TLDR. As somebody who is long term bullish on Bitcoin, I often speak to mainstream investors who are sceptical but interested. They want to know if the issues that famous Bitcoin sceptics tell you about in the media should worry them. This chapter of The Blockchain Economy book tells you why these issues are not real worries. They are like straw man arguments – easy to knock down. However, this chapter describes another issue that few analysts talk about but which I believe is more of a real issue for a Bitcoin investor to worry about. This issue is how Node Operators are compensated.
Personal bias disclosure: I am a Bitcoin Maximalist, for reasons outlined in this chapter of the Blockchain Economy book.
This post addresses long term investors who look at the fundamentals of Bitcoin. Short term technical traders have many other resources.
The usual arguments from Bitcoin sceptics
- Bitcoin does not have thousands of years of history as a store of value. So it cannot be worth anything. The first sentence is obviously true. The second sentence betrays a lack of understanding of disruptive technology. Many Tech giants, obviously worth a lot of money, have a lifespan of only a few decades.
- Bitcoin cannot be stacked in physical piles like gold bars. So it will be useless if we no longer have the Internet. Both statements are true but in the unlikely event that we no longer have the Internet a) have a few gold bars/coins just in case (nobody says Bitcoin will totally replace gold) b) in that dark apocalyptic scenario you will have other worries that are much more pressing (such as shelter, safety, water, food). Lack of Internet is an extremely unlikely scenario. North Korea is an exception that proves the rule. Even when dictators attempt a shutdown (for example in Egypt in 2011) it is temporary.
- Quantum Computing will make Bitcoin’s cryptography easy to crack. This can be fixed at the technical level using the same Quantum Computing technology, but there are some risks before Quantum Computing becomes commonly available. It is a nuanced issue, for a good discussion watch this video.
- Nobody is in charge. Fierce battles and forks show that the governance of Bitcoin is totally broken. Ahem, nobody is in charge of the Internet. Trusting a free market is hard for some people. For more, please go to this chapter.
- Bubbles prove that Bitcoin is a ponzi scheme. This also shows that trusting a free market is hard for some people (particularly those who have relied recently on Central Banks printing money to make sure market assets are kept at a high level). Bitcoin is like a startup where the market priced the startup’s valuation from day one. Imagine Facebook’s price volatility if the market had priced Facebook from the days when it was a Harvard dorm room project!
- Bitcoin cannot scale. At Layer 1 this is true. Layer 2 technologies such as Lightning Network are now coming on stream which will enable scaling far beyond current payments rails. For more, please go to this chapter.
- Bitcoin is not yet useful as a currency. This is true if you live in a country with a) a stable currency b) functioning bank payment rails. There are many countries where this is not true. For more, please go to this chapter
- Lots of fraud. This also true in Legacy Finance (Madoff, Enron, Mortgages, etc, etc). Change is coming from a) the market (eg investors avoiding centralised exchanges) b) technology eg Decentralized Exchange protocols) c) regulation and insurance.
- Wash Trading inflates trading stats. True, but even if you strip out all the fake trades you get a real number over $270m daily trading volume – not bad for an asset/technology that is only just over 10 years old!
Rear view analysis is not useful for investors
The Economist is a great magazine that I have been reading for decades. Occasionally they get it wrong – for example in their support for the second Iraq War. In their most recent edition, dated 30th March, their article on The madness of crowds gave a lot of reasons why cryptocurrencies are like tulip mania – worthless. A few days later the price started rising. Rear view analysis is not useful for investors, which is why our ambition at Daily Fintech is to be News Forecasters.
Lets see how many sceptic articles there are just before the next bear market appears.
The real issue to worry about is economic incentive for the people who run Bitcoin Nodes
Miners are rewarded by receiving Bitcoin, but there is no similar incentive for running a full Node. This is a problem, because Nodes are vital to the Bitcoin network and, like mining, involve real costs. Bitcoin enthusiasts say that you “should” run a Bitcoin Node. The problem of course is that “should” does not work at scale. It worked during Bitcoin Phase 1 when the Cypherpunks, Anarchists & Libertarians (who created the early traction that got Bitcoin from an obscure message board to the possibility of mainstream adoption) were motivated by rewards other than money. Should is irrelevant to Bitcoin traders/investors today and to future mainstream users.
This is why Ethereum has Gas costs. When I first encountered Ethereum in 2014, just after starting Daily Fintech, I struggled to understand the difference between ETH and Gas. At that time it seemed like a needless complication. Now I can see that Vitalik Buterin had learned from studying Bitcoin. When you pay for something via the Ethereum network, you pay in ETH. That transaction is processed on a decentralized computer. You pay for that computation in Gas (and Gas is paid in ETH). If Bitcoin had something like that, then Node operators could get paid in fees. For more on how Ethereum Gas works, please go here.
Yes, Governance is a tough issue for Bitcoin.
This Chapter describes Why Non State Governance For Bitcoin Ethereum And Other Cryptocurrencies Is So Hard. Fixing some code in Bitcoin is relatively easy in comparison to fixing an economic incentive issue; there is a super competent team to fix code issues. The market will also fill in the gaps that Satoshi Nakamoto deliberately left in there (such as a User Interface). However it is possible that the economic incentive for full node operators was a mistake by that legendary founder(s). Many commentators say there should be fees for full node operators, but it is hard to see how such good exhortations get translated into reality.
This problem also applies to Lightning Network – which could fix it
Lightning Network also requires node operators to be compensated. The good news is that Lightning Network is a protocol where the governance allows the problem to be fixed at Level 2 (because Lightning Network is funded by commercial interests). It would not fix the problem at Level 1 but it would makes that problem smaller.
Do you trust the free market to fix this problem? How do you see this problem being fixed?
Bernard Lunn is a Fintech deal-maker, investor, entrepreneur and advisor. He is CEO of Daily Fintech and author of The Blockchain Economy.
I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.
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