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  • Julie McKenna

Why Investors Should Look Beyond Bitcoin - Blockchain Basics for RIAs

Updated: Oct 3

In the realm of cryptocurrency and blockchain technology, Bitcoin is undoubtedly the cornerstone upon which this innovative ecosystem was built. As traditional investors contemplate their entry into the digital asset space, particularly with the advent of a potential Bitcoin exchange-traded fund (ETF), it's worth examining the motivations behind their choices. It becomes evident that, for most, Bitcoin stands as the primary gateway into this emerging realm of technology and finance. Is this due to Bitcoin's status as the first and largest cryptocurrency by market capitalization? Or is it because Bitcoin is perceived as the most established and trusted blockchain? While Bitcoin has its merits, it's essential to question whether investors are diving into this complex world without a full understanding of its intricacies or are merely following the crowd in pursuit of a piece of the blockchain pie.

Understanding Bitcoin's Technological Foundations

Before delving into Bitcoin's shortcomings, it's vital to acknowledge its pivotal role in the history of blockchain. As the pioneer, Bitcoin paved the way for countless blockchain innovations. Nevertheless, being the first of its kind comes with certain limitations. Just as technology continually evolves and improves, so does blockchain. While Bitcoin laid the groundwork for this technology, its original design has constraints that newer blockchains aim to overcome.

  1. Proof of Work (PoW) Energy Consumption: Bitcoin's PoW consensus mechanism[1] demands an enormous amount of computational power, which translates to a significant energy footprint. This has led to legitimate environmental concerns, as the energy consumption of Bitcoin annually is more than the entire country of Argentina.

  2. Mining Centralization and Miner Pools: Over time, Bitcoin Mining[2] has gravitated towards centralization. Large mining pools, where numerous miners combine their computational resources, dominate a substantial portion of the network. This centralization raises concerns about the potential concentration of power and control. Over 50% of the total Hashrate of bitcoin is controlled by just two mining pools.

  3. Halving and Reduced Block Rewards: Bitcoin experiences a "halving" event[3] approximately every four years, reducing the number of new bitcoins generated as block rewards. This diminishing reward poses challenges to smaller miners, potentially impacting the network's decentralization.

  4. Scalability Issues: Bitcoin's initial design imposes limitations on its transaction processing capacity.[4] This constraint results in network congestion[5] during periods of high demand, leading to slower confirmation times and higher transaction fees.

  5. Lack of Smart Contract Support: Bitcoin was initially conceived as a straightforward transaction ledger, primarily for peer-to-peer digital currency transactions. Unlike some other blockchain platforms, it lacks native support for complex smart contracts—self-executing agreements defined by code that offer a broader range of possibilities. In contrast, these platforms have evolved to accommodate more intricate database accounts and ledgers, expanding their capabilities to encompass a wider array of applications and functionalities.

  6. Long Confirmation Times: Bitcoin transactions can take a significant amount of time to be confirmed, especially during network congestion. This delay can be inconvenient for users requiring speedy transactions.

Bitcoin remains a significant and influential force in the blockchain landscape. However, it's essential to recognize its limitations and the ever-evolving nature of blockchain technology. Newer blockchains have emerged to address some of these shortcomings, offering enhanced features and capabilities. For investors looking to explore the full potential of blockchain, it's crucial to go beyond Bitcoin and delve into the rich diversity of blockchain projects. By doing so, investors can make informed decisions that align with their objectives while navigating the dynamic world of blockchain innovation.

Footnotes: [1] In blockchain, a consensus mechanism, such as Proof of Work (PoW), defines how a network of computers agrees on valid transactions, ensuring security and integrity. PoW, for example, is a specific mechanism where nodes compete to solve complex puzzles, confirming transactions and adding them to the blockchain while earning rewards. This process maintains the ledger's trustworthiness. [2] Mining refers to the process of validating and adding transactions to the blockchain while also earning rewards in the form of new cryptocurrency coins. [3] Halving events in Bitcoin reduce the number of new bitcoins rewarded to miners, occurring approximately every four years as part of the Bitcoin protocol. [4] Scalability issues in Bitcoin refer to limitations in its ability to handle a high volume of transactions quickly and efficiently. [5] Network congestion occurs when there are too many transactions being processed on the Bitcoin network, leading to delays and higher fees.

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