Altcoins will eventually fail

Why no altcoin can succeed

New ideas attract not only visionaries and pioneers, but also charlatans and fools. The former group understands the nature and potential of the new idea and tries to expand it in new ways. The latter observes the success of the former and expects similar results through blind imitation and empty hope, just like the cargo cult that emerged when the US military abandoned the airfields in Melanesia after World War II.

This analogy is absolutely appropriate to describe the many alternative cryptocurrencies modeled after Bitcoin , collectively known as altcoins. Technically, they are all very similar to Bitcoin: there is a blockchain to store transactions, a consensus mechanism to build the blockchain, and a cryptographic protocol to register transactions. Some prominent examples are PPCoin, Primecoin, Litecoin, and Freicoin .

Some altcoins contain interesting new ideas, but there is one fundamental feature that Bitcoin lacks. It's not a matter of technology, but of history and community. Quite simply, the medium of exchange that is more widely accepted in the market is more useful than the one that is not. This is called a network effect. An initial imbalance between two nearly equal mediums of exchange will favor the one with more widespread acceptance until the single one overwhelms the rest. There is no limit to this effect: eventually people will always expect one currency to triumph over all its competitors.

Because it started earlier and has had a greater opportunity to grow and attract users, Bitcoin’s market is much larger than all the markets for all altcoins combined, making it much more useful as a currency. To beat Bitcoin, an altcoin would need not only superior technology, but very, very superior technology to enable it to surpass Bitcoin and match Bitcoin’s advances over fiat currencies. Furthermore, truly great innovations will be incorporated into future versions of Bitcoin, rather than requiring them to switch to something else that will serve people better. Indeed, those who have come up with new ideas that are actually good, such as Zerocoin and mini-blockchains, have not developed their own currencies around them, but have simply described their usefulness as features. [1]

The Bitcoin community is not only much larger, it’s also much better quality. Bitcoin is surrounded by real entrepreneurs working to create new and useful services for Bitcoin. Altcoins are surrounded by loud pretenders who unreasonably want to replicate Satoshi’s success. This doesn’t mean there’s anything inherently wrong with altcoins: the problem is simply that once Bitcoin exists, there’s no additional value in making knockoffs from a monetary perspective. Can anyone really expect to create value by re-releasing Bitcoin under a new name and making some minor changes to its source code? What makes Bitcoin great can’t be easily copied. So while the Bitcoin community matures and grows as more and more entrepreneurs are attracted to its potential, the altcoin community can only grumble for attention.

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Motivated Reasoning

What is cryptocurrency actually for? I say its purpose is to be “money”. It is obvious that creating altcoins would hinder this purpose. Altcoins can only be explained if we believe that the purpose of cryptocurrency is to “make” money, not to “be” money. If you can trick people into investing in your new altcoin, then you can make a profit by trading or mining and selling it. All the arguments of altcoin promoters are misleading about this basic purpose. They develop a series of fallacies that can deceive new people into joining them, but they are all hypocritical.

The altcoin community is therefore not only embarrassing, it is dangerous. Desperately wanting to be taken seriously despite having nothing of value to offer, they will say absolutely anything to convince others to join them. They insist on saying things that are easily refuted by economic logic, common sense, or verifiable facts. They become belligerent when challenged. This is all they can do because they have nothing of value to offer. They are very good at deceiving people because they have successfully deceived themselves and cannot tell where self-deception ends and outright lies begin. This is bad for Bitcoin and it is bad for the people who are being fooled.

The claims of altcoin promoters deserve refutation not because they are clever, but because they are repeated ad nauseam. Ultimately, their content is secondary, and the real issue is the inevitable outcome to which they point. If the arguments I discuss here are ultimately discredited, altcoin promoters will simply fumble for new coins rather than admit mistakes. Therefore, it is likely that in the future, what I say here will no longer correspond to what they say. However, due to what I have said above, it is safe to assume that, whatever they are, they are wrong.

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But doesn’t Bitcoin deserve some healthy competition?

First, Bitcoin already has competition. It competes with the dollar, PayPal, and the entire banking system. It has a lot of competition.

Second, there is no reason to think that competition is inherently good. If people compete to be the most productive, that is good, because the result is more production. If people compete to control the government, that is bad, because the result is that the government will be controlled by the most ruthless and unscrupulous people.[2] There is a reason for having two competing businesses, even if they follow the same production model: there is a limit to how big one organization can get, not that it is more efficient than two parallel organizations. However, if an economy can support only one business for a given product or service, then there should really be only one business.

