• “Spend cash, invest in Bitcoin. Cash is trash.” – A ‘bon mot’ from one of the Winklevosses
  • “As of the end of Q2, we have converted approximately 75% of our Bitcoin purchases into fiat currency,” – Tesla Quarterly Earnings Statement (July 2022)
  • “Bad coin and good coin cannot circulate together.” – A version of Gresham’s Law

This week brought news of “The Merge” – a purportedly momentous singularity in the history of humankind, or at least a big new loop in the tangled story of crypto-currency. We are told that, from now on, Ethereum (the second most popular crypto offering) will no longer be based on “Proof of Work” but rather on “Proof of Stake” (whatever that turns out to mean). The big selling point of the Merge is that the cost of “mining” the stuff will be reduced. In fact, mining won’t even have to happen anymore (too bad for Nvidia, by the way, which has floated its market capitalization on sales of the mining hardware – its share price is 92.88% correlated with the price of Bitcoin since November 2021).

In any case, “Merge parties” are said to have broken out world-wide, live-streaming from every time zone. Meanwhile, the hedge fund world has crowded into the options market to trade on the volatility that they expect.

  • “‘A lot of smart money [is] Buying “… pending options contracts rose from 1.2 million at the start of the year to more than 4.6 million by Wednesday. About 80 percent of these contracts are call options… it is a sign of “Huge Rising Emotions.”

Of course, the presence of “massive bullish sentiment” would usually signal a drop in the market (investor sentiment is usually a mixed indicator). The next few weeks will reveal how the merger will take place for speculators. But we already know that in practice it will not make any difference to the fundamental long-term prospects of cryptocurrencies.

Model defects

There are a lot of things wrong with cryptocurrency and it’s hard to know where to start. Hit away at this piñata of fallacies and false hopes, and stickiness flows. The ugly things relate to what might be called the “moral flaws” of the crypto paradigm: facilitating illicit transactions, money laundering, extortion ransom, drug dealing, porn, and what God knows. Then there is the staggering wastefulness of the mining process with which tokens are “created”. Prior to the merger, the carbon footprint of Ethereum was said to be “roughly equivalent to that of Finland.It is clear that the price of climate damage for Bitcoin is somewhat greater, on a par with the total energy budget Sweden. Add the dozens of hacking scandals, and backgrounds all with the pain experienced by naive investors who engage in the totally unregulated crypto market. The overall Ponzi-ish nature of the phenomenon was clear from the start. (One typical Bitcoin feature was the one offered by the Bitcoin Savings and Trust – in 2011-2012 – which promised investors up to 7 percent in weekly interest. It ended poorly and predictably.) Today, even cryptocurrency proponents concede that “value” of their holdings based on the appearance of the Great Fool when they need it. Last fall, GF disappeared – and the price of bitcoin fell by 70% (although not quite as badly as the Chinese stock market – another realm of dreams – demonstrating that centralized and decentralized economies can match each other in destroying value).

Future historians will publish “what were they thinking” accounts of the cryptocurrency bubble alongside Dutch tulip madness and Bernie Madoff in the Exhibit of Scandal and Folly.

But regardless of all that - there is a deeper problem. Encryption is not working. It does not and cannot serve a valid economic purpose. Not as a store of value, obviously (see previous graph). Not as a hedge against inflation. Nor can it compete with the dollar, nominal or inflation-adjusted. Fiat money outperforms DeFi.

But the most significant failure of the cryptocurrency is its biggest practical failure: as possible average exchange.

Can you buy things with it?

The short answer: You really can't. For two reasons.

The first is the issue of "assimilation". where Can one pay for a real-world product (not just another crypto object) with bitcoin or something? There is a lot of noise around that, and it is said that there are solutions for sellers like Amazon that won't accept bitcoin directly. But the truth is that after decades of promises of cryptocurrency qua The coin is still not really fungible. It is discounted heavily on those few transactions where it can ostensibly be used.

Currency that cannot be circulated, nor can it be spent, fits the definition of "bad currency" under Gresham's Law. In the presence of a “good currency” (for example, the US dollar) cryptocurrencies cannot Generalization. Even in El Salvador, which has declared Bitcoin its national currency, and even in “Bitcoin City” - El Salvador's frontier for the crypto economy - Baron A reporter who went to check things out discovered that “the money was almost useless; only 3 of the 10 merchants we met in Bitcoin City would accept Bitcoin.” Crypto is still a speculative tool, with very limited transferability to the real economy.

