Thursday, November 15, 2012

Bitcoin, alt-chains, and fiat money

An "alt-chain" is any alternative to the flagship cryptocurrency, bitcoin. New alt-chains pop up all the time. Terracoin debuted just last week, and the month before an alt-chain called PPcoin began.

Most alt-chains are similar to bitcoin. Indeed, some are identical. From what I've read, terracoin developers just took the bitcoin source code and copied it, modifying only the name. PPcoin makes some changes to bitcoin's methodology by adopting a different method for adding to the blockchain, the cryptocurrency's digital memory of transactions. But the concept is the same.

PPcoin and terracoin join a long list of alt-chains that have emerged since bitcoin became popular in 2011, including namecoin, litecoin, solidcoin, Ixcoin, IOcoin, liquidcoin, geist geld, solidcoin, devcoin, tenebrix, fairbrix, and more.

Below is a chart of the market capitalization of bitcoin and its largest alt competitors, as well as the date they debuted. You can see that bitcoin is both the largest in terms of market cap and the oldest. Market capitalization is calculated by taking the number of coins in existence and multiplying this by their value in $US. A number of alt-chains have been delisted from public cryptocurrency exchanges like vircurex and BTC-e, so I've been unable to get a market cap for them. But you can assume they're more or less worthless. As for the alt-chains that continue to be listed, only litecoin comes even close to bitcoin's market cap, and even then it's little more than a nugget in comparison. Note that the scale on the chart is logarithmic.

The emergence of bitcoin alternatives ties into the theory of fiat money. Fiat money is an intrinsically valueless token that serves as a medium of exchange. Central bank liabilities like US paper dollars are not fiat. Central banks hold assets that have been ring-fenced from their parent, the government. The paper issued by a central bank is backed by those assets. What makes bitcoin and its alt chains truly unique is that they're the world's first fiat monies. There is neither assets to back these coins, nor do they serve as useful commodities in a non-monetary setting.

Intrinsically valueless and replaceable tokens that trade at positive prices should quickly collapse in price. That's because there are significant arbitrage profits in generating copies of these fiat tokens and selling them. The emergence of so many alt chains is testimony to these competitive pressures. Just start your own alt-chain, call it something.coin, "pre-mine" 100,000 coins for yourself, make the chain public, and sell your coins to latecomers.

That bitcoin's price hasn't collapsed yet could be due to a number of factors. It would seem that brand name is important in the cryptocurrency market. People are hesitant to switch out of tried-and-tested bitcoin into new alt-chains. Secondly, liquidity is sticky. There are difficult-to-harness network effects involved in becoming a liquid item, so just creating something entirely similar to bitcoin (except in name) isn't sufficient to attract participants away from bitcoin. Creators of new alt-chains must also promote that coin's liquidity in order to take away from bitcoin's franchise. Lastly, things take time. My hunch is that bitcoin still has a positive value because proper competition will take a few years to truly develop. Let's see where we are in December 2013.


  1. Umm ... no.

    A Litecoin is not like a smaller version of Bitcoin.

    A decentralized digital currency like Bitcoin is worthless without one thing -- trust. But why would someone trust Bitcoin which has no "master node"? Because the architecture was specifically created to prevent a single attacker or cartel from having control of the network. This architecture is such that those holding bitcoins are willing to trust that the economic cost from attacking the network is well above the economic benefit, and thus the network remains uncorrupted. Currently, there is well north of ten million dollars worth of GPU and FPGA hardware protecting the Bitcoin network, and that much or more previously spent on electricity for past protection.

    Bitcoin didn't always have this protection. At one point in time -- not all that long ago, had a single miner wanted to a couple more rigs would have provided the necessary gigahashes to hold 50% os the mining capacity, and thus the ability to control what is included in every block thereafter (until the rest of the network was to increase capacity where the attacker no longer had 50%).

    Bitcoin made it through that vulnerable period because nobody really knew if it would eventually be valuable. Nobody at the time cared enough to spend $20K USD on hardware to make Bitcoin fail.

    And for those with extra money, there was profit to be had by buying GPUs and mining so mining capacity came online at a blistering growth rate.

    In a matter of days there will be a lot of GPUs coming offline from Bitcoin due to its "halving" event.

    Litecoin doesn't have anywhere near enough value to support an influx of GPUs. There could be enough bored bitcoin miners willing to use these newly retired GPUs to grief Litecoin, and increase the value of Bitcoin as a result by banding together and eliminating on a whim Bitcoin's next closest competitor.

    It might be nice for there to be several competitors, but for the proof-of-work space, it might be that there is room for online one player.

