Alt-coins and Bitcoin: how they work together

About 6 months ago I wrote a piece on altcoins and why I think they are around. Since writing that not only has the price of both alt-coins and bitcoin increased dramatically, but the altcoin to bitcoin ratios have increased.

litecoin

LTC/BTC all-time exchange ratios

It is clear that altcoins do have individual value of there own outside of bitcoin, but they are part of a greater overlapping network of digital currencies.

Many people trade in both bitcoin and altcoins, but how many trade in only altcoins? The vast majority of altcoins have bootstrapped themselves to have value because of the insanely low valued transactions that you can do now with digital currencies. Currently you can buy 100 dogecoin for $0.06 (it was more than 10x lower than that in october)–and remember those dogecoin can be subdivided the same amount as bitcoin (0.000001).

This can occur because bitcoin exist. Unlike in 2011 when if you wanted to get any kind of digital money, you had to wire money to Mt. Gox. It was the bullshit that we put up with to get our hands on this stuff in 2011–and it was worth it. There was no way to do transactions for a tiny amount on the internet before bitcoin–now you can.

With that being said, it is also clear that altcoins have a value outside of bitcoin. Not only are several large exchanges starting to allow altcoin to fiat withdraws, but there is real economic activity preformed with only altcoins.  The dogecoin community has done of several fund raising efforts using their currency. It is hard to say how much of this value came from dogecoin being able to bootstrap value off bitcoin, but it is clear not all nor none, but somewhere in between.

Specialization

ugh, dogecoin

I personal have a distaste for Dogecoin. I find it immature and dislike how it pokes fun at cryptocurrencies in general, but perhaps that is also why some people love it. Who am I, or anyone else for that matter, to say what should or should not have value? In the case of Dogecoin I can see someone in the future make an amazing financial tool to teach kids how to use digital money. It can use that fun, immature, generous identity of Dogecoin to be a place that dogecoin can specialize, and how many other altcoins can specialize as well; through find a niche.

In the post that I linked to at the top I pointed out how Litecoin could be used as a sort of bitcoin insurance. Most of that is simply due to the second mover advantage that litecoin has in the world of digital currencies and the perception of litecoin being the silver to bitcoin’s gold. Other currencies can specialize in the same way (and have with their own unique attributes to do so), but the real question is more if we are going to see marketmakers do this. I think we will, but it may take a few years for any of the altcoins to gain their own independent traction, and to find where they really fit.

The Alts I’m putting my money on:

1) Peercoin

PPC/BTC all-time chart

PPC/BTC all-time chart

The first cryptocoin to have a proof of stake mechanism to it. I believe that this advancement is almost as substantial as bitcoin’s proof of work, in that it preforms the same action, but it is done through holding those coins, not mining. This generates interest that you earn on your peercoins from ‘minting’ them in this proof of stake mode. It’s high transaction fee discourages a bloated block chain, and makes moving it around a lot not too beneficial. I think that peercoin could one day perhaps serve as a much more stable, consistent, slow growing, savings vehicle in the world of digital currencies. It’s hard to see where the future is going to lead us, but I have high hopes for peercoin become the primary savings currency for the internet.

2) Litecoin

This is a gimme. It’s the second most popular cryptocoin and small-time miners seem to enjoy getting to help build the community (similar to how bitcoin was doing a few years ago before commercialization took over). Scrypt miners have just premiered, and I think that this will cause for a dramatic rise in the price of litecoin again, just as it happened after the bitcoin mining race took off. Furthermore, litecoin has some great devs, and litecoin’s creator works for Coinbase. You really couldn’t ask for a more clear sign that Coinbase will be working with litecoin someday soon, and once that happens there are more than 1 million Coinbase users, many of whom do not know about other digital currencies.

Furthermore both Huobi, and BTC China both just added litecoin trading. Keep in mind the last bubble for bitcoin was driven by the Chinese.

Perhaps by 2015 we will see litecoin on Coinbase, or perhaps even Circle, if they ever premier, and then we will see if that near $50 all-time high (ATH) can be kept. If litecoin behaves anything like bitcoin, we should see that ATH both broken, and to never be seen again. Only time will tell.

3) Namecoin

It’s a shitty currency in so far that it is only really a copy of bitcoin.  Where it is brilliant is how it operates as a namespace and domain system, which seems like it could have some real power. Namecoins help power .bit domains, which right now is pretty much squat central, but the idea is right. The world needs a decentralized DNS and namecoin could be it.

