I Love Bitcoin But I Hate Bitcoin: An Economist

At the current time, we see companies and institutional investors moving into Bitcoin left and right, which is genuinely good news for me, not only because a large share of my crypto holdings is in BTC. And yet, I am more thrilled whenever the BTC-dominance takes a nosedive. It somewhat saddens me that the large institutional crypto whales seem to favor Bitcoin above anything else. 

What’s even more frustrating, all of my no-coiner friends and family keep asking me about Bitcoin. While I cherish people around me taking up interest in the cryptoeconomy, I would strongly prefer them to invest into altcoins, or at least diversify their investments to many coins instead of just the leading one. Just imagine being a stock market analyst and everyone you know only asks you about Tesla, because they don’t know any other publicly traded companies. That would frustrate you as well I suppose. 

I also don’t think that Bitcoin is overrated right now. It’s just that altcoins are highly underrated. Undoubtedly, Bitcoin has been the best investment in our lifetime for those who got in early and I think and hope that it will continue to be the best investment opportunity throughout at least the first three quarters of 2021. In the long run though, I don’t think that Bitcoin should have a rightful place in the cryptoeconomy of the future.

In a bitter twist of irony, I have actually been one of the first adopters of Bitcoin. Now back in 2011, I first heard that some anonymous Internet madman invented a method to create a decentralized digital currency. I didn’t know anything about how this currency with its Proof of Work consensus and everything worked, but I quickly figured out how to use my graphics card to mine a total of 16 BTC on my home PC within a few days. 

Actually, I even learned that I happened to have one of the most energy efficient graphics cards at that time and I was living in a university dorm where I would have been able to get electricity for free. However, I didn’t have much trust in Bitcoin yet. I heard stories about students suffering heat strokes in their rooms from their mining rigs, which seemed like a majorly degenerate thing, and how Bitcoin was used mainly to buy contraband from illegal darknet marketplaces. Not that I have a problem with that, but by no stretch of the imagination, I would have seen Bitcoin become adopted by more than a few cryptography aficionados and the occasional pothead. 

Little did I know about Austrian Economics and how utterly broken our traditional fiat money system is back then. To me, Bitcoin certainly seemed like a cool idea, but not much more, so Ultimately, I sold my BTC on Mt. Gox at a price of maybe $3 per piece. In hindsight of course, this was a more than unfortunate decision, given that, if I had invested my time and freshly mined money into stacking sats, I would easily be a multi-millionaire by now. 

I finally returned to crypto in 2017 after I have taken up a doctorate position in techno-economics at Ghent University. This is a specialized field at the interface between engineering and economics and the 2017 bubble was in full force after last year’s halving event, so necessarily, a lot of office talk revolved around Bitcoin and occasionally altcoins like Ethereum. 

Also, I have educated myself about Austrian Economics and libertarian philosophy by that point and suddenly, I realized that cryptocurrencies and decentralized technology were something the world actually needs. I decided to let my contract in Ghent expire after a year to become a full-time crypto professional and, although not quite as rewarding, it turned out to make up for at least some part of the horrible decision I made in 2011. 

This shows itself most strongly during the COVID-19 pandemic. I am now considerably less concerned about my financial future than most people whose job is on the line due to the lockdowns and whose accumulated wealth is in jeopardy due to the central banks’ excessive money printing.

So what’s my sentiment about Bitcoin after knowing about cryptocurrencies for ten years and actively working in the industry for three? Well, as I mentioned earlier, I think that altcoins are massively undervalued. So let’s look at some of the fundamental sources that give different cryptocurrency their value.

Some people would call this intrinsic value, which is complete BS from my point of view. According to Austrian theory, the value of any asset is determined subjectively. A Bitcoin or, an Ether, or a US-Dollar, or an ounce of gold is at all times worth exactly what others are willing to pay for it. There is no intrinsic value. However, we can look at supply and demand to estimate how the subjective value of assets will develop over time. 

In the case of cryptocurrencies, the driving force behind their subjective value is utility. In other words, what can you do with a coin and why would people buy a coin? The reason people, and as of recently, companies and institutional investors buy Bitcoin is that they regard it as a provably scarce asset that is perfectly suited as a store of value. Rightfully so, but the same holds true for other crypto assets as well. 

Being the first of its kind, Bitcoin is everything but an ideal cryptocurrency. The Bitcoin blockchain is one of the slowest and most expensive blockchain networks that exist. Sure, there is some adoption by local vendors and online marketplaces, but it’s hardly ever used for everyday payments due to the high transaction costs. The Lightning network could help alleviate that, but adoption of Lightning payment technology by HODLers, exchanges, and vendors is lagging behind. 

Ironically, Bitcoin’s technological shortcomings might be part of the reason why it is being traded at such a high price. Remember that Bitcoin maximalists refer to BTC as the “digital gold”. In a certain light, there is actually some truth to that. Physical gold is not really that suitable as a currency, since it is less fungible and weighs more than paper money. This is why gold-backed currency systems rely on certificates rather than carrying a bunch of heavy coins and ingots around. 

