The Prediction Framework for Cryptocurrency

Cryptocurrency is all over the news and so are the predictions.  Don’t miss out, buy now!  Get Rich!!… “Bitcoin will end badly” per Warren Buffett… Media pundits and technical experts contradict each other regularly.  What to do? 
Introducing “The Cryptocurrency Futurescape”, a framework to help both technologists and investors put the hype aside and assess the scenarios that make the most sense to decide which are the most likely.

Comments in this article are from April 29, 2018 and reflect some new ideas or changes in my thoughts based on what I’ve learned and what has happened in the cryptocurrency space over the past few months.

2017 was a year that saw new levels of valuations and media attention for digital currencies.  2018 has started off with it’s own round of market drama.  So what’s going on?  Opinions from various kinds of “experts” come in a constant stream.  Many offering their opinions clearly don’t understand the technology behind cryptocurrencies, and others don’t seem to understand market economics.  Some lack an understanding of either topic but still share their hope-powered predictions to whoever will listen.

  • Investors and developers tend to predict that their preferred coins will rule out in the future.
  • The mainstream financial community tends to predict that cryptocurrencies will fail in the long-run, conveniently leaving the current systems and institutions where they earn their livelihoods in place.

Since nobody can truly predict the future, the right questions to ask are:

  1. What future scenarios make sense?
  2. Which are most probable?

The Cryptocurrency Futurescape Framework looks at two key dimensions:

  1. The number of cryptocurrencies that will survive and prosper in the long-run.
  2. The range of real-world use cases that cryptocurrencies find.

As a starting point of reference, I’ve plotted where we stand right now.  We have a large number of cryptocurrencies that have been around for at least a year.  For now I’ll count that as “success”.  As far as uses, there are a lot of concepts being discussed and developed, but actual real-world uses are still very limited.

Using the Framework, let’s have a look at seven commonly-predicted scenarios:

These scenarios are not all mutually exclusive, and the real outcome is likely to be some combination of the possibilities listed here along with a big dash of the unknown.  Comments or suggested additions to this list are welcome.

Crypto is a Scam

Storyline:  Cryptocurrencies are an interesting idea for geeks and libertarians, but in the long run they find no real-world use and their value fades to zero.  This story is often combined with the idea that blockchain technology will find other useful applications in industry or society in general, but that cryptocurrency will not be one of them.

Market Implications:. Obviously, this implies a complete crash of the current marketplace for cryptocurrencies.  It predicts that demand will effectively fall to zero and that supply in the form of mining and network participation would follow suit.

Chuck’s Take: Current cryptocurrencies have demonstrated they can be used for various types of transactions, and the blockchains that power them have proven secure.  Most disruptive innovations are met with loud skepticism from conservative voices.  For example, this infamous Newsweek article from 1995 “debunked” the hype of the time around the still-emerging public Internet ,

For these reasons, it seems unlikely that all the cryptocurrencies that have emerged will fade from use.

There is one possible development that could change my opinion on this.  If quantum computers become available that can easily break current encryption methods, that could cause a collapse of many or all cryptocurrencies.  However, that development would also disrupt the mainstream financial system.  Some cryptocurrencies are already working on cryptography that is (theoretically) secure against quantum computing  attack.

It’s All About Bitcoin

Storyline:  As the original cryptocurrency, only Bitcoin has real and sustainable value.  It attracts the best developers to its core management team and becomes the obvious choice for investors due to it’s security, sustainability, and scarcity.  All other digital currencies fade from use and value.

Market Implications: Demand would shift from the current range of cryptocurrencies to Bitcoin only.  Due to the very limited supply of Bitcoin, prices might move into the hundreds of thousands or even millions of US dollars since it becomes the only option for investors and users of cryptocurrency.

Chuck’s Take: As of this writing, Bitcoin is still the largest single cryptocurrency by a wide margin.  But, there are now several others that have demonstrated technical stability and real-world usefulness.  Data on shows that the trend for Bitcoin’s share of the overall market is generally declining.  So, although Bitcoin may remain the “gold standard” of cryptocurrencies, it seems unlikely that the tide of investment entirely reverses to focus just on Bitcoin.

