Bitcoin’s Biggest Threat is Right in Front of Us
While bitcoiners have been arguing about the merits of the bitcoin protocol’s energy efficiency and debating bitcoin skeptics out of existence, a new threat is emerging against bitcoin’s narrative. And it’s happening right under our noses.
That threat is Ethereum.
With Ethereum’s price skyrocketing due to the protocol’s biggest upcoming update in its history, ETH2, the value proposition for owning Ethereum is reaching a fever pitch. At 1/3 of Bitcoin’s market cap and climbing, the Ethereum community is seriously discussing the potential for their token to eclipse bitcoin in market cap.
If Ethereum were to reach the number one market cap, it would be a rather chilling achievement that may cast significant doubt on bitcoin’s network effect and sound money narrative.
For those of you not paying attention to Ethereum, Ethereum is attempting a massive reorganization of how their blockchain functions. Ethereum currently runs on a proof-of-work system, but as more users have joined the network thanks to innovations in DeFi , NFTs, and other areas, miner fees on the network have gone through the roof.
Scaling is a natural issue of any proof-of-work protocol. As more users come online and create transactions, the fees associated with those transactions go up because the blockchain can only confirm a set number of transactions in a given period. Bitcoin faced this dilemma in the lead up to the infamous 2017 Block War that concluded with the creation of bitcoin cash in a contentious hard fork. Following these events, the bitcoin community made it clear that any attempt to scale bitcoin transactions should be done on a Layer 2 solution that interacts with Bitcoin’s Layer 1. This has led to the rise of the Lightning Network.
The Ethereum community has been unwilling to go the Layer 2 route and instead desires to fix scaling issues from the base layer. But in order to do this, the miners have to be removed from the system. Therefore Ethereum’s new upgrade is moving away from proof of work and going all-in on proof of stake.
While bitcoiners argue that proof of stake compromises the decentralized nature of the protocol, and thus makes the blockchain less secure (among other things), the Ethereum community believes they have these security issues figured out. No one in the bitcoin community, or even more broadly, seems to be challenging them on this. And I think this is a mistake.
Up until now, bitcoiners have been able to point to bitcoin’s deflationary supply schedule and network effect as a reason for why Bitcoin is superior to all other assets in the crypto ecosystem. But Ethereum’s upgrade to ETH2 is directly attacking this, specifically with their EIP1559 proposal.
One of the major issues with a proof-of-stake protocol is the potential for uncapped inflation. New tokens are created by “staking” tokens you already own, and your payout is typically correlated to your staking amount. Over time, these rewards may need to increase to continue incentivizing network participation.
But Ethereum is proposing something that would attempt to counteract this inflationary pressure by taking the network fees that used to go to the miners and permanently destroying those tokens. In theory, this provides a deflationary pressure that may be so strong that Ethereum’s inflation actually goes negative.
Security aside, this is a novel idea, and one that not enough bitcoiners are paying attention to. The potential for a negative inflation rate on Ethereum has led many individuals in the Ethereum community to proclaim that Ethereum is better sound money than Bitcoin.
This, in and of itself, is easy enough to debunk. At least, I would think…
But the narrative gets harder to debunk if ETH2 investment momentum pushes Ethereum’s market cap above Bitcoin’s, causing the so-called “flippening”.
If this took place, the bitcoin network effect argument falls to pieces. New capital investment in the space, especially from institutions and individuals informed by a Keynesian economic leaning, would be more likely to invest in Ethereum over bitcoin. Value that would otherwise accrue to bitcoin would instead be allocated to Ethereum, causing a stagnation in bitcoin’s price and a dramatic increase in Ethereum’s price, further exacerbating the issue.
Sure, bitcoiners might argue that eventually a critical security threat would appear that destroys the Ethereum ecosystem, and that Ethereum is the hare racing the turtle… but what happens if ETH2 manages to achieve a decent deflation schedule and the cracks in the PoS dam don’t appear?
Would it be possible that this market, the one completely blind to fundamentals and reality, would view Ethereum as a sounder money than bitcoin? And if that’s the case, that over a long enough time frame, our institutions might chose to build on Ethereum instead of on bitcoin?
Perhaps governments and institutions, in their ESG craze, even use Ethereum’s success as a reason to attack bitcoin’s proof-of-work ecosystem.
Bitcoiners have a major distaste for discussing Ethereum, but I think that by avoiding discussion about Ethereum at this critical juncture we may feed the flames of disinformation. As an avid bitcoiner involved in educating my local community about the merits of bitcoin, I’d like to have more content that specifically discusses Pow vs PoS, Bitcoin governance vs Ethereum governance, and specific centralization risks with Ethereum and ETH2.
I am putting out the bat signal. Please help. Otherwise, the FUD we’re about to face from within our own industry will be unlike anything we’ve ever seen.