This is the second portion of this article responding to writing by Daniel Krawisz of the Nakamoto Institute. I recommend starting with his piece, found here, and then the first portion of this article, found here, before reading this.
At the end of the first piece, after attempting to demonstrate that the unstable potential equilibrium of multiple, equally-useful currencies is actually a self-stabilizing system thanks to the expected risk-averse behaviors of major participants, I said that this second part would explain how the necessary conditions for that could occur. After all, in order for the proposed self-sustaining equilibrium to be relevant, there must first be two (or more) currencies that are approximately equal in market capitalization and liquidity, and also universally accepted. Let’s start with that last one – acceptance.
Universal acceptance of multiple currencies at first seems like a near-impossibility, but it’s actually an eventual certainty. The cost for accepting Bitcoin is very, very low, and the additional cost of accepting, say, Bitcoin and Litecoin, is actually extremely, extremely minimal. Once you have a system that accepts one, accepting another very similar currency is trivial. As such, if one cryptocurrency can gain universal acceptance – which would occur necessarily if Bitcoin rises to global prominence – it follows that in the theoretical world where two or more cryptocurrencies are of equivalent market capitalization and liquidity, they will both be universally accepted. It’s a three-step process:
1. Cryptocurrencies are a nascent and growing marketplace as a medium of exchange (we’re currently exiting this status).
2. Cryptocurrencies begin to gain mass-market usability. Solutions are created (such as the Xapo or Coinsis debit card) that allow ordinary users to go full-cryptocurrency without cutting themselves out of large sections of the marketplace. This creates a virtuous cycle of increasing the asset price of cryptocurrencies and of increasing the number of transactions that can be performed without converting cryptocurrencies back into traditional currencies. This slowly creates a closed-loop system, which is nearly impregnable, from an economic standpoint. This in turn promotes further merchant adoption of cryptocurrencies (as their suppliers are beginning to accept it, and so it also promotes merchants entering the closed loop) – they see someone else (Xapo or Coinsis) cutting into their margins, and naturally they will move to take the margins back for themselves. Coinsis, Xapo, and other similar businesses will inevitably lose steam and fade to irrelevance – their only true purpose is to act as a bridge between step one and three. Not to say they aren’t good and relevant businesses – just that they are time-limited by the inevitability of Bitcoin.
3. Cryptocurrencies become the default medium of exchange globally thanks to their impressive and varied advantages over traditional currencies (lack of inflation, lack of middlemen, increased speed, peer-to-peer nature, increased security, ano(pseudo)nymity).
Now, as for how a second cryptocurrency could emerge to match Bitcoin? Let’s start by eliminating one option: Bitcoin’s failure. Obviously, if Bitcoin runs into a serious and unsolvable systemic issue of some kind, something else would replace it. Let’s ignore that possibility, and assume that Bitcoin succeeds.
As it stands, the Bitcoin market capitalization is about $7BN. That’s a trivial amount. Snapchat is valued at more than Bitcoin (which is nonsense in-and-of itself, but I digress). There are plenty of entities whose value dwarfs $7BN – let’s pretend that one of them wants to get involved heavily in the cryptocurrency world. They have two realistic options:
1. Buy Bitcoin.
2. Buy an altcoin and propel its market cap to or above Bitcoin’s.
Essentially, these are a low-risk and a high-risk option, within the risk spectrum of a cryptocurrency investment. Bitcoin is a lower risk; the altcoin is a higher one. I’d argue that the altcoin is enough of a higher reward to justify the risk, at least for some entities.
All that really has to happen to create a real competitor to Bitcoin is for some entity with a very large net worth to plant their flag in a cryptocurrency. There are several attractive options: NXT, DRK, LTC, PPC, and even DOGE all spring to mind as possibilities. That entity simply needs to acquire a large quantity of whatever cryptocurrency they want to plant their flag in, and then buy enough on the open market to raise the market cap to within striking distance of Bitcoin, and then simply post an announcement:
“I have chosen to increase the market capitalization of this coin to rival Bitcoin, in order to create competition within the cryptocurrency sphere. I will install a base support price on the open market such that the market capitalization of the coin will not fall below 90% of that of Bitcoin, and I will use my ownership of the coin to provide it with liquidity on the sell-side as well.”
This can happen very, very quickly, and it’s an extraordinarily powerful play, as well. If it can be sustained, it’s a very profitable investment to begin with – sending the coin up in value 50-100x from where it was when the entity was buying it off market. It also sets up for a very strong future – Bitcoin is greatly undervalued at current, and a rival cryptocurrency would be similarly undervalued.
There is a time limit to this, though. If Bitcoin’s next bubble takes it up to a stable market cap of $35-45BN, it would be hard for a single entity to accomplish this feat. They would have to act quite quickly – or already have acted.
I’m interested to hear why this would or would not be a workable plan, so please sound off in the comments if you have an opinion! Just remember, economics is not about ethics – if someone is doing this, they’re doing it for profit, not for justice.