The most compelling arguments I have heard from Bitcoin maximalists are based on the fact that many other cryptocurrencies started with pre-mining or pre-created money supplies, and/or their money supply is effectively controlled by some organization or group.  My opinion is that although that may make Bitcoin higher quality in terms of scarcity, it does not mean there is no room for those other currencies.  An analogy is that you could say the Mexican Peso is “lower quality” than the US Dollar due to inflation over time, but the Peso is still useful if you need to travel or do business in Mexico.  And, it is better than other currencies such as the Venezuelan Bolivar.  So, even if Bitcoin is “best” it does not mean there is no room for alternatives that offer unique capabilities such as smart contract support.

The Flippening

Storyline: With many technology innovations, the first implementation of a concept is not the best and most enduring.  In this scenario, one or a few later-generation cryptocurrencies unseat Bitcoin as the dominant digital asset.  Bitcoin may survive in some form in the long-term but drops significantly in importance.  This potential event is often referred to as “the flippening” by fans of alternate cryptocurrencies such as Ethereum or Bitcoin Cash.

Market Implications: The impact of such a shift on valuations is not clear.  If it were to take place while overall demand for cryptocurrencies was steady, it would mean a fall in the price of Bitcoin to the benefit of the currency or currencies that unseat it.  However, if the market for cryptocurrencies continues to grow that might not be the case – especially given how limited Bitcoin supply is.

Chuck’s Take:  This scenario, possibly in combination with others here, seems like a realistic possibility.  The evidence for the “first is not best” pattern in technology is fairly solid:

That said, there is also an element of recognition, momentum and scarcity in the value of any asset, and in those areas Bitcoin still appears to lead the market.  Also, the answer to which coin is likely to “flippen” first, and which others might follow is much harder to predict.   So, it is unclear whether Bitcoin will maintain its leadership in the long-run and also unclear which other coins are most likely to take the lead.

Since I wrote this article, Bitcoin re-asserted its dominance by performing better during the current downturn.  The only clear contender at this point is Ethereum, which has led Bitcoin since the market headed back up in the past few weeks.  But, it appears that for now Bitcoin remains the dominant digital asset.

One Coin Fits All

Storyline:  A more extreme version of “The Flipping”, this scenario predicts that some newer cryptocurrency will become the dominant platform for blockchain applications in the future.  Usually the likely contender is a “next generation” blockchain, but this same prediction is also applied to Bitcoin based on the idea that new layers of capability such as the Lightning Network will bring together Bitcoin’s current value leadership with the extended features needed to power next-generation applications.

Market Implications: The implications are also similar to “The Flippening” except that the shift of value to the then-dominant coin would be more extreme.  Prices for all other crypto assets might come to be be measured by their value relative to this “winning” cryptocurrency.

Chuck’s Take: The top candidate for this scenario right now is Ethereum.  In fact, many newer tokens that get lumped in with “cryptocurrency” are actually implemented via smart contracts on the Ethereum blockchain.  But, we are still early in the development of the blockchain space and a different contender could take over the lead.

This scenario has some precedents in technology history:

  • Microsoft became dominant for personal computer operating systems
  • Google is dominant in web index/search

However, there are also some contrary precedents:

  • The smartphone market is currently competitive, although just two operating systems dominate that competition
  • Facebook became dominant in social media, but in the past few years new alternatives along with concern over their level of influence has eroded their position

Based on the historical precedents, it seems possible that one or a few blockchains take a leadership role.  But the idea that one and only one system will completely dominate the space seems unlikely.

Survival of the Fittest

Storyline: In the long-run there is room for a handful of cryptocurrencies filling different needs and enabling different functions.  However, there is not room for all of the current 1,400 plus (and growing) digital coins and assets to survive.

Market Implications:. Demand consolidates around a relatively small handful of digital currencies.  The values of the “winning” currencies would climb as the values of currencies that fall out of use drop to zero.  As this trend becomes evident, investor appetite for new coin issuances would taper.  Only truly compelling and unique new offerings would have a chance of gaining traction.