In the case of a currency, it is inherently most useful when it dominates the competition. The less competition a currency has, the more useful it is. If you try to compete with the best currency against another currency that is exactly the same, you will make your currency worse, so you really shouldn't bother yourself with that.

Third, money is just a standard that people agree to use as a medium of exchange. In most cases, it is awkward to have competing standards. For example, do we really need a competition between miles and kilometers? Suppose the car has just been invented, and two groups have vested economic interests in arguing about whether to drive on the left or the right. The greatest benefit to ordinary people will come not from prolonging this competition, but from resolving it.

Finally, there is competition within the Bitcoin community, and this competition actually benefits people. There are exchanges, payment processors, online stores, etc. Every time someone starts a new Bitcoin business, he benefits the Bitcoin economy. Every time someone starts an altcoin, he makes it worse.

A related point is that altcoins can be used as experiments to see how different ideas work in practice. This use is perfectly legitimate and necessary. However, altcoins that are understood as experiments are not considered investments or standalone products. If that is how altcoins are treated, then that is fine. I am against lies and scams. If the people running it are lying all the time, then the experiment is worthless.

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Multiple blockchains will reduce network load

In the Bitcoin network that works today, all nodes receive all transactions. If Bitcoin grows to a very large network, that could be a lot of transactions that need to be communicated to everyone.

Altcoin promoters seem to imagine a world in which their own favorite altcoins have roughly equal status to Bitcoin, and each currency will be used for different kinds of things. This is impossible because network effects always favor imbalances.

However, even in the non-steady-state case of two roughly equal blockchains, this does not necessarily lead to less network traffic. If people have to use both networks at the same time, they still have to receive every transaction from both networks. If people have to frequently convert funds from one currency to another for different purposes, this can easily lead to more total transactions.

Regardless, while Bitcoin may experience growing pains in the coming years, there is no reason to expect it to outpace Moore’s Law in the long run. Network load is a problem that technology can overcome without requiring us to rely on an inferior monetary system.

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Altcoins are good for money laundering

This may be true today, but there is no guarantee that it will be true in the future. The idea is that you sell some Bitcoin for altcoins, and then buy back Bitcoin again. Then there will be no connection between the Bitcoin you had before and the Bitcoin you have now.

However, since altcoins are inherently volatile, there is no reason to expect that they can still be used for this purpose. In order for a currency to retain its value, there must be enough people who want to hold it, not just people who want to move in and out of it quickly. The altcoin must be good for something other than money laundering - if it were good for money laundering, at least some people would want to hold it instead of Bitcoin.

So if you really want to launder money, support ZeroCoin as an upgrade to Bitcoin. Beyond that, you're better off trading in commodities that are more likely to retain their value, such as gold or silver.

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Shouldn't we let the market decide?

This is by far the most ridiculous argument I have heard on this topic. The wisdom of the crowd is better than any one person, so people shouldn't presume to tell the market what to think, right? I find this viewpoint completely silly. It is wrong to impose the market's choices on it in a coercive way, but simply expressing an opinion is participating in the market process itself. To be consistent, the person making this argument would have to say that Consumer Reports was as tyrannical as Joseph Stalin.

To take it to its logical conclusion, suppose everyone just sat back and let the market decide. Then the market would never decide anything, because the market's decision would be the sum of all the individual decisions that made it up. None of them could make an argument that one product is better than another. There wouldn't even be any consumer reporting to protect people from scams and shoddy products. The free market doesn't work. When a libertarian steps back and lets the market decide something he has some reasonable opinion about, then he is preventing the market from doing the job it could otherwise do.

It is true that markets always make stupid choices, and I am not wrong to say so. This is because “markets” are just a group of people who make decisions that are just as stupid as the ones we know people actually make all the time. This does not mean that I do not understand the advantages of the market process over the systemic power of the state. If I want the market to triumph over the state, it would be absurd not to debate the correct decisions that might lead to such a triumph.

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Scrypt Currency

There is a very similar class of cryptocurrencies that rely on an algorithm called Scrypt as a hash function. I will refer to them as Scrypt coins. They also have faster block generation times and different coin mining schedules. In fact, they don't even have white papers. Perhaps they are so unoriginal that there is nothing to write about. Despite this, or perhaps because of this, Scrypt coins are surrounded by the loudest, least intelligent and most obnoxious communities, and the arguments supporting them are either wrong or out of touch with reality.

