Bitcoin vs Ethereum

It’s time to compare and contrast the two juggernauts of the cryptoasset universe. Did you notice I used the term cryptoasset instead of cryptocurrency? Bitcoin and Ethereum aren’t really currencies and neither are any of the 11,000 alternative “cryptocurrencies” in the market today. It’s a bit of a misnomer and I believe it is confusing to the layperson. Both Bitcoin and Ethereum are recognized as commodities by the CFTC - it is probably more accurate to refer to them as such - but we’ll stick with cryptoassets for the sake of this article.?

Let’s dive in.?

Proof of Work

Bitcoin uses a “proof of work” consensus algorithm.? This is a fairly deep concept and it’s at the absolute core of what Bitcoin stands for. It means the monetary policy is such that for a miner to receive a bitcoin subsidy for verifying transactions and adding a block to the Bitcoin blockchain, he or she must prove that real work was done. Huh?

It sounds odd, but it actually makes a lot of sense when we break it down. Miners must sacrifice land, labor, and capital in order to produce bitcoin.? They do this by converting those inputs into energy (electricity) which is then converted into the commodity that is bitcoin. This process is very similar to how Gold is produced - we can think of Bitcoin as Gold for a digital economy. The energy that miners use is expressed through a hashing function which allows them to solve complex math problems, verify transactions, and earn bitcoin.? When they verify the transactions and mint a new block to the blockchain, they are signaling to the network of decentralized nodes that they did the work. The network of decentralized nodes then validates that this is true and in line with the consensus rules of the network.? A bitcoin subsidy is then awarded to the miner - currently 6.25 per block.?

The protocol is such that you have to do something and prove it to get bitcoin. That something? Secure the network.?

If we let that sink in, we can see that this game theory gives merit to Bitcoin by aligning incentives to model proper behavior amongst miners, who secure the network. The only way that miners can earn bitcoin is by sacrificing land, labor, & capital while doing the right thing - verifying transactions that meet the consensus rules of the protocol. When miners verify transactions, they are proving to the decentralized community of nodes that they did the work and therefore earned the bitcoin reward. As they do this, they secure the network by ensuring that all transactions meet the rules of the protocol and that no bitcoin has been double-spent. If a miner decided to attack the protocol (take over 51% of the network -nearly impossible), they would be destroying their future earning potential. Miners have already invested capital in mining equipment (Capex) as well as energy costs and location (OPEX), so we can see that there would be no incentive for them to do that.?

This is an incredibly elegant structure when we contemplate how difficult this is to pull off in a decentralized format. Additionally, the protocol has an automatic mining difficulty adjustment every two weeks. You read that right. The difficulty to mine automatically recalibrates per the total hash power (# of miners) on the network, so that miners always remain economically incentivized to mine (validate transactions and secure the network). It boils down to creating proper incentives - the protocol has a beautiful incentive structure that forces all participants to do the right thing.??

Incentive structures flat out matter.? At a very basic level, incentives are the driving force behind human behavior and what motivates people.?

I don’t want to go on a tangent, but if we contrast this with how banks today can create money out of thin air, and how inherently flawed that could be in terms of incentives, we can start to empathize with why the Bitcoin community feels so strongly about proof of work and decentralization.?

Proof of Stake

Today Ethereum runs on a proof of work algorithm, just like Bitcoin. However, the Ethereum protocol has plans to move to a proof of stake model by the end of this year.? So, what’s the difference??

With proof of stake, capital is “staked” or put at risk by market participants, with the expectation of a future reward earned by locking up tokens over a set period of time. Stakers are randomly selected to automatically verify transactions on the protocol and are incentivized to maintain the integrity of transactions by being rewarded with new tokens (similar to proof of work).? If a staker behaves erratically by falsely verifying transactions or ordering transactions improperly, the protocol will automatically punish them and they will lose some or all of the coins they put at risk.??

To summarize, Bitcoin’s proof of work algorithm is proof that capital was already spent - mining equipment, location, and energy costs. Ethereum’s proof of stake algorithm is proof that capital is at risk (the native token of the network).?

