Is it difficult to create digital sound money?
We are big fans of cryptocurrencies. Despite that, let's be a bit critical to it and have a look at whether is it really so easy to create digital gold.
Every investor searches for a project that will succeed in the future. In the digital world, projects have coins or utility tokens. The ultimate question is whether project coins are good for anything sensible and how valuable can be in the future. The possibility of the creation of sound money might be the most promising investment. However, are we able to create something like that in the digital world?
In our article, we focus on a property that is mostly overlooked despite the fact that it is the most important one for something that should stay valuable in the long term.
Comparing cryptocurrencies with fiat and gold
There is plenty of articles on the internet showing the advantages of cryptocurrencies over gold or fiat. You can see one of the many comparison tables below. However, the key property is missing. It is stability.
Before we explain what we exactly mean by the stability have a look at why we think it is difficult to create a digital gold.
Can ADA become Sound Money?
A blockchain is essentially a trust machine. It is able to gain people's trust and ensure that some data or information remains unchanged forever. People started talking about the possibility that we can create sound money based on blockchain technology. We know how sound money looks like from the economic point of view but we have not a clear definition of how it should look like from the technol Read more
It is difficult to create a digital gold
Gold is a scarce natural resource. Bitcoin is a technology. Gold is just here and it is not dependent on nothing else to exist. It is possible to utilize gold in many industries or keep it as a store of value. Bitcoin, as a technology, depends on many unpredictable things and its properties can also change in time. Bitcoin is a software and there might be a bug. All bitcoins might lose significant value in a minute when some nasty bug appears. In the worse case, the network might collapse or Bitcoin might never get the trust of people back. It is hard to destroy gold and nobody does it intentionally. Bitcoin can disappear quite easily if it is sent to a wrong address or an owner lose private key. Currently, ~1/5 of coins are probably forever lost. Technically, all coins can be destroyed without any effort. A protocol is not able to ensure that digital wealth does not disappear due to silly human mistakes that cannot be taken back.
It might be difficult to perceive Bitcoin as gold since the properties of gold never change. You can use gold properties nowadays in the same way as 1000 years ago. Properties of Bitcoin changes every day. Hashrate can go up and down and Bitcoin is more or less secure. You can say that Bitcoin’s hash rate is the highest in the market but it is possible that some other projects can have a higher hash rate. Bitcoin used to be the fastest decentralized network 10 years ago. It is not true nowadays. Bitcoin is a transaction network and can serve a few people at the moment (10 transactions per second). If there are more people using Bitcoin the transaction fee will be higher and they can wait for settlement even days. One could say that Bitcoin is not perfect or usable at that moment. You can never say that about gold.
Bitcoin is not able to keep its properties unchangeable. It is no possible to create better gold. Moreover, it is very easy to create a better transaction network, a more secure network, or a more scalable network. You can even create a project, that will be better in all aspects. Gold is precious since it is unique, nobody can mimic it, and nobody can create something better. It will never be true in the technology world. It is naive to think that people will adopt a protocol or technology as a standard forever and will use it as gold. Protocols and services are here to reliably and quickly transfer data, offer some utilities, facilitate tasks, improve something, make things cheaper, more transparent or more reliable. Bitcoin does not do much of all that effectively.
The value of bitcoins is dependent on electricity. In case the protocol is not able to add a new block then coins will not be liquid basically immediately. Bitcoin requires a big amount of electricity to exist and again, it can hardly be considered as something stable. Bitcoin’s PoW requires a big amount of electricity in comparison with PoS. PoS can achieve stability much easier since significantly less energy is needed to keep the protocol work.
As a technology, Bitcoin will always have competitors and there is no generally accepted rule what to consider as digital gold. Any technological feature can be easily replicated and improved. We can measure the level of decentralization, security, speed of transactions, etc., but it does not help us. The majority of people choose the best solution for a given task. People's preferences always differ so there will be more similar networks. It is not simply possible to create a unique feature that would ultimately determine the winner. Gold cannot be challenged by other natural resources. It can happen that we need some other resources more than in the past so they become more valuable. Still, gold is number one also due to public acceptance.