When Bitcoin first came out, anyone could mine the coin with his CPU. Once software was developed to mine using GPUs, CPU mining quickly became obsolete. GPU mining remained profitable for a while afterward because the price of Bitcoin continued to rise as more and more people became miners. This couldn't continue indefinitely, and eventually, development work began on FPGA and ASIC mining. Once these technologies were developed, GPU mining would also become obsolete.

However, some miners who have invested heavily in GPUs do not want to see this happen and do not want their investment in GPUs to go bad. Obviously, this is a futile hope. An average computer cannot be expected to run profitably for a long time. Profits attract more investors, which leads to declining profits as available opportunities are exhausted.

Scrypt is designed to be a memory hog and therefore unsuitable for mining using machines consisting almost entirely of ASIC chips, such as those used for Bitcoin, so it is assumed that mining of Scrypt coins will always remain in the hands of GPU owners. This is wrong, by the way. If it becomes profitable enough, ASIC machines with shared memory could be produced, and it would also make GPUs no longer suitable for Scrypt mining.

The Scrypt phenomenon can thus be likened to the Candlemakers’ Petition[3], a brilliant satire by Frédéric Bastiat. It presents a fictitious argument, purportedly from candlemakers, that all windows should be legally closed during the day to prevent unfair competition from the sun. All arguments for Scrypt should be viewed in this light. They are a mask for the hope that someone’s GPU mining rig should not turn out to be a foolish investment.

The first Scrypt coin was Litecoin, but soon other nearly identical Scrypt coins were developed by people who wanted not only to use GPUs, but also the added benefit of being the first mover of a new currency. Feathercoin, Terracoin, CHNCoin, and Yacoin are a few others I can think of, but there are new ones every day, which is a simplification of the whole altcoin concept.

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The emergence of ASIC mining has put Bitcoin mining in the hands of a few elites

No, it will not, at least no more than any other mining technology. In the long run, regardless of which technology is needed, one would expect mining difficulty to rise to a point where investing in mining technology yields returns similar to investing in the rest of the economy. Of course, as I mentioned above, it is false that Scrypt coins are immune to ASIC mining.

This argument highlights the emphasis that altcoin followers place on mining rather than monetization. Why would any average Bitcoin user want to become a miner in the first place? There is no logical reason. In the early days, it was profitable for average Bitcoin users to become miners because few people knew about Bitcoin. Mining now requires capital investment, just like everything else in the economy. The shift toward lower profitability and higher capital intensity is inevitable for any mature industry. This does not make it elitist; it just means that the industry is becoming more professionalized. This is better for everyone, and it is what Bitcoin needs. As Bitcoin grows, significant investment will be required to ensure its network can handle the increased traffic. This will not be possible if mining remains in the hands of amateurs.

This is not to say that a mining industry dominated by a few large companies does not have potential problems. Such a system would be more susceptible to regulation and corruption. However, this is by no means an argument for altcoins, as their mining industry is dominated by two graphics card manufacturers and there are fewer individual miners than Bitcoin.

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Shorter confirmation time can better prevent double-spending attacks

This is a really misleading statement.

The problem here is the risk of a double-spend attack. If you receive a payment notification from someone, they could have made two conflicting payments using the same bitcoins. In this case, there is a chance that the other payment will be accepted by the blockchain instead of yours, and your payment will be considered invalid. This is a theoretical way to defraud Bitcoin merchants. [4]

Since Scrypt coins have a shorter block generation time, people will see which of two conflicting transactions will end up on the blockchain more quickly in the Scrypt coin network (unless someone maliciously attempts to manipulate the blockchain - see below). In addition, a double spend attack can only occur if the two conflicting transactions occur within a few seconds of each other, so the best way to prevent double spends is to watch the network for a few seconds after receiving a payment. If no conflicting payments appear, then there is nothing to be afraid of in a double spend. This feature is a planned upgrade for Bitcoin version 0.9, so it won't be long before any small benefit of the shorter confirmation time is eliminated.

Furthermore, there is no record of any successful double-spending attack in Bitcoin history, although there have been rare implementations under special or controlled conditions as experiments. Therefore, in the current context, this is not a real risk and not a valid argument for using Scrypt coins.

* * *

Scrypt coins are more secure against 51% attacks

No, they don't.

Performing a 51% attack means controlling enough computing power to generate blocks faster than the rest of the network combined. The attacker can then generate a fork of the blockchain from some earlier time and eventually grow it to be longer than the main branch, and other nodes in the network will begin to recognize the new branch as the legitimate one.