Comparing the Two Consensus Algorithms

There are a number of trade-offs between these two incentive structures.? Bitcoiners will argue that their system of proof of work is truly decentralized and merit-based.? To get bitcoin, you have to either mine it by sacrificing land, labor, and capital upfront or buy it in the open market - with the price floor likely being the cost to mine it.? This differs for Ethereum in that they had a select group of early founders/investors/developers that received a large allocation of pre-mined coins when the protocol was launched.? The Bitcoin community strongly disagrees with this and it’s the main point of contention between Bitcoin Maximalists and Etherians - yes, “Bitcoin Maximalists” and “Ethereans” are real people - welcome to the future.? Bitcoiners would argue that Ethereum’s model looks more like our traditional system today which could be less merit-based and more about “who you know.” Additionally, with proof of stake, it is possible that those with large allocations of Ethereum will be able to use them for staking and continue to garner a larger and larger share of the value on the network.? Again, this looks similar to our traditional system, where inequality and capital concentration tend to consolidate over time. Bitcoin, on the other hand, tends to become more and more distributed over time.??

Proof of work uses energy as its staking mechanism - an important point to hone in on. Energy is something that has had value globally over thousands of years. On the other hand, proof of stake uses the native asset of the protocol - in Etherum’s case, it uses Ether. Ether has been around for 6 years. If the market decided Ether doesn’t have value or there was some other issue, then there would be no incentive for anyone to stake the protocol (validate transactions) and its value could collapse. With that said, it’s highly unlikely that the market will decide that Bitcoin’s energy use does not have value anytime soon. This is why the Bitcoin community is adamant that its energy use is valid - it is absolutely critical to securing the network. There is no free lunch in this world.?

Another consideration with proof of stake is that if the native asset of the protocol is inflationary (Ethereum currently is, with plans for this to potentially change in the future), staking is required to protect against dilution. Again, this is similar to our current system.? Today, we have to take risks and invest our savings because the central bank is always creating more dollars and debasing the value of the currency already in existence. With Bitcoin, one can simply hold the asset without worrying about being devalued.?

Finally, earning rewards through staking is a taxable event. This is like earning interest income.? Taxes are due in the year in which the earnings were received. This could potentially be problematic if the value of Ethereum were to drop while tax payments are due. Holding bitcoin, which is a disinflationary asset, is not taxable.??

So, why is Ethereum moving to proof of stake? To reduce the energy costs and carbon footprint of the network.? Proof of stake is much more efficient when compared to proof of work. Bitcoin is currently the cryptoasset of choice for institutional investors but Ethereum is looking to position itself for the next wave of crypto adoption.? With a lot of chatter coming out of Wall Street regarding ESG considerations, Ethereum is marketing itself as less energy-intensive in an attempt to increase its market share.?

With that said, below are some stats regarding Bitcoin’s energy use as reported by the Bitcoin Mining Council. The nice thing about Bitcoin’s energy use is it’s easy to track and very transparent:??

• Bitcoin mining uses about .117% of global energy - that’s less than 12 basis points or less than 12 one-hundredths of 1% of global energy.?
• 67.6% of the energy used by members of the Council (32% of the entire global network) comes from a sustainable energy mix - hydro, wind, solar, nuclear, geothermal power sources.?
• With this data, it is estimated that 56% of all global mining is derived from renewable sources - this is higher than any country or industry in the world.?
• Finally, about 31% of all energy produced worldwide is wasted each year. The global Bitcoin network uses about .4% of this wasted energy.?

Bitcoin’s energy use is largely misunderstood by the market today - the Mining Council was formed to educate and bring transparency to this important issue.

In addition to reducing energy use, Ethereum's move to proof of stake should help scale the network. Today, Ethereum struggles to process enough transactions to support worldwide settlement. When network activity on Ethereum picks up, transactions slow down and the fees increase. Ethereum's move to proof of stake should allow the network to grow and scale over time, increasing its usability for the general public. The key distinction is that Ethereum is making this change on the base layer. Bitcoin would never do this because it would introduce security risks. Bitcoin chooses to scale on its layer 2 lightning network.

