Why Bitcoin Dominates

20 Pages Posted: 11 Jul 2019 Last revised: 19 Jan 2021

Date Written: July 9, 2019

Abstract

Just as network effects can dramatically increase value through positive feedback, value can be lost as networks shrink due to competition or incompatibility. In the instance of cryptocurrency as a network and with Metcalfe’s Law as the methodology, we illustrate by numerical example that holding less than 100% of the dominant coin results in sub-optimal value for all network participants. We calculate the economic impact of competing coins (“altcoins”) on Bitcoin’s value and find that they may negatively impact the entire cryptocurrency ecosystem theoretical maximum value by several billion dollars.

More importantly, we illustrate that the trade-offs between a dominant cryptocurrency network and a competing alternative are not one-for-one. Metcalfe’s Law gives a simple approximation rule: the percent change in value is approximately twice the percent change in users. In the four currencies we studied, we found that without exception, price sensitivity to change in users centered around 2×. The asymmetrical nature of network effects also means traditional “money flow” analysis used in equity markets incorrectly estimates the impact of capital movements across network assets.

Furthermore, we find network size dominates transaction activity as a price driver in at least three of four coins examined. Value is impacted asymmetrically and favors or disfavors the dominant coin, depending on whether a currency is being adopted or shunned: abandoning one currency in favor another will affect the dominant coin with greater impact. This finding offers a possible explanation for the resistance of governments and central banks to Facebook’s planned offering of its digital currency Libra.

Keywords: bitcoin, cryptocurrency, valuation, growth model, network economics, network effect

JEL Classification: C22, C49, C51, C53, C58, D85, E40, E42, E49, E51, G12, G17, L14

Suggested Citation

Peterson, Timothy, Why Bitcoin Dominates (July 9, 2019). Available at SSRN: https://ssrn.com/abstract=3417334 or http://dx.doi.org/10.2139/ssrn.3417334

Timothy Peterson (Contact Author)

Cane Island Alternative Advisors ( email )

9550 Spring Green Blvd Ste 408-114
Katy, TX 77494
United States

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