Bitcoin has not had a good past few months. I am not going to take all the credit, but I did write my post “Why I Would Bet Against Bitcoin” on December 16, and the very next day Bitcoin began it’s tumble that has brought it down 50% in value. As far as calling a peak goes, you must admit this chart is pretty good timing.
A 50% decline really doesn’t look like a very good store of value does it? The recent stock market decline of around 10% is nothing compared to this. Again I think this sort of volatility undermines the fundamental value and usefulness of Bitcoin.
But volatility and hordes of bubble-chasing speculative investors are not Bitcoin’s only problem, there are technical shortcomings as well. For this, I recommend reading Eli Dourado. Eli is a phd economist who is an actual expert on the economics of cryptocurrency, and coauthored the cryptocurrency chapter for the New Palgrave Dictionary of Economics. Like myself, Eli is actually an optimist about the potential for cryptocurrencies. However, he argues that when you look at all the important features for a cryptocurrency, Bitcoin is either dominated by Ethereum or soon will be. Given the strength of Ethereum, he argues “I no longer believe there is a stable place for Bitcoin, Ripple, or most other cryptocurrencies that exist today”.
I won’t give you all of his reasons Ethereum dominates Bitcoin, you should read the whole piece yourself, but here are a few important ones. One issue is transaction fees, which are significantly lower for Ethereum. The high transaction fees are one reason why the Bitcoin conference famously and hilariously had to stop taking Bitcoin payments for ticket.
Another issue Eli says favors Ethereum is governance quality. The leadership, developers, and community matter a lot for a cryptocurrency. Writing his New Palgrave article in 2014, Eli was optimistic about Bitcoin governance quality, but since then, he writes, things have gotten ugly:
“Bitcoin has been unable to seriously address its on-chain scaling problems. Its community has alienated, marginalized, and purged dissenting voices, notably Mike Hearn, Gavin Andresen, and Jeff Garzik. Its core development team has been captured by an ideological faction committed to only off-chain scaling in the name of decentralization. This faction has undermined consensus scaling agreements and trashed the reputation of anyone who points out any of the above. As early as September 2015, I was concerned about Bitcoin governance quality, but still—mea culpafor that 2014 paragraph. I really got it wrong.”
From Eli’s analysis, it seems that governance quality is a key competitive advantage for a cryptocurrency. While source code and technical parameters can be copied, and network effects can change, governance institutions can’t simply be copied:
Governance institutions are especially important for cryptocurrencies because they can’t be simply copied. You can perhaps copy the institutional structure, and you can copy the outcomes and decisions, but when a crisis occurs, you want the A team to handle it as calmly, reasonably, and professionally as possible. Source code and technical parameters can be copied. Adoption and network effects can be replicated over time. Good governance—like good culture at a company—is a challenge to develop, and once you lose it, it’s hard to get it back.
One irony of this is how similar this is to the institutional quality problem of central banking. For a central bank to manage a currency well they need to be politically independent and technically capable. Central banks that have failed to follow modern central banking best practices or have been captured by politicians have done poorly throughout history. Despite the much advertised decentralization of cryptocurrencies, these historical central banking issues of institution quality and governance quality seems to matter a lot. And for Bitcoin this seems like bad news.