Bitcoin Ecosystem Health-check

When you get a physical check up, you want to know the numbers. You also need to know what the numbers mean. What is good v.s. bad cholesterol and does cholesterol even matter?

Blockchain.info has the numbers.

The question is – what numbers really matter?

Bitcoin is like an animal with three parts – brain, heart and gut – that all need to be healthy. In the case of Bitcoin:

1. Currency to pay for stuff (lets call this the heart).

2. Asset to invest in/trade with (lets call this the brain)

3. Payment rail working in background (lets call this the gut)

For the currency use case, the most important number to track is merchant transaction volume. This is not the same as number of merchants accepting payments. There were lots of press releases during 2014 about merchants accepting Bitcoin. Transaction volume tells us whether Bitcoin is moving the needle for these merchants. Transaction volume means consumer traction.

I prefer to look at Estimated Transaction Volume in Bitcoin (rather than looking at in USD as this is distorted by Bitcoin exchange price). What does this chart tell us? If this were a stock market chart, the pundits would be talking about a “sideways drift market”. A school report would say, “could do better”. The doctor might advise making some dietary changes but would not pushing pills or operations. IOW, Ok but not great.

For the asset to invest in/trade with, the chart is very simple – the price chart. As in any market, it depends on your time horizon:

• Short (30 days, recovering a bit).

• Medium (12 months, looks ugly, trader talk is “don’t catch a falling knife”).

• Long (since the first Bitcoin – a moving average looks good but is meaningless to investors/traders because very few people bought in the 2009-2012 period. It would be like a moving average of Yahoo stock since their IPO, meaningless to a decision on whether to buy their stock today).

No matter which way you cut it, the price chart looks bad. To invest in Bitcoin, you need to believe in it as a hedge against inflation, as an alternative to gold. Like gold bugs, Bitcoin hoarders want nasty things like hyperinflation, Eurozone break up and governments stealing money from citizens. These are the drivers of long term Bitcoin price appreciation. Of course, none of us know if these things will happen and certainly not when they will happen; if you encounter somebody telling you they are certain they maybe selling you something or be “true believers” who won’t let facts get in the way.

This is the problem for the Bitcoin ecosystem, the heart and brain are working against each other. For the currency use case to work we need people with Bitcoin to spend them. For the asset use case to work, we need people to buy but not sell (aka “hoard”) and that will weaken transaction volume which is the key health indicator.

For the payment rail use case, it is hard to figure out what metric matters. This is where one sees heated debate around block size, sidechains and Bitcoin maximalism. The question is, if we have an interim token of value that the customer never sees, should this be Bitcoin or some altcoin? Remember that the customer never sees this interim token of value, so the things we track for the Currency and Asset use cases don’t matter.

I think that two things matter for this interim token of value – the usual “time and money”

1. Time. How long does it take to confirm a transaction?

2. Money. How much does it cost to confirm a transaction?

I went onto Blockchain.info searching for the answer.

First, cost per transaction. In this chart, a falling line indicates health. At first it looks like it is falling merrily in line with Moore’s Law, but then it appears to flatline in 2015. The problem is that this chart is in USD, so the exchange price gets in the way. What we need is cost per transaction in Bitcoin (just like we use transaction volume in Bitcoin). If anybody knows where to find this, please tell me. Maybe one could compute this from a mix of things like Hash Rate and Difficulty.

Secondly, time to confirm a transaction. The Average Transaction Confirmation Time shows this. There is nothing dramatic about this chart, it looks stable as one would expect unless there had been a significant change to the protocol. The problem is simply the numerator, which is in minutes. Alternatives such as Ripple and Ethereum are measured in seconds. Of course, speed and money are not everything. In payments, security trumps time and money; if it costs 1c and takes 10 seconds to send $100, it is not much good if the payment rail loses my $100. The altcoin that offers faster + cheaper + as secure as Bitcoin will be an effective alternative to Bitcoin as a payment rail use case. None of the altcoin candidates are proven, but a couple look promising.

The debate over increasing the block size is really a debate about the health of the Bitcoin ecosystem. Is it seriously sick and needs an operation (increase block size)? Or is it suffering a temporary malaise that time will cure (do nothing)? I do not intend to offer an opinion as a) the data is inconclusive and b) this is a debate where neither side appears interested in an opinion (it is like a political debate i.e a dialogue of the deaf).

If I had to choose only one metric to track, this would be merchant transaction volume in Bitcoin. If Bitcoin does not work as a currency, none of the other use cases will work. Market price is a lagging indicator. Merchant transaction volume is a leading indicator.