Every time I find a new cryptocurrency, I look at the price charts and almost every time it's constantly losing value. Ether and Bitcoin are the only exceptions, and have gained value on the long term. Why is that?
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2 Answers
The simple answer is that this is a product of the network effect. Bitcoin has a massive advantage in that it was the first blockchain-based currency, so it is the gold standard of the technology. A competing cryptocurrency needs to not only be better than Bitcoin, but be much better than Bitcoin. It's not enough to be slightly better, as the momentum Bitcoin has in the market outweighs slight advantages other coins may offer.
As you've identified, the only cryptocurrency that has made any headway in competing with Bitcoin is Ethereum. This because the Ethereum blockchain does not attempt to compete with Bitcoin as a currency, but rather as a smart contract platform. In that regard, Ethereum provides a significant advantage over Bitcoin. However, Bitcoin still has proven to be a more robust and trustworthy currency, so Ethereum is unlikely to replace Bitcoin when it comes to being used as a medium of exchange and a store of value.
These two blockchains are the market leaders in what they do, and don't really directly compete with each other. If a new chain wants to unseat one of them, they would have to be a clear and significant advantage over the current market leader. So far, that hasn't happened.
There is this classic bootstrapping problem. To make a successful cryptocurrency it needs:
- Miners (so that it's secure)
- Users (to attract miners, users also want it to be secure)
- Value (to attract users and miners)
So new cryptocurrencies need to find a way to jump-start all those things at the same time, which it turns out- is not easy.
Here's a great description of it from Bitcoin and Cryptocurrency Technologies by Arvind Narayanan, Joseph Bonneau, Edward Felten, Andrew Miller & Steven Goldfeder:
Getting a cryptocurrency off the ground
Another subtle concept is that of bootstrapping. There is a tricky interplay between three different ideas in Bitcoin: the security of the block chain, the health of the mining ecosystem, and the value of the currency. We obviously want the block chain to be secure for Bitcoin to be a viable currency. For the block chain to be secure, an adversary must not be able to overwhelm the consensus process. This in turn means that an adversary cannot create a lot of mining nodes and take over 50 percent or more of the new block creation.
But when will that be true? A prerequisite is having a healthy mining ecosystem made up of largely honest, protocol‐following nodes. But what’s a prerequisite for that — when can we be sure that a lot of miners will put a lot of computing power into participating in this hash puzzle solving competition?
Well, they’re only going to do that if the exchange rate of Bitcoin is pretty high because the rewards that they receive are denominated in Bitcoins whereas their expenditure is in dollars. So the more the value of the currency goes up, the more incentivized these miners are going to be.
But what ensures a high and stable value of the currency? That can only happen if users in general have trust in the security of the block chain. If they believe that the network could be overwhelmed at any moment by an attacker, then Bitcoin is not going to have a lot of value as a currency. So you have this interlocking interdependence between the security of the block chain, a healthy mining ecosystem and the exchange rate. Because of the cyclical nature of this three‐way dependence, the existence of each of these is predicated on the existence of the others. When Bitcoin was first created, none of these three existed. There were no miners other than Nakamoto himself running the mining software. Bitcoin didn’t have a lot of value as a currency. And the block chain was, in fact, insecure because there was not a lot of mining going on and anybody could have easily overwhelmed this process.
There’s no simple explanation for how Bitcoin went from not having any of these properties to having all three of them. Media attention was part of the story — the more people hear about Bitcoin, the more they’re going to get interested in mining. And the more they get interested in mining, the more confidence people will have in the security of the block chain because there’s now more mining activity going on, and so forth. Incidentally, every new Altcoin that wants to succeed also has to somehow solve this problem of pulling itself up by its bootstraps.
