Thesis:
All current cryptocurrencies can not scale. Either they become insecure or cost-prohibitive to maintain.
Details:
This one is real simple: - Bitcoin or maybe Ethereum have the biggest name cache. If any other crypto builds a better algorithm in an open-source manner, they can simply elect to steal it. As such, the upside to real ideas is low - see Bitcoin Improvement Proposal
- Proof of work, the method used by Bitcoin, Ethereum, and most cryptos has some pivotal flaws it can not get away from:
- if the work is too easy, then too many miners will solve the next block at the same time. As such, the ability to manipulate the chain is high, and one has to wait for multiple confirmations, and it could lead to multiple forks if there is a disagreement.
- if the work is too hard, it takes too long to process transactions and costs more electricity to do so
- when the price of a coin is high, too many miners try to flood the system as they don't care about the electricity prices
- when the price of coins is too low, the network is vulnerable to a single entity causing the chain to diverge, potentially approving transactions others would t agree to. Aka, the security of the entire chain is at risk.
Decentralization is a lie:
Some have tried to change the algorithm to vary which hardware can perform well on the task at hand; however, ASICs will always have the edge in a consistent algorithm from an electricity standpoint. It costs millions, if not billions to run an ASIC fabrication facility - few can do this and hold centralized power.
For CPU-based systems or proof of stake systems, again, those with the most money will be able to buy control. Voting blocks can easily form to take control. Consider a proposal that decides to print additional coins and issue them to the top 10% of coin holders.
Currencies are about enforcement:
Consider for example if the US government decides not to honor contracts based on Bitcoin, then the entire legal structure is not available to enforce these contracts. This means all pricing will be in US dollars, even if the exchange is in Bitcoin. At that point, Bitcoin is just a medium of exchange. Whether a paper currency transaction is for $100 or $1 doesn't change the cost of the paper necessary. Paper is just the medium of exchange. CPUs, networking hardware, and electrons are the real mediums of exchange, not Bitcoin.
Global currencies are backed by the US dollar (and somewhat the Euro):
USD is the reserve currency, combined with the Euro they are the vast majority of the reserves other countries hold to give their currency value. The export/import balance combined with interest rates that country promises (how fast they inflate their currency) can help you determine how that currency will trade to the US dollars. This makes sense.
Bitcoin is not a currency:
Unlike global currencies, earning and spending aren't done in those currencies. Irrespective of the cost of imported goods rising, local goods are pegged to a stable currency. Bitcoin is no more a currency than gold.
Bitcoin is not a store of value either:
Unlike gold or other raw materials that can be turned into goods and sold for utility, Bitcoin is not a commodity. Commodities have a physical use, giving them value.
What remains is the value behind the "greater fool theory". Specifically, the belief that there will be someone who wants the Bitcoin from you in the future, but if no one wanted it, it would not hold any value.
How does fiat currency have value then? As we've seen already, all currencies are effectively US or Euros. The US and European governments enforce contracts in their currencies via their police and military - this is what gives their currencies value. You can think of each dollar in the M0 as a share in that countries ability to enforce contracts/rule of law.
Bitcoin isn't the only hedge against inflation:
Inflation fears are overblown. I'll explain this in a follow-up post. That said, hedging against inflation can be done by holding commodities or other non-cash assets (like stock/real estate). Each carries its risks. My suggestion is to always carry things you can use in the future in their raw form. For example, a company should hold futures on raw materials necessary to make their products, than Bitcoin. If there is price inflation due to currency valuation, import/export, or even supply chain issues, the company is insulated. If prices decline, they can choose to buy off the market directly, effectively providing minor arbitrage opportunities as well.
Conclusion:
It is difficult to see how Bitcoin or any other crypto provides value. The fundamental problem is that decentralized systems are inherently less optimal; however, the security these systems provide through decentralization is not as secure as the security provided through fiat currencies secured by the enforcement might of governments.
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