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In Defense of Alternative Cryptocurrencies

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Alternative cryptocurrencies, like Litecoin, Primecoin and PPCoin, have gotten a significant amount of bad press recently. Lead Bitcoin developer Gavin Andresen wrote an article criticizing altcoins as being a way of getting around Bitcoin’s 21 million currency supply limit and “getting back to an ‘inflate on demand’ world” and, more recently, Daniel Krawisz from The Mises Circle wrote a lengthy post entitled “The Problem with Altcoins”, raising many other concerns. Krawisz’s arguments received a substantial amount of support from the Bitcoin community, showing that there are many Bitcoin users who disapprove of alternative cryptocurrencies in principle. Quite a lot of the time, the arguments made against specific alternative cryptocurrencies are justified; however, a strong case can be made that the position provided by Krawisz – that altcoins are bad in principle, and not just in implementation, goes too far.

The first argument that many people raise against alternative currencies – although, fortunately, one that is ignored by both Andresen and Krawisz, is that most of them offer essentially no value over Bitcoin itself. IXCoin is nothing more than Bitcoin with a steeper currency supply curve, flattening out around 2020. Feathercoin is a clone of Litecoin with the only major change being that the final currency supply is 336 million instead of 84 million, although Feathercoin developers do emphasize the currency’s well-maintained and active community as a counterpoint. Anoncoin is a version of Bitcoin that works over the anonymizing network I2P – certainly a valuable feature for I2P users, but a superfluous one now that I2P clients exist for Bitcoin itself. And it’s hard to tell what’s “American” about AmericanCoin, “Chinese” about ChinaCoin or particularly “global” about Worldcoin. These are all good arguments against those individual cryptocurrencies; however, when used as an argument against alternative cryptocurrencies in general, the fallacy becomes obvious. The fact that most altcoins offer little value and are forever doomed to the obscurity of sub-$1 million market caps is actually rather unsurprising; in fact, it is exactly what you would expect the alternative currency ecosystem to produce. It has been known for years that 90% of small businesses fail, and the principle has been generalized as Sturgeon’s Law: ninety percent of everything is junk. Did anyone ever expect that alternative cryptocurrencies would be any different?

However, the two do make a number of other arguments against alternative currencies. Krawisz makes a lengthy post detailing a number of arguments both against specific currencies and altcoins in general, whereas Gavin Andresen’s article on the subject is much shorter, and focuses specifically on one particular problem: inflation. Andresen writes:

One of the big appeals to me for Bitcoin is the fact that it is inflation-proof– the supply of Bitcoin is fixed and completely predictable. Everybody knows that 21 million Bitcoins will be produced, and everybody knows approximately how quickly they will be produced.
Creating gazillions of alt-coins seems to me to just be a way of getting back to an “inflate on demand” world. Not enough genuine Bitcoin money for you? No problem! Create a new alt-coin to produce more!

Meanwhile, the core of the Krawisz’s argument is this:

A medium of exchange that is more widely accepted on the market is more useful than one which is not. This is known as the network effect. Thus, an initial imbalance between two nearly equal media of exchange will benefit whichever is more widely accepted until a single one overwhelms the rest. There is no limit to this effect: ultimately one would always expect a single currency to overcome all its competitors.

The first thing that one needs to notice at this point is this: these two arguments are mutually exclusive. If Krawisz is correct, and there will inevitable be one cryptocoin dominating the market, then the only way an altcoin can succeed is by replacing Bitcoin entirely. Thus, there will not be any pseudo-inflation through multiple currencies. If, on the other hand, the total currency supply expands due to multiple coins being on the market simultaneously, then that will prove wrong Krawisz’s assertion that the cryptocurrency market necessarily tends toward monopoly. If one opposes altcoins, one must therefore choose to oppose them from Andresen’s line of reasoning or that of Krawisz; one cannot take both.

My personal position is that Andresen’s argument is technically correct, although the potential for it to cause price inflation is somewhat overstated. If alternative currencies have a future at all, it will be a future where cryptocurrency in general becomes more prominent, not less. In such a world, the larger problem is not price inflation (ie. Bitcoin’s value going down); rather, it is price deflation – Bitcoin’s value going up. Why is this a problem? First of all, nearly everyone agrees that having wealth be more equally distributed across many individuals is a good thing; opponents of wealth redistribution, by and large, only target the methods (eg. inflation and taxation) by which redistribution is attempted in practice. If altcoins cause Bitcoin’s value to go up by a factor of fifty rather than a hundred, and thus give rise to, say, fifty people split between five currencies with $1 billion each rather than ten people with $5 billion each, then by all standard measures of welfare economics that will be a positive outcome.

Second, it is the very potential for Bitcoin’s value to go so high up that makes the currency so unstable. When Bitcoin had its bubble to $266 in April, the reason why the market bounced back and forth so wildly before settling down around $100 is that the stakes were so high; everyone knew that, if successful, Bitcoin’s value can reach as high as $10,000 to $1 million, and the wild swings in prices represented people’s varying estimations of the probability that Bitcoin will indeed see such a success. However, if it is understood that if Bitcoin succeeds there will also be many other altcoins, then Bitcoin’s value might only end up between $2,000 and $200,000 in the case of extreme success – creating a lower “ceiling” on what the price can be and thus narrowing the range within which estimates of Bitcoin’s value can take place. The net result of this will, in fact, be reduced volatility – a positive outcome for people who are looking into Bitcoin as a store of value to protect themselves from having their bank deposits confiscated or their pension plan nationalized, and not as a “maybe get rich quick” investment. There is certainly nothing immoral about the latter, but the far larger value that Bitcoin can provide ultimately rests in the former. Once the cryptocurrency market is mature, we can expect cryptocurrencies to go down just as often as new ones come up, so the currency supply should remain roughly stable in any case.

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