Thursday, 4 August 2016

Bitcoin vs. Ethereum

Ever heard of Ethereum? A new cryptocurrency created in 2015, it’s been dubbed Bitcoin’s experimental younger brother.

Like Bitcoin, Ethereum is a decentralized cryptocurrency. Unlike Bitcoin, it runs smart contracts which execute autonomously through code. The smart contracts can interact with other contracts, make decisions, store data and send the currency to others. For instance, a parent’s contract can automatically transfer money to their child every Christmas. Contracts are specified by their creators, but the execution is done on the Ethereum network. The contracts will only be eliminated if self destruction was part of their programmed code.

Ethereum hasn’t reached the scale of Bitcoin but it has increased in value to a market capitalization of around $1 billion. It is currently the second most popular cryptocurrency behind Bitcoin. One unit of this currency, known as an Ether, is currently worth $10.52 following a hack on its system in June. Prior to the hack, the price was reaching highs of almost $20.   

When people talk about Ethereum, they usually also refer to the Dao, a Decentralized Autonomous Organisation. Its goal is code the decision making tools and rules in an organisation, which in turn would result in decentralized structures as the need for documents and governing persons is eliminated. The Dao can be thought of as a crowd sourced venture capitalist company. People add funds to the Dao through buying tokens that symbolize ownership. The funding was reportedly the biggest crowd funding campaign ever. After funding, people submit proposals to the Dao regarding how to allocate its funds and members vote to approve the proposals.  This is different to equity stake- the contributions give voting rights, not ownership. Nobody owns the Dao as it is software running on the Ethereum network.  

Some claim Bitcoin and Ethereum are direct competitors whilst others perceive the two cryptocurrencies as complimentary features of the innovative blockchain economy. Bitcoin’s niche is its role in virtual gold, providing a reliable monetary system unaffected by uncontrolled inflation and political interference.  Ethereum’s niche involves evolving into a universal computer having a blockchain-based coding language allowing codified contracts and decentralized applications.

However, neither cryptocurrency actually has their operations so clearly specified. They have similarities and minimal barriers to user migration. For instance, the smart contract platform is a threat to Ethereum, as it does everything Ethereum does with the added bonus of extra security on the already more secure Bitcoin network.  But given its growth statistics, Ethereum is starting to catch up as an investment tool. Their competition will result in better cryptocurrencies.

Total annual Ethereum issuance is restricted to 18 million per year. This reflects it being an inflationary currency, with an inflation rate of approximately 20% of current supply. The future value will decrease as the currency is sent to the miner rather than the program. Total Bitcoin supply has a limit of 21 million coins. The amount issued is halved every four years. The most recent halving in July sees Bitcoin’s inflation rate decreasing to a rate of 5% per year. The continuation of this produces a deflationary currency, encouraging savings and profiting those who bought in cheaply.

So what type of people prefer Ethereum to Bitcoin? Ethereum users are less politically and economically conscious. They are happy with ultimate authority in the inventor Vitalik Buterin.  They are more focused on how industries can take advantage of Ethereum. Bitcoin users are more supportive of individual sovereignty, hence the emphasis on decentralization. Metcalfe’s law expresses the network effect, where a network’s value depends on its number of users. People are more likely to join already popular networks, so Bitcoin has the first mover advantage.

When something is popular it is important it is secure. Bitcoin enables coins that have been sent to be locked for a specified time period. It’s effective in transaction processing. Ethereum however is Turing compete, expanding its instructions into a coding language like JavaScript. But, this actually increases risk of an attack. Basically anybody can program up a smart contract for the Ethereum network. Whilst innovative, the number of bugs and the recent hack has shown it is not a reliable base for the new blockchain economy. Additionally, given the investments in hashrate (Bitcoin’s hashrate is 1.8 whilst Ethereum’s hashrate is 3), the monetary cost to breech Bitcoin’s security is proportionately greater.

Both cryptocurrencies have a Proof of Work blockchain, with Ethereum mining at 25 transactions per second performed by graphics cards and Bitcoin mining at 3 transactions per second performed by ASIC devices. Whilst Ethereum is more scalable, its proposed transition to Proof of Stake will move away from decentralization.

Ethereum can be summarized as an innovation taking advantage of blockchain technology, supportive of Bitcoin though does have the same structure. Its rising popularity makes it a competitive cryptocurrency, and its volatility makes it a great trading tool. Both Bitcoin and Ethereum must overcome challenges to establish themselves, though the industry’s intellectual minds will no doubt see to that.

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