Chuck’s Take:. There are a few good precedents for this concept, including:

  • Computer operating systems, where features and price balance with familiarity and interoperability needs
  • Automobile manufacturing, where economies of scale balance with consumer desire for variety
  • Major consumer brands, where competition for share of mind tends to lead to a relatively small number of household names

There are limited exceptions to all of those examples, but they all relate to the network effect of value.  Since recognition and demand for a particular cryptocurrency are fundamental to value, this scenario seems likely.

Different Coins for Different Needs

Storyline: Many different use cases for cryptocurrencies and blockchains will require some kind of digital payment.  In addition to the digital assets that are broadly recognized and used for general payments, many other specialized cryptocurrencies exist to fulfill specific purposes, such as:

  • Specialized smart contracts
  • Management of personal data across social media networks
  • Privacy-centric Internet of Things (IoT) data
  • Decentralized file storage or backup

Market Implications:  As with the prior scenario, most investment demand focuses on a small handful of top currencies, and their values climb at the expense of most others.  But, there is an exception for specialized currencies that meet very specific needs via unique capabilities not possible using other digital assets and blockchains.  Valuations for those specialized currencies would be in proportion to the demand for whatever services they enable.

Chuck’s Take: The challenge with a large number of cryptocurrencies is the difficulty of moving between them when needed, and the potential price instability that kind of system might bring.  To be worthwhile, the new currencies would need to truly enable capabilities that are not possible with popular general-purpose options like Ethereum.  It is debatable whether any current application-specific digital assets meet that requirement, but blockchain technology is relatively new. It is entirely possible that new currencies with clearly unique capabilites may be developed.  For that reason I consider this scenario possible, depending on future developments.

Crypto is Everything to Everyone

Storyline:  Unique cryptocurrencies or digital tokens are created for a broad array of decentralized services.  Some relatively large general-purpose cryptocurrencies like Bitcoin and Ether maintain relatively high values and act as units of exchange between the many smaller currencies used to pay for specific services or capabilities.  Uses would be similar to the prior scenario except that separate currencies would exist for competing or alternative versions of each possible service.

Market Implications:. Some smaller number of general-purpose cryptocurrencies might still see the majority of use and investment, serving as stores of value and a means of exchange between the many individual currencies.  Under this scenario, new currencies might constantly come to market while unsuccessful ones fade from use.  This is the scenario that would theoretically allow for the success of many current cryptocurrencies as well as the continuous creation of additional coins.

Chuck’s Take:  It would be difficult for cryptocurrency exchanges in their current form to support the volume of trading and the speed of transfers required to support this scenario, but atomic swaps could potentially make this scenario realistic.  This possibility also seems very complex from a consumer/user perspective, and as with the prior scenario it would only seem attractive if each specialized currency brings some special capabilities.  A look at the history of new technologies shows that innovations often drive a large number of product/service launches that tend to consolidate significantly over time.  So, I believe this scenario is relatively unlikely.

Since I wrote this article, the environment for new ICOs has cooled considerably and many of the worst have already failed.  We will see continued failures, possibly increasing in pace, until the market is rid of tokens and coins that were poorly designed or outright scams.  That will probably be painful in the short-term for overall values, but it will be good for the development of cryptocurrency in the long-run.  Once that culling occurs it will make this future scenario even less likely.

Putting it All Together

Bringing it all together, here are the seven scenarios color-coded based on which seem most likely:

Perhaps it’s not surprising that the extremes seem far-fetched when considered in detail.  In the middle there is a good bit of uncertainty, but I’ll be placing my bets of time and money on a future that has some limited set of cryptocurrencies.  One where some act as general currencies and platforms for broad uses, and a limited list of others targeting specific needs where they deliver unique value.

Disclaimer and Disclosure:. I am not a financial advisor and this article does not constitute financial, legal, nor personal advice.

Chuck Bair is a Partner with the Lapine Group where he focuses on technology and operations strategy.  He has been investing and active in the cryptocurrency and blockchain space since 2014.

Second Edition, 29 April, 2018

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