It’s kind of weird to say this, but after more than a decade of Bitcoin’s existence, there’s finally some consensus about what it is.
Hardcore Bitcoiners liken it to “digital gold” – a safe-haven asset whose primary use case is holding. And even people who aren’t so into it more or less accept that narrative. Barely a day goes by where we don’t hear from some legendary investor opining on TV, saying something like, “We believe Bitcoin is an emerging store of value, which, like gold, can play an important role in a diversified portfolio.”
Nobody even talks about how it’s not used in day-to-day transactions. Or how it’s too slow or too volatile to be a useful currency. That all may be true, but those are old talking points. By and large, the HODLer narrative has won.
Of course, people still scoff at the idea that something so volatile could possibly be considered a haven. After all, it’s had numerous drawdowns of 50% or more, including quite recently.
But on the other hand, you have to give it some credit. A nearly $1 trillion asset has been memed into existence, despite being backed by nothing.
(This is where someone jumps in and says I’m wrong, and that Bitcoin is backed by electricity and math! But that is wrong. The Bitcoin network is secured by electricity and math. Being secured is not the same as being backed. You’re not entitled to redeem your Bitcoin for anything.)
The fact of the matter is that there’s nothing fundamentally underpinning the value of Bitcoin other than the belief among some people that space on the network is valuable. (The blockchain can be likened in some sense to a big, decentralized spreadsheet and a “coin” could be said to represent some space on it.)
I mentioned above that Bitcoin’s value has been memed into existence. And of course, when it comes to memes and coins, people think about Dogecoin. But Bitcoin is also a memecoin. It’s just that digital gold is probably one of the best memes out there.
Bitcoin also has plenty of absurd memes, like the Magic Internet Money wizard.
Bitcoin shares other properties with gold, beyond just a good meme, though:
- Beyond holding, it’s not used for much. Yes, you can make jewelry with gold. And it has some industrial properties. But for the most part, people hold gold as a financial asset.
- There’s no Saudi Arabia of gold (or Bitcoin). Both can be mined basically anywhere in the world. Unlike say, oil, no one place on Earth has an unusual bounty of access to it.
- Both are energy-intensive and difficult to mine.
- Gold’s supply schedule isn’t quite as absolute as Bitcoin, but barring a gold asteroid hitting the Earth, the total amount of it out there is pretty predictable.
- Bitcoin and gold both have mystical origins. Bitcoin has Satoshi (plus numerous other religious parallels). Gold was viewed by the ancients as divine because it didn’t tarnish.
Again, you can agree or disagree about Bitcoin’s haven properties. But that’s how more and more people see it and use it.
Of course, differences of views have always been part of Bitcoin and crypto more broadly. Within Bitcoin, there have been numerous schisms about where it should go and how it should be used. And of course over time, tens of thousands of more coins have been launched, all with ostensibly different aims or goals.
The last really big Bitcoin battle was from 2015 to 2017 – The Blocksize War – when one faction wanted to make a change in the code to make it more of a spending currency. Without getting too technical, there’s a fairly hard limit to how many transactions the network can process at the base layer, every second. Numerous miners, exchanges and other companies fought to make base-layer transaction throughput faster and cheaper by expanding the size of each Bitcoin block.
That seems innocuous enough, but if you’re trying to be “digital gold”, pushing through big changes is risky. Imagine tweaking gold’s atomic structure to make it even more shiny. That might look good, but then is it really still the same gold that people have trusted for thousands of years? More concretely, adding more capacity was seen by many in the community as a threat to the decentralization of the network.
How is more transaction capacity a threat to decentralization? Well, one core tenet of the community is that anyone anywhere in the world should be able to run a full Bitcoin node, which can download and monitor the entire network. That way, any individual can verify independently what’s going on, how many coins are out there, what transactions have been made, and so on. This can currently be done on basically any cheap computer right now. But if the base layer were to get too heavy (i.e., if too many transactions pile up), it might become prohibitive for anyone to download and watch, meaning only those with stronger computing capabilities could monitor it, thus limiting the breadth of the nodes.
It should be said that while this was a technical fight, there were also political elements, with suspicion on both sides that some players were attempting to control the network for their specific purposes. Anyway, in the end, Bitcoin basically stayed unchanged. Some tweaks were made, but nothing immediately drastic. In general, the core Bitcoin development philosophy is extremely conservative and resistant to change. It’s kind of the exact opposite of Silicon Valley’s “move fast and break things” ethos. It’s not about constant iteration at all. Again, if your goal is to just be gold, this is probably sensible.
