[Note: This was originally published on September 18, 2014 at Melotic.com]
One of the common talking points in social media related to cryptocurrencies today is that there is an impending collapse of altcoins – that anything non-Bitcoin will be squeezed out of the marketplace soon. This is not the venue for that debate.
Instead however, one question that could be asked is, why are additional coins being added to the market in the first place?
There are at least four reasons for why this “extinction” of coins will probably not occur anytime soon and people will continue to create altcoins:
Scarce labor and lack of compensation for working on Bitcoin core. There is currently a public goods problem: because there is no overall patron to Bitcoin, therefore there is no one to pay for continued development of the code. Those that do contribute code do so as an act of charity. Over the past two years, some solutions have arisen to plug this hole: organizations (e.g., the Bitcoin Foundation) and companies (e.g., Bitpay) have begun hiring and paying developers to continue development on the code. In addition, a new project called, “Lighthouse” is attempting to allow users to create “smart contracts,” such as an assurance contract (e.g., crowdfunding), which interacts directly with the blockchain. It is hoped that programs like this will allow users to pay developers to continue working on projects like Bitcoin (though it can be used for any number of other time-locked-based projects). In the meantime, however, those with scare labor have an incentive to work on an altcoin that can pay them for their abilities.
Depreciating capital goods (ASICs) incentivize pointing towards other profitable chains after 4-6 month window. Mining equipment, or more technically, hashing equipment, has a limited profitable shelf life. Once this window closes the owner of the equipment can either sell it to a new buyer (e.g., move it from China to Russia) or point the equipment to another, profitable chain. There is then an incentive for farm and pool operators to create and develop new coins that can utilize their equipment. This cycle could run into a wall, once the top of the “S-curve” in fabrication limitations of chip manufacturing arrives (e.g., due to diminishing marginal returns the jump in performance from 28nm to 20nm is not as large as the jump from 130nm to 65nm).
Open source turnkey solutions (e.g., create a new coin instantly via a script) make it easier to tinker with blockchain attributes now more than ever. Building, breaking, learning and reiterating are the zeitgeist of digerati and altcoins allow this recursive derivation to take place quickly. How do faster block timings, like Geistgeld, impact orphan rates? Can a demurrage, like Freicoin, incentivize spending? Can privacy-focused zero knowledge proofs (e.g., Zerocoin, Zerocash, Darkcoin) be integrated into and scaled at a global level via distributed consensus? These questions are being tested out on a daily basis by a variety of coins, providing feedback to developers in a way that could not occur with Bitcoin due a number of factors but primarily because of the paramount desire to not break several billion dollars in assets.
Market participants generally like choices and the freedom to try out alternative attributes. Historically, market-based signaling mechanisms spur new entrants in an open market even decades after a first-mover creates the industry. The aerospace industry was not closed to competition after the original Wright Brothers flight at Kitty Hawk (even though they sued their competition) nor did the automobile industry become impenetrable after the 106 km jaunt by Bertha Benz in August 1888. Time and again profits serve as signals to the rest of the industry, which in turn incentivize (or discentivize) entry. This includes building new: boats and trains, credit card systems, social media, portable media players, televisions, mining for resources, operating systems and even protocols themselves. So as long as developers have the freedom to tinker and the motivation to do so, altcoins will likely to continue to be created.
I think its mostly the second cause you mention. I do like the idea behind the third point – tweaking without affecting bitcoin – but I don’t think developers of altcoins are thinking of bitcoin when they innovate. Once I understood that once most of these new features proved themselves they could probably be integrated into Bitcoin.