Is this move to proof of stake going to benefit Ethereum? Only time will tell.? Anyone comparing the two protocols should note that these changes to the protocol by The Ethereum Foundation demonstrate that the protocol is not really as decentralized as it may be marketing itself to be. If Vitalik Buterin, the founder of Ethereum, can influence important aspects of the protocol as he chooses, we should not view Ethereum as truly decentralized.? Furthermore, critics of Ethereum point out that a large portion of the decentralized network of Ethereum nodes is hosted by Infura, a blockchain developer suite, which is hosted by Amazon Web Services.? This means Ethereum could potentially be shut down by a central player like Amazon - something that cannot happen with Bitcoin. Decentralization is ultimately about trust - without it, we have to trust a central authority. With that said, one could argue that true and absolute decentralization is probably more important for a global monetary network like Bitcoin vs a more complex utility network like Ethereum. Ethereum's complexity almost guarantees that tweaks will need to be made to the protocol here and there over time. Ethereum and the applications built on it are still far less centralized than the applications we use today.?

Use Cases - Bitcoin

Bitcoin does not compete with Ethereum and Ethereum does not compete with Bitcoin.? It’s unlikely that the cryptoasset economy will have a winner take all.? Comparing Bitcoin to Ethereum is like comparing Netflix to Google. Do they compete against each other for the global pool of investment capital? Sure. Do they compete against each other on features, customers/investors, or use cases? Not really.?

Bitcoin is seen as a monetary asset, similar to digital Gold. Ethereum is more like a utility asset, similar to digital oil.???

Let’s explore this further.?

Bitcoin uses blockchain as a savings & payments technology, and the base layer is elegantly simple. It focuses on doing one thing exceptionally well: storing and settling value.?

The prevailing narrative for Bitcoin today is that it is an emerging store of value or digital Gold.??

What makes Bitcoin a store of value?

Bitcoin has a simple, elegant, and predictable monetary policy. There will only ever be 21 million bitcoin. Today, 18,749,318.75 are circulating (89%). Every 10 minutes, miners mint a new block of transactions and 6.25 BTC are awarded. This will happen like clockwork until the next halving. The halving occurs after 210,000 blocks have been mined - at that time the reward of new bitcoin for each block will be reduced (or halved) to 3.125.? This disinflationary monetary policy will continue every 210,000 blocks (4 years) until all 21 million bitcoin have been mined, sometime in 2140. Scarcity is critical to economic value. Predictability allows market participants to plan ahead with clarity.?

Here’s a visual of the monetary policy. The blue line is the amount of bitcoin circulating in the economy and the orange line is the issuance schedule for new bitcoin. ?

Absolute scarcity without utility wouldn't be worth much. Utility without scarcity also wouldn't be worth much. When we combine the two, we get something that looks very much like Gold, except Bitcoin is far superior to Gold for three reasons:?

1. Bitcoin is a bearer asset that can be transported all over the world at the click of a button - something we cannot do with Gold. Additionally, Bitcoin settles in a decentralized manner, without relying on a central authority.? This makes bitcoin a revolutionary innovation - a permissionless, trustless, global monetary network with a provably scarce native asset. This is something that could have major implications for world trade and global commerce.

2. Bitcoin has absolute scarcity.? There will only ever be 21 million bitcoin.? Bitcoin is perfectly predictable - every 10 minutes a new block of transactions is minted by the network. The reward for minting those blocks is on a disinflationary schedule, halving every 4 years. When we contrast Bitcoin’s supply issuance schedule with that of any other commodity or investable asset, we can quickly see that Bitcoin is an exceptionally unique asset.??

