Cryptofuel Rather Than Cryptocurrency
Crypto market has turned into a nightmare. While it almost reached $20,000 one year ago, bitcoin has lost 80% of its value in the past 12 months. What has gone wrong?
In my opinion, there has been a dramatic confusion about cryptocurrencies. Bitcoin is not a currency. Neither are ether or ripple. They are commodities.
Commodities? Ethereum’s co-founder Vitalik Buterin has used the right word. Cryptocurrency means ‘cryptofuel’. When you buy ether to process a transaction on Ethereum, it is like when you buy electricity to run an electrical machine.
Imagine that you need electricity right now. What options do you have? The first and most obvious one would be to go on the market and pay the price asked by vendors. The second option, more complex, would be to build your own power generator and produce electricity yourself. The choice depends on how much power you need, and you must make an arbitrage between the market price and the unit cost of self-generation.
The same idea applies to cryptocurrencies. If you need ether right now to process a transaction, you can go on the internet and pay the asked price on the crypto market. But you can also choose the second option: producing ‘cryptofuel’ yourself to process your own transaction. This is ‘mining’.
How does it work? First, you must buy a powerful mining computer with an elevated hash rate. That will cost you around $8,000. Don’t forget that you might have to replace your server every 6 months so as to stay competitive as a miner. You also need to buy a cooling system and you will have to pay high electricity bills. As a result, the annual cost of your hash production could reach $50,000.
Of course, you won’t pay any fee to other miners but $50,000 may seem huge when you think that current transaction fee on Ethereum is just $0.007. But what happens when you process millions of transactions every day? For instance, think about Alipay processing almost 200 million of transactions per day.
Remember that $50,000 is a fixed cost. How much would cost a single transaction if you run the equipment for a year?
Given current network hash rate (295,912 GH/s), average block time (14.1 s) and our hash rate (14,000 GH/s), you would win a block every 298 seconds. Which means that you could mine at least 503 transactions per second (and this is a conservative assumption), 44 million transactions per day and almost 16 trillion transactions per year. Paying $50,000 to process 16 trillion transactions a year means that the cost of a single transaction can drop to $0.000003.
If you operate a major application, with millions of transactions each day, why would you accept to pay $0.007 per transaction when you can do it for only $0.000003?
One might argue that if all this model was right, then miners would already benefit from the arbitrage. It is a good point, but the arbitrage is not possible today for two reasons. First, there are too many miners in the world because of the crypto bubble. Second, transaction volume has remained too weak. That is why mining yields have been so disappointing.
What’s next for blockchain and fintech?
Blockchain is a great technology. It is probably the best transaction protocol to provide data integrity and protect people’s financial holdings. Like the internet, you must think of blockchain as a low-level infrastructure that might change the way we work. But like the internet too, it has first led to irrational expectations and a huge speculative bubble.
Once again, we should stop to regard bitcoin and other cryptocoins as real currencies. They are computing commodities. One unit of ether represents what the market is willing to pay for hash capacity. Nothing less and nothing more.
Of course, bitcoin might still be used as a medium of exchange for criminal activities since it offers full anonymity to its holders. But I don’t believe that Satoshi Nakamoto’s utopic monetary system will expand beyond that dark trade scheme.
Whatever happens to blockchain and cryptocurrencies, we have previously seen that the cost of a digital transaction can drop to zero. And this is the only thing that actually matters. Indeed it is the reason why fintech may disrupt any business model relying on transaction fees sooner or later.
There is no doubt that huge payment platforms, like Alipay or WeChat in China, can process basic operations for free. So financial institutions had better brace themselves. Because game changers are coming.
This article war originally published on LinkedIn December 9, 2018.