Why Bitcoin Crashed And Why It Will Crash Again

Bitcoin is the dominating crypto currency. The recent crash only managed to get its price back to where it was last December, which means it is still profitable compared to a few years ago. Yet the digital currency that started it all suffers from some serious flaws, from volatility to its core algorithms.

Volatility

This November, bitcoin broke the floor and went below the $6,000 limit. As of this writing, it has even broken the $5,000 and $4,000 lines.  While some specialists expected the currency to reach $25,000 in December, the market is currently “bearish.”

There have been many speculations around the cause: some suggest the massive sell-offs, while others point to news around Goldman Sachs abandoning plans to launch a crypto currency trading desk. Some simply suggest that since many bitcoin investors are young adults, they want to cash in before college. Another theory is the fear of huge capital gain taxes. But before all of these, we had the bitcoin cash split. To understand the split, which affected the community so heavily, it is important to know how bitcoin “upgrades.”

Bitcoin’s evolution

Unlike regular (centralized) software, where a company owns a product and can upgrade it anyhow it likes, decentralized protocols such as bitcoin rely on several thousands of nodes, each of them having a version of that software installed. And there is no central place to automatically upgrade them (like Playstore) as that would defeat the purpose of decentralization. For this reason, all nodes must agree on the best way to go forward.

This process is called “forking,” where a new version of the software is created and installed on all nodes. And if the fork is a “hard fork,” this means the new software becomes “incompatible” with the old one, effectively resulting in a new coin. This is what happened to bitcoin cash.

It’s worthwhile to mention that bitcoin cash was a fork from bitcoin itself, and the reason behind it was limitations in bitcoin’s algorithm. Bitcoin can only process seven transactions per second, compared to Visa’s 24,000. As bitcoin adoption was increasing, the scalability problem had to be solved.

Bitcoin uses a CPU-intensive “Proof of Work” algorithm which requires the miners to spend a lot of time and resources on computing a hash value that verifies the transactions. In return, the one who solves the algorithm is rewarded in bitcoin.

To increase the chances for reward, GPU mining, ASIC mining and mining pools were created, with Bitmain currently being the largest. But the increased hashing power of these pools (with a majority of them residing in China) also increased the worries of a 51% attack, where one pool could overwrite the entire history of bitcoin and redefine the contents in all wallets.

To solve the problem of scalability, the community had to make a choice. The problem could be solved by increasing the “block size” (limited to 1 MB) which would allow a lot more transactions to be processed per second, but this meant that smaller devices would have no chance to compete with the bigger players. It was an issue of centralization vs. decentralization. The community could not agree, and bitcoin cash was born as the alternative which could process more transactions per second.

Bitcoin cash: civil war

On November 15, bitcoin cash officially split into two versions: Bitcoin ABC (Adjustable Blocksize Cap) and Bitcoin SV (Satoshi’s Vision). To keep it simple, both factions had different views on how bitcoin cash should proceed, with one of the debates circulating around the block size. But in this split, the chains tried to eliminate each other, partially fighting over who should own the BCH symbol.

When a crypto currency splits, the users on the old chain double their coins, as they receive a similar amount of coins on both sides of the chain. But without a mechanism called “replay protection,” if a user spends coins on one of the chains, it automatically deduces from the other one as well.

Bitcoin SV initially refused to implement this feature. Furthermore, Craig Steven Wright (who supports bitcoin SV) explicitly stated that they will use any hash power under their control to 51%-attack the bitcoin ABC chain, resulting in a “hash war.” For these reasons, many exchanges stopped supporting bitcoin cash altogether until the dust settled off.

Winners and losers

For now, it seems like bitcoin ABC has won the civil war, but the entire crypto community has paid the price. Bitcoin is driven by opposing visions; some consider it a vehicle for investment, while others want to use it to “pay for your coffee.”

Bitcoin did a great job in introducing crypto currencies to the world. It seized the right moment after the financial crisis, and became the first and biggest digital currency. Yet, it has many flaws: volatility, scalability and the power-hungry algorithm are some of them.

For these reasons, we now have stablecoins and third and fourth generation blockchain projects which rely on totally different algorithms (some that rely on RAM instead of CPUs). Bitcoin probably cannot become a mainstream payment mechanism, but it has paved the way for other digital currencies. If its flaws are not fundamentally resolved, it might lose its dominating position.

Bitcoin did a great job in introducing crypto currencies to the world. It seized the right moment after the financial crisis, and became the first and biggest digital currency. Yet, it has many flaws: volatility, scalability and the power-hungry algorithm are some of them.

For these reasons, we now have stablecoins and third and fourth generation blockchain projects which rely on totally different algorithms (some that rely on RAM instead of CPUs). Bitcoin probably cannot become a mainstream payment mechanism, but it has paved the way for other digital currencies. If its flaws are not fundamentally resolved, it might lose its dominating position.

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