Frameworks for Understanding the Bitcoin Ecosystem

| Originally published on on January 3, 2014 |

One of the main issues standing in the way of a wider understanding of Bitcoin is that there are a number of concepts that have not always been well explained in the general media writeups on Bitcoin. These concepts relate to both technology and business.

With that in mind, here are 5 (sort of) frameworks that are worth thinking about and that I’ll expand on and use in future posts:

1) The Bitcoin protocol vs. the Bitcoin currency

This is a foundational topic for the whole discussion. “Bitcoin” as normally discussed actually comprises two different things:

First, the Bitcoin protocol – a set of technologies and algorithms enabling transactions that are:

  • Decentralized
  • Anonymous (or at least pseudo-anonymous)
  • Trustworthy

Second, the Bitcoin currency – an application of the Bitcoin protocol to enable an entity that can be used as:

  • A store of value, and/or
  • A medium of exhange

This protocol vs. currency distinction is very important. While the main use of the Bitcoin protocol today is the Bitcoin currency, this is by no means its only use. The protocol is an elegant solution to the Byzantine Generals Problem (see this post by Chris Dixon) and different versions of it will find many uses in the future in finance and other fields. 

2) Bitcoin as a store of value and/or a medium of exchange

Once you are talking about the Bitcoin currency, it is just like any other asset and there are 2 potential uses for it:

  • A store of value, and/or
  • A medium of exchange (i.e., payments)

I say “like any other asset”, because any asset can be used in these 2 ways – the problem is that different assets are differently well-suited to these uses. Some assets (e.g., a car) are bad stores of value while others (e.g., gold) are good (or at least better). Similarly, some assets are good mediums of exchange (e.g., a standardized piece of paper) and others are bad (e.g., try bartering a couch for a computer).

When talking about Bitcoin as a store of value, it is most often compared to gold, but it could be just as easily compared to a financial instrument like a stock. This is a whole topic in and of itself. 

When talking about Bitcoin as a medium of exchange, it is most often compared to the dollar, and this is an even bigger topic (see separate framework below).

More on both of these coming soon.

3) Bitcoin in payments

I’ve split this out from the framework above because it’s a big topic and it’s worth expanding on a bit more now (and of course later). 

Bitcoin’s success here will depend on whether it truly adds value for both merchants and consumers.

A merchant is anyone selling something – the prototypical and most common merchant is a small bricks & mortar retailer, but you also have to consider larger entities, online-only entities, etc. Merchants primarily care about (in no particular order):

  • Reducing transaction fees
  • Reducing transaction time
  • Reducing any sort of currency-related risk
  • Making their customers happy (e.g., accepting what customers want to pay with)
  • Reducing admin/overhead costs

A consumer usually means an individual buying something that is relatively small, but it can also mean another company. Consumers care about several things as well, but it usually just boils down to convenience. And that is what has made adoption of new payment mechanisms/instruments very tricky over the last 10 years: paying with cash or credit cards is pretty darn convenient.

I’ll discuss these areas in more detail soon.

4) Bitcoin vs. other crypto-currencies/protocols

The Bitcoin protocol has been used, either directly or as inspiration, to generate other similar currencies or protocols. The best known examples are probably:

  • Litecoin, which uses the Bitcoin protocol with some adjustments and is sometimes called “silver” to Bitcoin’s “gold”.
  • Ripple, which is conceptually similar to Bitcoin (both protocol and currency) but whose protocol works in fairly different ways and enables different scenarios.

There are some important questions around whether there is a need for multiple crypto-currencies, what applications/uses they may serve, and how they could interact. I’ll write more on those soon.

The public discussion is complicated by the existence of “joke” crypto-currencies like Dogecoin and Coinye. While I have nothing against these efforts (they are definitely amusing), they do contribute to the general feeling that crypto-currencies in general are one big bubble or Ponzi scheme.

5) Players in the Bitcoin ecosystem

Most of the business action (and discussion) in Bitcoin today revolves around Bitcoin as a currency, and more specifically around Bitcoin as a medium of exchange. However, since the concepts of:

  • protocol and currency, and
  • store of value and medium of exchange

are tightly coupled, there is a lot of overlap in what the different companies are doing in these areas. A quick rundown (to be expanded on later) of the different players:

  • Mining hardware makers
  • Miners
  • Exchange enablers
  • Exchanges
  • Trading platforms
  • Payment processors
  • Consumer wallets
  • Other payment service providers
  • Other non-payment service providers

I’ll have more to say about each of these, along with some analysis of what each is doing, their general attractiveness and more.

These 5 frameworks lay out a pretty good structure for a bunch of posts. There is a lot to analyze in each of these areas.