Of course, there are people in the world who are drawn into Satoshi’s breakthrough – which for the first time established the ability to create decentralized scarcity online – and who want to do more than just create something to hold. Some people want to do something with this technology. It’s understandable to be honest.
One of the people who wanted to do something with this technology was Vitalik Buterin, who published the Ethereum white paper in 2013, arguing that with some modifications, a blockchain could do so much more than just be a money database. His vision included serving as a repository for identities, decentralized file storage and financial derivatives, among others. Basically a lot of what people are excited doing today with DeFi, NFTs, DAOs, etc. (all of which we’ll get back to) were spelled out pretty explicitly in that paper.
And it’s here that we get to a real schism in the crypto world, one that’s leading two very different ideas about what all this technology is actually for…
Cryptocurrencies vs. Tokens
There is a sense in which both Bitcoin and Ethereum could both be described as the official currencies of two distinct digital tribes. A lot of people obviously own both currencies. And what you’re about to read is a gross generalization. But there is something to it.
Bitcoiners tend to place a high value on adversarial thinking. Trust nobody. Did you buy your Bitcoin on an exchange? Get it off there immediately, and move it to your private wallet so that you don’t have any counterparty risk. Run your own node so you can monitor the network directly. Over the last several months, Bitcoiners on Twitter have adopted the laser-eyes meme.
As the influencer Anthony “Pomp” Pompliano put it recently, it’s “Bitcoiners vs. The World.” Bitcoiners distrust banks. They really distrust central banks. Hardcore Bitcoiners say that you should treat everyone like they’re a scammer. It’s crucial to the Bitcoin project that Satoshi disappeared, because if he were still around then some people would trust his judgment. Bitcoiners also eat a lot of meat. That’s not really related to trust, it’s just a distinct fact about the tribe. That’s not universal by any stretch, but it is a thing.
Ethereans are different. Their founder is still alive and highly influential. Vitalik Buterin doesn’t have laser eyes. But he has been photographed several times wearing T-shirts with kitties on them. Rather than eating meat, he eats a lot of coconut, dark chocolate, nuts and avocados. The biggest decentralized crypto exchange on Ethereum is called Uniswap, and it’s got a whimsical unicorn-themed motif. No macho bro stuff. After Pomp’s tweet about Bitcoiners vs. the world, some Ethereans responded saying their mission is to be for the world, not vs. the world. It’s a different vibe all around.
Again, of course, these are all generalizations. The world is big. Lots of people are part of both scenes. But if there are any anthropologists out there, I’d recommend someone really dig into this and write a book about it, because the difference is noteworthy.
What’s interesting for our purposes is that in addition to being a cryptocurrency, Ethereum is also a token. What’s a token? Well, the easiest metaphor, frankly, is to just think about a token at a Chuck E. Cheese. It’s a kind of money that’s redeemable for goods and services within a very specific environment. At Chuck E. Cheese, obviously, the tokens let you play videogames and pinball and Skee-Ball and whatever else.
In Ethereum world, the currency (ETH) lets you pay a network of computers to run various applications that are built on top of it. One of the biggest applications running on top of the Ethereum network is the aforementioned exchange Uniswap, where you can trade different coins for each other. Each time you place a trade, you have to pay a “gas fee” (denominated in ETH) to the network of computers that processes the transaction. So Uniswap, in this analogy, is like one of the games in the arcade.
There’s something important that happens when you move from being a currency to being a token, which is that the necessity of pure belief starts to fade. If someone hands you $100 worth of Chuck E. Cheese tokens, you might be annoyed, and you might find them to be completely useless. But you probably accept the premise that if you drive to a Chuck E. Cheese, then you’ll be able to use them to play the games. You might not want to. You might not have any use for it. But you know that you can. You don’t have to subscribe to any Chuck E. Cheese ideology.
For Bitcoin to have value, you kind of just have to accept that it has value. Either you believe or you don’t. With a token, there’s less faith involved. If you want to use an app that is built on top of Ethereum, then you have to use it. If someone sends you Ethereum, you know you’ll be able to use it within the overall environment. You might be skeptical of the whole thing and think it’s all speculative games. But as with the Chuck E. Cheese token, it works and it’s necessary if you want to participate in that world.
So what’s it all for?
So once you’re in the realm of tokens, you don’t need faith, but you still need a point. It’s fun to trade coins on a decentralized exchange, but presumably at some point the things you’re trading need to produce real-world value beyond just more trading of coins. Otherwise it all implodes eventually. So where does it all go? Here are three possibilities.
