A Profit-Seeking Prophecy
By Vin Armani
The seeming aversion to profit within certain influential sectors of the Bitcoin community has always struck me as a rather peculiar neurosis. Bitcoin is money. It’s designed specifically to be peer-to-peer cash, in fact it says so in the title of the white paper. Profit-seeking represents, in large part, a desire for the acquisition of money through valuable economic activity. One would think that the relationship between Bitcoiners and profit-seekers would be harmonious and symbiotic, and yet it isn’t. Granted, Bitcoin emerged from an already established and vibrant open source software community. At the core of the open source ideology is the notion that unpaid contributors offer code, free of charge, to the world. The fact that Bitcoin was offered as open source from the beginning has been a prerequisite for its growth and adoption. You can’t turn a profit on something you give away for free. But Bitcoin is money, and money isn’t free. Ten years into the experiment, with a need to spur mass adoption, the time has come to reexamine the role of profit in Bitcoin.
Profit is literally a fact of life. No organism can survive and grow if it does not take in more energy than it expends acquiring that energy. In economic terms no actor (be that an organization or an individual) can survive and grow if it does not take in more revenue than it expends acquiring that revenue. In short, you can’t pay bills with a bank balance below zero. You might be able to forestall disaster for a limited amount of time by incurring debt, technically driving your bank balance deep into negative territory, but an economic actor cannot sustain debt for long. On the other hand, a profitable entity can theoretically sustain itself indefinitely. Profitable businesses regularly outlive their founders. There are several companies in Japan alone that have been in continuous operation for over 1000 years. If Bitcoin is to survive and grow, it will be profits – in Bitcoin, not fiat – that provide the necessary fuel.
HODLing is not profit-seeking. HODLing is, fundamentally, interest-seeking. Interest is income generated from the lending of money. Someone who buys and holds bitcoins for the purpose of being able to sell them (hopefully) at a higher price at some point in the future is akin to the purchaser of a government bond, a debt instrument. The entire point of acquiring a bond is that it represents a promised payment of an amount greater than the discounted purchase price at some point in the future. Instead of a fixed maturity date stamped on a government-issued bond, HODLers are waiting to “cash out” (presumably back to fiat) on some future date when the price has gone “to the moon.” The HODLer is betting that others will create profitable enterprises in the Bitcoin ecosystem, increasing the overall value of the tokens through increased demand. The HODLer himself, however, is not participating in the creation or implementation of a profit-making enterprise merely through the act of buying and holding tokens. The HODLer is betting on a sporting match. The profit-seeking entrepreneur is the one actually on the field of play. It is the players who will be responsible for Bitcoin’s growth and survival.
Austrian Economics represents three basic modes (or classes) that an individual can occupy within the economy – that of the Laborer, Capitalist, or Entrepreneur. The Laborer earns a wage. He exchanges his conscious, focused action (labor) for payment by the Entrepreneur. The Capitalist earns a return on investment (or rent), paid to her by the Entrepreneur. The Entrepreneur, by organizing the capital investment of the Capitalist and the labor of the Laborer, produces a good or service that the Entrepreneur is able to sell for more than it cost to produce and deliver. The difference between the selling price and the cost is profit. To summarize: Capitalists earn returns on investment, Laborers earn wages, and Entrepreneurs earn profits. Entrepreneurs are profit seekers and profit-seeking is entrepreneurial activity. To “earn profits in Bitcoin” means that the good or service being delivered costs bitcoins to create and is sold for bitcoins. While there are profitable businesses in the world of cryptocurrency, most of those businesses are seeking profits in fiat. It is worth examining what those fiat-profit-seeking businesses are and also what a Bitcoin-profit-seeking business looks like.
The first fiat-profitable business model in the world of cryptocurrency is mining. While not all mining companies are even fiat-profitable, the major miners have been, in recent years, some of the most profitable businesses in Bitcoin. A miner can turn a profit when the fiat price of a single bitcoin is greater than the cost for that miner to mine a single bitcoin. Both price and cost use fiat (generally USD) currencies as a unit of account. This is because the major expense for a miner is electricity which, as of yet, must be purchased exclusively with fiat. To my knowledge, there are no public utilities in any country that accept the cryptocurrency being generated through the use of that utility’s electrical power. There are miners who pay their employees in the cryptocurrency that has been mined, but without being able to pay in crypto for the largest expense of the operation, miners are seeking fiat profits. We know this is true because, although they may be earning the same number of Bitcoin tokens per day and even using less electricity, mining operations have shut down as the fiat price of Bitcoin and other cryptocurrencies has fallen. The business model incentivizes miners to either find ways to lower their cost-per-hash – using more efficient hardware like ASICs or moving to locations with cheaper electricity – or inflating the fiat price of the asset being mined – market manipulation like wash trading. It is important to note that, because the block rewards (the new tokens created upon the mining of a block and given to the miner that found the block) are currently of so much greater value than the mining fees resulting from transactions, miners have very little motivation to actually increase the number of transactions flowing over the network.