  2. Hi anon, thanks for commenting.

    Your point seems to be that litecoin is categorically different from bitcoin because litecoin is not able to withstand a 51% attack. But it seems to me that while a 51% attack on litecoin would require less computing power, it would also yield less profit. After all, litecoin has a smaller market cap so there isn't much "double-spending" value compared to bitcoin. If litecoin were to rise in value, it would become more tempting as a target for a 51% attack. At the same time, the larger real reward provided by mining litecoin blocks would attract more miners, thereby adding more protection.

    It seems to me that a rough equilibrium exists for any cryptocurrency whereby at a given price, just enough miners control the capacity necessary to prevent a 51% attack. If there aren't enough miners, two things can restore equilibrium. Either the price of the coin falls as trust in the chain deteriorates, reducing the profitability of attacking the chain, or a 51% attack occurs, destroying it.

    In any case, my point is that litecoin and bitcoin are not categorically different. They are each characterized by an equilibrium of sorts. The major difference between them are in degree, not in kind. On this front, I'd say that the major degree of difference is in each coin's liquidity. There is no Mt Gox for litecoin, for instance.

    1. Either the level of security is sufficient or it is not.

      An armored courier normally has three guards. If one calls in sick they don't remove a third of the cash and continue the mission. They either line up a replacement or they don't go.

      The threat (robber with a gun) is the same no matter how much money they are carrying.

    2. But the robber has a cost too. If in removing the cash the armored courier company brings the potential reward below the robber's cost then the company can safely proceed with the delivery.

  3. Suppose I write a paper IOU promising to deliver 1 bitcoin on demand, and I use it to buy groceries. That transaction puts me in a short position in bitcoins. But my IOU can be used as money, and can therefor reduce the demand for bitcoins. This reduces the value of bitcoins, and allows me to profit from the inflation that I caused.

    1. Getting your IOU to be used as money on the internet would pose some complications. But ignoring those complications, I'd agree.

      Even easier, if their intrinsic value is 0, then why not just short bitcoins outright? There is an active bitcoin lending community:

      Which makes one wonder why the value of these coins haven't fallen to 0 yet. Why hasn't a $5 billion hedge fund allocated some capital to shorting it?

    2. Very interesting. But what about now when Bitcoin is primarily used as an "investment" and not for exchange. Do derivatives like the new futures market put downward pressure on Bitcoin? After all they're competing for the same pool of dollars and they would both have 0 intrinsic value.

  4. When you borrow the bitcoin (or write an IOU) you'd have to promise to return EITHER 1 bitcoin or something of equivalent value. As you issue your IOU's and they drive the value of bitcoin from $10 to maybe $6, you can then pay off your IOU with $6. This prevents you from having to buy bitcoins to cover your short. The reason it matters is that otherwise, the covering of your short could drive bitcoin right back up to $10.

    I'd be happy to explain this to any $5 billion hedge fund managers for my usual 15% fee.

    You're welcome.

    1. Lol, once I get a billion I'll hire you, Mike.

      A bit more data for you. You can borrow bitcoins, but the rate is crazy high. Something like 25%-200% a year.

  5. Wikipedia: "Fiat money is money that derives its value from government regulation or law" - You have to pay taxes in it.
    In that sense, Bitcoin is not fiat money. (maybe only in the sense that it has no intrinsic value - but thats another (long) discussion.)

    Most importantly, our current fiat money has a bad rap because it´s supply is almost ulimited. Not so with Bitcoin, there will never be more than 21 million.

    1. Hi Henq,

      There are a lot of definitions for fiat and this can cause problems in reaching conclusions.

      Let's put it this way. Bitcoin is unique in that it is the first medium of exchange that has neither a non-monetary value (like gold), nor assets backing it (like bank notes and deposits), nor does the government give it value by forcing people to pay their taxes with it (there's no MOE in the world like that, some historical ones). Given these 3 features we can define bitcoin as a fiat money, or if we want we can give it an entirely new name, say giat money. (lol, that's all I could come up with in 3 seconds). But the point remains that it is an odd cookie.

    2. Yes bitcoin is an "odd cookie" and that is what makes it unique and valuable.

  6. My expectation is the opposite of the first comment: once ASICs come, many GPU miners may find interesting to go to mine alt.coins instead of just stop mining (Terracoin are better for GPUs respect to Litecoins, just because they are the same of BTC, that is, they overheat much less the GPU compared to Litecoins).
    And when an alt.coin network hashrate goes up massively, it becomes more secure, and becoming more secure it may well become more appealing for investors. From then onward, it could become a self-feeding process, where there is a positive correlation between network hashrate and coin's market price.

  7. Hey! Here we are in December of 2013! Any updates?