It is 2021, and as institutions finally start to rally around Bitcoin and Ethereum as the future of finance, it is increasingly clear that both technologies are very much outdated.
They are not, however, outdated in the same way. And if that much has been evident for a while, the conclusion we draw from it may be shifting.
Even a few years ago, it was already easy to say that Bitcoin had no possibility of updating to become a fast and convenient global currency while Ethereum very much did. Our conclusion might have seemed obvious: Bitcoin, already outpaced, would be relegated to the historical curiosity shop of Ataris, phonographs, and fax machines, while Ethereum would become the platform of digital finance at worst and actual digital currency at best. Given the rich ecosystem of ERC-20 projects, NFTs, and trading platforms cameoing across mainstream news, it is tempting to think that this is exactly what has happened: Ethereum has shown us the future, built not only on Bitcoin’s foundations, but its long, slow demise.
It is a bit startling, then, to realize that the opposite could be true: that Bitcoin’s outdatedness may actually secure its future while Ethereum’s may not.
Bitcoin as Gold
To understand why this might be true—why a fairly useless technology looks more and more likely to last while an extremely useful one faces an increasing risk of fading away—it could be helpful to consider the history of metal money. As the internet works to recreate thousands of years of financial development in a single decade, metal money offers the clearest example of a form of money whose outdatedness makes it all the more prized.
Let’s focus on utility. Metal moneys began with clear use-value: Bronze rings in Europe, Bronze knives in China, and copper axes in Mexico all took the form of items that would necessarily be replicated repeatedly as common utensils for everyday life, and so, then, as fungible tokens as well. The fact that they were items of mass-reproduction means that ancient civilization knew there was just one crucial quality for money to serve as a medium of exchange: its standardization in quantifiable, identical units.
But cutlery coins raised other issues too. First, tokens didn’t need to have any use-value, and in fact, might gain value as axes or knives that was quite different from their value as currency. Second, bronze, and to a lesser degree, silver and copper, could be diluted through various alloys; after the Peloponnesian war, the debt-struck Athens would replace its pure silver coins with cheaper bronze coins that were artificially pegged to the price of their predecessors.
To put that another way, an Athenian economist of the time could be forgiven for thinking that perhaps money should be more than some substance that can be demarcated in fungible units. To really have clear value, it would need to be scalable (reproducible), decentralized (not open to the artificial valuations of an Athenian state), and secure (unable to be counterfeited through alloys). Years later (2018 or so), Vitalik Buterin would label the challenge of attaining all three the “scalability trilemma,” and indeed, for the past few thousands years, government institutions have been able to manipulate money to attain scalability and security at the expense of decentralization.
Still, we might add two other qualities too that don’t necessarily compromise these other three but pose challenges of their own. First, money should be scarce: if it should be reproducible enough to serve every level of an economy, it still needs to be scarce enough to have value. And finally—and this might seem obvious for a medium of exchange—money should be interchangeable and even interoperable with other forms of money as well.
In a physical world, the scarcity is the bigger challenge since money needs to scale as well; in other words, there needs to be enough of it to reach everyone but not so much that it’s valueless. This scarcity-scalability dilemma is not an issue digitally, where tokens in limited supply can be continually subdivided to produce infinite units of currency with a hard-capped total supply, but in the real world, the best proxy would have to be a metal that’s hard to mine (limited total supply) but easy to subdivide (very malleable). We’ll come back to this in a second.
In the case of interchangeability/interoperability, the problem flips. In the real world, this is fairly easy to solve: once a culture accepts a certain form of currency as a medium of exchange, it can be exchanged in turn with other cultures’ mediums of exchange, though assets rarely have full interoperability with different currencies. It is not easy, for example, to sell your house in the United States for euros, or to trade your prized Black Lotus Card in Chongqing for someone else’s in Milwaukee, but you can at least trade these for currencies and then trade the currencies with each other. Such an exchange might seem easier to perform online, but as of 2021, that’s not the case. Interoperability between currencies and platforms—what the folks at Radix refer to as “atomic composability”—remains a defining challenge between various codebases and languages.
Once we’ve expanded the trilemma to a pentalemma (scarcity, scalability, security, decentralization, and interoperability), it’s easy to see why gold would become the preferred currency of ancient civilizations. In terms of scarcity, it could be mined with slow, diminishing returns (at least until Europe began plundering South America in the 16th century and the world began moving away from gold money). In terms of scalability, it’s an extremely malleable metal, easily subdivided to as many units as necessary without changing the total value of circulating supply. In terms of security, gold is an ideal transition metal that can’t react with other metals and can’t be forged. In terms of decentralization, these qualities also make gold fairly immune to centralized monetary policy that might try to inflate the value of a coin—one reason the US would leave the gold standard. And finally, in terms of interoperability, gold is found across the world, so it can serve as a universal standard.
