What Is Bitcoin?
Bitcoin is a fully decentralized digital cash system. It is meant to enable peer-to-peer transactions that do not rely on a trusted third party. Bitcoin has a finite supply: there will never be more than 21 million bitcoin.
Due to its decentralized nature, Bitcoin is censorship-resistant, meaning that any transaction which is valid according to the rules of the network can be included in a block.
These features make Bitcoin the prime candidate to become the reserve currency of the world.
What Is Ethereum?
Ethereum is an alternative cryptocurrency, with different goals and design features than Bitcoin. Ethereum is more accurately viewed as a platform for executing financial smart contracts. It has often been described as a distributed world computer.
The Ethereum platform hosts a large number of tokens, but its native token is called ether (ETH). Ether is used to pay transaction fees for the various smart contracts executed on the Ethereum platform.
Why Ethereum Was Invented
In 2014, a few developers became dissatisfied with Bitcoin’s perceived lack of flexibility. These developers believed Bitcoin’s blockchain should host all possible financial activities. However, the majority of Bitcoin users and developers wanted to keep Bitcoin safe, simple, and scalable. These conflicting goals led to the creation of Ethereum.
Ethereum was created as a new blockchain with a new scripting language called Solidity. Unlike Bitcoin Script, Solidity is Turing complete, meaning its code includes loops. This means that an Ethereum contract can be far more complex and take up more compute resources than a Bitcoin transaction.
The Ethereum blockchain hosts a more complex, wider variety of smart contracts than Bitcoin. In addition, many different types of tokens can be issued natively on the Ethereum blockchain, while bitcoin is the only token transferred directly on the Bitcoin blockchain. However, Ethereum’s design decisions come at a cost, including a significant increase in complexity and a loss of true decentralization.
Comparing Bitcoin and Ethereum
Bitcoin and Ethereum are two projects pursuing different goals, and their designs reflect this difference. Bitcoin aims to be decentralized, universal money for the world, a sound store of value, medium of exchange, and unit of account. Ethereum aims to be a distributed computing platform for all kinds of applications, including games, social media, and finance. In many ways, the two projects are not comparable.
Nonetheless, Ether and the myriad of tokens issued on Ethereum are considered investments by some. Thus, investors often compare the two projects and the value of their respective tokens. While Ethereum boasts greater current flexibility and a faster rate of change, Bitcoin has clearly established a superior monetary policy, true decentralization, ultimate security, and long-term scalability.
Bitcoin Monetary Policy vs. Ethereum Monetary Policy
Bitcoin is primarily a monetary innovation rather than a technological innovation. Bitcoin is the first asset in history with provable, absolute scarcity and unforgeability. Since its inception, Bitcoin’s monetary policy has never been altered, creating credibility around its long term immutability.
➤ Learn more about why Bitcoin’s hard cap cannot be altered.
Hard money is money whose supply cannot be easily, arbitrarily increased. Gold is relatively hard money because the only way to increase its supply is via costly mining. Bitcoin is absolutely hard money because its supply will never reach 21 million, making the cost of producing the 21 millionth bitcoin infinite.
Hardness is of no importance however, if the monetary policy is not sound. Sound money is money that is not susceptible to arbitrary changes in its supply. A money cannot be sound if it is governed by a centralized entity or is otherwise subject to arbitrary changes. Ether could be decreed by the developers as finite tomorrow, but at any later point, the same cabal might reverse this policy, as they have in the past.
– Ethereum Improvement Proposal 1559, which alters Ethereum’s monetary policy.
Ether’s monetary policy has been updated and revised several times over the course of its history. As of 2021, the policy is being altered once again by Ethereum Improvement Proposal 1559. These arbitrary changes make Ether’s monetary policy unsound, and undermines any possibility of Ether being absolutely scarce in the future.
Auditability
A common slogan used by the Bitcoin community is “Don’t Trust, Verify.” Bitcoin is a completely open, transparent system, and this is critical to the credibility of its monetary policy. Every single Bitcoin user can independently and objectively verify the total supply of Bitcoin and the validity of each coin by typing a single line of code on their node.
The same cannot be said for the total supply of Ether, which is calculated differently by different members of the Ethereum network. This means that even if Ether were a finite, sound money, users would have little to no ability to verify that fact. This problem is exacerbated by the fact that Ethereum nodes are difficult and expensive to run, leading to greater centralization.
Bitcoin Decentralization vs. Ethereum Decentralization
Decentralization is a critical feature of Bitcoin, and is necessary for its continued success and integrity. Bitcoin must be decentralized on several levels in order to maintain security, censorship-resistance, and its open, transparent monetary policy.
On several of these levels, Ethereum has shown itself to be more centralized than Bitcoin. This centralization has revealed itself through network downtime and arbitrary changes to the protocol.
Bitcoin Nodes vs. Ethereum Nodes
Nodes are important to Bitcoin’s decentralization for three reasons. Firstly, Bitcoin’s rules are enforced by nodes, not miners or developers, so it is important that a large number of Bitcoin nodes are operated by many parties. If one or a few entities control all or a significant majority of the nodes, they may be able to implement changes at will, degrading Bitcoin’s consensus.
Secondly, node count ensures that the Bitcoin network is available non-stop. Bitcoin has an unprecedented uptime, even when compared to the world’s largest tech companies, such as Google, Amazon, and Facebook.
Thirdly, a large number of nodes ensures that any user can broadcast their transaction and route around potential censorship. Nodes are responsible for relaying transactions to miners. If a user can only connect to malicious nodes who refuse to relay their transaction, the user will be unable to have their transaction confirmed.
