“A natural monopoly is a market in which production is most efficient with a single producer.”
This sentence is inherently false. Many markets could be most efficient with a single producer from a production perspective (Cars, mobiles, TVs, etc). But many of these markets are not, due to humans acting within their knowledge bounds to provide products which customers will desire, or miscalculating demand for their product enabling the potential of a competitor to enter the market and fill the demand gap. Therefore, a comparison of both competitive markets and naturally monopolistic markets is required in order to determine the cause of natural monopolies.
Cars are an example of a competitive market. Cars on the road today all comply with the general protocol requirements in order to be a car. They usually have 4 wheels, a steering wheel, brakes, etc. This means that their operational usage / product viability is not heavily dependent on network effect. A driver can go from driving a Toyota Camry to driving a Holden Commodore and only have to adjust to some minor differences (Like accidentally engaging your windscreen wipers to indicate turning a corner).
Contrast this relatively competitive market to a highly monopolised market like desktop operating systems. Operating systems enable people to run software designed for that operating system. That software enables people to communicate information in different ways (Spreadsheets, Web browsers, etc) or to be entertained (Computer games). Much of this software market is designed to work on a single protocol (Microsoft Windows), and for a user to relearn how to use the basic interface, it can be daunting. Because much of the utility of this software is dependent on network effect (For example, if you want to play a certain game but it only works on Microsoft Windows), this keeps the market highly monopolised. Additionally, the monopoly can sign agreements with OEMs, coercing more market participants to use their product.
Microsoft’s competitors can then create software which enables Microsoft’s formats and protocols to be compatible with their competitor operating system (For example, the WINE project or a word processor which is compatible with the Microsoft Word format due to the works of reverse engineering). This can significantly lower the network effect barrier, but it’s still an order of magnitude more difficult to both design and then to convince others to actually purchase the alternative at little benefit to their everyday lives.
Therefore, natural monopolies occur when the utility of the product is most highly dependent on network effect. Natural monopolies do not occur simply because production could be most efficient with a single producer. Another interesting observation is that competitive markets only occur on top of a protocol (Which can alternatively be described as ‘language’ or the market good with high network effect). See the picture below for some real world examples:
“Back in August 2014, I discovered that the bitcoin mining industry had the industrial structure of a natural monopoly.”
Since I have already demonstrated that the article’s underlying premise of what causes a natural monopoly is false, I will instead demonstrate how the Bitcoin mining industry is not a natural monopoly under the actual criteria of its true cause, high network effect.
If a miner expends resources to mine, they require profits to outweigh their expenditure through a reduction in time preference. In other words, they must spend now in the hope of profiting later. If another miner enters the market, transaction fees are divided among the new total of miners. Additionally, the blocks are mined slightly quicker which results in a temporary increase to the block reward divided among the total miners. However, this side effect is quickly cancelled out once the 2016 block reward difficulty adjustment kicks in (Occurring roughly every 2 weeks) guaranteeing that only 21 million bitcoins will ever be mined by the year 2140.
For any given miner the cost of the reduction in time preference may outweigh their views as to what is sustainable (Or their endeavour could have been rendered permanently unsustainable), and they may therefore exit the market. However, there is nothing to stop another market participant entering the mining market with large enough capital, mining rigs of higher efficiency and/or ‘low enough’ time preference as to sustain themselves.
Therefore the entrance of a miner ‘slices the pie’ of the market, while the entrance of a participant on Facebook primarily increases utility. Another way of saying this is that the dominant function of miners is to compete on gaining capital at the expense of others, while the dominant function of Facebook participants is to expend resources to the benefit of everyone including themselves. Therefore Bitcoin mining is a competitive industry under natural circumstance, while money* and communications are examples of natural monopolies.
* Note: Not to be confused with the current day national currencies which superficially compete through monopoly of violence enforcing market conditions (Unnatural monopoly per State).
“The second is that in markets with zero regulatory entry barriers, an inferior product cannot survive long-term.”
That is correct. However I would point out that this argument is in conflict with the Professor’s earlier argument that a ‘natural monopoly is a market in which production is most efficient with a single producer’. Clearly with this sentence he recognises that if a producer was able to produce the most units most efficiently, it has no correlation as to whether the market even wants that product.