The first possibility is that it all implodes. This really can’t be ruled out. This is basically what happened in 2017 with ICOs. You needed to buy Ethereum to buy into ICOs, and those got tons of hype at the time, but that mania fizzled out. A bunch of the projects went on to be total flops. And beyond that, a lot of these were just IPOs but with a different currency, and so they were unregistered securities offerings that fell foul of the law. That all collapsed (along with a bunch of other stuff in crypto). And the public lost interest for awhile. Crypto winter.
The second possibility is that new modes of social coordination emerge. You might think NFTs seem kind of dumb. (Disclosure: I think NFTs are kind of dumb.) But obviously a lot of people think differently. People continue to pay real money for the right to claim ownership of some piece of digital content. It definitely seems kind of faddish, but there are more experiments in the space being done all the time. And even if it’s not NFTs per se, it’s possible that a new type of easily programmable money network might spawn modes of activity that we’re just not used to.
In this conception, perhaps Ethereum ends up as the substrate for a new type of decentralized social network: It has games (like digital horse racing), it has artwork (like Beeple), it has publishing and more. Since the beginning, people have been fascinated by the concept of a DAO (a decentralized autonomous organization) where people pool their money together in a way that’s kind of like a corporation, but also kind of different, with a new mode of governance that’s maybe more like a co-op. It’s hard to say where it all goes. The point is that there are examples of “real-world activity” that these tokens enable that don’t have a perfect analog to things that were done before. They’re just new.
A third possibility is that DeFi becomes something that matters for Fi. In the last few months, you’ve heard a lot about the rise of so-called DeFi or “decentralized finance.” This is a term that encompasses many different things. There are venues where you can stake your coins in a liquidity pool and collect trading fees from other participants. Other models involve posting coins as collateral in order to borrow more coins. There’s a ton of money in this space – the decentralized lending protocol AAVE has over $20 billion in locked-up funds – and a lot of people are excited about the prospect of disrupting traditional finance. So far, however, the main use case (as many participants will admit!) is just… speculation on more coins. People lend money to people who want to go long more coins.
If you squint hard you can kind of glimpse a future where DeFi becomes more than just a gambling game. From a tech perspective, it’s exciting to think that anyone can write some code and launch a de facto bank into the world that matches borrowers and lenders in some novel way. It’s also already possible on Ethereum to represent some kind of “real-world” asset on chain. For example, there are dollar-denominated stablecoins that exist as Ethereum tokens (in a format known as ERC-20). There’s an Ethereum coin backed by physical gold. And in theory, a stream of cash flows from a business or household borrower could be turned into a token.
Currently, all the lending and borrowing that happens on these platforms is overcollateralized. So you might post $110 worth of Ethereum and get $100 worth of a stablecoin back, which you can use to speculate on more coins. This type of lending is easy for a smart contract to handle because the collateral liquidation can be automated if the price of Ethereum goes down. This kind of model makes sense for speculative purposes, because lots of people have coins and want to borrow money against them to buy more coins.
Building a DeFi lending model for, say, getting a mortgage, is way more complex. The chain can’t judge your creditworthiness. The chain can’t just evict you if you stop paying. The chain can’t go out and do an appraisal. The chain doesn’t know if the market price of your home has gone down or anything like that. For all of that, you need actual humans.
People are working to solve all of the above, but it’s complicated and legally kludgy. Right now, they involve a hybrid of DeFi capital with human agents. There’s a startup, for example, called Centrifuge, which lends money into a Special Purpose Vehicle, which then goes on to finance small real estate investments. The income stream from that SPV then gets turned into an Ethereum ERC-20 token, which is then used as collateral in a protocol called Maker, which backs a stablecoin called Dai. Centrifuge is allowed to mint Dai (which it can then sell for actual dollars to an OTC crypto trading desk), and in theory this allows for real-world investment to be financed on-chain.
The degree to which this is actually going to work at any kind of scale is far from settled. And it’s also not clear what kind of edge these projects will have over traditional finance. (Centrifuge claims that its cost of capital is cheaper this way, and that the system can be used to finance projects that are too small for bigger banks to worry about.)
Another startup called Maple is doing something similar, building a platform that (theoretically) makes it very easy for anyone to create a lending portfolio, where an individual or team sources qualified borrowers, with funding drawn from decentralized pools of capital. The main pitch is basically that DeFi platforms are incredibly simple and elegant, with fewer middlemen and paperwork and so forth.
