Sound Money

Part 1 explained the basic differences between Ethereum and bitcoin.

The future is uncertain for both assets, but in different ways. Bitcoin’s protocol is ossifying, while Ethereum has protocol uncertainty as it targets lofty “unconstrained” goals. Coming back to the questions from part 1, investors need to consider the value proposition, the need for each “product”, the risks attached to each network, the probability that goals are met and your specific investment thesis. I’m ideologically aligned with bitcoin’s constrained vision and I appreciate the certainty it offers in a very uncertain world. This doesn’t rule out consideration of ethereum’s innovative promise, but it should help the reader understand the different value propositions and risks.

Bitcoin could serve numerous purposes; a medium of exchange, a unit of account, a store of value, a payments network, a settlement network or a speculative asset. It has the potential to serve as all these functions. We can hypothesise about the future and we can try to influence the outcome through our interactions, but we cannot control it. Use cases will play out through time as people interact with the network and determine its use. Despite this uncertainty, we have elevated confidence that the protocol will continue to run in a similar fashion to its current state. A brief look at bitcoins’ history makes this point.

In 2017 the bitcoin community went through an intense debate regarding the future of the protocol with some sections of the community desiring larger block sizes in order to reduce transaction fees, in the hope of enhancing merchant adoption. This debate ended in a fork of the network, creating a new chain called bitcoin cash in addition to the original chain. Most of the computing power and funds remained on the original chain. Since Feb 2018 Bitcoin cash has lost more than 80% of its value vs. bitcoin. Gravitation towards bitcoin, rather than bitcoin cash, is a show of faith in an unchanged protocol and reduces the chances of structural protocol changes in the future. There will be innovations around the edges and lots of work is being done on second layer solutions to improve the usability of bitcoin, but there is limited desire to structurally change bitcoin’s economic structure. This heightens the probability that bitcoin will be used as a store of value asset with deflationary supply and decentralised mining. Transaction fees are a lower priority within the community. Many ethereum advocates view bitcoins’ protocol ossification negatively, but bitcoiners applaud this characteristic. Generalising, bitcoiners hope that bitcoin can become a monetary standard. If these dreams are to be realised then you need a stable, safe and secure system that’s resistant to change.

By contrast, ethereum has protocol uncertainty. Currently ethereum uses bitcoin’s consensus mechanism, otherwise known as Nakamoto Consensus. Sequential single signature blocks are weighted in importance by Proof of Work (PoW) to determine the longest chain and therefore the current state. Ethereum is planning to shift to a Proof of Stake (PoS) weighting voting mechanism in the future because the developers are worried that ethereum won’t scale with PoW implementation.

PoW is costly and quite cumbersome, particularly if one is trying to run a complex decentralised computer programme with millions of users. PoW blockchains can become bloated and transaction fees can increase when volumes increase. Additionally, some people are concerned about the electricity usage of PoW (as a side note, I’m not concerned about bitcoin transaction fees or energy usage, but that’s a topic for another article). The ethereum community hopes that PoS could solve these challenges. But the underlying change of the economic structure presents risks. Many smart developer friends, are unconcerned by the roadmap from PoW to PoS. But it has never been done before! Certainly not on a network that already holds significant value. From an investment perspective, it’s difficult to have high conviction on an asset that will undergo a structural change over the coming quarters. You’d never expect the definition of an investable asset to change, while you’re holding it.

Once again, one can view the ideological component to bitcoin vs. Ethereum debates. Ethereum wants to innovate, test, pivot, programme and move forward. Many programmers gravitate towards ethereum because of its functionality, the opportunity to build new use-cases and create solutions to any problem. This is terribly exciting and innovative. Returns from new projects can be incredible as capital and energy floods towards the new big idea. But there are risks below the surface that must be accounted for.

So, choose your poison and position size your investment appropriately. Relatively speaking, bitcoin is low and steady with reasonable certainty on certain foundational principles vs. exciting potential with a fair amount of structural uncertainty on foundational principles. To be clear, I think bitcoin is incredibly innovative, potentially the most important invention in the last 50-100 years. I’m merely trying to describe the contrasting design principles between bitcoin and ethereum by calling bitcoin “slow and steady” and ethereum “exciting”… In part 3 we cover the Investment Thesis, which is the real clinching factor for me.