“There is also the argument that the price of bitcoin must go to zero because an inferior product cannot survive long-term in the absence of regulatory barriers to entry.
Imagine you have a market with no entry barriers. The first firm to enter the market has 100 percent of the market share, as bitcoin once did. Competitors then come along and make inroads into the market.
Some of these offer products that are superior to the product produced by the first firm, not least because their producers have learned from some of the design flaws in the first firm’s product.”
This is a common error among people who are illiterate on the subjects of basic monetary economics, human action and computer science. Bitcoin is not competing with the buzzword social signalling pump & dump altcoins and ICOs. Many of these products boast to have faster base layer transaction speeds / bigger blocks (Directly sacrificing decentralisation), hard fork every other month (Proving that they’re centralised) and/or are pre-mined by the ‘developers’ (Or more accurately stated, are a rent seeking scheme for script kiddies to live off a bunch of gullible speculators).
In order for a good to become money it must first start as a collectable, become a store of value and then become a common unit of account enabling everyday medium of exchange. In other words, monetary goods initially compete on distribution, calcification and wealth protection enabling building of capital. Harder forms of money may even possess micro-deflationary attributes, further encouraging people to build their wealth by storing their value in it.
The nature of money is therefore as such that not only does it possess high network effect attributes, but unlike other high network effect goods (240VAC Power Outlet, Roads, etc) humans are driven towards methods to protect their own life and build their own wealth. Human action therefore makes money the good with the highest network effect attribute compared to all other goods.
Bitcoin takes this calcification and hard money attribute one step further on a philosophical level unintelligible to today’s mainstream economists. Bitcoin chooses openly verifiable mathematics and market consensus to be in charge of the money supply, rather than fallible human central authority. This is purely a philosophical and principled argument against all other forms of money pre-Bitcoin.
Therefore Bitcoin is far superior than any of these products released after its creation due to far better market distribution, extreme simplicity at the base layer enabling high decentralisation, calcification and hard money micro-deflationary incentives.
“according to CoinMarketCap, Bitcoin’s share of the cryptocurrency market had fallen to 94.29 percent by April 28, 2013 (the first date for which they provide data) to 52.29 percent by today.”
CoinMarketCap is an extremely flawed metric. For example, I could create a cryptocurrency right now and premine 99.999999999999999999999% of it for myself. When the product is introduced onto the exchange, my ‘Market Cap’ could be something like 4,000 times larger than the GDP of the United States. Any Economics Professor that deals in real economics (That is, the study of humans acting within a market) should have realised this.
A superior alternative to Market Cap is the Buy Support metric. One website which attempts to measure cryptocurrencies by this metric is: https://coinmarketbook.cc/. Measuring buy support enables comparing ‘skin in the game’ rather than fluff / fraud. To ensure that fake buy order fluff is kept to a minimum, the site measures only the sum of buy orders at 10% distance from the highest bid price. Additionally, percentages are calculated out of Bitcoin’s total buy order percentage.
“The innovators — the early movers in a market — rarely survive long-term under conditions of free entry. An example is the Ford Model T. This automobile was first produced in 1908 and soon came to dominate the market. But competitors learned from its design flaws and built better cars, which eventually stole its market share. The Ford Model T now survives only as an antique.”
A Model T Ford is an example of a low network effect good. Market participants simply chose better products because switching to those better products did not result in a destruction of the ‘car’ network effect. Different types of roads didn’t need to be built and the same fuel could be used. Car mechanics may have needed to stock up on certain special parts if they didn’t hold them, meaning that network effect requirements were low, but not zero. If a new market participant had a choice to purchase the improved car or the Model T, their decision would be little impacted by the fact that other market participants were using one or the other.
In conclusion, the author shows little knowledge in the fields of monetary economics and network effect. Natural monopolies occur because the nature of the good gives rise to greater utility with more users, while production efficiency is secondary to this attribute. Competitive markets occur when the properties of the good do not require other participants to be using the same good for an increase in utility and occur on top of a protocol (Roads, Internet Protocol, etc). The Professor's premise for the entire article is therefore flawed but a worthwhile read to demonstrate the lack of intellectual critique in mainstream economics.
