Which one is real?
Cryptocurrency is the newest asset class, but it’s confusing, complex, and candidly speculative. Investors chase digital coins in the hopes of a repeat 1849 California gold rush. Developers scramble to build sound money that acts as both a secure store of value and a worldwide medium of exchange. Miners compete for hash power with the goal of generating profits on every transaction. Governments issue sweeping measures to prevent fraud while simultaneously saving face on their fiat currencies. It’s the wild west of a new forex, a bit-sized pay dirt, and a technological marvel holding the potential for life-changing outcomes.
As cryptocurrency adoption has become increasingly accepted, one might wonder if there is an opportunity for investment. Surely, there are different avenues to gain exposure, but each approach carries with it varying risk, depending on the method. For example, Bitcoin Core (BTC-USD) (COIN) is the original coin that was born out of Satoshi Nakamoto’s white paper. Then, there’s Grayscale’s Bitcoin Investment Trust (OTCQX:GBTC) that has returned 482% in the past twelve months. Or, one could invest in Ethereum and its smart contract approach. Litecoin represents another cryptocurrency similar to Bitcoin, but it is worth noting founder Charlie Lee liquidated his entire stake last December. Each has opportunity, but with so much information available, the problem becomes choice. Which one is best? Which one will last? Which one is real?
Finally, we come to Bitcoin Cash (BCH-USD). Spawned from the Bitcoin hard fork on August 1st, 2017. Although the crypto has been embattled since its inception, there are technological, scientific, and monetary reasons to believe an investment in Bitcoin Cash is warranted. The May “hard fork” upgrade (as well as other planned forks down the road) will increase the block size to 32MB, allowing another step toward competition with global pay merchants like Visa (V) and MasterCard (MA). The addition of “Colored Coins” into the Bitcoin Cash protocol will help it compete with the Ethereum blockchain project that uses smart contracts. Lastly, Bitcoin Cash more closely represents the founding concept of a “peer-to-peer electronic cash system” than the original Bitcoin Core. Put it all together, and Bitcoin Cash represents the best opportunity for obtaining direct cryptocurrency exposure and achieving investment returns while participating in the advancement of a new asset class.
Even though the hard fork in Bitcoin that occurred on August 1st, 2017, went smoothly, the battle between the two cryptos is hardly over. Samson Mow, Chief Strategy Officer at Blockstream, once described the creation of Bitcoin Cash as an “orchestrated scheme, rushed to the point of engendering significant safety risks”. At the time, Mow inferred that BCH’s value would drop below $100. However, it currently trades over $1,000. Before the fork, BCH developer Amaury Sechet described a possibility that BCH could overtake BTC. But he was also quoted as saying that anyone who thinks they know where both coins will go in the future is downright foolish:
“What if I’m wrong?” That’s a question I’m asking myself all the time. In fact, this is the very reason I think it is misguided to bake economic constants, such as the 1 megabyte limit or the weight system, into the protocol. Not only do I know I may be wrong, but I’m also convinced that most people don’t know any better than I do. Figuring out what the market wants is a fool’s errand. You got to try to do what you think is best and adapt as the situation changes.
I think it is pretty much inevitable that [Bitcoin Cash] starts as a minority coin. But longer term, it will either overtake Bitcoin or it will create an incentive for Bitcoin to scale. In either case, that’d be a win.
As an allegorical aside, I often wonder what it was like to live in California during the gold rush circa 1848. And then, I think about how some people probably risked all they owned to find a few nuggets and get rich, while others conceivably lost everything digging up fool’s gold. So here we are, over 150 years later, and history is repeating itself, only with a lot more choices, incredible amounts of information, and more likely than not “most people don’t know any better than I do”. That said, I’ll do my best to highlight some key differences among Bitcoin Core, Bitcoin Cash, Ethereum, and Litecoin in order to achieve a base understanding of each crypto.
Bitcoin Core and Bitcoin Cash have a limited amount of coins that will ever be in existence (~21 million coins for each of them). Proponents of each coin believe their respective currency can serve as both a store of value (like gold) and a medium of exchange for goods and services (like cash). Bitcoin Core has a block size limit of 1MB, while Bitcoin Cash will increase the block size limit to 32MB this month. Similarly, developers of Bitcoin Core have a vision of 2-layer sound money, like the gold standard. Imagine it’s the year 1970, before President Nixon changed the dollar/gold relationship to $38/ounce and prevented the Federal Reserve from redeeming dollars with gold. The U.S. dollar being pegged to the illustrious metal means anything you buy is attached to a piece of Fort Knox gold. Every transaction is trusted, backed by the U.S. government and bolstered by gold reserves. Fast-forward to the present day and, in crypto terms, the Lightning Network serves as the dollar while the Bitcoin Core network represents the gold. You can buy a coffee on the Lightning Network, and every transaction will be backed by Bitcoins. On the other hand, proponents of Bitcoin Cash want the crypto to be exchanged millions of times each day, regardless of what you’re buying or selling. Some will hold it as an investment, and others will buy coffee – like gold being freely traded across borders (no U.S. dollar, British pound, Chinese Yuan, or Japanese Yen necessary).
