The 451 Take
The original idea behind Bitcoin was to create a decentralized electronic currency for everyday purchases; however, it's currently primarily a speculative asset. Can Bitcoin become a true currency? For that to happen, it must demonstrate some level of value stability, and be easily and widely usable. Bitcoin's current price volatility and long transaction-processing times do not make it an ideal candidate. Hundreds of cryptocurrencies have been created to address Bitcoin's fundamental flaws or offer a broader capability. Over time, this huge array of cryptocurrencies will likely consolidate. Will Bitcoin be one of them? And will it ever provide an Apple Pay-like experience?
Bitcoin was born amid eroding public trust in financial institutions with the goal of circumventing currency control by any centralized power and simplifying online transactions by cutting out intermediaries. Although Bitcoin was the first implementation of a cryptocurrency (based on a whitepaper by Satoshi Nakamoto, published in 2008), there were previous attempts at creating digital currencies, including B-money (proposed by Wei Dai and referenced in the Bitcoin whitepaper) and Bit Gold (proposed by Nick Szabo). Both of these proposals were theoretical, and neither of them got implemented, so it's hard to tell with certainty how well they would have worked in practice. Nevertheless, Bitcoin uses many of the ideas presented in these proposals. Actually, some believe that Nakamoto represents a team (rather than one person) that includes Szabo and Dai.
Currency or asset?
When the mysterious Satoshi Nakamoto wrote the whitepaper about Bitcoin, it could not have been predicted that the actual implementation of the idea of 'a purely peer-to-peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution' would become a highly speculative alternative investment asset that is creating a frenzy around the world.
Although there are a growing number of businesses that accept Bitcoin (BTC) as payment (e.g., Expedia, Microsoft, Subway, Virgin Galactic), one doesn't just go to a random coffee place and pay with Bitcoin – it's not a currency that people use on a daily basis. Pricing products in BTC is currently not viable because of its price volatility – Bitcoin's price hit nearly $20,000 in mid-December 2017 and halved a month later. Its primary purpose is hardly other than speculation (and store of value), at least for now.
In 2009, Bitcoin was only mined (not traded or spent), and was worth $0. In 2010, a developer called Laszlo Hanyec bought two pizzas from Jeremy Sturdivant (aka 'jercos') for 10,000 bitcoins. This transaction gave Bitcoin a value. Since then, a lot has changed. Bitcoin had a wild ride in 2017 – its price surpassed the price of an ounce of gold in March 2017, and nine months later hit an all-time high of nearly $20,000.
Today, there are more than 1,000 digital currencies, and the existence of so many alternatives is not good news for Bitcoin. Most altcoins have been created to address Bitcoin's fundamental flaws, such as long processing times (it can take hours to confirm a transaction) and high transaction fees, as well as to introduce new features such as the use of smart contracts or integration with the Internet of Things. Ethereum, for example, has a broader capability than Bitcoin. Ethereum is a platform for executing smart contracts. Ethereum does have its own currency – Ether – which is primarily used to pay for processing transactions to reward those nodes underpinning the Ethereum network. Ether (ETH) is also mined, and can be traded on exchanges. Zcash's (ZEC) structural design and supply model are similar to Bitcoin's; however, it offers improved privacy through the use of zero-knowledge proofs (a technique that allows one party to verify a statement without revealing any other data about it).
Bitcoin has also created a market for specialized mining equipment. At the very beginning, a single CPU could handle small amounts of encrypted data, but as the Bitcoin blockchain grew, the time to mine new coins scaled rapidly. Miners started using multicore servers and GPU-based hardware, and renting dedicated servers and datacenter space. Today there are specialized ASIC chips and computers built and sold specifically for Bitcoin mining, with new specialty hardware coming into play for other popular cryptocurrencies as those blockchains grow. One of the most important players in this space is Chinese firm Bitmain, which sells specialized mining equipment not only for Bitcoin, but also for Litecoin and Dashcoin. Diversification of supported currencies will become critical for these companies as the battle for the most trusted currencies takes place.
Initial coin offerings
A new financial instrument has also come out of the cryptocurrency and blockchain community with its own benefits and risks: initial coin offerings. Mastercoin (rebranded as Omni) was the first project to launch an ICO in 2013, followed by Ethereum in 2014. Since then, according to CoinDesk's ICO tracker, more than $3.5bn has been raised through ICOs. Nevertheless, ICOs live and operate in a gray zone that is outside of traditional legal and financial frameworks. It is fueled by speculation – nothing is guaranteed and funds can be lost. Many of the ICOs that have launched in the last three years seem to meet the criteria to be classified as securities, although they don't typically register with the SEC. This year, we would not be surprised to see more litigation and hefty fines, as well as government initiatives attempting to regulate this market. China and South Korea banned ICOs in 2017.
With the proliferation of ICOs, Bitcoin has increasingly been used as a vehicle to invest in other cryptocurrencies and digital tokens. Bitcoin is the oldest and most popular digital currency – it has been getting more coverage and exposure than other cryptocurrencies. However, as interest in alternative coins has grown, the dominance of Bitcoin has dropped. According to CoinMarketCap data, Bitcoin's market share has been below 40% this month (a year ago it was over 80%). We believe that, going forward, unless there is some heavy external manipulation of this market, there will continue to be significant diversity in the cryptocurrency market.