OneName.io seems to be the only thing that has been on my radar using namecoin. The idea is right, so we will see where they are in a year.

namecoin

NMC/BTC all-time price

Conclusion

Altcoins have an opportunity to present themselves as unique currencies to bitcoin that do not necessary need to compete with bitcoin. In order for that to happen an altcoin is going to need to develop its own unique identity, and build out its own network separate from that of bitcoin. In someways this is being explored by altcoins like auroacoin, which quite frankly I’m curious to see how it turns out. Perhaps this could serve as a model for States to covert to a digital currency.

In the end it is going to be the unique qualities of the altcoins which will make them successful. If they are to survive beyond the trend of bitcoin, they are going to have to establish their own unique networks or reasons for their existence. It will be interesting to check back sometime in 2015 to see where these coins are and how they are doing.

 

Why I’m bullish on Alt-coins

Did you know that bitcoin is not the only digital currency? There is also litecoin (LTC), Namecoin (NMC), and Peercoin (PPC) among dozens of others.  Some believe that these coins do little outside of what bitcoin has already done, so why should they have any value at all?

For the same reason that bitcoin has value:

These are all sound forms of money

Free markets and currency competition 

Despite the fact that the altcoins are much less known and much less disseminate than bitcoin they still have all of the same fundamental features that bitcoin has that makes it good money, and good storage of value. More important than any of the additional features that altcoins offer is they compete with bitcoin on a free market. This is what Austrian economist Friedrich von Hayek spoke of in his final treatise on money, “The Denationalization of Money.” He believe that in a world of free money currencies would be forced to compete with one another (similar to on the forex market) and the superior currencies would win out over less efficient currencies through free market mechanisms. What I took away from this is that there must be currency competition to compare and contrast currencies against one another, and to help mitigate against any disasters one currency could have, and also ensure that there is not a monopoly on digital currencies.

Bitcoin has the first to market advantage, which means many, many more people accept bitcoin than litecoin today, and more accept litecoin that peercoin. This is significant advantage bitcoin has over altcoins is because it is hard to convince people to use an alternative currency–particularly one that people cannot hold. But what about getting people using bitcoin to use altcoins? That seems like a much easier jump to make than from not using digital currencies to using altcoins.

So if bitcoin becomes successful (which it already is) there is little reason why altcoins would not also become successful. The biggest barrier today is simply getting more people to accept altcoins–and the more people that accept bitcoin, the more potential people there are that may accept altcoins. And because they also have fixed supplies, the more people that use altcoins, the more likely the price will increase. That seems to be what happened with the most recent spike in LTC volume when the price went over $9. This seems to have been caused by the influx of Chinese digital currency users that also caused for the recent rally on bitcoin.

Pushing Altcoins

With Altcoins being just as efficient as bitcoin in terms of their moneyness, there is a huge opportunity for someone to create a digital currency bank using one of these altcoins. The biggest advantage that one would have in do this would be market making, after purchasing a large supply of the available coins. Through offering support, and more importantly, having a sales team that shows businesses the direct advantages from using digital currencies, a company like this could do very well. The biggest question is will someone see this in any of the altcoins? Time will tell us.

Catastrophe Insurance 

Another reason that altcoins are could be successful is the possibility that the bitcoin network could somehow become compromised or enter into a full panic of confidence. If that were to happen, altcoins–being the quickest way to convert bitcoin to another currency, outside of selling directly for cash–would be the quickest alternative to flee to. One could also think of litecoin, and other altcoins as being a tool to diversify one’s digital currency holdings as well, to hedge against any sort of catastrophic disaster to bitcoin. The future is impossible to tell, and the more digital currencies there are in the world, the less likely it is that digital currencies on a whole will fail or be compromised.

In conclusion, I believe that altcoins will be successful because the technology is just as good as bitcoin, with a few significant improvements over bitcoin in some ways. Altcoins help strengthen the total digital currency network through offering competition between currencies, which helps create efficient, powerful currencies according to consumer preference.

Bitcoin, Alt-coins, and Free Money Theory

Gavin with some BitBills

Gavin Andresen wrote this piece on his blog about alt-coins and several of the issues they create. As much as his concerns are valid, there is a different perspective where digital currencies of all kinds can compete in an open market to capture the most customers bases off of the greatest advantages they offer. This was presented in “The Denationalization of Money,”  the magnum opus of Fredrick Von Hayek, Nobel laureate in economics and close friend of John Maynard Keynes. Hayek’s primary argument in this work was that through allowing the private issuance of currencies, banks would be forced to compete on the open market to have the most competitive currency. Below I am going to explore some of the concerns that alt-coins present and how they can be understood from the perspective that Hayek offers in the Denationalization of Money.

Free money theory

Bitcoin has a significant advantage over other digital currencies with that it is the first digital currency, and no other digital currency is significantly different from bitcoin. With that being said, alt-coins not only help legitimize bitcoin as THE currency of the internet, but also help create a whole new digital currency economy, in which alt-coins can specialize, or succumb to market forces.