Since there are costs attached to making payments with physical gold, it is suitable as a store of value, since gold tends to sit in vaults, rather than circulating. The same mechanic might be at work for Bitcoin. Due to the high transaction costs, there is an incentive to keep BTC as a store of value and to not move it around for payments, thereby keeping the supply low.

As mentioned above, Bitcoin is far from optimal for anything we expect a cryptocurrency to do. It is slow, expensive and, most importantly, the Bitcoin blockchain does not support smart contracts. This means that the most attractive crypto use cases at the moment, such as DeFi, tokenization, or NFTs are not supported natively.

There is only one thing Bitcoin really excels at and this is enabling large (we’re talking about tens and millions of US-Dollars) transactions for relatively low costs. Sadly, most of us will never get to make use of this ability and for lower sums, there are much cheaper and more practical alternatives like Bitcoin Cash, Litecoin, or modern PoS chains. 

Now compare that to Ethereum. On Ethereum, we have all these novel smart contract use cases and using smart contracts requires you to pay ETH for the gas fees. In other words, there is an organic demand for ETH and this demand increases with every new way people figure out what smart contracts can be used for. 

If you go further down the line, there is Binance Coin, which can do anything Ether does, but even better since the Binance Smart Chain is faster and a lot cheaper than Ethereum. On top of that, you can use BNB in order to get access to trading fee discounts and various other perks on the world’s largest crypto exchange. 

Below that in market cap ranking, there is a plethora of other fast and cheap smart contract platforms, as well as DeFi or other highly specialized blockchain projects, each with their own utility sources. Regarding all of that, I really don’t see a reason why Bitcoin should have a share of more than 60% of the combined market cap.

At the moment, Bitcoin is the best-suited blockchain for whale transactions, but this can instantly change the moment another coin takes the lead position away from Bitcoin, as it almost happened in 2017 with Ethereum. 

At the moment, Ethereum is sitting comfortably at 20% of Bitcoin’s market cap and it has been gaining ground since the beacon chain for ETH2 launched in December 2020, so it is not unlikely that there will be a flippening at some point during this mining epoch. If that happens and if Ethereum shows that it can be as good a store of value, Bitcoin will lose its last raison d'être since whale transactions can then be processed on Ethereum with a higher efficiency. In that case, do not expect Bitcoin to ever return to its current number one spot.

Another problem I see is the growing energy consumption of Bitcoin. To be perfectly clear, I am anything but an environmental activist and yes, I am aware that a large percentage of Bitcoin’s energy input comes from eco-friendly sources. But is it really necessary when we have a better solution right in front of us with Proof of Stake consensus, which is faster, cheaper, and does not consume as much energy as a small industrialized country and produces tons of electronic waste?

To me, Bitcoin maximalists seem to cling to the naive, almost childish belief in the magical 21. Sure, Bitcoin’s supply is provably limited, but it will take another 120 years to actually hit that ceiling. Until then, it will remain an inflationary asset, just like any PoS coin. And with PoS, there is a simple solution to combating inflation: just stake your coins and you are guaranteed to receive a higher return than the inflation rate. Additionally, there is a good chance that Ethereum will even become deflationary soon with the approval of EIP-1559.

Also, I have yet to hear any good arguments in favor of Proof of Work. On paper, PoS might have some security flaws that PoW doesn’t, but in practice, there haven’t been any successful consensus attacks against PoS blockchains yet, at least to my knowledge. On the other hand, there were 51% attacks against several PoW chains, most notably the serial offenders Ethereum Classic and Bitcoin Gold. Seriously, why are these coins still a thing in 2021?

Another argument I’ve heard is that PoS runs the risk that nodes centralize too quickly. Since all you need to do for staking is to buy the coins on an exchange, whales will amass coins and thus exert an enormous amount of governance power over the chain. With PoW mining, it becomes significantly harder to amass governance power after all. But somehow, a chain which generates over 60% of its hashrate in China, a country whose totalitarian communist government is fundamentally opposed to crypto, is supposed to be decentralized?

In the last year, I had the opportunity to interview Travin Keith, who actually made a somewhat valid argument against PoS, since the initial distribution often unfairly favors team members and high-profile investors. It is true that the ICO/IEO model used by most of today’s PoS powerhouses is not ideal in that regard, but this is just a matter of distribution. 

With the rise of DeFi in 2020, we have seen novel launch models that distribute most if not all tokens directly to contributors. The Polkadot-based chain Edgeware made the first move with their Lockdrop distribution, which worked out perfectly and many DeFi projects copied that model with yield farming and liquidity mining.

Travin also criticised that when you want to start staking, you have to buy the coins from someone else first. In order to participate in PoW consensus, you can simply buy off-the-shelf hardware and mine away, which automatically guarantees a fair launch. You contribute with your hashrate, you earn some coins. That’s as fair as it gets, with just the caveat that mining will only be profitable if you have access to cheap electricity. I don’t see why people living in areas with high energy costs should be excluded from the launch.