So people are, in fact, trying to solve the “what for?” question. There are active efforts to make this all something beyond just people borrowing money to buy more coins.
Whether they actually scale up and become useful is a separate question.
The other huge question is whether governments end up being cool with people launching apps that are basically banks or lending institutions or stock markets or synthetic derivatives exchanges, all without adherence to existing financial regulations.
Like right now you can go to Uniswap to connect your Ethereum wallet, and trade it for a token that will track the price of Apple. Check it out yourself.
There’s no registering for an account at Uniswap. They don’t have your name. There’s no KYC/AML or anything like that. All they have are the numbers and letters that constitute the Ethereum address you’re using to connect.
The general bet for DeFi at this point seems to be: Regulators will be cool with all this. Or: If they did want to stop it, they couldn’t because it’s just open-source software and that even if the companies were to go away, the software will live on. We’ll see about all that.
And again there’s the question about how well it all scales if it goes after under-collateralized lending, which is necessary if DeFi will actually be responsible for credit creation. If you need actual humans to underwrite loans and sue delinquent borrowers in court, that raises some significant costs. You might just end up doing fintech, but with ambiguous rules and a clunky database. (Blockchains are necessarily going to be clunkier and costlier than a standard database, since that’s the price you pay for achieving decentralization, lack of transaction censorship, and a permission-less system where anyone is allowed to build for any purpose.)
Meanwhile, TradFi capital is pretty cheap right now, so cutting into traditional financial activities may not be so easy in a space where part of the attraction for lenders is the fat yields. The point is though there’s a lot of techie optimism in DeFi that may at some point run into some serious headwinds (legal, scaling, etc.) that don’t have an easy software fix. But anyway, let’s set all these questions aside.
The problem with being used for something
So, the problem with being a coin that’s actually used for something is that it has to be good at its job. Bitcoin is slow, inefficient and transactions are costly, but nobody really expects anything more from it.
(Also: Yes, to be clear there are projects that already exist that create ultra-fast payments and smart contracts on top of the Bitcoin network. I’m acknowledging them here because otherwise someone is going to freak out and say that Bitcoin has solved these problems. They remain pretty niche. And more importantly, even if they don’t take off, Bitcoin’s digital gold application narrative would remain intact).
Ethereum, as it currently stands, has more or less the same problems as Bitcoin when it comes to scaling. It’s fairly slow and transactions are expensive. Slow and expensive is fine if you’re gold. It’s not great if you’re trying to power financial services. Let’s go back to the arcade analogy for a second. One difference between Ethereum and Chuck E. Cheese is that the price of a game isn’t fixed. It’s a little bit like surge pricing. When lots of people are suddenly trading (during a spike in volatility), your fees go up, as the system can only process so many transactions at a time and traders compete with each other for scarce block space. So if you’re playing digital racehorses, and suddenly there’s a market crash and transaction fees surge, that’s not ideal.
Here’s something that actually happened: A few weeks back, the cost of using the Ethereum network surged because someone made a parody coin of Dogecoin, and it was briefly so popular that everything else got slowed down or more expensive. Because there’s a finite amount of Ethereum transaction capacity, anyone else using the network either had to wait their turn in the back of the line, or pay more to jump ahead of the dog token traders.
This dumbass token SHIB and all exchanges listing it really set a bad precedent. Now these new SHIB copycats are quite literally rekting Ethereum’s gas fees. Look at the most recent blocks and transactions with the highest gas. It’s all these meme tokens pic.twitter.com/F7T3bOpKHw
— Larry Cermak (@lawmaster) May 10, 2021
There are theoretical fixes to all this. Ethereum also has so-called Layer-2 solutions designed to make transactions faster and cheaper and more reliable and all that. But building these things take time, and people have been working on them for awhile. In the meantime, you have to accept that if market volatility spikes or there’s a meme token mania again, everyone has to pay higher fees or accept sluggish service.
The other thing is that once you’re measured on performance, another platform can come along and theoretically offer superior performance.
Around the end of May, Kyle Samani of the crypto fund Multicoin Capital wrote a blog post arguing that DeFi is the killer app of blockchain technology. Bitcoin had its day, he says, but now we’ve found a much better use. What’s interesting is that his argument isn’t a ringing endorsement of Ethereum per se. Instead it talks about Multicoin’s bullish case on Solana, which is totally separate platform which competes with Ethereum to power decentralized finance applications. The basic gist of his piece is, simply, that Solana has better specs than Ethereum, that it’s already scaling better with sufficient levels of censorship resistance and decentralization. Solana launched in March 2020 with the specific purpose of creating a high-speed blockchain platform aimed at financial services.
