How Bitcoin is a Successful Cryptocurrency

Ecosystem

There is always the first-mover advantage and Bitcoin has certainly emerged as the leading cryptocurrency with an estimated 6 million electronic wallets, 70,000 merchants, and a market capitalization of USD5 billion. For the 6 months leading to October 2014, there were 50-80k transactions daily, and approximately USD50 million (equivalent to over 110,000 bitcoins in 2014) are traded daily.

The number of wallets is small given that we have more than 7 billion people in the world. Bitcoin has been successful so far and an ecosystem is up to support its existence. Even though the network effect is kicking in, there is still a long way to go. A successful digital currency must be able to ride on its initial success and leverage on the network effect. The more people use the coin, the more valuable it will become. 

As it becomes more valuable, the reward for mining will increase, and more miners will join in the competitive accounting exercise. Bitcoin is subject to the same problems we mentioned earlier.

Incentives

As the mining costs go up because equipment becomes more expensive, mining pools will be formed as miners are usually risk averse and want better odds in winning the race. This increases the possibility of an attack or the emergence of a gold finger that determines to cause problems. There are slightly over 13.4 million bitcoins in circulation as of October 2014. 

Twenty-five bitcoins are created approximately every 10min from 2013 to 2016 and the number of new coins created will halve every 4 years. As soon as the full supply of 21 million bitcoins are issued by the year 2040, which is still very distant, the risk of miners dropping out may increase. 

If the only reward is transaction fees and if fees become too high, the merchants are likely to drop out. Of course, there are technical solutions to all these and some cryptocurrencies have come up with the idea of proof of stake reducing the probability that any single person can use a quantum computer to overwrite the whole system. There are also attempts to lower the cost of mining so as to reduce the so-called 51% attack or gold finger problem. However, there is still no fool proof solution to the gold finger issue that if anyone with enough financial strength wishes to mess up the record, he or she can theoretically do it.

Identification

There are also cryptocurrencies that are looking into proof of identity to reduce the possibility of using the currency for money laundering or terrorism activities. If that problem can be resolved, cryptocurrency has a very real potential to be very popular. If a particular cryptocurrency is able to accept that the government is part of the ecosystem and its community engages with the government meaningfully in creating the ecosystem, that cryptocurrency is likely to become more widely accepted. 

Given that most of the welfare improvement comes from the bottom of the wealth pyramid, emerging markets have the upper hand in harnessing the low-hanging fruits of cryptocurrency via a decentralized but not necessary distributed system. A cryptocurrency that addresses those issues mentioned will have a bright future.

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