The reason why we're covering Litecoin vs. Bitcoin in this piece is because it appears that there is a similar phenomenon occurring between the two as what we witnessed at some points in 2017
Specifically, it appears that Litecoin is what economists would refer to as a substitute good for Bitcoin, and based on what we know about Bitcoin, it should be no surprise that Litecoin has and will continue to reap some major rewards for us.
Quick Review on Substitute Goods: "A substitute, or substitutable good, in economics and consumer theory is a product or service that consumers see as essentially the same or similar-enough to another product. Put simply, a substitute is a good that can be used in place of another." (Per Investopedia)
In a nutshell, a substitute good refers to an instance where increasing the price of one good drives up the demand for another.
Quick example here - Bob owns a shoe store that only sells Nike and Adidas shoes. Customers buy either brand of shoe at the same frequency (50/50 they pick either). However, due to a recent price hike, Bob was forced to charge double the normal price of the Nike shoe. The end result was that customers began buying Adidas at a much greater rate than before.
In that scenario, the Adidas would be considered the substitute good.
How is Litecoin a Substitute Good For Bitcoin?
To understand how Litecoin can be a substitute good for Bitcoin, we need to at least have some understanding for why there would ever be a substitute good for Bitcoin to begin with.
Litecoin Began as a Literal Clone of Bitcoin
In every facet and sense of the word, 'clone', except for a few key differences:
- The block time shorter for Litecoin (2.5 minutes) than it is for Bitcoin (10 minutes). This is a critical difference for reasons we'll get into further down.
- Litecoin uses Scrypt as its mining algorithm instead of SHA256.
- There will be 84 million (x2) total litecoins created vs. approximately 21 million total bitcoins
Apart from that, there are no other major differences between Litecoin and Bitcoin, which means that everything else is virtually the same.
That includes wallet generation, the 'Proof of Work' concept, the UTXO-based transaction model, HD wallet generation. Nearly all of the commits made on the Bitcoin main code are subsequently merged into Litecoin's codebase as well, including major ones like the "soft fork" that brought SegWit to the network a good link to read for more information on soft / hard forks, consensus and other related Bitcoin concepts can be found here.
Getting to the Point
Despite the fact that the two protocols are so vastly similar, the few tweaks that Charlie Lee (the project's creator) did make have had a significant impact on Litecoin's ecosystem...for the better.
In fact, in many ways, Litecoin operates in a manner akin to how most probably envisioned their experience with Bitcoin would be.
Unfortunately, that imagined reality (buffered by the exuberant, hyperbolic statements about Bitcoin's capabilities), sets users up for the frustration and disappointment that they were forced to come to grips with back in 2017 when Bitcoin was at its height.
The primary reason for this were the exorbitant fees being charged on the protocol at the time (and even then, users still sometimes found themselves waiting for a substantial period of time for their transactions to 'confirm').
Evaluating Bitcoin's Fees
This part was simply inevitable and, until addressed in a direct and comprehensive manner that effectively "solves" this issue, Bitcoin's ceiling as a technology will always be exponentially lower than it otherwise could or should be because it simply won't be a currency that can be viably used.
Yes, what you're reading above is correct. The median transaction fee on November 2nd, 2020 was a resounding $13 / TX.
The 'bottom 10th percentile' (shown in the graphic above), tells us that in the best case scenario, the fee one had to pay in order to have their TX confirmed was $3.80 / TX.
To say that these fees are prohibitively expensive for most users would be an understatement.
A System That Exclusively Benefits Wealthier Traders
Despite the seemingly egalitarian principles espoused by many in the 'crypto community' on social media and elsewhere - the reality of things appears to be substantially different than advertised.
Doing the Math
Going back to the fees for a moment, there are a few unstated truths that will always lead to a system where only the wealthiest users are able to transact back and forth with one another.
Understanding the Purpose of the Fee Model
Fees are required in order to send any funds on the Bitcoin blockchain (assuming that this s the end goal - which it must be for the time being).
- That means that TXs cannot be sent over the network at no cost. However, this is a desirable trait
- What this means is that users could 'bog down' the network by merely spamming it with tens of millions of transactions. Miners, having no way to prioritize between each transaction would be faced a task that's more difficult than the Proof of Work itself - and that would be keeping up with the influx of said transactions.
- Thus, Satoshi instituted a 'fee' mechanism, where a user must submit some lower-bounded threshold amount before their transactions are to be considered 'legitimate' by the protocol (and not dust).
In addition to #3, Satoshi also instantiated this new feature for Bitcoin in the hopes of creating another 'free market' by which users would be able to pay miners extra to be included ASAP (in the next block).
Brief Look Back at the Bitcoin Whitepaper
Below is an excerpt from the Bitcoin whitepaper (no reference needed, you know where to find this):
The most relevant sections are highlighted above.
How This System Has Transformed into One That Inherently Favors the Wealthy
Simply put, this is the result of two different factors:
Fees are determined by the amount of "space" available in the next immediate block. Since blocks on the Bitcoin protocol are capped at 1 MB and they occur, on average, once every 10 minutes.
Regardless of how large a transaction (in terms of financial value) is, its actual weight remains unaffected (by this factor alone).
This Makes Bitcoin Feasible as a Novelty but Far From Practical
At $13/TX (at the median), Bitcoin cannot realistically be something that users would ever adopt on a widespread level because of this.
Not to mention that the variance in the targeted block time (10 minute - going by Poisson's distribution) makes it worth asking whether the targeting algorithm for Bitcoin is entirely accurate.
This part is never easy, nor is it fun - but we will be back to pick up this portion of the segment very soon.