Even that's not the worst of it. One could imagine, or at least argue, that over time the adoption of cryptocurrency in the real economy by merchants might improve in some way, perhaps with some guarantee. This is the basis of the concept of Stablecoin, in which crypto values ​​are allegedly guaranteed by pegging the currency to real money, i.e. the US dollar. Rather like the relationship of the dollar to gold in the old days.

But there is a bug in the crypto framework that neither Merge nor Stablecoin kluge does anything to fix. that it Very low transaction processing capacity One of the primary blockchains that support Bitcoin and Ethereum. For Bitcoin, the maximum seems to be about 7 transactions per second - for the entire planet. For Ethereum, the limit is said to be around 15-20 transactions per second.

Apple sells about 10 iPhones every second. That would eat up Bitcoin's capacity there. On Amazon, it averages 18.5 transactions per second throughout the day - much higher during peak hours. Or maybe it's 100 requests per second. In the Christmas season, the volume reaches 300 orders per second. Walmart processes something on the order of 100-200 transactions per second. No cryptocurrency can even handle the current level of business of Walmart or Amazon — not to mention the transactions flowing from tens of millions of other sellers around the world.

Extremely low limits on Crypto's transaction processing capacity translate to higher costs and long delays. Baron The reporter found that even a simple Bitcoin transfer took six hours Implement. (Keep in mind how long you might wait for a credit card transaction to confirm at the supermarket before you get impatient.) In terms of cost, Ethereum transaction fees averaged around $2.00 lately — but earlier this year the fees were at several Tens of dollars per transaction with individual highs up to $200. (It's not clear that the merge will change this.)

Current reality-based payment systems such as Mastercard, Visa, and American Express process about 1,250 transactions per second on average. Peak sizes can be much higher, and these real-world systems are designed to handle them. Visa is said to be able to process up to 65,000 transactions per second. Alipay (Alibaba's version) was said to have achieved actual payment volumes of 250,000-500,000 transactions per second during some major shopping days in China.

Crypto promoters have their answers, in the form of future plans. In the next big Ethereum modification, something called a “hash” will be introduced – which will split the blockchain into many pieces and increase the tps rate to 1,000, presumably. The next modification may include additional rebuilding of the ecosystem, with "roll-ups" - and the waiting world will be blessed with volumes of up to 100,000 tons per second. Then there is Solana, who supposedly has a “proof of history” mechanism for validating the blockchain, and says it could achieve much higher throughput:

  • Solana is gaining momentum… the blockchain processes 50,000 transactions per second, and the average cost per transaction is $0.00025, according to its website. Ethereum can only handle approximately 13 transactions per second, and the transaction fees are much more expensive than Solana fee.But the past year and a half have been exposed [Solana’s] The trade-off as the blockchain network has suffered multiple outages. Most recently, on May 1, Solana shut down for several hours before re-launching similarly after restarting its verification network.”

Meltdowns spread:

  • “On September 14, 2021, the Solana blockchain disconnected after that.” Transaction boom It caused the network to split and the auditors had different views of the state of the network. Solana blockchain shutdown again on May 1, 2022 and May 31, 2022 [first] The power outage lasted 7 hours, and [second] One lasted 4.5 hours. On August 3, 2022, the Solana ecosystem was targeted by hackers, affecting 9,231 Solana wallets [stealing] $4.1 million in casualties. On July 1, 2022, a class action lawsuit was filed against Solana.” (wikipedia)

It would be interesting to see the scope of the disruptive "surge" that appears to have broken Solana's regime.

Blockchain is not designed for this purpose

No cryptocurrency has anything like the ability to serve as a medium of exchange in the modern retail economy. Blockchain is an interesting and useful technology, suitable for small, centrally managed networks, which need fast and reliable execution of high-value transactions. An example that appears to be working is the Onyx system developed by JP Morgan for settling interbank wholesale repurchase transactions. But the blockchain cannot currently meet the capacity requirements of massive retail payments systems.

Bitcoin or Ethereum cannot be used as a medium of exchange. Merging, whatever it is, doesn't change that.