This weekend Dogecoin is celebrating it came into existence three months ago; a good moment to assess what it brought to the world of digital currencies. How does it contribute to the global adaptation of cryptocurrencies? What makes it different from Bitcoin, which just got slammed by the famous Economist Nouriel Roubini?
In essence, Dogecoin is a cryptocurrency like any other. It is in fact a fork of the Litecoin project. Cryptocurrencies seek to create a decentralized and secure economy with restricted inflation. The latter is achieved by defining this in the code upfront. Another big advantage should be the possibility to transfer funds to anywhere in the world at low costs and high speed.
A cryptocurrency network is maintained by its users. Transactions are validated by so-called “miners”, who have to solve computational puzzles to this purpose. The security of the network is determined by the total computational power in it. For their effort, the miners receive new coins and transaction fees. A difference between Bitcoin and Dogecoin is that the latter will perpetually release a fixed amount of new coins to its miners, on top of those already in circulation. There will be about five billion new Dogecoins annually. This form of fixed inflation is also referred to as “Dogeflation” by Dogecoin’s co-founder. Dogecoin isn’t the first digital currency with inflationary properties, but without a doubt the most popular one. Bitcoin on the other hand reaches a hard cap of 21 million coins in 2040. By the time the release of new Bitcoins will stop, the transactions fees will have to be enough to support the network.
A big problem for Bitcoin, however, is that a fixed supply means that, like gold, its perceived value will keep on increasing. This is a nice property for those who want to do nothing more than making a large profit by holding money. But people tend to be reluctant to spend money that will be worth more in a certain amount of time. This will put pressure on the number of transactions done in Bitcoin. A good example of this is Japan, where the Yen experienced deflation for many years, hurting the economy. But unlike Japan, Bitcoin cannot solve this problem. A recent study showed that a significant number of Bitcoins has never changed hands. This is unlikely to change as by design Bitcoin will encourage people to just hold the digital currency rather than spend it, and might push up transaction fees relative to other digital currencies. Even worse is that it will keep price volatility high, as a fixed supply won’t be able to adjust for demand.
Unlike gold, Bitcoin isn’t backed by any real asset. Roubini referred to this as well: “Bitcoin isn’t a store of value as little wealth is in Bitcoin and no assets in it.” If transactions fees were to increase, the switch to a new coin is easily made. A new cryptocurrency that releases tons of new coins will always have an advantage over one that can only fund itself with transaction fees. By perpetually releasing new coins annually, Dogecoin made itself more sustainable in the long run. This flexibility should have a stabilizing effect on the value of the currency, while continuing to provide a good reward to its miners. This stability is considered crucial for being viable as a currency. This was emphasized by Roubini: “given price volatility it [Bitcoin] is a lousy store of value.” On the other hand, Dogecoin isn’t backed by any real asset either. It is also to be found out if the inflation in Dogecoin is enough to actually stabilize it. But on the whole, Dogecoin is a big step in the right direction.