Gold will never become obsolete, old, or broken. It is quite common in the technology world mainly due to never-ending innovations. At some point, it is not possible or easy to maintain old software and it is better to rewrite it from scratch. Bitcoin is a protocol working on TCP/IP and it was to be replaced many times in our history. It can happen one day. Cryptography ciphers getting old and are broken. There is plenty of reasons why protocol must be maintained, improved or even completely replaced. It is a risky business.
The team behind a protocol is also very important for the protocol. In an ideal case, the team should be decentralized. The team is maybe one of the most important properties of the protocol and any technology cannot exist without a strong team behind it. So also the stability and professionalism of the team play a vital role.
Andrew Chow, Bitcoin Core Developer working for Blockstream, recently complains that Bitcoin developers are underpaid and considers that
as a key issue that was holding back Bitcoin’s growth. He mentioned that contributors and developers who were working for the Bitcoin core network had to invest time and effort but they did not get paid until their contribution was significantly high and based on the long term. He said:
“It takes quite a bit of time before you can get funding to really work on Bitcoin Core.”
It is not good news for Bitcoin. A few issues are reported every day and currently, there are over 750 open issues in Bitcoin’s GitHub. You can clearly see how important is establishing a governance model and project treasury. Long term existence of any decentralized open-source requires a professional team and a lot of money for them. Only with that, Bitcoin will not be threatened by innovations like quantum computing and others. At the moment, it is a significant weakness of the Bitcoin protocol.
The majority of the population has no doubts about gold as a store of value. Only 1-3 % of the population believes in Bitcoin. The future success of Bitcoin depends on adoption. So the question is how it will evolve. We do not think that it is going to happen via price speculation. The adoption of cryptocurrencies via real utility is more probable and it might be faster.
The most attractive property of cryptocurrencies is decentralization. We try to achieve decentralization from the 19th and 20th centuries and using distributed networks is just a continuation of our effort. Bitcoin was decentralized at the beginning when coins were mined on desktop computers and later via 3rd cards. Nowadays, the reality is that Bitcoin is criticized for centralization. The most important property changed within 10 years.
The open decentralized network is kept running by people and they have to be incentivized. Thus, an economic model must be sustainable in the long term. Incentives change in time and it cannot be considered as stable if we discuss what happens after the next few Bitcoin halving.
It is a significant difference between vector attacks to gold and Bitcoin. A robber can always try to steal a piece of gold from someone and other gold is safe. A robber can try to steal gold from a bank. Still, gold stored in a bank beside is safe. In the case of Bitcoin, hackers can try to steal coins from individuals. However, hackers can try to attack the whole network and put all coins in danger. All big networks in the world are permanently under attack. Distributed networks are less vulnerable than traditional client-server networks but it does not mean that some attacks could succeed in the future. Even if coins will stay in the hands of owners the attack (or more sequential attacks) could damage the reputation of the network. It can never happen to gold.
Network properties are also unstable. For example, the more people try to use the Bitcoin network the higher transaction fees are. Media write articles about that and people are nervous if their transaction stuck in the pool for a few days. It is also something that does not look well and prevent further adoption. A network protocol is something that can never be completely done forever. However, people must not have a feeling that they use something that is not prepared or ready to use. No protocol can fully satisfy all users. Technology is always about the user’s preferences.
Read the following article about the bug in the Bitcoin source code that allows creating 184.467 billion Bitcoin out of thin air. It happened on August 15 of 2010 and Satoshi Nakamoto quickly fixed that by the hard fork:
What we mean by the digital stability
As you can see, it is probably impossible to create a reliable level of stability similar to natural resources via digital technology. Digital technologies are everything but not stable and reliable. With every new version of the software, some bugs are fixed and some new unexpectedly introduced. There are so many unpredictable factors in the real-world and the internet that building digital gold is a very bold attempt.
