Is Bitcoin Poised to Be Overtaken by Altcoins?

Researchers Are Turning Against Bitcoin and Predicting Its Demise

Prasad said a few things about Bitcoin in his interview with CNBC, none of which were particularly flattering.

“Bitcoin’s use of the blockchain technology is not very efficient. It uses a validation mechanism for transactions that is environmentally destructive, that doesn’t scale up very well […] Given that bitcoin is not serving well as a medium of exchange, I don’t think it’s going to have any fundamental value other than whatever investor’s faith leads it to have,” he said.

This comment on fundamental value chimes with similar remarks made this past week by the Bank of England’s deputy governor, Sir Jon Cunliffe, who told the BBC that bitcoin’s price “could theoretically or practically drop to zero.”

It also chimes with remarks to the effect that, because Bitcoin uses a proof-of-work consensus mechanism that consumes prodigious amounts of energy, it will inevitably be superseded by cryptocurrencies that use a proof-of-stake mechanism.

Experts speaking to CNN in an article published at the end of November said just as much. For instance, finance professor Bruno Biais of HEC Paris told the news network that the “electricity consumption of Bitcoin is about the same as the electricity consumption of the Netherlands. It’s crazy […] this cannot continue.” He also noted that increasing numbers of cryptocurrencies (including Ethereum) were turning to proof-of-stake, but chided Bitcoin for not “moving in that direction at all,” implying that its days were numbered.

Even onetime Bitcoin holder Nassim Nicholas Taleb published a paper this year in which the Black Swan author argued that BTC fails as a currency and as a store of value. He also took a swipe at the fact that proof-of-work results in an “exponential increase in computing power requirements, making at the time of writing onerous energy demands on the system.”

When taken together with the fact that even Ethereum (which is still currently proof-of-work) is planning to shift to proof-of-stake, these comments may indeed serve to convince more than a few people that Bitcoin’s days really are numbered. Is it just a matter of time before it’s overtaken by Ethereum and other altcoins?

Why Proof-of-Work May Be More of An Asset than a Liability

This debate really hinges on the underlying debate between proof-of-work and proof-of-stake. Critics correctly point out that Bitcoin annually consumes the same amount of energy as a medium-sized country, but they may be premature in concluding that proof-of-stake offers all of the same benefits as PoW but without the environmental impact.

In fact, it’s arguable that proof-of-stake doesn’t offer all of the same benefits as proof-of-work, in terms of security and blockchain integrity. Or at the very least, it certainly hasn’t proven in practice that it’s as secure.

Note that the two largest cryptocurrencies by market cap (including the longest-running and one of the longest-running major cryptos) use proof-of-work. One of them — Ethereum — may be planning to transition to proof-of-stake next year, but it doesn’t change the fact that, up until now, its success has been based on its use of PoW. By contrast, no proof-of-stake cryptocurrency has really reached the scale of either Bitcoin or Ethereum in terms of market cap, longevity, value transferred, and general use or investment.

This author has recently spoken to a variety of researchers and experts for the purposes of a Business Insider article on proof-of-work, and they said much the same thing.

Imperial College London’s William J. Knottenbelt noted, “Security-wise, proof-of-work has empirically been shown to work very well for more than 10 years. The jury is still out on proof-of-stake: although there are some theories about the security of proof-of-stake systems, the proofs typically make assumptions that may not hold in reality (e.g. that time passes in discrete time slots).”

Likewise, as part of research for an as-yet unpublished article, Blockchain.com’s head of research Garrick Hileman told this author that “a concern with proof-of-stake is whether these networks can ultimately remain as secure, tamper resistant and trust minimized as a proof-of-work network.”

Again, it’s not certain that this is the case, with some independent researchers even going so far as to call proof-of-stake a “scam” (in the sense that it doesn’t live up to its promises of achieving decentralized consensus). As such, even reducing the environmental impact of a cryptocurrency to zero won’t be that significant if users can’t even trust that its blockchain will remain secure and free from threats or violations.

Proof-of-work offers security and stability precisely because it’s so expensive, with the extrinsic cost of spending energy and computational resources on verifying transactions anchoring a PoW cryptocurrency’s blockchain in reality.

As Knottenbelt told this author, the ‘jury is still out’ on whether proof-of-stake’s internal mechanisms can replicate such a secure system. By extension, it’s still out on whether a PoS crypto genuinely has a chance of overtaking Bitcoin.

Medium of Exchange, and Fundamental Value

Turning to other criticisms against Bitcoin, it’s worth pointing out two things. Firstly, Bitcoin need not be a medium of exchange to be valuable, with its limited supply and secure network enough to ensure that its price rises over the long-term (i.e. that it functions as an asset or quasi-store of value). Secondly, technology is being developed which will make it more viable as a means of exchange.

This technology is, of course, the Lightning Network, which has grown steadily in the past year in various ways, leaving behind its former reputation of being a buggy and over-complicated layer-two scaling solution for Bitcoin. In particular, it now has a capacity of 3,300 bitcoins, up from 1,000 BTC at the start of the year. It has also seen its unique channels increase from 33,000 at the start of the year to 79,000 now, while nodes running Lightning Network channels have increased to 19,100, up from 8,200. This is in line with the number of nodes for Bitcoin as a whole.

While the Lightning Network still needs refinement and further testing, its use in El Salvador (which made bitcoin legal tender in September) shows that it can be used to make Bitcoin payments more scalable. In turn, it also suggests that, with time, Bitcoin can become a viable medium of exchange, as well as a sound long-term investment.

Of course, one final objection against Bitcoin might be that it could never become a real currency (or even a store of value), since it has no fundamental value. In other words, there is nothing inherent to Bitcoin that makes it valuable.

This depends on your definition of Bitcoin, and on where you draw its boundaries. Looking only at 1 bitcoin, there’s arguably nothing inherent to that particular unit of cryptocurrency (which is basically just some code generated by a software protocol) that would make someone want to own it. Unlike a bar of gold, you can’t make jewelry out of 1 bitcoin, nor use it for any practical purposes.

However, if you define Bitcoin in terms of its wider network, then it arguably does possess fundamental value. This network performs a substantial amount of computational work in order to create a secure yet decentralized blockchain. Yes, such work may be energy intensive, but it ensures that Bitcoin will remain more secure — and more decentralized — than any PoS-based rival. And this stability is arguably one of the most fundamentally valuable/important features any store of value (or medium of exchange) could have.

So while we continue to be left with Bitcoin’s eyebrow-raising energy consumption, it would certainly be very premature to conclude that the original cryptocurrency is on its way out.