The next profitable business model in the world of cryptocurrency is the exchange. The most valuable exchanges are those that allow the exchange of fiat for crypto. Two notable examples of major exchange players are Coinbase (most recent valuation: $8 billion US) and BitPay. At both companies, according to CNBC, the majority of employees (payroll is a major expense for these companies) take their salaries in fiat, not cryptocurrency. In the case of both Coinbase and BitPay, the business model consists of selling customers either fiat or crypto at a premium (as opposed to running a marketplace and taking a percentage of each trade). This is the same essential business model of the fiat currency exchanger you walk past at every international airport in the world. The exchanger doesn’t care what the price of the individual token is at any given time, because he is always taking in more value than he is giving out. So long as demand stays healthy and stable for both sides being traded (fiat and crypto), the exchanger remains profitable. In the current exchange climate, the current stablecoin craze, with tokens pegged to fiat currencies, is further proof that it is fiat-profit-seeking at work. An important consideration regarding the exchange business model is that exchanges, because they charge a percentage premium (or commission) on every trade, are incentivized to increase the aggregate value, in a reference currency, of the trades in a particular time period. They are not necessarily incentivized to increase the number of trades. For instance, an exchange prefers one trade worth $1 million, at a 3% commission or markup, to 100 trades worth $1000 each ($100,000 aggregate) at the same commission rate.
There are a growing number of profitable merchants, selling their goods and services, either in part or exclusively, in cryptocurrency. The numbers are still small, however, and most businesses can’t pay any of their suppliers or vendors with Bitcoin yet. This will be the last business model where Bitcoin-profit-seeking is a viable option, but I mention it here because merchants are the true barometer of adoption. When we start to see even a few merchants moving exclusively to cryptocurrency and paying their employees and vendors exclusively in cryptocurrency, it will be a powerful signal that mass adoption is on the horizon… a tipping point.
So, what does Bitcoin-profit-seeking look like and why does it matter?
The first pure Bitcoin profit-seeking entrepreneurs will have a business model that will essentially have the same incentives that miners will have when the block rewards finally disappear. In 2020, the Bitcoin block reward will be cut in half, to 6.25. It will be cut in half again 4 years later. Without a block reward, the income for miners will come exclusively from the fees paid by users with every transaction broadcast to the network. The nature of bitcoin transactions is that the fee amount is determined by the size, in bytes of the transaction itself (determined by the number of inputs and outputs), and not the nominal value of the transaction. That means it is entirely possible for a transaction worth $1 US to pay a higher miner fee than a transaction worth $1 million US. This creates an inverse incentive structure from that of the exchanges. Where exchanges are incentivized to increase aggregate fiat value of trades made during a time period (even if it means lowering actual transaction volume), a business being paid in mining fees is incentivized to increase the total number of transactions (even if it means lowering aggregate fiat value of those transactions). A business incentivized to increase Bitcoin transaction volume is a business incentivized to increase Bitcoin adoption. In this way, enabling on-chain Bitcoin profit seeking is enabling Bitcoin adoption.
Well before the block rewards become insignificant, a new class of profit-seekers will emerge whose incentive structure matches the structure described above. The revenue of these businesses will come from charging a per-byte fee for transactions which pass over the businesses infrastructure. This fee is in addition to a mining fee and is paid by the user for some service that the business is providing which enables greater ease of use. The business I founded, CoinText, is an early example of such an enterprise. CoinText is an SMS cryptocurrency wallet, currently available in 40 countries. By using CoinText’s service, users can send and receive cryptocurrency without internet, without an app or account, and without a smartphone – some or all of which have been a prerequisite since Bitcoin began. Each transaction sent via CoinText has an additional output, with a per-byte fee, added onto it. This revenue model allows CoinText to remain completely non-custodial. We are incentivized to, first and foremost, increase the number of transactions being sent across our platform. This is, fundamentally, an incentive to increase the total number of individual users of cryptocurrency, and incentive to increase adoption.
I have begun using the term Non-Custodial Financial Services (NFS) provider to refer to the business model of CoinText and other newly emerging services. Because of Bitcoin’s transaction model, multiple entities can be paid (via multiple outputs) in the same transaction. This allows for affiliates and brokers to participate in the NFS ecosystem. It is a model for profit-seekers, entrepreneurs, to do what they do best: solve problems in exchange for payment. Ryan X. Charles has recently explored this idea in some detail. It allows for permissionless competition because prices can be set lower by competitors in order to gain a competitive advantage. Most importantly, because they do not take custody of user funds, Non-Custodial Financial Services providers are exempt from most (if not all) money service business regulations.
Because NFS providers are software platforms (although hardware interfaces are to be expected), startup costs are extremely low. Businesses bootstrapped by the founders will have a competitive advantage. The main expenses of such a startup are primarily server costs. There is already a competitive market for virtual private servers and cloud services providers that accept the cryptocurrencies in which such businesses earn their revenue. Founders can take profits in the cryptocurrencies they earn. This is a signal that the NFS business model is the first that allows for pure Bitcoin profit-seeking. Because their profits are derived in the same form as miner fees, NFS providers are incentivized to build their products on top of the networks which have the lowest minimum miner fee (I recommend Daniel Krawisz’s work exploring this concept). Those networks whose thought leaders recognize the need to enable profit-seeking will be the networks which see the most adoption, due to the incentives described above.
These ideas regarding profit have been embodied for years now in Bitcoin, seeds germinating in fertile soil. I believe 2019 will be the year that we see the first green shoots of a prophecy made by Rick Falkvinge in his “Letter From The Bitcoin Cash CEO”:
But – here’s the key – other people are not going to be joining Bitcoin Cash for our reasons. They’re going to be joining Bitcoin Cash for their reasons, or they’re not going to be joining at all. And their reasons aren’t going to be “decentralization”, “censorship resistance”, “non-aggression money”, or any other nice theoretical construct. Their three reasons for joining Bitcoin Cash, in 99.999% of cases, are going to be profit, profit, and more profit, in that order. This applies to merchants in the first world, it applies to migrant workers sending funds home, and it applies to the poorest billion people just trying to get out of the slums. We can provide liberty to all of them, and many more, by means of profit motive.
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