Deducing the probability that a 51% attack will succeed is a difficult problem that requires random walk theory [5]. However, in the end, this deduction is unnecessary, since the attack can only succeed if other miners agree. There is nothing to stop the rest of the network from ignoring the attacker and declaring his branch invalid. If the attacker's branch is obviously malicious, then this should not be a difficult decision. If the other miners accept it, they will also lose a lot of cash. In fact, the Bitcoin community successfully dealt with a similar incident in March 2013, where a software bug caused the blockchain to fork and consensus needed to be reached on which branch should be considered the correct one.

Furthermore, the Bitcoin network is huge and growing exponentially. A 51% attack on it would require a higher cost than any other altcoin network, so the question is purely theoretical, as in practice Bitcoin offers greater security. The cost of a 51% attack on Bitcoin is unknown, as performing it would require a continuous exponential investment to keep up with the rest of the network.

However, there is a way that Scrypt coins can stand out. Consider an attacker who has 49% of the network instead of 51%. This attacker's branch is expected to grow more slowly than the main branch, but it is still possible to accidentally produce a longer branch in a given time. If there are two attackers who each have 49% control of the Bitcoin network and a Scrypt network, and both can afford to continue the attack for the same amount of time, the attacker targeting the network with the shorter block generation time will have a much lower probability of success. However, this should not be a reason for any reasonable person to think that Scrypt coins are superior.

* * *

PPCoin

I have discussed PPCoin [6] and proof of stake from a theoretical perspective. Proof of stake encourages people to hold coins, which is necessary for a currency to gain initial value. However, this is most important in the early stages of a currency. Because people lose their proof of stake when they create a block, proof of stake discourages professional miners from having an incentive to keep the network running at the highest possible capacity.

One thing to say about PPCoin, however, is that altcoins are a product of the proof-of-work system. Proof-of-stake will not lead to them. If Bitcoin had transitioned to a proof-of-stake system before it was valuable enough for ASIC mining to develop, then perhaps there would be no altcoins.

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Primecoin

Primecoin [7] is a cryptocurrency whose proof of work is based on finding various prime number sequences rather than hashing algorithms. Its existence is based on the fallacy that Bitcoin mining is useless. However, as I showed in Concepts of Proof of Work, this is not true. Bitcoin’s proof of work system is a consensus mechanism. It is essentially a way to overcome the prisoner’s dilemma among Bitcoin users. This cannot be done without some proof of spent resources that have produced no personal benefit.

Primecoin undermines this process by attempting to make its proof of work accomplish something valuable. This inherently undermines its value as a consensus mechanism. Therefore, it is wrong to claim that Primecoin's proof of work is "useful" and Bitcoin's is useless. In fact, Primecoin's approach is even less "useful" because it introduces an inherent conflict of interest that does not exist in Bitcoin. Although, to be fair, generating sequences of prime numbers is "almost" useless, so I don't think it is likely to cause any real-world problems.

Primecoin is a fuzzy idea. It tries to do two unrelated things at once, which is the opposite of good design in general. Its prime-number-based proof-of-work is just another gimmick to make people forget that altcoins are a waste of time. That's not to say that distributed computing isn't a good thing. But there are probably better ways to do it using cypherpunk technology that aren't disguised as a currency.

* * *

Freicoin

Unlike other altcoins, Freicoin [8] appears to have been created with good intentions and is not backed by disingenuous arguments. These arguments are still wrong, but Freicoin deserves more respect than the others.

This is not the place to refute the economic theory behind Freicoin, but it is essentially based on the idea that interest rates are a purely monetary phenomenon and not the result of time preference. Rather than free transactions, Freicoin charges a fee for holding coins. Freicoins decay at a rate of 5% and transactions are free. Miners are paid from decaying Freicoins in all non-empty wallets.

Thus, by design, Freicoin discourages hoarding and encourages consumption. It is touted as a currency for the working class rather than the rich, as it is considered not to be usable to grant loans. In reality, however, Freicoin loans will be granted at the same interest rates as the rest of the economy, as they will compete with loans granted in more durable goods, such as Bitcoin. There is no reason for a lender to accept a different interest rate on freicoins, as there is nothing requiring him to hold freicoins. He can convert from Bitcoin before the loan is granted, and convert back to Bitcoin immediately after the loan is repaid.

