The short and long term consequences of financial crises on Bitcoin

Altcoins in a financial crisis

While the speculative bubble in bitcoin and altcoins in general can only be understood as a consequence of easy money allowing people to engage in unsustainable speculative bubbles across the economy, the outcome of financial crises is likely to be different between bitcoin and altcoins.

Bitcoin is the only digital currency that is strictly scarce, because it is the only one whose supply can only be increased through expending resources roughly equal to the value of the coins produced - i.e. bitcoin is the only hard money among digital currencies. Thanks to Bitcoin's difficulty adjustment, nobody has ever been able to produce a single bitcoin without expending resources roughly equal to its market value. Bitcoin is pure hard money, and it does not make any promises for being anything else. It offers no returns, promises no "killer apps" for which it can be exclusively used. Anybody who bought Bitcoin has bought it for no purpose other than to sell it later on, in other words, bitcoin's demand is purely demand for liquidity.

While other currencies may theoretically have a fixed supply, it must be understood as a monetary policy with nowhere near the credibility that bitcoin's monetary policy has. As I've discussed frequently, bitcoin was the only network that grew organically as a neutral protocol, available to any one to use, with a scarce resource whose production cost was always around the range of its market value. Had any altcoin begun with this format, it would be highly unlikely to survive or attract any market share from bitcoin, as bitcoin would have more liquidity and hashrate. It would also be quite easy to attack and destroy it when at its infancy, turning away all real value. That any currency has managed to survive, and attract attention and capital is purely down to having a dedicated team or foundation of individuals investing time and resources into coding, mining, and maintaining the network. It is trivial to pinpoint a few individuals that are extremely decisive in the running of the network. This carries several implications. No altcoin has any contentiousness in its operation, they are run like businesses, controlled by a group of people working toward a set goal. With such a structure, no coin can credibly claim to have an immutable monetary policy. It would be trivial for any altcoin to carry out a hard fork to change its monetary policy, as has happened repeatedly with many of these coins. Perhaps more pertinently, the people controlling any altcoin are a single-point-of failure which can be attacked to cripple, coopt, or derail the project.

This, of course, is in stark contrast to bitcoin, which has thoroughly earned the right to make a very credible claim to have an immutable monetary policy after the events of the Segwit2x hardfork, summarized here by Kyle Torpey. When a majority of the owners of the bitcoin hashrate, a majority of the mining processing power, a majority of businesses dealing with bitcoin, and a large number of influential and early bitcoin developers and holders agreed to hard fork bitcoin to change the blocksize, a technical parameter nowhere near as contentious as the monetary policy, they failed miserably, and had to submit to the consensus of the network. For more on this episode, I highly recommend this piece by the ever-excellent Pierre Rochard on Bitcoin governance.

To summarize, I will quote what I said in The Bitcoin Standard:

In conclusion, the Bitcoin coders face a strong incentive to abide by consensus rules if they are to have their code adopted. The miners have to abide by the network consensus rules to receive compensation for the resources they spend on proof-of-work. The network members face a strong incentive to remain on the consensus rules to ensure they can clear their transactions on the network. Any individual coder, miner, or node operator is dispensable to the network. If they stray away from consensus rules, the most likely outcome is that they will individually waste resources. As long as the network provides positive rewards to its participants, it's likely that replacement participants will come up. The consensus parameters of Bitcoin can thus be understood as being sovereign. To the extent that Bitcoin will exist, it will exist according to these parameters and specifications. This very strong status-quo bias in Bitcoin's operation makes alterations to its money supply schedule, or important economic parameters, extremely difficult. It is only because of this stable equilibrium that Bitcoin can be considered hard money. Should Bitcoin deviate from these consensus rules its value proposition as hard money would be seriously compromised.

Altcoins do not even come close to demonstrating this. It is simply inconceivable to imagine an altcoin resisting a coordinated campaign to change their parameters from their major stakeholders,as was the case with bitcoin with the Segwit2x hardfork. The second largest network after bitcoin, ethereum, has in its short history already had several hard forks, and it has no clear plan of what exactly its monetary policy will be in the future, currently holding meetings to decide on a future course of action. Other altcoins, with smaller communities would likely find such changes even less contentious.

No altcoin even attempts to compete with bitcoin on its one value proposition: immutability. They focus on speed of transactions, adding fancy buzzword features that have no hope of ever functioning, and even if they did, they would never have a millionth of the importance of a digital sound money. Even if these supposed apps work, none of them will create significant enough demand for people to hold the token, rather than just buy it when needed, for the very same reason that people don't hold any serious wealth in the tokens of any real world business that issues tokens. There is no comparison for demand for the US dollar to demand for casino chips or Chuck E. Cheese tokens, and that is precisely why grouping bitcoin with altcoins makes little sense.

Whereas ultimately demand for bitcoin is demand for a hard money, demand for altcoins is a wide variety of usecases and buzzwords that attract speculators. Even if these usecases and buzzwords work, there is nothing scarce about them, and there is nothing to stop the inflation of their supply, both on an individual and aggregate level.

On an individual level: If one altcoin becomes increasingly valued, it would not be very difficult for its makers to change the rules of the supply, either to benefit themselves, or under pressure from political authorities. To imagine that governments will abdicate monetary policy responsibilities to currencies which are run by private citizens is naive to the extreme. It would be trivial for authorities to take any altcoin and force its founders to change the monetary supply if the need arises. Bitcoin's track record in segwit2x shows it has a chance of resisting such an attack. Altcoins' collaborative communities with clearly identifiable figureheads stand no chance.

On an aggregate level, the problem altcoins face is that none of them can ever build scarcity for its token around any particular usecase, even if they succeed in demonstrating successful market-adopted usecases. For every supposed usecase for cryptocurrencies, there are already several projects vying for the attention of the investor. For every person who wants to invest in smart contracts, for instance, there is a growing number of projects regurgitating the buzzwords that ethereum first popularized, but with new qualifiers. So as every novel idea gets an ever-increasing number of currencies, they are not only easy money individually because their creators can make more of them, they are also easy money in the aggregate because nothing stops other projects from creating similar coins.

If any novelty can have its own coin, and minting coins can make someone rick quick, then every novelty imaginable will be used to make coins. As Tuur Demeester explained:

A problem with coins that trade on novelty (rather than utility) is that the market creates novelty faster than they can.

An ever-growing number of novelty usecases, an ever-growing number of coins for each use case, the possibility that the creators of a coin could alter its schedule to increase the supply, and with liquidity and security significantly inferior to bitcoin, altcoins are firmly perched at the highest reaches of Exter's inverted pyramid. They have low liquidity, carry a lot of risk, but offer potentially high returns through quick appreciation. Most significantly, their supply can be increased quickly. They are clearly different from Bitcoin whose value proposition as hard money is uncontested by any altcoin. The only truly scarce digital tokens are bitcoins. This is why, over the years, one would expect bitcoin to drop down Exter's pyramid.