To make matters even worse, PoW mining might even have a built-in tokenomic time bomb. The energy consumption for Bitcoin is proportional to the BTC price. If the price goes up, it becomes profitable to start up more rigs. At the moment, we’re standing at 1% of the world’s total energy consumption. Let’s suppose Bitcoin reaches $200,000 in this epoch, this can reach up to 4%. Another five-bagger in the next cycle might catapult Bitcoin to up to 10% and in the mining epoch afterwards, Elon Musk will have to send large solar sails into the orbit, just to satisfy Bitcoin’s never ending hunger for energy.

All of this is theoretical of course. In practice, I don’t think that we will keep up with the production of mining hardware, but this brings even more problems. If the price keeps going up and we can’t keep up backing the price with a higher hashrate, this might lead to situations where it suddenly becomes profitable to run 51% attacks, just like on Ethereum Classic and Bitcoin Gold. Although I don’t think that a single mining pool or a coalition of pools will become powerful enough to raise more than 50% of the hashrate, the idea that it might at one point become profitable to do so should concern you at least a little bit.

The biggest problem I am seeing in Bitcoin is its recurring four-year market cycle that, due to Bitcoin’s dominance, has a large impact on the whole cryptoeconomy. At the current time, the Bitcoin price is surging following the halving of the mining rewards in the last year. 

If history repeats however, the bubble will burst in a few months and the BTC price will come crashing down. Usually, the Chinese New Year creates a supply shock as Asians are pulling their money out of crypto at that time for red packets. The next lunar new year is on February 1st, 2022, so the very latest date I would expect the bubble to burst is around mid January. 

There is however still enough time to go until then, so this might just as well happen earlier. If the price continues with the current trajectory, it may hit the deep red zone in the Bitcoin rainbow chart as early as May. And then we’re in for a bear market for the next 18 months. 

The question is, when the Bitcoin bubble bursts, what happens to the altcoins? It is a well-known fact that cryptocurrencies are highly correlated among each other. This does not necessarily mean that they are correlated to Bitcoin specifically, since they are indeed able to make moves on their own. One could say that, like stocks, cryptocurrencies are an asset class that generally moves together in the same direction. 

In the last cycle, Bitcoin had hit its highest point in December 2017, while the altcoin markets continued to surge for about a month until they collapsed as well. Now this doesn’t mean that the same will happen in this cycle. First of all, the largest altcoin markets are now quoted in USD(T) instead of BTC and Tether has increased its market cap more than 28-fold since the start of 2018. So if the value of Bitcoin plummets, altcoins don’t necessarily have to follow suit. Also, institutional investors could be a decisive factor if they shift their focus more on altcoins once the halving effect subsides.

However, when the bubble bursts, there will be substantially less money in the cryptoeconomy, just because a whole 62% of it is locked up in Bitcoin at the moment. So the more likely scenario as it stands now is that all cryptocurrencies will crash and 2022 will be a bearish year for the whole industry. 

It’s not hard to guess which scenario I would prefer. In my opinion, if we hit the ideal timeline, the bull run will continue for the rest of 2021 of course. Bitcoin will make huge gains and we’ll close the year at a price of about $200,000. Altcoins will make higher gains moving Ethereum closer to Bitcoin and then, once the bubble bursts, some more investments will flow into ETH, making the flippening complete. 

Let’s face it, Satoshi Nakamoto launched Bitcoin in 2009 as an experiment to create a decentralized currency. And as I see it, he did not put much thought into its tokenomics, just because this field did not exist yet. Otherwise, we wouldn’t have so many open questions about Bitcoin’s design. 

Why is the supply capped specifically at 21 millions? Why does the halving occur every 210,000 blocks with such a sharp drop every four years that creates these weird market cycles? Wouldn’t a smoother inflation curve make more sense? Did Satoshi think about the enormous energy consumption of mining once Bitcoin hits a trillion dollar market cap? Did he even expect such an enormous success?

Who is Satoshi Nakamoto anyway? Maybe he mined his 1.1 million BTC (more or less on his own) and then threw his private key away since he couldn’t do anything with them. Now I don’t think this is likely, but somehow, the idea that there’s an even bigger fool out there than I was in 2011 and who is mad like hell about himself because with just a little bit more faith, he could be a multi-billionaire by now amuses me.

So when Bitcoin was launched, it was completely experimental and 12 years of development didn’t change much about it. The other Proof of Work chains that came afterwards, these were the prototypes. This is also the reason why Ethereum now wants to switch to PoS, which is a truly herculean task. It then took until 2018 for blockchains to become ready for series production with the emergence of Proof of Stake. Their current market cap just does not reflect that. 

So let’s be rational about this. Once again, Bitcoin was an experiment and I am absolutely grateful that it happened and that it worked to such perfection. I am also grateful that so much money is flowing into the cryptoeconomy right now. But when we now have to decide which coin we should put all of our money on, Bitcoin is really the worst possible of all choices. Except Dogecoin maybe…