Others can debate whether it’s actually better or not, but the point is, when you read Kyle’s post, it reads like an evaluation of two different software projects, like someone comparing AWS to Azure or Oracle. There’s not much talk about culture or any of the things that have characterized Bitcoiners and Ethereans. The argument is basically that this can get the job done now in a powerful way, and that it doesn’t have the roadmap ambiguity that Ethereum currently has. In a tweet reply (to me), Samani says that he’s intellectually short Bitcoin (not literally short it) and that the most valuable cryptocurrency will end up being the native token of whichever network ends up winning.
Anyway, the big picture is that this thesis is radically different than the original Bitcoin vision. Nothing about Solana requires any faith or mystical belief or culture like Bitcoin. If decentralized finance takes root, and one chain or another becomes the dominant platform for it (whether it’s Solana, or Ethereum or some other chain we’re not even talking about) then its native token will have value.
Going back to the Chuck E. Cheese analogy, in addition to there being tokens and games, there are also the tickets you win from Skee-Ball, and the knick-knacks (real world assets) for sale in the gift shop in exchange from tickets. Presumably, the implied markup of those sales of stuffed animals, alarm clocks and stickers in the gift shop was egregious. But in a sense, their existence anchored the value of the other assets inside the arcade, the tokens and the tickets.
You can theoretically imagine an open-source arcade, where everyone is free to build a game and place one inside the Ethereum (or some other network) universe and when you play it, you get some kind of ticket that has rights to real world assets or cash flows. Again, you don’t need faith or culture to make the assets have value. There’s enough real world activity to anchor them.
Wall Street And Silicon Valley get ETH-pilled
Let’s zoom out for a second. All blockchain-based systems share two basic ideas. The first is that for the first time you can have a thing online that can be provably yours. A coin, a token, an NFT… whatever it is. You have it and control it and no third party has any say. Alice can own something and then send it to Bob. Alice doesn’t have it anymore and Charlie can’t interfere. The other core idea is that part of achieving this involves a sufficiently decentralized network of computers, such that no individual, company, or government has a say in what goes on.
But this is where the fork in the road emerges. The Bitcoin vision is to create a new form of money outside the authority of any central issuer. The DeFi vision inverts this, and takes the money creation part for granted. After all, you can spend a dollar on the Ethereum network using a USD-backed stablecoin, so why reinvent the wheel? Instead, the DeFi-based vision is to build unstoppable blockchain-based software and services that then do something with this money.
A couple weeks ago, I wrote that Wall Streeters are increasingly getting ETH-pilled and the above is why. There’s a certain concreteness to the value proposition. If a decentralized network of computers can match borrowers and lenders in some powerful and novel way, then the software and the tokens that power it should be valuable. And in general, this vision jibes much more with the Silicon Valley ethos. Trying to create a new form of money? That’s not really a thing you learn about at Stanford. Writing software to disrupt traditional financial services? That they get. Furthermore, Bitcoin frustrates many people in tech because of the community’s move slow and don’t break things approach.
All this being said, all these different factions and visions… they remain something of an inside game. It’s not clear how much your average crypto investor is paying attention to any of these different modes and models. If you look at the coins, you’ll mostly see a high degree of correlation. Either they’re all going up at the same time or down at the same time. This includes Bitcoin and Ethereum and Solana, but also a bunch of other coins that don’t map to a trendy narrative. (For example Litecoin is still one of the world’s biggest coins despite its founder having peaced out from the project in 2017, and neither has a store-of-value narrative nor a DeFi narrative or anything else really.)
Here’s a chart of Ethereum, Bitcoin, and Litecoin going back to the summer of 2017. You can see, everything just kind of rises and falls at the same time.
The market strongly gives off a vibe of people wanting to get into crypto and then placing their chips on a bunch of different squares without too much thought. Maybe they buy a few that they’ve heard of, maybe they buy a few with a low nominal coin price because it’s fun to have a lot of coins and maybe they buy a few that just seem interesting. That still seems to be how flows work in the space. And as long as this is all the case, we’ll probably still have these generalized boom-bust cycles where coins rise and fall together along with the animal spirits of investors and traders.
But the differences in approach and philosophy between different coins and projects is very real. The stuff tech people are hyped about right now is radically different from Bitcoin, in both its assumptions and in its purpose. And eventually as this space matures, returns should become less correlated and more distinct, as different approaches win out over others.