And yet, all these qualities that make gold useful as money are what make it fairly useless for anything else (besides jewelry, whose function is arguably to serve as a signifier of its own financial value, truly luxurious due to its own truly useless nature). Gold is valuable because it’s pretty impractical: hard to attain, difficult to combine with any other substance, a pain to carry around. To go even further, these qualities are what make gold fairly useless as a medium of exchange in a modern world, and the history of money over the past few centuries has been the history of trying to create gold derivatives (cash) and then move beyond a gold standard altogether.
At the same time, it is this uselessness as a medium of exchange in the contemporary world that arguably makes gold even more powerful as a store of value. The fact that it has been prized for centuries and can’t be used for anything except money makes it the ultimate form of money as well, a universal standard of wealth that is not subject to metallurgical manipulation or the vagaries of political policy. Unlike nearly every other currency, it doesn’t reflect the status or actions of a state, and it can’t gain or lose value by how it’s used. That is, perhaps, because it’s not really used at all.
By now, the parallels to Bitcoin are probably clear. Like gold, Bitcoin started as a subpar medium of exchange for the ancient digital civilizations of 2010 and 2015, and its extreme limits as a technology have made it increasingly difficult to transact. Yet this history as money—a very good ledger and a widely-accepted store of value—means that it is money, a form of money whose modern-day uselessness might turn out to make it more useful in the end.
Like gold, Bitcoin will never reflect the value of its use, of its team, of its underlying technology, the way that the dollar will inevitably reflect the status of the US or that ether will inevitably reflect the status of the Ethereum blockchain. Like gold, it will never be inflated or deflated, as the US dollar and ether will, in order to meet the prerogatives of a community that uses it. That might actually make Bitcoin more valuable as an impractical safe haven, once again like gold: scarce, annoying to acquire and hold, impossible for any power to modify or change. If Bitcoin is as unlikely to be used in the digital world as gold is in the physical world, that’s another way of saying that its value will be long-lasting and likely to grow. Its uselessness is its value.
Ethereum and the Trend-Setter’s Trap
Ethereum, which is not at all useless, faces the opposite problem: it provides the first fully functional medium of exchange for digital currencies, not only through its own token ($ETH), but through thousands of others built on its technology and executing transactions through its code. Ethereum, in other words, is far more than a breakthrough product like Bitcoin; it’s an entire ecosystem with its own language and rules. If strong network effects traditionally accrue to consumers and providers who need each other, Ethereum’s network should be the strongest of all: by allowing tokens to trade with each other and contracts to transact, Ethereum makes every user a source of supply and demand alike. It also has a booming market and a team that’s likely better than any startup, encompassing not only Buterin and his associates, but any developer who’s excited about the space.
The charm of doing anything in the Ethereum ecosystem is in realizing how revolutionary the technology will be when it’s solved its intensive jankiness. Manually checking each of the 64 characters of a wallet’s address, selecting the appropriate gas fees from a series of exorbitant options, and waiting minutes on ethscan to see if $60 really was enough for a transaction to go through—it’s all a bit like searching a Yahoo! directory for a website, or searching Craigslist for a job, plus gigantic fees. It feels like glimpsing into processes of the future, even if the technology can’t quite deliver.
Bitcoin is a great store of value, not least because it’s a subpar medium of exchange; its real function, like gold, is to lay in vaults and be hard to manipulate or transact. Ethereum, however, is built as a medium of exchange, and at best, it’s a fairly laggy one. As of March 2021, “Ethereum Killers” include Polkadot, Cosmos, Avalanche, Solana, Near Protocol, Algorand, Elrond, Radix, and even the hard-forked Binance Smart Chain, all promising and delivering substantially more transactions per second for a fraction of the cost. Ethereum developers are all-too-aware of the necessity to upgrade the system, and so, March 2021 also carries a host of promises for Ethereum over the next year: optimistic rollups, zk-rollups, and the forever-at-the-horizon Eth 2.0, along with interventions from projects like Polygon, 0x, OMG, Offchain Labs, and so on. Whether Ethereum can upgrade quickly enough to protect its moat is unclear, and even if it does, it’s unlikely to match the speed of a Hedera Hashgraph or Radix.
