Long Term Bets and the Scaling Debate

You should always prefer improvements to the economic incentives of a coin as opposed to mere technical improvements. There are myriad examples of this and the lines are not always black and white. Most improvements to the economic model of a coin come from technical changes; but not all technical changes lead to improvements in the economic model of a cryptocurrency. It is important to understand how all of this applies to our theory of investment.

Our model is pretty simple, we make some basic assumptions:

Most new cryptocurrencies are dead after the first 18 months.

A cryptocurrency continues to exist because it has an increasing user base. Coins with decreasing user bases die off.

As your coins user base increases, your coin will appreciate in price over the long term (5 years plus) due to supply and demand.

From this model it stands to reason that what we are trying to do as early stage investors is select coins that will attract large numbers of users and be here many years from now, because odds are, if its still around, price will be higher than when you first purchased it due to supply and demand. But what is it that attracts a large user base to a particular coin? Positive economic incentives.

Community, philosophy, vision, etc. are all part of an economic model of incentives. For the sake of brevity we will focus on economic incentives that have a practical application in the day to day lives of users. These are the strongest incentives as relate to user adoption. For example, if you can make a cryptocurrency that lets me send money around the world one thousand times more cheaply than normal, and I am a regular money transmitter, then that technical improvement is a great economic incentive that will lead to my day to day use of your platform.

Regarding Bitcoin Core, lighting is a technical improvement that does not create great economic incentives for day to day users. Let’s talk about the elephant in the room. As I write this, Bitcoin Core has a market cap of over one hundred and ten billion dollars. It dwarfs the market cap of the next largest cryptocurrency, Ethereum, by a factor of five.

A lot has been said of the small/large block debate with much smearing of persons and technologies. In simple terms, Bitcoin Core wants to take transactions off chain and do them through private channels where a fee will be collected by channel owners, incentivizing them to fund these channels and process transactions. The argument for all this technical busy work is that the Bitcoin blockchain cannot scale over the long term by increasing block size so transactions are being taken off chain.

On the other hand we have an offshoot of Bitcoin Core, Bitcoin Cash, which argues that transactions should be kept on chain, and has effectively raised the block size while maintaining a transfer fee of a few cents. Bitcoin Core’s refusal to institute large blocks has led to transfer fees that are normally at least one hundred times larger than for Bitcoin Cash. Often, much, much larger.

Now there is a lot of extra information here. We can discard the technologies: “payment channels” (lightning) and “block size”. All we need to know is this: In Bitcoin Core, we want to incentivize some of our users (channel owners) by having users pay them high* fees to facilitate transactions through private payment channels. In Bitcoin Cash, we are incentivizing all our users by making it cheap for them to move money by keeping transactions on chain.

And here is the crux of the thing, under our model of the system, both of these methods of scaling will work out, but let me tell you this: Incentivizing all your day to day users as opposed to only a subset of your users, is the right play. To maximize our chances of profiting long here, we need a firehose of incoming users. Think if it this way: In Bitcoin Cash, near free transactions are the default incentive, with Bitcoin Core, they are not. It’s a simple observation but an important one.

It is interesting to see how the two currencies we have discussed, handle incentives and how each of them has managed to grow into multi-billion dollar market caps by using incentives. The question we must ask ourselves is, “where will these incentives take them in the next 5 years?”

*Since lighting has not been deployed it is hard to say exactly what the fees will be, but consensus seems to be that they will be competitive with Bitcoin Core miners fees, making them by default more expensive than Bitcoin Cash. We concede they may be lower than this, but channel owners are unlikely to set up channels and lock up funds long term for marginal amounts.

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