After the ETF: ​​Bitcoin’s Coming Power Struggle

• Last week's spot ETF approvals means giant institutions like BlackRock and Goldman Sachs are entering the bitcoin market.
• Wall Street could privilege Bitcoin that's mined with green energy or that provably untouched by nefarious activity.
• That could set off a struggle for Bitcoin's future akin to the acrimonious "Blocksize Wars" starting in 2017.

A sizable crypto community’s presence at the World Economic Forum in Switzerland this week highlights an inherent tension: on the one hand, the industry’s desire for acceptance by the business establishment and, on the other, a concern that engaging with it could undermine crypto’s disruptive, rebellious ethos.

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With 2024 shaping up to be the year that traditional finance (TradFi) arrives, that tension seems especially acute. After all, the U.S. Securities and Exchange Commission’s long-awaited approval of bitcoin exchange-traded funds (ETFs) sets the stage for giant asset managers such as BlackRock and Fidelity, and for massive banks like Goldman Sachs and JPMorgan, to participate in the bitcoin market.

The question is: will these institutions’ participation affect the power dynamics within Bitcoin itself. Will “Bitcoin maxis” and “degens,” who place a high value on censorship resistance and decentralization, see their influence over Bitcoin diminish as these large regulated entities start to engage?

Might BlackRock, Goldman or JPMorgan, for example, insist only on buying coins mined with renewable energy, or that are “clean” of any past connection to non-identified actors? Would their demand for bitcoin be so substantial that such policies would materially change the behavior of others, such as miners, so as to change the very makeup of Bitcoin itself?

It’s too early to say. While that might be a frustrating answer, the lack of predictability around that question stems from the complex power dynamics within Bitcoin’s very decentralized, diverse ecosystem. That complexity is part of Bitcoin’s appeal and, in the long run, leads me to believe these Wall Street titans will be unable to alter it significantly.

The New York Agreement precedent

A reference point for this was the outcome of the so-called “Block Size Wars” in 2017.

At that time, 58 crypto businesses lobbied to support a proposed “hard fork” upgrade in Bitcoin’s Core code that would increase the amount of memory for each block. The so-called New York Agreement was intended to reduce logjams on the network, allowing those businesses to process more transactions and so earn more fees. After a number of mining pools said they supported an increase, many thought the increase was a fait accompli, as the miners, in choosing which blocks to mine were kingmakers in determining whether a new version of the software would be adopted.

But a core group of developers and users argued against increasing the block size beyond the existing 2MB capacity on the grounds that data storage costs would rise for anyone running a node to validate the blockchain. That, ultimately, would squeeze out smaller participants, leading to a more centralized network, they said.

Instead, they advocated for a modification known as Segregated Witness, or SegWit, to lower the data needs for each transaction, while also enabling layer 2 solutions such as the Lightning Network to process transactions off-chain and minimize on-chain fees. They launched a so-called User Activated Soft Fork (UASF), in which anyone who opposed the block size increase would boycott accepting any coins mined by miners that were supporting it.

In the end, the UASF rebels won. It was celebrated as a victory for the little guy, for the idea that users, the ultimate beneficiaries of the Bitcoin network, had real, effective power, since it was their end-demand for tokens that would drive market-led decisions.

New whales

One reason to question whether the “little guys” can continue to dictate Bitcoin’s direction is that the post-ETF newcomers will likely own a very large chunk of it.

A number of analysts estimate that the demand for bitcoin ETFs could run as high as $100 billion. If so, that would represent about an eighth of the total market cap, which was just above $800 billion at the time of writing.

So, very big, but not totally dominant.

But let’s now adjust for so-called dormant coins. It’s reasonable to assume that a decent number of bitcoins that have not moved out of their current address for more than five years won’t ever be moved – either because they are controlled by diehard HODLers or because their owners have lost the private keys. Those coins – currently representing around 30% of the total market cap, according to Glassnode – cannot be treated as an exact proxy for “dead coins,” but should be taken into account when estimating the size of the active Bitcoin ecosystem.

So now, we have $100 billion worth of ETF demand at 17% of the “active” bitcoin market of around $581 billion. That’s starting to look like these institutions could have real clout. A 2017-like UASF might be harder to pull off if such heavy-hitters can put their foot on the scale.

And yet, Wall Street won’t be the only giant holder of bitcoin. There are currently around 1,500 so-called “whale” addresses holding more than 1,000 bitcoin each, together controlling around 40% of the total bitcoin supply. Many of those are true believers who’ve “HODLed” for years. They can move coins among themselves, or among their own self-owned addresses, and in doing so make demands of miners and other participants in similar ways to the UASF rebels. The Bitcoin OGs still have clout.

One thing’s for certain, if a battle for Bitcoin’s soul emerges, it will be extremely hard fought, as the Blocksize Wars were hard fought.