When will crypto be useful?

Mike Novogratz

Enrobed in a purple satin vestment as interesting, eccentric, and colorful as the man himself, Mike Novogratz, the high priest of Crypto, thrilled and delighted his disciples, adherents, and devotees from the main stage of Bitcoin2021 Miami. Confirming what the audience of crypto-revelers already deeply believe, the crypto-billionaire explained, “What gives it [value] is this social construct, that we believe it’s got value. It’s the narrative. And so we need more and more storytellers, and the optimism is, we’re gettin’ ’em. (Applause).” Mr. Novogratz has a good reason to believe that crypto is valuable. In March 2021, he revealed that cryptocurrencies made up nearly 85% ($4.8 billion) of his $5.65 billion net worth.

Awareness is not the issue

Practically everyone has heard of crypto. But as fun and interesting as investing in a new asset class on new trading platforms may be, the market cap of all the crypto ever created represents under $2 trillion, which is about 0.2% of the estimated $1 quadrillion of accumulated wealth in the world. Said differently, to grow to any significant size, cryptocurrency is going to have to become as useful and accessible as fiat currency. This isn’t an awareness issue, and it isn’t an issue you can solve with storytelling. It’s a technical issue − a big one, actually.

Scalable. Secure. Decentralized. Pick any two.

The promise of Decentralized Finance (DeFi) is the financial freedom afforded by three critical attributes: scale, security, and decentralization. Unfortunately, there are some significant technical hurdles preventing any system from attaining full measures of all three. So, in practice, your network can be big and secure, or decentralized and secure, or big and decentralized. But it cannot be big, decentralized, and secure.

Visa

According to Visa, there are approximately 3.3 billion Visa cards worldwide and VisaNet, the company’s global processing network, can handle more than 65,000 tps (transactions per second). On an average day, Visa only processes about 2,000 tps, but it’s nice to know that if everyone on earth had a Visa card, VisaNet wouldn’t blink. Fast, secure, reliable payments are core values for Visa. It has been scaled to global proportions, and it is one of the most secure financial networks in the world. But, alas, it is centralized.

Bitcoin

By comparison, a Bitcoin block holding between 2,500 and 2,700 transactions gets mined about every 10 minutes. This translates to ~5 tps. So, in practice, you can’t have 3.3 billion people spending Bitcoin. It would be impossible to confirm the transactions in any reasonable timeframe.

How about mining bigger blocks?

Bitcoin blocks are 1 MB each. As of May 16, 2021, the Bitcoin blockchain was ~337.35 GB. Remember, the entire Bitcoin blockchain must reside on all ~11,000 nodes in the Bitcoin network. (Learn how to run your own full node here.) This means each new 1 MB block must be transmitted through a peer-to-peer network over the public internet to ~11,000 computers. This takes about 14 seconds.

You can make the blocks bigger, but bigger blocks mean a bigger blockchain. At a certain point, only massive data centers would be able to hold full copies, which would “centralize” the world’s first decentralized cryptocurrency.

It should be noted that Bitcoin’s slow transaction speed is traded off for exceptional decentralization and security. Ethereum is in the same boat.

Layer 2 to the rescue!

The promise of Layer 2 solutions (such as Ethereum’s Optimism) is that they will scale because they are much, much faster. But imagine the following: you build a Layer 2 solution that can handle 1,000 tps. That’s excellent scale. You grow your community to 2,000 nodes. That’s excellent decentralization. Your Proof of Stake protocol calls for 1,001 validators to confirm each block. That’s excellent security. Problem solved! Except it isn’t solved, because now lots of people are starting to use your network to do ordinary things and the peer-to-peer networks over the public internet can’t handle the amount of data you need to move around to keep all your validation nodes in sync. So you have two choices. You can reduce the number of validators (reducing security) or you can put the validators in commercial data centers where the internet speeds are not an issue (reducing decentralization). Like I said: scale, security, and decentralization. Pick any two.

The Workaround

This is one of those “deep in the weeds” problems most people ignore because they are sure that some smart engineers will work it out. And even if that’s not possible, they figure the exponential rate of technological change we experience in the normal course of our lives is sure to provide a solution. Maybe. In the meantime, Polygon and Polkadot are doing exceptional work in this area. I am a huge fan of both. And even with the trade offs we’re exploring here, Layer 2 solutions are going to change the world.

That said, you’re going to have to pay close attention to the strategies and philosophies of this new class of DeFi solutions. Each new network and protocol — in fact, every blockchain-based solution, will have to be designed to balance security, scalability, and decentralization for its specific use case. You will want to be well aware of those tradeoffs.

The downside to these workarounds is that we are likely to see an explosion of centralized high-performance blockchains that people will not recognize as such. Governments will use them for central bank digital currency (CBDC), vaccine passports, tax records, PHI, PII, and, sadly, a bunch of other surveillance-state, Orwellian stuff that nightmares are made of.

You will make crypto useful

Mike Novogratz has it right. You are the most important part of the DeFi story. Like all tech, DeFi is evolving at an exponential rate. So just pretend everything you can imagine is already possible. Take a moment to “blue sky” a new business model that would thrive in a world where value could be exchanged as easily as information. When you invent and build a business that profits or grows by leveraging DeFi or you start exchanging cryptocurrency for everyday goods and services, crypto will evolve into an asset class that is both valuable and useful.

 

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Author’s note: This is not a sponsored post. I am the author of this article and it expresses my own opinions. I am not, nor is my company, receiving compensation for it. I am not a financial advisor. Nothing in this article should be considered financial advice. If you are considering any type of investment you should conduct your own research and, if necessary, seek the advice of a licensed financial advisor.

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