For example, Gold is a scarce asset, but even Gold has a supply response to increased demand. If the price of Gold increased to $3,000 per ounce, Gold miners would expand operations. New miners would come into the market. More Gold would be mined. Supply would increase (with a delay), and the price would have to account for the new supply.? This is true of any commodity. It’s true for real estate. It’s true for stocks - new companies are going public all the time. Additionally, companies can raise equity and dilute their current stockholders. This can never happen with Bitcoin. It doesn’t matter how much demand there is, supply issuance remains fixed per the protocol. Supply is completely inelastic to demand. That means the price is the release valve when demand increases. People call Bitcoin “Number Go Up” technology because of this. It sounds silly, but it’s also been true since its inception.?

3. Divisibility - each bitcoin can be divided into 100 million units for microtransactions - functionality and flexibility that we do not have with Gold.?

Gold was chosen as money throughout history because it meets the most important traits of money: scarcity, divisibility, portability, recognizability, and durability.? In addition to its monetary value, Gold is shiny and pretty and can be melted down and used in jewelry and electronics (utility). When we take a step back and look at Bitcoin from the first principles of money, we can see that it has these traits in spades. Keep in mind that Bitcoin’s utility is that it comes with a worldwide monetary network, offering nearly instant, final settlement - 24/7, 365 days/year.

In a world of out-of-control central banks, negative real interest rates, increasing inflation, and historically high government and corporate debt levels, Bitcoin doesn’t need to be anything more than a store of value. It can be wildly successful just doing what it’s doing today.?

That’s because Bitcoin is singularly focused on creating sound money that cannot be debased or corrupted by a central authority.? That’s it. To achieve this, Bitcoin keeps things really simple. The blockchain itself is designed for simplicity and immutability.? The idea is that scarcity, security, and incentive structures are the most important thing - adding functionality to the base layer of the blockchain would introduce unneeded complexity and additional attack vectors.? Therefore, Bitcoin’s base layer changes very little over time because it simply optimizes for security and predictability.?

With that said, Bitcoin continues to scale onto its second layer, the lightning network.? The lightning network allows Bitcoin’s transaction throughput to scale to Visa/Mastercard levels and would facilitate bitcoin’s use as a medium of exchange. The lightning network is the primary reason El Salvador recently adopted Bitcoin as legal tender - it allows for instant and final remittance payments to their citizens from America - something that was costing them 10-15% in fees through Western Union. Remittances are 24% of El Salvador’s GDP. We are also seeing decentralized finance (lending, borrowing, derivatives, exchanges, oracles, etc) being built on the lighting network.? Again, Bitcoin doesn’t need to do much to continue to be successful - but it’s still important to note that it is being built to potentially be a medium of exchange and a settlement network for global commerce & finance.?

Use Cases - Ethereum

While Bitcoin is focused on solving one particular use case - store of value/sound money, Ethereum is focused on allowing developers to build smart contract applications on top of its base layer blockchain. We can think of Ethereum’s blockchain as an artist’s blank canvas that has been set up with simple tools (smart contract programming language) which allow other artists (software developers) to build financial applications on top of it. That sounds simple but this is a much more complex blockchain than Bitcoin.? Some refer to Ethereum as a world computer or a distributed operating system that could serve as the base layer of a new financial infrastructure - Wall Street 2.0.? Developers flock to Ethereum because they can easily build decentralized applications on Ethereum’s blockchain. Today Ethereum is an ecosystem with hundreds of other applications built on top of it. We can think of this as a decentralized financial marketplace - where the underlying technology uses smart contracts instead of central intermediaries to execute trades, lending, borrowing, derivatives contracts, etc.?

Ethereum’s native token, Ether, powers this marketplace. Want to build smart contract apps as a developer? You need Ether to do so.? Want to trade your Ether for a stablecoin? You need some Ether to do that. Want to stake and validate transactions? You need some Ether to do that.? Want to earn a yield on your Ether?? Better have some Ether. You get the point.? Market participants refer to Ether as “digital oil” for this reason - a utility token greasing the ecosystem. If you want to interact on the platform, you must acquire some Ether first.? This is what gives Ether value, and as its network effect grows, so too does the value of its native token.?