Gavin makes an excellent point that alt-coins don’t do too great of a job differentiating themselves:

“So what?  The free market at work, right? If they’re good they’ll survive, if not, then they’ll fail. If they’re better than Bitcoin somehow then maybe someday one or more of them will usurp Bitcoin as the biggest and best!”

He then goes on one to voice his concern that:

“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!

As much as this concern is valid, I think we can see that his first point seems to be the direction we are heading. The value storage of the number of alt-coins in circulation vs. their price simply does not compare to bitcoin. There are more than 20 million litecoins today, with the total supply capping out at 84 million. LTC price in recent months has gone from  $2.75 per LTC, to under $2. You can see that despite there being a total cap on the supply of LTC at 84 million, it is still is valued 30 to 40 times less than bitcoin, despite being a pretty good copy of it. This is because bitcoin has the first-mover advantage behind it, and thus has had more time to establish a market for itself.

If bitcoin is doing such a good job, than why are alt-coins valued at all?

Each one has its own reason, so I’ll just use litecoin as an example for now. Litecoin has value most because of speculation, but it is also a good bitcoin catastrophe insurance, it has second-mover advantage, and it is the most liquid way to get out of bitcoin, but not back into another fiat currency.

Insurance

Let’s face it–bitcoin does not have a lot of friends, and it has a bad reputation

Personally I’m bullish enough on digital currencies to believe there will be a $10,000 bitcoin one day, and so are others like Max Keiser. Gavin hypothesized this may be part of the reason why alt-coins are around.

Maybe altcoins will be an important safety valve in some future crypto-currency-dominated world. Maybe if there is lots of economic growth and some technical reason prevents the velocity of money from accelerating to match the increased demand for transactions people will use alt-coins to fill the gap.

And I think what Gavin is saying about the velocity of money is true. I believe this is the behavior that we are seeing with litecoin being used as a shelter during turbulent bitcoin times.

Even if alt-coins were to become a threat to bitcoin, it would most likely be for a good reason. Perhaps mining centralization could lead to some issues down the line, or pump and dumps too frequent–who knows? Other than a faster block-time, and 4x the supply of coins, I don’t see any difference of advantage of using litecoin as a storage of wealth, or a mode of exchange.

I do however see how it is useful as a short-term hold of wealth for shelter during turbulent bitcoin market periods. There are members of the /r/bitcoinmarkets is an example of a community that utilizes this technique. There is also ample evidence that this is also done on the Russian exchange btc-e.com as well in order to do ‘pump n’ dumps–where one inflates the price through rapid buying, and then dumps to collapse the price and buy back at a lower value.

Litecoin may also become valuable as a mode of exchange. We can see that the recently closed online drug market place, Atlantis, accepted litecoin, in addition to bitcoin. Litecoin could very well bootstrap its way to become more valuable, similar to how bitcoin did with The Silk Road.

Other Altcoins

Namecoin, Peercoin, and Primecoin all have there own unique features that one day may make them very valuable, but today that is not the case. As Gavin pointed out, these developers could focus more on their alt-coins unique features (which I’ll discuss in a separate post), but to simply have it be another bitcoin copy is little more than inflationary flack. There are always 51% attacks, and people simply not accepting alt-coins to solve that. I believe from seeing where we are at in this very new economic paradigm we are see exactly what we need to see: A few unique and well-differentiated alt-coins seeing limited success, along with the death of dozens of other more useless coins.

When we look at bitcoin through the eyes of Hayek, none of this is surprising. Digital currencies represent Free Money, or money that has no monetary authority other than itself. This means that the value of digital currencies can only come from their intrinsic value which is established through the market. This is one of the reasons that bitcoin’s first-mover advantage is so important–it was the first digital currency to gain a wider following and create market legitimacy, thus it has the largest market cap of all digital currencies in circulation.

This also helps explain why alt-coins do have some limited success. Because they still have the same money function that bitcoin has, which is more efficient that fiat currency, that can be used to give them value. Yet, because there are fewer people accepting alt-coins today, nor do they differentiate from bitcoin greatly, many of them are still highly-speculative prospects that have gained little traction because of this lack of differentiation.

Conclusion

Hayek’s theory on free money found in the denationalization of money helps explain why digital currencies have value. This theory also helps explain the complex market relationships that allows for some currencies to keep and hold value, while limiting the success of others. It will remain to be seen how successful alt-coins will become, but it is most likely that because of bitcoin’s first-mover advantage that it will always remain the primary digital currency. With that being said, alt-coins will always be needed in the market for bitcoin catastrophic insurance, and to act as an alternative mode of exchange.