The scalability problem
Efforts have been made to improve the scalability of the Bitcoin blockchain. SegWit2x was a proposed upgrade aimed at lowering transaction costs and improving confirmation speed by doubling the block size (to 2MB), in an effort to make the network more functional as a payment system. This upgrade would have implied a hard fork (a permanent divergence from the previous version of a blockchain), which never happened – due primarily to a lack of consensus in the community. The Lightning Network is another upgrade proposal that would allow peers to quickly and inexpensively transact among themselves on private channels, with the final outcomes broadcast to the Bitcoin blockchain.
Ethereum is also working on an off-chain scaling solution called Raiden Network, which, similarly to Bitcoin's Lightning Network, aims at enabling near-instant and low-fee payments.
Dash (formerly known as Darkcoin) is exploring the use of very large blocks to achieve true on-chain scalability. The first version of Dash Evolution (supporting 5MB blocks) is scheduled to be released this year. Further versions will support 15MB and 45MB blocks. According to the Dash developer team, with the 45MB block size, the network will be able to support 50 million users.
Cryptocurrency exchanges are not risk-free
While cryptocurrencies are praised for the decentralized experience, the most well-known exchanges trading cryptocurrencies are centralized and present risks of mismanagement and hacking. Furthermore, high traffic and volumes are causing operational problems. Less dangerous than hacks, but still a source of pain for many are the fees that these exchanges charge.
Bitcoin exchange Mt. Gox suspended trading in 2014 after the disappearance of $450m worth of BTC. Another exchange, Coincheck, was recently hacked – about $530m worth of NEM was stolen. Coinbase users have also reported that the exchange was withholding or complicating withdrawals, causing users to lose gains as a result of a loss in price. Binance temporarily disabled new-user registration due to an overwhelming surge in popularity.
Atomic swaps – a new technique that claims to allow two parties to directly, swiftly and inexpensively exchange any cryptocurrencies – are an attempt to bring decentralization to the exchange and trading of cryptocurrencies. However, before atomic swaps can enjoy mainstream use (they require a certain level of technical skills), user-friendly platforms will need to be developed. For example, Altcoin.io (in beta) brands itself as a truly decentralized cryptocurrency exchange powered by atomic swaps.
What the future holds
Some financial experts believe that the price of Bitcoin will reach unimaginable highs this year, and in a few years' time, will 'stabilize' closer to its production cost (which is heavily dependent on electricity price), which will make its commercial use more feasible. Others still believe that it is a bubble in the waiting. Predictions also point to nations launching their own digital currencies backed by their governments in an attempt to outlaw Bitcoin and its rivals.
A good thought experiment here is to ask oneself why Bitcoin is more likely to be the viable cryptocurrency compared with the other options now available? Bitcoin is essentially the first widely used cryptocurrency, with the highest market rate and trading volume. But is it really the best society can do? Can it be improved? Which cryptocurrency would you choose?
Fiat currencies exist because of belief – belief by those using them that they possess current and future value. The US dollar is believed in by billions on consumers because it is official – in the US, it is the de facto method of trade. A volatile market and abundance of alternatives suggest that the belief in Bitcoin is more variable. And generally, this belief is for short-term gains (speculation) rather than its ability to be traded for goods and services in the future. Over time, through demonstration, take-up and reliability, this huge array of cryptocurrencies will likely consolidate. Will Bitcoin be one of them?
Much of the potential in a cryptocurrency lies in making it suitable for the everyday shopper, who wants to pay swiftly, securely and simply – an Apple Pay experience without the Apple. This isn't easy to achieve. Although many complain about credit card transaction fees, consumers have a party to complain to when a mistake or fraud takes place.
With all this said, cryptocurrencies have become part of our financial system, and they are here to stay. Bitcoin continues to be an experiment from which we can learn, and which we can use as the basis for new cryptocurrencies or improved integration of the existing ones. Perhaps Satoshi's biggest legacy won't be Bitcoin, but the inspiration for civilization to start thinking outside the box. 'Why do currencies have to be centralized?' It is a simple question that yielded a whole new field. It's also worth asking the question 'What do we want/need cryptocurrencies to be?'
Csilla Zsigri is a Senior Analyst for 451 Research’s Cloud Transformation channel. Csilla also works on custom research, providing strategic guidance, as well as market and competitive intelligence, to technology vendors, service providers and enterprises.
As Research Director, Owen Rogers leads the firm's Digital Economics Unit, which serves to help customers understand the economics behind digital and cloud technologies so they can make informed choices when costing and pricing their own products and services, as well as those from their vendors, suppliers and competitors.
Keith Dawson is a principal analyst in 451 Research's Customer Experience & Commerce practice, primarily covering marketing technology. Keith has been covering the intersection of communications and enterprise software for 25 years, mainly looking at how to influence and optimize the customer experience.