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cryptocurrencies are future-proof

- 8 Minute Read

The trillion dollar question everybody is asking is whether or not cryptocurrencies are here to stay. Cryptocurrencies have yet to accomplish the goal set out in the original Bitcoin whitepaper that started it all: replacing modern financial institutions with a decentralized system of exchange. Keep reading and learn what's currently holding them back, why they'll likely replace fiats in the long run, and how cryptocurrencies can best compete against each other.

Cryptocurrencies Are a Platform

Like Uber, Airbnb, and Amazon, cryptocurrencies are a platform. Platforms are network-based business models which take advantage of the networked properties of multi-sided marketplaces to outperform traditional pipeline business models. Multiple agents in the financial market—sellers, buyers, application developers, payment processors, etc.—all come together, through cryptocurrencies, to engage in exchange. With cryptocurrencies as the platform, these market agents can connect where previously impossible to create mutual value.

This is an important distinction because cryptocurrencies adhere to the same properties as platforms. They face the cyclical challenge of finding initial adopters, they carve out niches in competitive multi-sided marketplaces, and they compete against other platforms to obtain a critical mass of users.

The Chicken and Egg Problem

Platforms derive their efficiency from large and integrated networks, however building those networks can be difficult. In order to attract network participants, the platform requires utility. However, in order for a platform to provide utility, it requires network participants. The core value of a currency stems from its ability to be exchanged. A currency platform depends on a financial market of buyers and sellers who are willing to transact with the currency; in order for buyers to join the platform, sellers must be present, and in order for sellers to join, buyers must be present. Getting either side to the platform is not an easy hurdle to overcome.

Adoption Coaxing

Many platform developers resort to a technique called coaxing to attract a single side of the market. Coaxing involves reducing the cost of adoption for a given side of the market, typically with incentives. For example, Uber has subsidized the cost of rides on its platform in order to compete against the cost of alternatives and attract new ridership. For years Uber has operated at a loss because of this, yet investors continue to dump billions of dollars into the platform. They hope that by coaxing users onto the platform, they will reach a critical mass of users such that network effects kick in, and the platform becomes valuable enough that incentives are no longer needed to attract future riders.

Adopter Benefits

Coaxing is not the only technique used to overcome adoption challenges. When considering platforms such as Uber and Bitcoin, the benefits of adoption can be broken up into network benefits and standalone benefits.

Network Benefits

Network benefits are dimensions of value that become realized as more users participate in a network. For example, on the Uber platform, as more drivers join the network, it becomes cheaper for riders to join due to greater competition among drivers. As riders join, this, in turn, provides more opportunities for drivers.

For cryptocurrencies like Bitcoin, verifiability, transaction speed, and places to spend the currency are all examples of network benefits. These benefits increase as more participants use the currency.

Standalone Benefits

Standalone benefits are dimensions of value intrinsic to the platform. Uber's in-app navigation system is an example of a standalone benefit. It is a piece of software that will work and provide value to users regardless of how many participants are on the network.

Good platforms rely on a mixture of standalone and network benefits to create value for users and move beyond the chicken and egg problem. By applying the chicken and egg problem to cryptocurrencies, cryptocurrency developers can utilize platform adoption levers, such as participant coaxing, adopter benefits, and network effects to overcome the cryptocurrency adoption challenge.

Cryptocurrencies vs Fiat currencies

Unlike cryptocurrencies, we do not release patches and upgrades to the traditional financial system; fiat currencies have remained largely the same for decades. In competition against fiat currencies, cryptocurrencies have the unique advantage of rapid evolution. Thus, in the long-run cryptocurrencies will out-compete fiat currencies.

Fiat currencies can still put up a good fight. It's in a government's best interest to maintain control over its existing currency. As cryptocurrencies become a more competitive threat to long-standing currencies like the U.S. dollar, regulation will work to curb the use and adoption of cryptocurrencies. In the long-run however, the value gap between fiat and cryptocurrencies will become too great to ignore. Many governments are considering the possibility of replacing their cash-based fiat currencies with new cryptocurrency alternatives.

Fiats are not a threat to cryptocurrencies; the greatest threat to the adoption of a cryptocurrency is its ability to sustain an advantage against competing cryptocurrencies.

