be subverted. Every component of the bitcoin value proposition will be destroyed. The bitcoin system will then become a house of cards: there will be nothing left within the system to maintain confidence in the system."
This trend isn't really disputed in the cryptocurrency world. On the contrary, it's become increasingly accepted and the new trend among emerging proof-of-work projects is to explore ways of managing the risks of an inevitably monopolistic environment.
For example, Siacoin is deliberately embracing controlled monopolies with a system designed to pass the crown from one monopolistic manufacturer to another in a way that lets the community as a whole control the provider rather than vice versa. And aeternity is looking for a way to level the playing field for miners and reduce the barriers for entry.
Bitcoin by contrast, is still mostly adapting to the inevitability of miner centralisation by pretending it's not happening and that it's all going to work out. Which leads neatly to Dowd's second point: that an inferior product cannot survive in the long run.
He points at bitcoin's market share as a simple sign of this. It's clearly trending downwards.
The same people who will point at bitcoin's upwards-trending prices since 2013 as evidence of its inevitable takeover will happily ignore its downward-trending market share as evidence of its inevitable demise.
Predecessors can take advantage of being the first-mover, which manifests as an abnormally high market share. But over time, their market share diminishes as superior products take over.
"Some of these [newer competitors] offer products that are superior to the product produced by the first firm, not least because their producers have learned from some of the design flaws in the first firm’s product. And eventually superior rivals displace it completely and the market share of the first product goes to zero."
The centralisation inherent to proof of work might be a clear example of one of those design flaws.
One reason bitcoin will survive
"I've been through the ups and downs with bitcoin, and I am as certain as ever that the bitcoin revolution is coming," Draper writes. "It is here to bank the unbanked, to democratize economic opportunity and to reevaluate governance. I expect that it will change everything from the banks and the financial system to healthcare, to democracy, even the government."
To support his argument, Draper points at some of the "downs" he's experienced, including pre-ordering high-speed miners from Butterfly Labs, which went out of business after it was revealed that the company was using pre-ordered customer machines to mine bitcoin for itself and then only shipping them after they were obsolete. This practice is believed to still persist in the crypto mining world and is often cited as one of those ways that proof of work leads to centralisation.
Draper also gives the example of buying $250,000 of bitcoin at $6 apiece, and then losing it all on Mt Gox.
"But something important happened with the failure of Mt. Gox. The price of bitcoin only dropped about 20 percent, and the currency continued to be traded on other exchanges. I was flabbergasted and fascinated," Draper explains. "I realised that the demand for this new digital currency was so strong that even a huge theft would not keep bitcoin from creating a new way for us to transact, store and move money."
He would later buy back in, purchasing almost 30,000 Silk Road bitcoin at above market price – $632 each.
"Bitcoin is just beginning, Tim Draper writes, because "it is honest, incorruptible, secure, and fair."
Of course it won't be if the predictions of mining centralisation come true, but it's still a nice sentiment.
What to make of it all?
There are some very dearly-held opinions on both sides of the fence, and both can still be correct. It's possible that bitcoin will be corrupted under the weight of centralisation, but it can also be correct that it doesn't really matter and that people will happily continue to turn a blind eye to bitcoin's downsides on account of its brand name.
As Draper's article suggests, bitcoin isn't about hard-nosed examination of market forces. It's about aspirational language and emotional appeals. Plus, true decentralisation and the nuances of chip manufacturing are somewhat complicated subjects that go well beyond the bounds of what most people want from their money. It's perfectly possible that people will keep ignoring all of these obvious downsides. It's also possible that "no-coiners" will keep arguing until they're blue in the face and that none of it will make a difference.
It's also worth noting that Dowd didn't just start making these arguments now. He wrote the Bitcoin Will Bite the Dust paper back in 2015, outlining the exact same arguments, which are still relevant today. And in the intervening period, bitcoin has obviously not bitten the dust.
And as Draper pointed out, incidents like Mt Gox didn't kill bitcoin, and neither did its longstanding history of being black market money. If there's one thing people can learn from the history of bitcoin, it's that people are perfectly willing to look past these kinds of incidents in the pursuit of
massive Lambo gains a decentralised global currency that can bank the unbanked.
The reasons bitcoin will die are because every ounce of rationality says it should. The reason bitcoin won't die is because it's not rational, people aren't rational and the concepts of value are not rational. This is not unique to bitcoin.
Just take a look at the per carat price history of diamonds over the last few decades.
Synthetic diamonds became more cost-effective for industrial applications in the 1950s, and gemstone-quality synthetic diamonds arrived in the 1990s. Rationally, one would expect either of those to cause prices to plummet. But all this common sense and pragmatism is nothing in the face of artificial cultural significance and the fact that they're shiny.
Just like bitcoin.
Bitcoin is also shiny, and ethically the grey areas in bitcoin's history are nothing next to the sea of blood behind diamonds. And a lot of work is going into manufacturing the artificial cultural significance for bitcoin.
"Bank the unbanked" has a nice ring to it. It fits on a bumper sticker and really goes right to the Zeitgeist of today's increasingly sceptical and interconnected world. Bitcoin's branding is very much on point, and there are a lot of people ready to evangelise its shininess.
Disclosure: At the time of writing, the author holds ETH.