In other words, Ethereum faces what might be called the Trend-Setter’s Trap. The Trend-Setter’s Trap is not quite the same thing as other perils faced by early-movers. First, it is not quite the “first-mover disadvantage,” which requires ventures to invest so heavily in developing their own market that they can barely afford to invest hours and money in their product. Certainly, Ethereum developers have managed to open the market of digital finance to the mainstream through a combination of promotion and innovation, but this has only made their community stronger and larger than any competitors’.
More importantly, it is the opposite of the Innovator’s Dilemma, in which an incumbent refuses to replicate the model of a leaner competitor that would undercut its own core business model (hence Blockbuster refusing to mime Netflix). Ethereum’s issue is not that it doesn’t want to upgrade. It’s that it very much wants to upgrade, but it is losing time and ability to do so.
This is the core of the Trend-Setter’s Trap: a venture creates an entire market through a groundbreaking technology that promises far more than it can deliver, and as a result is eventually crushed by the same market it helped invent. Yahoo! is one example: its directories built an entire market for internet search through a terrible initial iteration that Yahoo! tried and failed to upgrade. The common story of Yahoo! is how its media-magnet leaders myopically refused to focus on engineering or buy Google (and Facebook) when they had the chance. That story isn’t wrong, but Yahoo! clearly knew it needed better technology that it couldn’t make itself; for years, it outsourced its search to Google (even and especially offering $3 Billion to buy it) before acquiring Overture in a last effort to stop its competitor.
In fact, the even more boring tale might be the most important one: Yahoo! had atomized software that required upgrades to be recreated individually for each segment of its business whereas Google invested in an underlying architecture that could be upgraded all at once for every piece. Ultimately, Yahoo! had the platform and the audience, like Ethereum, but there was better technology in the wings that it just couldn’t replicate.
A more telling case of the Trend-Setter’s Trap—a venture that really tried to upgrade its infrastructure but couldn’t—is AOL, the company that created the market for at-home internet. Pieces on the failure of the AOL Time Warner merger typically focus on the disastrous decision to turn AOL into a content provider for a single company (Time Warner) rather than a content distributor for the entire internet, but it’s not as though AOL failed because its users wanted non-Warner content. It failed because broadband succeeded, as AOL knew it would. “We expect America Online to help drive the growth of cable broadband audiences,” thanks to “our combined infrastructure and cross-promotional strengths,” AOL’s COO announced at the time of the merger in 2000, clearly aware that Time Warner had the physical infrastructure in cables to drive adoption in ways that AOL did not.
Nor was AOL wrong. Three years later, Time Warner had 2.6 million broadband users (24% of total users) while AOL had 650,000 (2.5% of total users), but these numbers also point to AOL’s demise. Ultimately, consumers used their cable providers for broadband; bundles incentivized behavior, but really, the cables were already in-home. Meanwhile, companies like AOL and Microsoft struggled to recreate an infrastructure that was already in place.
Writing on AOL, Rita Gunther McGrath has used the term “transient advantage,” referring to first mover’s advantage like internet directories or dial-up models, that quickly become outpaced by new technology. McGrath prescribes that companies pay better attention to their competitors, and while it’s easy with hindsight to say that Yahoo! should have bought Google and Facebook, AOL is a demonstration that self-awareness may not be enough to solve the Trend-Setter’s Trap. Early technology is the gateway to better technology, but it is not always the foundation for it. In the case of Ethereum, it is clear that it needs to upgrade its technology to meet the promises of the market it invented, but it is not entirely clear that it has the infrastructure to do so.
Back in 2003, pundits wondered whether there was a mass market for a pricy, premium internet option like broadband; most of the internet, after all, didn’t really require such speed. What they missed, of course, is that the internet would require such speed once the premium option became the norm. Already DeFi has created opportunities that weren’t possible pre-Ethereum: flash loans, NFTs, selling one’s data or research, and so on. It is tempting to say that if Ethereum’s many deployments over the next year succeed, they will remain the de facto platform for the future. But who’s to say that 100,000 tps will be enough for the future? The reason to remain excited about Ethereum is for all the possibilities it portends; the reason to remain concerned is that it won’t be the best technology to live up to them.
In other words, Bitcoin’s outdatedness is a mark of its longevity; Ethereum’s outdatedness is a warning that it may be short-lived.
Disclosure: I own Bitcoin, Ether, and a variety of ERC-20 tokens.