Quote from altoid:
For purposes of argument, letâs say that a year from now Bitcoin is priced at $500. Then you want some Bitcoin, letâs say to buy some drugs. And you find someone willing to sell you Bitcoin for about $500.
But then the QuitCoin company comes along, with its algorithm, offering to sell you QuitCoin for $400. Will you ever accept such an offer? Well, QuitCoin is âcheaper,â but of course it may buy you less on the other side of the transaction as well. The QuitCoin merchants realize this, and so they have built deflationary pressures into the algorithm, so you expect QuitCoin to rise in value over time, enough to make you want to hold it. So you buy some newly minted QuitCoin for $400, and its price springs up pretty quickly, at which point you buy the drugs with it. (Note that the cryptocurrency creators will, for reasons of profit maximization, exempt themselves from upfront mining costs and thus reap initial seigniorage, which will be some fraction of the total new value they create, and make a market by sharing some of that seigniorage with early adopters.)
Letâs say it costs the QuitCoin company $50 in per unit marketing costs for each arbitrage of this nature. (Alternatively you can think of that sum as representing the natural monopoly reserve currency advantage of Bitcoin.) In that case both the company and the buyers of QuitCoin are better off at the initial transfer price of $400 and people will prefer that new medium. Over time the price of Bitcoin will have to fall to about $450 in response to competition.
But of course the story doesnât end there. Along comes SpitCoin, offering to sell you some payment media for $300. Rat-FacedGitCoin offers you a deal for $200. ZitCoin is cheaper yet. And so on.
Once the market becomes contestable, it seems the price of the dominant cryptocurrency is set at about $50, or the marketing costs faced by its potential competitors. And so are the available rents on the supply-side exhausted.
This OP's "Tyler Cowen" piece is flawed in many ways. Two of them, I will try to debug below.
Two flaws are pregnant:
1) he mixes Centralized and Decentralized economics.
2) he doesn't reckon the differences between SHA256 and sCrypt networks.
The first point: he writes "But then the QuitCoin company comes along" and this one (central) company competes with a lower price, forcing Bitcoin (decentralized network) to lower its price. Well, this may work in a centralized economy, where the one supplier can set his price, but this isn't possible in a decentralized economy. First of all a Central-Coin cannot compete with a decentralized Coin (it misses essential features). And secondly, if QuitCoin would be a decentralized-coin then it cannot
set its price (price is pure on Supply-of-many and Demand). Actually, to become a real competitor to Bitcoin, QuitCoin's supplier-profit (the miners in the decentralized network) should be much higher than Bitcoin's. The incentive for miners should be higher in order to persuade miners to switch from Bitcoin to another network. Which means an upward price pressure instead of a downward as Tyler Cowen argues.
The Second point: He doesn't understand what it takes to issue a new decentralized Coin. Sure, Bitcoin is open-source, can be copied very easily, and use top class marketing to promote it. But that will not make a new Coin, let alone be a serious competitor to Bitcoin. No! a decentralized coin needs an as large as possible P2P network of miners (the larger the more secure). This means that tens of thousands, geographically separated, individuals need to invest in costly equipment and electricity to connect to each other and mine the new coins. It took Bitcoin 5 years and more than $200.000.000 (in 2013 alone) to create the network of today. It should be clear that any new coin who wants to compete with (nearly) the same copy of open-source code has a nearly impossible task to gather enough miners for its new network: professional Miners will only join if incentives and success-rate are better than Bitcoin.
I see you thinking: but why do we have so many copycat-coins?
To answer this you need to separate the two encryption families: The SHA256, which needs extremely expensive ASIC-hardware. And sCrypt which can be mined by common PC's with a gaming-video-card. Bitcoin is member of the SHA256 family, and because of its hardware costs ($5000 to $13000 per Miner) is run by professionals. These professionals will not easily switch their expensive hardware to a new Coin. And this is why Bitcoin doesn't have any serious competition within the SHA256-family (PPC is a runner up, but I'm not aware of any shop that accepts them). And be aware: SHA256-hardware, physically cannot be used in sCrypt-networks, the opposite is possible but not profitable at all.
The major coin in the sCrypt-family is Litecoin. And yes, Litecoin is a competitor to Bitcoin (which is a good thing). Litecoin is a keeper, it was the first in the sCrypt-family and its network has grown in 2 years time to more than 40.000 Miners (a stable and secure network indeed).
In contrast to the SHA256, the sCrypt-family has many copycat-coins. But they all compete with Litecoin (not Bitcoin). Many Litecoin-copycats try to lure Litecoin sCrypt-miners to their coins, but that proves to be hard (but much easier than Bitcoin, due to the fact that many kids and amateurs, switch their relative cheap sCrypt-hardware for a
few days to new networks to make a quick buck). In order to succeed, new coins need to attract Miners
permanently (for security and supply) and it needs demand (which doesn't exist if it hasn't any major improvement). These copycat-developers try pump & dump schemes and are in no way competitive to Bitcoin (in contrast to what Tyler Cowen suggests).
