Here’s how I feel about cryptocurrency today compared to my earlier posts from last March. I’ve spent a lot of time (too much) arguing with Bitcoin true believers on Twitter, so I think I have a compelling case to make for them as to why they should shift their loyalties at least from BTC to ETH in preparation for the big Proof-of-Stake transition that will be triggered by a planned “difficulty bomb” that is currently set to be triggered on May 2022.
The people who try to convert me to the Bitcoin cause share some interesting beliefs about currencies that aren’t true. They’re hateful about inflation, which is an unpleasant but neutral feature of fiat money that’s intended to incentivize some behaviors (investing) and disincentivize others (hoarding). There are feedback loops that lead to rising prices for goods and services (inflation) but inflation can also have positive effects, like offsetting the cost of servicing loans and making a country’s exports more attractive (if your currency weakens compared to others).
In order to buy into Bitcoin, you have to first disbelieve in everything the central banks and experts in economics tell you that they’re doing and believe instead that some malevolent forces are conspiring to cheat you out of the money that you’ve chosen not to invest. There are many 100% safe ways to keep up with inflation, like U.S. Treasury debt, which you can buy in $100 increments (the interest rate paid is determined by auction).
I want to keep this post as short as possible, so I’ll link to Bitcoin, Currencies, and Fragility (PDF) by Nassim Taleb. I think that paper most convincingly lays out why Bitcoin is not some concentrated investment but rather a mirage that’s ultimately worth $0 because it has no intrinsic function and requires the network to be continuously sustained in order to be tradeable. If the network crashes or the transaction fee becomes too high, your “money” is simply stranded. It doesn’t have to fall linearly to $0. It can’t, because electricity and mining hardware expenses are too high.
Honestly, the one individual who I blame the most for the out-of-control bubble that Bitcoin has become is Michael Saylor, the CEO of MicroStrategy, a company that’s ostensibly about selling a business analytics product (see their website), but has now become completely hollowed out in order to accumulate a massive stockpile of Bitcoin. There’s a certain MLM / get-rich-fast aspect to the Bitcoin is Hope site that’s linked to from the MicroStrategy page. Based on the way he talks in interviews, Saylor is a true believer.
Let’s crunch some numbers. Under Michael Saylor, MicroStrategy has acquired 124,391 bitcoin at an average price of $49,229 per BTC, for a total value of… oh no! BTC is now $41,911, which means their holdings are worth $5.21 billion, but the company actually paid $6.12 billion to acquire them! What happened to this white-hot source of concentrated energy that the true believers claim?
I’m already tired of talking about this topic. Michael Saylor has put the company he’s in charge of into $2.2 billion in debt so he can play around buying a “security” whose intrinsic value is $0. I’ll put some essays here for anyone who needs further convincing.
- The Bitcoin Bubble and a Bad Hypothesis (Apr. 2013)
- Beyond the doomsday economics of “proof-of-work” in cryptocurrencies (2019)
- The ‘To the Moon’ Crash Is Coming (Dec. 2021)
- Bitcoin diehards are about to find out if it really was a bubble (Jan. 2022)
There are many things that concern me about the Ethereum blockchain, particularly the dangers of “DeFi”. Here are a few links about how “automatic arbitrage” works. You can imagine the problems if there are any bugs in the code, particularly vulnerabilities that are discovered and exploited.
- DeFi Explained: What is a Yield Aggregator?
- What Are Flash Loans? The DeFi Lending Phenomenon Explained
There’s also a problem in Ethereum where miners can reorder blocks for profit, which is called Miner Extracted Value, and an entire complex parallel ecosystem of “flashbots” to counter it. This all seems like more trouble than it’s worth to me, but at least Ethereum won’t be Proof-of-Work for too much longer.
I wanted to write this post to summarize the points I’ve been making, with references, so I don’t have to write them again, but I also want to end on a positive note, because I believe that, finally, the Ethereum Proof-of-Stake transition will finally happen, perhaps very soon after the difficulty bomb I mentioned earlier is finally triggered this mid-year. I just read, or tried to anyway, because it’s very mathematical, this paper titled:
In this paper, the authors define the miners’ behaviors, including a risk factor they call “temperature” to describe an individual miner’s coolheadedness or rationality. Then they show how “the phase transition from PoW to PoS emerges endogenously by analyzing a standard evolutionary learning model, Q-learning, where agents trade off exploration and exploitation.” There’s a tipping point phenomenon studied by catastrophe theory and when I Googled that term and Bitcoin, the paper I just linked to came up, and it was exactly what I’d hoped to find.
I believe that we should be seeing the PoW to PoS transition happen within the next 6 months, although what that means for the future of Ethereum is anyone’s guess. I’ll look silly if I try to predict how that will play out, but I feel extremely confident in predicting that Bitcoin will have to reckon with:
- limited practical utility (banks are building instant inter-institution payments now using ISO 20022, Ethereum is a better blockchain)
- based on kooky, faith-based Austrian monetary theory
- static rules can’t be changed easily (unlike Ethereum or fiat currency), although Taproot does now enable smart contracts
- the creator and early holders of large stakes are unknown
- not backed by anything and no clear plan to transition to PoS
- promoted by religious zealots who often stand to gain from new investments that further raise the price (in fiat money)
- ASIC mining hardware is expensive & useless for any other purpose; profits from mining alone can’t pay off the capital expenses (even if electricity is free!) because you have to regularly upgrade it, leaving behind 26.31 kilotons of e-waste each year, equivalent to that generated by The Netherlands
- disrupting national energy markets, e.g. Kazakhstan
- incapable of scaling; increased activity leads to longer transaction times and higher fees
On the scaling front, I urge you to look at the charts of median confirmation time and median transaction fee and then ask yourself if this mundane and slow real-time gross settlement system is worth it, given the poor performance and unpredictability of its service.