In recent months there has been a surge of interest in cryptocurrency and in particular a wave of interest in the panoply of altcoins that have been (and are being) built on Blockchain technology. I’m known to be a crypto enthusiast among my friends so many of them are surprised to learn that I don’t personally hold any altcoins. As with the last time we discussed crypto I found myself sending similar notes to multiple friends and decided to write them up here so they can be easily shared. These are just my personal opinions. I am not an investment advisor and this is not investment advice.

Why I am still a Bitcoin maximalist:

Currencies compete via network, not technology

Cryptocurrency have two basic components: the code/technology (i.e. the consensus rules) and the network (i.e. the ledger and the users vested in it). To be decentralized, the technology has to be open sourced and no special nodes can be privileged. Since the code must be available, any enterprising developer or stakeholder can take the code behind any technological advantage and apply it to the ledger of their choice. The existence of Hypecoin implies the existence of Hypecoin-but-with-Bitcoin’s-network, which means Hypecoin and Bitcoin don’t compete by featureset (because features can be freely co-opted) but instead compete strictly on network.

One way to observe this in practice is to note that as of writing 3 of the top 10 cryptocurrencies by market cap are Bitcoin, Bitcoin Cash and Bitcoin Gold. Like their predecessor, both BCH and BTG have a very limited featureset and in fact even roll back some of the recent updates to the BTC blockchain. But in spite of their relatively primitive features, they have rapidly outpaced more technologically advanced cryptocurrencies in value. Co-opting the Bitcoin network turned out to be more valuable to the market than a great many competing technologies. One suspects the founder of the next Hypecoin will choose to launch their currency as a Bitcoin fork, or perhaps as a side-chain.

The reason the Bitcoin network is so valuable is that Bitcoin has the most wealth, the broadest userbase and the longest history of successful operation. Since money is a network effect good, these advantages are self-reinforcing: a larger network means more liquidity, which attracts more use cases, which strengthens the network. To overcome those advantages any new currency will need to find a way to compete with the BTC network, but as recent forks have demonstrated, it would probably be easier just to co-opt it.

The fastest way is slowly

Trust in new financial instruments is slow to build. For those of us considering adopting crypto already it can be hard to understand how slowly this trust will build for most of the world. Passive investing is provably better than active management and was introduced more than 50 years ago but is still only responsible for ~40% of U.S. invested assets. Writing good cryptographic code is also fundamentally hard, which means that defensive posture is completely reasonable.

The only way to learn the risks and failure cases of a crypto-economic system is put wealth into it and observe whether anything goes wrong. One of the central reasons that Bitcoin’s featureset is compelling even though it is very limited is because it is battle tested and reliable. Bitcoin has been operating for almost a decade with billions of dollars of value flowing through it and the system continues to operate as intended. The simplicity of Bitcoin and it’s reliability are different aspects of the same quality.

Conversely, the flexibility and featureset of the some of the newer cryptocurrencies is inseperable with their more complex security exposure. You can see this in practice with the Ethereum DOA hack or Parity bug, both of which involved losses in the hundreds of millions of USD and founding members of the Ethereum team. The very qualities that make it easier for Ethereum to do more interesting things also make it harder to be certain exactly what things any given smart contract will do. Trust for every smart contract will need to be bootstrapped individually. Even if the killer app were invented tomorrow it would take a long time to gain any confidence that it was working as intended.

Some argue that the sturm und drang over trying to launch SegWit signal a failure of Bitcoin governance and a counterargument to the reasoning above that Bitcoin could in practice actually adopt the features of a competitor. Personally I see the fact that Bitcoin is challenging to change as a feature, not a bug. Decentralization is the reason for the blockchain’s very existence and a decentralized monetary system should reflect the conservative preferences of the market about adopting new technologies.

It’s not as easy as it looks

The challenges of building a crypto-economy are non-linear. There is considerably more incentive to spam, attack and exploit the market leader than the competitors. Weaknesses in other systems are left unexploited not because they don’t exist but because the targets they protect are not sufficiently valuable to justify the effort. Congestion is lower not because of advantages in scaling but because there is less competition for limited network resources.

Many of the sharpest criticisms against Bitcoin (high fees, for example) are inevitable consequences of a thriving network. Many of the strongest claims of altcoins (strong privacy guarantees, for example) remain essentially untested until they accrue enough significance to be worth trying to defeat. To properly assess the value of a cryptocurrency we must account for the advantages and disadvantages of being / being sheltered by the market leader.

Altcoins don’t make a great hedge

One common and understandable reason for seeking exposure to altcoins is the desire to ‘diversify’ one’s crypto portfolio. In investing terms diversifying your portfolio means putting wealth into assets that are uncorrelated — those whose prices move as independently as possible. It’s this independence that provides the risk benefits of diversification. Buying a government bond, a blue chip stock and a gold bar is diversification. Buying shares in three different tech companies during the .com bubble is not.

In general altcoins as a market tend to rise and fall with the Bitcoin price, which means they make a terrible hedge. It would be safer and more lucrative to take a leveraged position in Bitcoin. This ongoing experiment has been demonstrating how Bitcoin has outperformed an index of 31 major altcoins. [Editor’s note: this was true at time of writing but has not remained consistent in the time since. Leaving as originally written for posterity.] While it may indeed still be possible given insight and research to pick winners from the fray, the market is too young and unrefined for strategies like indexing to yet be viable.