For the time being, I’ll add that Litecoin is similar to Bitcoin Core & Bitcoin Cash, as it is a finite cryptocurrency (Ethereum has an infinite supply) that will have four times as many coins as Bitcoin (except with a slightly different proof of work). Many consider Litecoin as the silver to Bitcoin’s digital gold.
Moving on, if Bitcoin is digital gold, then Ethereum must be digital oil. The protocol includes computer-programming language that can enable “smart contracts” that only execute through given instructions. A simple example might be paying rent. Suppose that you rent an apartment for $500 a month, yet both you and your landlord have Ethereum wallets. Well, instead of writing a check you write a small program that continually pays your rent on the last day of every month. Here’s what a small If-then program loop might look like:
If I have $500 in my ETH wallet on the last day of the month
then transfer $500 in ETH to my landlord.
Else If I don’t have $500 in ETH, send me an alert
It’s not unlike setting up automatic payments from your bank account to your landlord, except in the case of Ethereum, no middleman (the bank) is required. It is a simple example yet serves its demonstrative purpose – trusted monetary transfer for all, no bank required (in fact, JPMorgan (JPM) recently stated in the “risks” section of their annual report that “both financial institutions and their non-banking competitors face the risk that payment processing and other services could be disrupted by technologies, such as cryptocurrencies, that require no intermediation”). A Blockgeeks article entitled “Smart Contracts: The Blockchain Technology that will Replace Lawyers” provides more detailed examples for those who want to learn more. Despite the novel idea, there are some issues with the Ethereum smart-contract protocol. In our rudimentary example, both you and the landlord must have the same crypto-tokens. Second, those tokens must have some ascribed value to them (i.e., ETH is currently trading at about $700). Third, anyone on the Ethereum blockchain can create his or her own token. This adds a layer of complexity to Ethereum making it useful but possibly harder to understand. For example, we could envision the landlord accepting only “Rentcoins” instead of ETH. While certainly a technological innovation on money, it is also likely the cause of so many risky – almost downright dangerous – Initial Coin Offerings (ICOs) that duped some investors into donating ETH hoping to find the next big thing (investors lost $350 million in the OneCoin offering). Similarly, the boom-and-bust ICO culture quickly drew attention from governments worldwide as regulators continue to crack down on crypto in an effort to protect users and investors alike.
Bitcoin Cash Investment Point – Block Size
Now that the truncated background is established, it is time to move on to points that might set Bitcoin Cash apart from other cryptocurrencies as a productive investment. The first and most obvious factor that differentiates Bitcoin Cash is the block size. Towards the end of 2017, at the height of Bitcoin prices, the Bitcoin Core network experienced a massive increase in fees, costing users amounts in upwards of $40 per transaction (it’s not exactly practical to pay $2 for a coffee and $40 in fees). But in perhaps counterintuitive fashion, the fees were not altogether correlated with price. The block size was also a factor, as scores of transactions effectively clogged the network. Bitcoin Cash, on the other hand, experienced spikes greater than Bitcoin Core’s 1 MB block limit, and despite fluctuations in block size and price, the fees have remained minimal over the past 6 months. That said, even though Bitcoin Core prices appreciated (and so did fees), it appears that the block size was responsible for congesting the system with inexorable costs. To demonstrate, below are three six-month charts of BTC and BCH, showing average transaction fee (in USD), block size (in MB), and price (in USD).
Chart 1 – BTC, BCH Transaction Fees (USD)
Chart 2 – BTC, BCH Block Size (in megabytes)
Chart 3 – BTC, BCH price (in USD)
(Source: Bitinfo Charts)
Once again, notice the stark differences in block size between the two cryptos. On first glance, there doesn’t seem to be definitive relationships among the transaction fees, block size, and price of Bitcoin Core, but we can infer that a block size greater than 1 MB does not adversely affect Bitcoin Cash fees. This was the primary intention involved with the Bitcoin hard fork. Similarly, one would think that if transaction fees increased, so would mining profitability. However, the chart below shows that mining profitability between the two currencies remained in relative unison over the past six months at a few dollars per day per hash rate:
Chart 4 – Mining Profitability (USD/Day, for 1 THash/sec)
Bringing it all back to block size and transaction fees, Bitcoin Cash developers plan to increase the block size limit to 32 MB this month and are scheduled to upgrade the protocol again six months down the road. Why increase the block size in the first place? Well, at size 1 MB, the Bitcoin Core network handles about 7 transactions per second. At size 32 MB, the Bitcoin Cash network can handle 224 transactions per second. Comparatively, Visa’s network can handle 24,000 transactions per second. Some elementary math reveals that, given full scale adoption across the globe, a cryptocurrency network would have two options: achieve a block size limit of over 3.4 GB (Bitcoin Cash’s future protocol) or find some other way to transact (Bitcoin Core’s future Lightning Network).