For these reasons, Bitcoin’s blockchain is designed to grow at a slow, limited pace, and all changes are backwards compatible. Ensuring that any user can participate in the network using inexpensive hardware is a top priority for Bitcoin developers.
The same is not true for the Ethereum network. Ethereum nodes are more resource intensive, both in terms of memory and computation. This results in many users and services relying on third parties for access to the blockchain.
In the past, several exchanges have been forced to halt Ethereum trading or withdrawals due to a small number of nodes being offline. These events have exposed the fragility and centralization of the Ethereum network.
Bitcoin Developers vs. Ethereum Developers
Another important aspect of decentralization is that a small group of developers should not have unilateral decision-making authority over the rules and operation of the network. Bitcoin developers write the code to implement upgrades and protocol changes, but they deliberately do not push these changes on users. Instead, nodes decide whether or not to run the new updates.
The upgrade process of the Ethereum network and the enforcement of its rules is more concentrated in the hands of a few developers. Unlike Bitcoin, whose founder withdrew from the project and disappeared, Ethereum development is still led by a single individual. Centralized influence over a network is not always immediately apparent, but in times of crisis, it can become painfully obvious.
The DAO Hack
In 2016, the Decentralized Autonomous Organization (DAO), a platform built on top of Ethereum, was hacked for $60 million worth of Ether. Because the DAO’s contracts were open source, poorly built, and hosted on an open platform, the hack was entirely legal, unlike most hacks, which involve compromising the hardware of the victim. In this case, the attacker had simply taken advantage of a loophole in the smart contract.
With no legal avenue for reclaiming the funds, Ethereum’s founder proposed and implemented a hard fork despite heavy controversy and disagreement from the community. The Ethereum blockchain, which had been supposedly immutable, was rewritten to exclude the transactions which had paid out the hacker.
Arbitrarily invalidating valid blocks and rewriting the history violates the primary rule of a blockchain: the chain with the most work is the valid chain. For this reason, many Ethereum users were outraged by the hard fork and rejected it. These users supported the legitimate Ethereum chain, now called Ethereum Classic, while most users followed the hard fork.
Bitcoin Scalability vs. Ethereum Scalability
Scalability is a well-known obstacle for all blockchain-based projects. In order to successfully establish security, immutability, and decentralization, blockchains are slow and can process a limited number of transactions per second.
There are several responses to this problem. Some dismiss blockchains as entirely unworkable. Others claim that blockchain technology can be made more scalable through technical improvements. Finally, some plan to scale using layers on top of the base blockchain.
While Ethereum and several forks of Bitcoin have attempted to scale the blockchain itself, Bitcoin is scaling off-chain by using layers such as the Lightning Network and the Liquid Network.
Scaling on the blockchain is a poor decision for two reasons. Firstly, it greatly increases the resource costs of running a full node. The size of the Ethereum blockchain is larger and is growing faster than Bitcoin’s blockchain. This already makes running an Ethereum full node prohibitively difficult for the average user.
Secondly, by enabling Turing complete smart contracts to be executed on the blockchain, Ethereum encouraged a large number of other tokens to be issued on its blockchain. This design creates a tragedy of the commons: Every new decentralized app launched on the Ethereum blockchain increases the burden on the nodes.
If Ethereum is to be the distributed computing platform of the future, it must allow the thousands of decentralized applications to operate without competing for Ethereum compute power and sustained high fees.
Bitcoin’s layered scaling approach allows the exact same apps to be built on Bitcoin without consuming the limited space on the Bitcoin blockchain. This separation allows a greater range of economic activity, including any variety of smart contracts, but without placing the computational burden on all Bitcoin nodes.
Bitcoin Flexibility vs. Ethereum Flexibility
Ethereum advocates often cite the greater number of “decentralized finance” projects being built on top of Ethereum as a reason Ether will overtake Bitcoin. Indeed, Ethereum has made it easier to launch new tokens and applications directly on the blockchain. For several reasons, this will not likely increase the long term value proposition for Ether.
Hundreds if not thousands of different tokens have been launched on Ethereum. These tokens are not launched and maintained with the high level of forethought and caution given to Bitcoin development, and a large number of them have been exploited, leading to financial loss for investors. Even more have simply collapsed in value after a speculative bubble burst. The constant cycle of new projects, exploits, and collapses is damaging to the overall reputation and reliability of Ethereum and decentralized finance.
Additionally, most new projects on Ethereum launch their own new token. The proliferation of new tokens has prevented network effects from growing, spawning a large number of illiquid tokens. Novel and complex smart contracts are not useful in an unstable and illiquid environment.
Proof-of-Work vs. Proof-of-Stake
Ethereum’s failure to scale is a well-established fact within the developer community. This much was admitted by the Ethereum Foundation and Consensys, a company dedicated to building on Ethereum and funding its development. For this reason, Ethereum 2.0 was announced and built as the scalable version of Ethereum. The new version will transition Ethereum away from Proof-of-Work towards Proof-of-Stake, an alternative solution to the Byzantine Generals Problem.
➤ Learn more about Proof-of-Work vs. Proof-of-Stake.
Notice: River does not provide investment, financial, tax, or legal advice. The information provided is general and illustrative in nature and therefore is not intended to provide, and should not be relied on for, tax advice. We encourage you to consult the appropriate tax professional to understand your personal tax circumstances.Key Takeaways
- Bitcoin is decentralized, peer-to-peer sound money.
- Ethereum aims to be a distributed world computer hosting a wide variety of economic activity all on a single blockchain.
- The Bitcoin blockchain is intended as a settlement layer while scaling solutions are built atop the blockchain.
- Ethereum suffers from centralization and uncertain monetary policy, which will prevent it from becoming money.