Technology can never achieve the stability of natural resources. Still, if we wanted to define what has to be done to at least approaching optimal stability it would be the following properties.
- The minimum number of bugs in the protocol.
- Resistance against human mistakes leading to loss of digital wealth.
- Minimum possible dependency on external resources like electricity.
- Team stability and professionalism. Reliable reward mechanism for people behind the protocol (if needed).
- High level of decentralization.
- Maintain the high-tech quality of the protocol to keep users. For example, the protocol must scale.
- The economic model must be sustainable in the long term.
- The protocol should be resistant to network attacks.
- In the ideal case, the protocol should serve people without technical limitations.
We also talked about an open competitive environment where projects always challenge each other. There could be established one project as the absolute winner. However, it would have to be publicly and globally accepted without any doubts. It is not probably possible within any technology. Nobody would claim, that operating system Windows is the best one and will be here forever and everybody must or should accept it as a fact. It is not a common mindset in the technology world. Contrary to that, we wait for innovations and better features. We do not care about a producer, type or owner. We care about utility and search for benefits.
Can we achieve a solid level of digital stability
We hope we have not scared you much. We do not want to tell you that it is impossible to create digital scarcity. We obviously have a few running networks. We wanted to show you the difference between the stability of gold and technologies where we are not able to achieve the same qualities. We should definitely continue with improving current networks and do our best to achieve the best possible quality.
What would be the simplest definition of digital sound money if we closed an eye and do not see our definition of stability?
It must be ensured that anybody, and even significant minority with direct influence to distributed network consensus, is not able to change the max supply of coins in circulation. In other words, the decision power must be distributed to as many independent entities as possible. The most important property of digital sound money is decentralization. It is what distributed cryptocurrencies networks are about. There is a piece of software installed on many independent computers and they try to come to a mutual consensus to change ownership of coins via transactions.
Decentralization is never a constant value. It permanently changes as external conditions change. As we have already mentioned, Bitcoin centralization is disputable and PoW is not probably the best approach to create digital sound money.
To build digital sound money is difficult from a technological point of view but even more difficult from the adoption point of view. People must believe in the protocol and the best way how to do it is to let people use it. Why is it so important?
We already have established a store of value and it is gold. If we want to create a digital analogy we definitely need more than just scarcity. We already have scarcity in the physical world. If we have a look at the current cryptocurrency adoption, including Bitcoin, people do not care much about digital scarcity.
Our point here is that we need to add some extra features or abilities to achieve mass adoption. We need to offer abilities that fit into the internet world. It is definitely the scalability since if we want to have a digital store of value or digital wealth, the transfer must be as fast as sending an email. New digital wealth should be programmable. It allows replacement of institutions and it is added value that gold does not have. We need to bring people higher freedom and allow them to take care of themselves. If technology can help her it will be valuable.
Adoption is still a problem
Nearly all properties are somehow influenced by the level of protocol adoption. It is less critical for smart contract platforms since they will be as valuable as they are useful. Adoption of Bitcoin is basically about accepting it as digital gold or a store of value. If people should hold it for a long time they must believe that the value will be preserved. It is the truer the more people hold coins. Imagine, that all coins hold just a single person. Will bitcoins valuable in this case? No. Why should be? People stop to be interested in something that they do not need for survival. It is water, air, soil, maybe the internet. Not Bitcoin. So what if 1% of the population holds bitcoins proportionally? It is a bit better. How many percents of people need to hold bitcoins to become really relevant and accepted in the long term? Our guess is at least 15 %. If it is only a few early adopters and banks it adoption remains low. On the other hand, institutions could push acceptance and they could definitely succeed.