Bitcoin Cash Investment Point – On-chain technological upgrades
Interestingly, in a comprehensive blockchain study performed by the National Institute of Standards and Technology at the U.S. Department of Commerce, entitled “Blockchain Technology Overview”, researchers commented that, after the Bitcoin Cash hard fork, BCH more closely resembled the original bitcoin peer-to-peer electronic currency initiative. The report drew praise from BCH supporters and criticism from BTC proponents, driving a wedge even further between the two factions. Nevertheless, it is worth mentioning what U.S. scientists published regarding Bitcoin Cash:
In July 2017, approximately 80 to 90 percent of the Bitcoin computing power voted to incorporate Segregated Witness (SegWit, where transactions are split into two segments: transactional data, and signature data), which made it possible to reduce the amount of data being verified in each block. Signature data can account for up to 65 percent of a transaction block, so a change in how signatures are implemented could be useful. When SegWit was activated, it caused a hard fork, and all the mining nodes and users who did not want to change started calling the original Bitcoin blockchain Bitcoin Cash (BCC). Technically, Bitcoin is a hard fork and Bitcoin Cash is the original blockchain. When the hard fork occurred, people had access to the same amount of coins on Bitcoin and Bitcoin Cash. (Blockchain Technology Overview pp. 41)
While probably only aesthetic in nature, the statements add credence to the viability of Bitcoin Cash as a peer-to-peer electronic currency. Furthermore, Bitcoin Cash developers are seeking to improve the protocol at a fundamental level by including smart contract capability. Some of the scripting features present in the original Bitcoin programming language were disabled several years ago, but are now being considered for reactivation in the most recent protocol upgrade. Now, Bitcoin Cash users & developers should be able to create a layer of smart contracts that can be executed on the blockchain, effectively putting Bitcoin Cash on a path to compete with Ethereum (recall our paying the landlord example). Stated another way, Bitcoin Cash scripting will now be enabled, and users will be able to write programs to execute on the protocol. Proponents of the additional scripting layer have also hinted at the idea of using “colored coins” – a way to develop your own Bitcoin Cash colored coin – similar to creating a token using the ETH protocol, except that you are still using a Bitcoin Cash coin. So, instead of our landlord demanding “Rentcoins” with no tangible ascribed value, he’ll request payment via a BHC colored coin that can be summarily converted back to BCH.
We’re getting a little deep into the complexity of crypto protocols, so circling back to the potential upside of an investment, it is sufficient to say that Bitcoin Cash will continue its on-chain scaling (note that the May upgrade is actually not a hard fork, and end users will not get additional coins like they did when Bitcoin Cash was first created), and its developers are working toward scaling the currency to a level of global acceptance.
Risks: Not A Conclusion, But A Continuation
Investors know by now that delving into the crypto space is fraught with potential dangers. All of the currencies discussed here are highly volatile. The discussion here has also revolved less around price and more on technological catalysts. Granted, cryptocurrency is a new asset class, but that also means that the coins could be misunderstood, rejected by the general public, destroyed by adoption failure, or all of the above. A collapse in the network would lead to catastrophic losses. One of the goals here was to present Bitcoin Cash as a viable crypto investment, yet from an investment perspective, there are also multiple avenues for participation.
Although, on a personal level, I only own Bitcoin Cash, as a matter of risk management, one might consider two ways to mitigate downside when incorporating cryptocurrency into an investment portfolio: sizing and diversification. On the one hand, putting 1-2% of the portfolio into cryptocurrencies allows for taking part in a new wave of technology that has the potential to scale on a global level, while at the same time limiting the maximum loss. On the other hand, taking a full position in a “best of breed” cryptocurrency can lead to outsized return on investment. But rather than putting all the crypto nuts in one basket, being wrong and losing everything, one could own multiple currencies and diversify, and still achieve investment success even as other currencies crumble.
While Bitcoin Cash represents an interesting investment and carries with it the potential for generating outperforming returns, the crypto asset class as a whole is both complex and in its fledgling state; now is perhaps the riskiest time of all to invest. However, it is only the beginning in terms of research and technological innovation, and whatever comes next will make for a monumental investment venture, regardless of the outcome.
Disclosure: I am/we are long BCH-USD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Nothing contained in this message is an offer or solicitation to buy or sell any security/investment, and is for informational purposes only.