Sound Money

BTC vs. ETH Part 1: Basic Differences between bitcoin & Ethereum

I’m often asked, “why bitcoin?”, “why not ethereum?” and “what about diversification into cryptocurrencies?” There’s a lot that can be said on this topic so I’m going to break it up into bite-sized chunks. In part 1, I’ll tackle the similarities between bitcoin and ethereum, the major differences and the questions an investor must ask when approaching these projects. Part 2 covers protocol certainty and Part 3 is the real crux of the matter, the investment thesis. Enjoy!

TLDR: Bitcoin’s protocol certainty and alignment with my investment thesis makes it my overwhelming focal point.

Most of the information on ethereum comes from reading the first chapter of Andreas Antonopoulos’ Mastering Ethereum.

Similarities

8 characteristics of a public blockchain:

1. Peer to peer network connecting participants, propagating transactions + blocks of verified transactions, based on the protocol
2. Messages in the form of transactions
3. A set of consensus rules, governing what constitutes a transaction and what makes a valid state transition
4. A state machine that processes transactions according to the consensus rules
5. A chain of cryptographically secured blocks that acts as a journal of all the verified transactions
6. Decentralised control over the blockchain through a consensus algorithm, forcing participants to cooperate in the enforcement of the consensus rules
7. A game-theoretically sound incentivization scheme to economically secure the state machine
8. One of more open source software implementations of the above, called a client(s)

In these respects bitcoin and ethereum are similar because they are public blockchains, but that’s where it ends. Their goals are remarkably different. Bitcoin aims to be digital decentralised permissionless money. Ethereum aims to be a decentralised, permissionless world computer.

Ethereum is a globally decentralised computing infrastructure that executes smart contracts, which are effectively computer programmes. It uses the blockchain to synch and store state changes of those computer programmes. The network enables developers to build powerful decentralised applications, while providing auditability, transparency and neutrality; eliminating censorship and reducing counterparty risks.

Ethereum has a native token, ether, which can be traded like bitcoin on exchanges. Ether is intended as a utility currency to pay for the use of the world computer platform. Ether is not intended for the payments of final goods and services.

Ideology explains a lot

A significant amount of the difference between bitcoin and ethereum can be viewed through an ideological lens, reminding me of Thomas Sowell’s constrained and unconstrained visions.

Bitcoin has a constrained worldview. It has a limited and simple scripting language. The algorithm is merely asking whether the transaction is valid and if the spender has the keys to transfer ownership. The simplicity makes bitcoin less “useful” for new applications and innovations, but the simplicity has advantages too. The bitcoin network is robust and unwavering to its core principles, which means that its reliable at executing its current function. Bitcoin allows the exchange of digital decentralised deflationary value. It has worked for over 10 years and for each additional year that it lasts, there’s a higher probability that it will continue to serve this function in the future (Lindy effect). A competitor would need to rival its deflationary and decentralised characteristics, and it would need to build a bigger network effect, which is notoriously difficult once there’s an established player.

Ethereum has an unconstrained worldview. The scripting language is a general purpose programmable blockchain that runs a virtual machine, the Ethereum Virtual Machine (EVM), capable of executing code of arbitrary and unbounded complexity. Ethereum is what they call “Turing Complete” meaning that is can be used to simulate any Turing Machine, functioning as a general-purpose computer. Turing Completeness isn’t necessarily hard to achieve. For example, a printer is Turning Complete, which means that you can send any file type to a printer. The wrong file can freeze your printer, but at least you can easily restart your printer. Restarting a public blockchain is far more problematic.

In summary, Turning Completeness brings with it flexibility and functionality, but the trade-offs are complexity, security and resource management problems. If the wrong type of programme is sent, then it could run indefinitely and consume resources in a loop. A nefarious attacker can create an infinite loop, which is called a Denial of Service (DoS) attack whereby the intended users of the network cannot use it.

Gas is the metering mechanism to respond to the DoS challenges posed by Turing Completeness. As the EVM executes a smart contract, it carefully accounts for each instruction, each of which has a predetermined cost in units of gas. Each transaction must include an upper limit gas consumption and the EVM terminates execution, if the gas consumed is greater than the gas available. Gas cannot be purchased on exchanges; it can only be purchased as part of a transaction and can only be bought with ether.

The goals of ethereum and bitcoin are both noteworthy. If they’re successful there will be significantly more value in both networks in the future. Just imagine, all global payments settle in bitcoin… Bitcoin will be orders of magnitude higher, and the network more valuable! Or imagine all computer programmes are executed on ethereum. That could be super valuable. Numerous of applications are currently being built on top of ethereum. If these provide the value that developers hope, people will need a lot more ethereum to run those programmes.

I’m going to leave it there for part 1 in this series. Bitcoin and ethereum are remarkably different to each other with different goals. Investors must consider the value proposition, the market need for each “product”, the risks attached to each network, the probability that goals are met and their specific investment thesis. What are you trying to achieve? How will ethereum or bitcoin allow you to achieve this goal? In part 2, I’ll cover structural protocol certainty vs. uncertainty, which takes us into Proof of Work and Proof of Stake. In part 3, I’ll cover investment thesis, which is the most critical component.