What is more stable? Something that poses 1% of early adopters and big whales included banks and institutions or something that poses more than let’s say 25% of the population? Definitely the other case seems to be more stable. There always be whales when there is something precious. Still, the adoption around the whales is also necessary. It is possible that Bitcoin adoption will continue after institutions pump the price. Gold is also kept by whales and institutions but everybody would like to have a piece of it. At the moment it is not true in the case of Bitcoin.
It is fair to say that at the moment a few individual whales could decide in a minute to dump bitcoins on the market. High volatility does not help to perceive Bitcoin as a store of value. The price would be more stable if more persuaded people kept Bitcoin.
We think that projects like Cardano will have it a bit easier with the adoption if they deliver useful features.
Cardano decided to take this approach and offer a bunch of useful features. To succeed here, the protocol must be decentralized, must scale and must be secure. Cardano has the best team in crypto-space that consists of many researchers and developers. The project attracts new people from the academic world. They see what the IOHK team has done so far and want to help. Thus, from a technology point of view, Cardano will be competitor number one for all other projects.
In our view, it is easier to create a decentralized network with a bunch of useful features than digital gold with a limited feature set. A useful network can directly compete with current big internet companies and banks in order to take over some functionality. People are used to consuming some services and even pay for them in some way. Either directly or indirectly. If there is a competitor offering better features then it is very likely that at least part of consumers migrates to new service. The adoption of the service can rise as more and more people find it useful.
Can this approach lead to establishing digital sound money? Yes. Imagine the situation that a significant part of the population uses the Cardano network as a financial backbone of the world. In this case, it will be a very valuable and important network. ADA will be used to govern the protocol. Moreover, every holder of ADA will get a staking reward. Keeping the Cardano protocol running is cheap. If there is a big amount of transactions than ADA holders get a very nice reward.
Let’s have a look at our stability definition and try to check whether Cardano can succeed. As we have already mentioned, Cardano has the best team in crypto so there is a high probability that the number of bugs will be minimized and the network will more resistant to attacks. The team tries to deliver a secure and scalable network and thinks about how to help people to avoid silly mistakes during sending transactions. For example, the protocol SYRE. Still, 100% resistance against bugs and mistakes is impossible to achieve and there will always be plenty of attackers. The team might ensure that the protocol stays relevant for a long time. Cardano will build a governance model and treasury system so there will be enough resources to maintain the protocol. Cardano will be sustainable in the long term. PoS is better than PoW from the stability point of view. PoS consumes less energy and the protocol might be more decentralized. We need both these properties.
It might be difficult for Bitcoin to just keep the narrative about digital gold without interesting features, with scalability issues, underpaid development team, and debatable decentralization. The Bitcoin team works on improvements so the protocol is able to compete with others.
Can a protocol be valuable if it is inefficient as the technology? Will be Bitcoin considered as the best digital gold if it can never be the best as the protocol or technology? Is PoW the feature that cannot be challenged? Hard to say. It is not impossible.
It makes no sense to speak about digital gold in the digital world since we can never achieve the stability of gold. It is a fact that can hardly be denied. Cardano has the potential to be a very successful project since it will offer a valuable network with a bunch of features. All users might own a proportional part of the network and benefit from it. There will be no single owner or group of owners. People holding ADA can use the Cardano protocol and will be responsible for the future. In our view, it is a true digital value. And, we cannot necessarily call it digital gold. It is just a service that can transform our world into a better form.
Nothing lasts forever in our world. We could say it about gold. We can hardly claim the same about the always evolving technology. However, we can argue that people always use the best available technology and there can be a value behind a useful protocol. It is not about competition between Bitcoin and Cardano. It is about all projects in the crypto universe and our decentralized future.
To finish positively, we do not want to say that it is absolutely impossible to have something like digital gold in the digital world. It is possible, however, it is needed to know risks and limitations. If we are aware of that then we can better create a technology that will not cause damage. In the future, technology will improve and maybe it will be easier to create a reliable and stable digital gold. Cardano is built as a mission-critical project so it might the way.