A decay rate of 5% will have an impact on capital taxes, such as property taxes. This means that prices will be lower than other prices by a proportion determined by the overall interest rate in the economy. For example, suppose I wish to hold x freicoins. Because freicoins decay, this will incur an expense of x/20 freicoins per year. The present value of all expenses will be an infinite sum, decaying according to the overall interest rate in the economy. If the interest rate is i, then the present value of all expenses will be one expense times (1 – i) /i. For example, if the interest rate is 10% and I wish to hold 20 freicoins, then the value of the expense will be 9 freicoins. Therefore, in this example, I must pay 9 freicoins to hold 20, and therefore the value of the freicoins will be 20/29 times lower than they would be if they did not decay.

Now, if something is created to provide a clear incentive to get rid of it, it makes sense that they would be less likely to want to buy it in the first place. So Freicoin is actually designed to discourage investing in it, which is the very thing that gives money its value in the first place.

Freicoin is an idea whose time will never come. Because it condemns the buyer, it refuses to have value. Freicoin is therefore less a scam than an abortion. Its ideals are so refined that they shun the slightest chance of impacting the real world. Perhaps it can be seen as some kind of ridiculous parody, which is brilliant. I hope this is true, otherwise it would be too sad.

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in conclusion

The overwhelming reason Bitcoin is superior to its altcoin competitors is that it is incredibly popular. Some of its competitors might work just as well or better if they were invented first, but given the history that has led us here, none of them should be considered the slightest bit competitive with Bitcoin. If altcoins somehow beat the odds and end up being more popular than Bitcoin, then I would have to switch my allegiance. However, if that does happen, I think it calls into question the viability of cryptocurrencies in general. If they can rise and fall like fads, then it’s hard to justify investing in any of them or believing that any of them have staying power. I look at Bitcoin’s past success as evidence of its future prospects, but if it can be surpassed by an initially small competitor for no apparent reason, then the early success of any other coin doesn’t necessarily mean anything.

In short, the altcoin phenomenon is a product of greed and bounded rationality. They should be held in contempt, and anyone who hopes that cryptocurrencies will improve the world should avoid them altogether.

[Updated 25 August 2013: Freicoin has been changed from an earlier version to correct an economic error.]

[Updated 28 August 2013: Added two references. Last paragraph added to competition section.]

References

1. See Miers, I., Garman, C., Green, M., Rubin, A., “Zerocoin: Anonymous Distributed Electronic Cash from Bitcoin,” April 9, 2013, for information about Zerocoin, a proposal that would greatly increase the anonymity of Bitcoin. It would be great if this could be accomplished, but it would require a significant coordination effort to implement, as it would involve incompatible changes to the Bitcoin protocol. This is actually one way that an altcoin might be useful—it could use Zerocoin as practice for doing the same thing with Bitcoin later. For a proposal to limit the size of the blockchain, see JD Bruce, “Purely P2P Crypto-Currency With Finite Mini-Blockchain,” April 2013. Currently, the storage cost of a blockchain becomes higher as it grows, and there is no built-in way to compensate for this. This paper shows that it is possible to split the functionality of the blockchain into three different data structures whose combined size grows much more slowly. Users (but not miners) can already store shortened versions of the blockchain, a feature that is already implemented in clients such as MultiBit. However, shortened blockchains require clients to make some assumptions about the validity of the full blockchain, which mini blockchains do not.

2. See Hayek, F., The Road to Serfdom, Routledge Classics, 2006, on “Why the Worst Get to the Top” and Hoppe, H., Democracy: The God That Failed, Transaction Publishers, 2007, on “On-Time Preferences, Government, and the Process of Decivilization” for discussions of unhealthy competition.

3. Bastiat, F., Petition of the Manufacturers of Candles, Wax Lamps, Lamps, Candlelights, Street Lamps, Snuff-Apparatus, Fire Extinguishers, and of the Producers of Petroleum, Tallow, Resins, Alcohol, and of Everything Related to Lighting in General, Vol. 1, Ludwig von Mises Institute, 2007.

4. O.Karame, G., Androulaki, E., Capkun, S., “Two Bitcoins for the Price of One? Double-Spend Attacks on Bitcoin FastPayments”, Cryptography ePrint Archive, 2012.

5. See Grinstead, C., Snell, J., Introduction to Probability, American Mathematical Society for a delightful discussion of random walks. See if you can solve the 51% attack problem yourself!

6. King, S., Nadal, S., “PPCoin: A Peer-to-Peer Cryptocurrency with Proof-of-Stake,” August 19, 2012.

7. King, S., “Primecoin: A Cryptocurrency with Prime Number Proof of Work,” July 7, 2013.

8. Freicoin developers, “Freicoin: About,” 2013.