First- and second-generation cryptocurrencies (like Bitcoin and Ether) invented the technology. That was a great feat. The developers decided to have a 100% trustless system. Like every new technology, the trustless network is an experiment. By 2019, it has become apparent that this design comes with a high price:
- transaction fees
- still a few threatening attack vectors
- still one central ledger, although decentralised
- inefficient expensive operation with limited scalability
- unbalanced incentives leading to unequal power and abuse
While so-called third generation cryptos (EOS, NEO, etc.) try to improve governance and scalability, they still have the above flaws to a greater or lesser extent. Pacio proposes a fourth generation: Trustless where needed, trust-based where it is the cheaper and safer option, and with no scalability limits. This document is a proposal for this ideal.
Leaks in existing cryptocurrencies
“Leaks” are losses due to fees, friction, speculation, volatility or attacks.
Transaction fees
Older currencies like Bitcoin and Ether have transaction fees, therefore leaks. The recipient receives less than the sender has sent. When network use is low, fees are usually low as well. But the fees can cripple the network when bandwidth use (volume of transactions) is high [6]. There are a number of newer currencies that claim to be zero fee (such as EOS). However, closer inspection reveals that there are always indirect costs. That makes sense: if there is a middleman managing the network, his expenses must be paid. In Bitcoin and Ether it is the miners, in proof of stake coins, it is the stake holders. These network managers control the price. When usage is high they increase prices, holding the users for ransom. Thus, the system is not balanced.
Developers business model
In general, crypto users also pay the developers and their investors, depending on what business model they opt to choose: an ICO, fees or price appreciation of underlying tokens. If providing the network is the only business model, the creator has to profit from its use. After an ICO, the project usually holds up to 50% of the tokens, thus immediately halving the value for buyers. That is a massive leak.
Exchange Fees
There is at least one exchange fee that must be paid: from fiat to crypto and then back again from crypto to fiat.
Price appreciation / artificial scarcity
Many economic systems that are based on assets work with a balance of supply and demand. Two of the main uses for such systems are means of transfer and store of value [7]. With store of value, it is in the interest of users that demand always outweighs supply: if this is the case, the price of the asset will rise. Participants will take steps towards the ideal outcome by either increasing demand or reducing supply. An economic system that is primarily used for means of transfer desires a stable asset that makes transactions predictable. Network managers will manage the circulation of the assets (amount of money) to keep a balance. This distinction makes physical assets such as gold or commodities a reasonable means for storing value and fiat money a reasonable means of transfer.
Most cryptocurrencies were designed as means of transfer but are treated as a store of value by the network managers. In most cases, the two use cases are incompatible. When the store of value users (for instance speculators) have greater power than the transactional users (for instance for remittance), then the system can no longer be used efficiently as a means of transfer.
Take EOS for example: it considers itself a blockchain economy that can be used for transactions. While transactions in EOS are “free”, you have to stake currency to access the network. The currency staked must correspond with bandwidth (i.e. volume of transactions * transaction size). With growing use, more coins need to be staked, reducing the circulating supply. When demand keeps up and currency becomes scarce, the price rises, which is not in the interest of application users who want stable prices. Most cryptocurrencies suffer from this incompatibly, even if they differ from EOS in the details.
Cost of volatility
Volatility arises to a great extend from the imbalance of incentives and interests. Bitcoin is a good example. Network managers have the incentive for prices to rise so that they receive more money for their services. This price expectancy brings in speculators. They can benefit from either rising or falling prices. They gain from volatility. This process changed the use case for Bitcoin. It started out as money and has now become “gold” or a penny stock. Users forced to use Bitcoin as means of transfer, e.g. people in Venezuela, would prefer a system with greater stability.
[6] In December 2017, a Bitcoin transaction cost a minimum of $35, even to send just $1 in Bitcoin. Even with these high fees for transactions, they took many hours due to network congestion.
[7] In addition to the often theoretically used unit of account