Some interesting developments on Ethereum include Uniswap, a decentralized exchange (one of many) where market participants add liquidity (to earn fees) to the protocol which then uses the liquidity in conjunction with smart contracts to execute trades. Uniswap is less than 3 years old and is doing 30-40% of the trading volume that Coinbase does. We’ve also seen the proliferation of stablecoins on Ethereum - crypto tokens that are pegged to the dollar. In the last 6 months, we've seen the value of stablecoins explode - the stablecoins market is currently the size of 3 PayPal networks. Stablecoins allow market participants to trade in/out of various assets without incurring the volatility of the various native tokens. Additionally, borrowing and lending protocols (Compound, Aave, etc) are available on Ethereum as well as gambling/prediction markets, and gaming applications that use NFTs, or Non-Fungible Tokens.?

If you’re interested in exploring the various apps on Ethereum, you can do that here: https://dappradar.com/

And if you’re interested in looking only at the decentralized finance apps (DeFi), you can do that here: https://defipulse.com/

Critics of Ethereum would say that today, it functions as a big operating system/world computer powered by crypto tokens, for the purpose of moving around...crypto tokens.?

A healthy banking system in the real world would consist of people depositing money, and the banks making various loans for mortgages and for business financing, to generate real-world utility. Ethereum today looks more like a speculation-based banking system.? That said, we shouldn’t expect this to persist forever - the technology solves real problems and is far superior to legacy systems. We should expect this circular economy to expand out to more real-world use cases over time. Hint: this is already happening with real estate and bonds.

Remember when Bitcoin was only used by criminals? It’s now owned by some of the smartest macro traders alive, large multi-national insurance companies, publicly traded companies, sovereign wealth funds, pension funds, and nation-states.??We see this same progression happening on Ethereum.

Ethereum’s monetary policy is quite different from Bitcoins as well.? As stated, Bitcoin has a fixed monetary policy that will never change.? Ethereum, on the other hand, was launched with a 72 million pre-mine of coins. 60 million was issued to the general public who paid about 30 cents/Ether. 5.9 million coins went to 83 early contributors, and the remaining went to the Ethereum Foundation. Vitalik Buterin, the found of Ethereum, received 553,000 coins. In total, Ethereum raised $18m (in BTC) from the general public when they initially launched the protocol. There is quite a bit of propaganda around this from Bitcoin maximalist who believe this is proof that Ethereum is not decentralized and generally more extractive than Bitcoin. While it is true that The Ethereum Foundation raised $18m, they have turned that into $360b in less than 6 years. That figure doesn't even include the amount of venture capital pouring into a business that will make it easier for the general public to engage with apps built on Ethereum. I think we can all agree that this was a very efficient use of capital. Bitcoiners have a problem with this because they did not have a pre-mine - the anonymous founder mined coins to get the protocol started, and then walked away from those coins and let the market take over. Anyone can validate this because the blockchain is transparent - we can see the initial coins that were mined in 2008/2009 and that they have not moved.? There are currently approximately 115 million Ethereum in circulation. ? The monetary policy has already changed a few times and will change again as part of EIP 1559. The plan is to burn some of the base transaction fees, rather than give them to the validators. This will offset the new issuance of Ethereum when blocks are minted and could potentially make Ethereum a deflationary asset, or at the very least, less inflationary.??

Key Takeaways

Bitcoin is the OG cryptoasset and was built to solve one incredibly important problem - sound, global, non-sovereign money that is decentralized and incorruptible. The Bitcoin ethos is all about transparency, merit/proof of work, and equal access.? Its origin story as well as the incentive structure built into the protocol solidify its brand and integrity around these core tenets.? It’s the reason Bitcoin has an absolutely organic, decentralized, and fervent global community backing it.?