A Tool for Comparing Currencies

The value curve is a graphical representation of a platform's ability to create value. Along one axis are dimensions of value—such as price, customer service, and utility—that reflect participant's needs. Along the other axis is the degree to which the platform delivers on that value in relation to other platforms. When read together, the dimensions of value and the offering level form the platform's value proposition.

Cryptocurrency advocates can utilize the Value Curve to analyze cryptocurrencies against alternative cryptocurrencies. For cryptocurrencies: community size, security, liquidity, volatility, transaction speed, and exchange rate are each prominently discussed dimensions of value. The following value curve (Figure 1) provides an example of three cryptocurrencies competing along these dimensions.

Modeled in the value curve framework is the concept that dimensions of value reflect tradeoffs of the platform. For example, prioritizing security may involve sacrificing transaction speed. By prioritizing different dimensions of value, unique and competitive cryptocurrencies can be built.

In Figure 1, Crypto A provides an appealing currency to participants seeking fast and cheap transactions. Crypto B appeals to participants looking for a reliable currency with strong fundamentals. Crypto C, while not the most appealing along a given dimension of value, provides appealing intermediate value across all dimensions.

The application of this framework to cryptocurrencies provides a mechanism to assess the value proposition of a given currency. With it, cryptocurrency advocates can evaluate competitive characteristics of a given currency.

Cryptocurrencies vs Other Cryptocurrencies

Few currencies will make it to the tipping point where network effects kick in; Among them will be those those that coaxed users with a selection of competitive standalone features to incentivize adoption.

  • Ethereum smart contracts provide a meaningful effort towards building additional standalone value into the currency; they have exponentially increased the utility and adoption of Ethereum and have created new use cases for the currency, such as NFTs, which have attracted network participation.
  • The proof-of-stake (PoS) model also serves as a beneficial standalone benefit. Without changing the network size, cryptocurrencies which have adopted PoS have exponentially increased their transactions throughput, while also decreasing energy usage.

Cryptocurrency hype has brought thousands of new currencies into the market. The implementation of standalone benefits is an essential mechanism that cryptocurrencies must utilize to compete in the space. As the hype fades, the currencies which have built strong fundamentals, appealing adopter benefits, and an engaged community will emerge as market leaders.

Multihoming - Can One Currency Rule Them All?

Multihoming is the choice of an agent in a user network to use more than one platform. For example, users of ridesharing apps often switch between Uber and Lyft to find the most available rides for the lowest fares. Because of multihoming, platforms such as Uber or Lyft struggle to exert monopoly power in a given market.

Central to the value provided by currency is a unified system of transaction. Before currency, ancient barterers recorded the exchange rate between myriad market goods and determined trading pathways to liquidate their assets. The introduction of a standardized currency provided a liquidation pathway with a fixed end, the centralized currency.

For this reason, fiat currencies, such as the US dollar, singlehome. U.S. residents transact using the U.S. dollar when in the U.S. market. An individual traveling within the U.S. would be hard-pressed to find a vendor that accepts Euros. Due to the online and available nature of cryptocurrencies, however, users can choose between cryptocurrencies which suit their needs.

Multihoming is a challenge unique to cryptocurrencies. A currency that multihomes disturbs the central system of exchange model; multihoming poses a great challenge to the long-run adoption of cryptocurrencies. As multiple cryptocurrencies continue to be developed and adopted, it becomes increasingly difficult to liquidate any given currency. We may see a select set of cryptocurrencies that emerge with clearly defined use-cases and liquidation pathways. If platforms like Uber and Lyft, Amazon and Walmart, and Airbnb and VRBO can do it, then perhaps there's hope for cryptocurrencies as well.

In Conclusion

Cryptocurrencies are here to stay. Fiat currencies cannot sustain a long-run advantage against them. Governments may continue to impose regulation that curbs the adoption of cryptocurrencies, but the value gap will eventually become far too great to ignore. The greatest threat to cryptocurrency adoption is significant competition against alternative cryptocurrencies. As the hype dies down, market leaders will emerge that compete in a multihoming environment. The question cryptocurrency followers should be asking is not, "Are cryptocurrencies here to stay," but instead "Which cryptocurrencies will rule them all."