Ethereum builds on the most basic elements of Bitcoin by allowing developers to create decentralized applications on its blockchain using smart contracts. Ethereum makes it straightforward for them to do so and has created a vast network effect as a result. The blockchain is essentially a circular marketplace in that the native token of the network, Ether, will be staked in the near future to validate transactions and secure the network. Additionally, Ether is needed by developers and market participants to build, trade, lend, borrow, etc on the platform. The Ethereum Foundation embraces experimentation and creativity while Bitcoin is focused more on security and predictability.? Bitcoin has a pure and predictable monetary policy while Ethereum’s tends to change from time to time.?

Finally, Bitcoin is truly decentralized - there is no central founder governing the network, and the network of decentralized nodes running the software are not at the mercy of a central cloud storage operator, or any other central party. Furthermore, anyone can set up a full node that captures all transactions ever recorded on the Bitcoin blockchain - it’s fairly straightforward and costs less than $250. This increases decentralization and the network effect. Ethereum does not offer this easy access. Anyone can set up an Ethereum node with all transactions but it is more technical and more costly. Regarding decentralization - if a protocol can be shut down, we cannot consider it to be truly decentralized. Ethereum could potentially be shut down due to its reliance on Infura and Amazon Web Services today.??

If both are successful, Bitcoin will be a global store of value and potentially a medium of exchange for global commerce - a reserve currency for the internet. Ethereum will become the base layer settlement for highly liquid markets - a Wall Street 2.0 with stock, bond, private equity, and real estate trading (tokenized/digital twin of the assets or NFTs), lending, borrowing, gaming, gambling/prediction markets, insurance, derivatives, etc.?

The bottom line here is that venture capital is pouring into this space.? Blockchains, in conjunction with IoT technology and AI, are on a collision course to disrupt and slowly dismantle the banking and financial services industry.? There are several reasons for this:

• Blockchains offers superior payment rails and settlement technology - faster, cheaper, more secure, available 24/7 & 365 days/year, instant/final settlement, and are open & interoperable with existing global payment rails
• Blockchains remove the unnecessary middleman from the equation - smart contracts will replace fee takers and paper pushers. It’s more efficient, cheaper, and it returns power to the individual.
• Blockchains are open, transparent, immutable, and auditable. Data provenance can be tracked and validated. This allows for trust to be established in a digital economy.
• Blockchains introduce triple entry accounting - all transactions are recorded as a debit/credit, with a network of decentralized computers also recording the transactions - introducing an automatic audit function.
• Blockchains are superior data capture systems because they are immutable and auditable. In financial markets, data allows for the asymmetry of information to be reduced amongst market participants. By tokenizing real assets and underpinning them with validated data, we allow for trust and fair value to be established, which allows for liquid markets to blossom.?
• There is a growing distrust amongst younger generations of the financial and banking system - 77% of millennial respondents (30,000 sample size) in a 2018 World Economic Forum study indicated they believe “the whole financial system is designed to favor the rich and powerful” and that “it’s only a matter of time before the bad behavior of the financial industry leads us to another global financial crisis.”?Does anyone think this sentiment is going to change anytime soon? We already found a solution.
• The world currently has about $14 trillion in negative-yielding debt. Debt to GDP around the world is at historically high levels, particularly in America. What happens when people decide they don’t want to hold sovereign bonds?
• This debt overhand is slowing growth, forcing more aggressive monetary and fiscal policy and market intervention by central banks - this is driving distorted markets, high inflation, and increasing inequality.
• The invention of the internet created the underpinnings of a new information infrastructure, by changing how information was consumed and also created - democratizing access on both ends. The same thing is happening today, but in finance.
• Blockchains allow financial access for all. The world currently has over 2 billion people that are unbanked - blockchains can help solve this.?

We cannot predict the future. But we can certainly use history, macroeconomics, social and demographic shifts, as well as the progression and powerful network effects of open-sourced, distributed ledger technologies to get a sense of where things are heading.?

Pulling on these threads indicates that Bitcoin and Ethereum are likely here to stay.?

Thanks for reading - I sincerely hope you got some value. If you did, I'd appreciate it if you could leave me a comment or share this with your network.