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Advisory Board Meeting Q1

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Ronald Stöferle 

Hi and thanks for joining. To give you some background on our company; Incrementum was founded in 2013 in Liechtenstein and we’re currently managing five investment funds. We’ve also got a wealth management department which is led by our CEO, Stefan Kremeth, and we also have a research department that produces the “In Gold We Trust report”, which is well known all over the globe. Similar to the approach of the In Gold We Trust report, we launched the first edition of the crypto research report in December.

We’re truly looking forward to this discussion. We like to think out of the box and we are very open to the crypto space, especially since we believe in the free markets and  competing currencies.

Mark Valek 

I think we are covering two very emotional topics, gold and cryptocurrencies. Sometimes you have different opinions between people who like gold and people who like cryptos. I believe we are at the intersection. We are not only open-minded towards crypto, but we actively embrace it because it’s a huge influence on monetary affairs. If you close your eyes to the developments in the crypto scene, you won’t get the big picture. Crypto is now a part of the investment ecosystem and it will stay a part going forward.

Demelza Hays 

Wonderful. I think we should allow each of our advisers to briefly introduce themselves and explain which company they represent and how they became interested in cryptocurrencies. Stefan, why don’t you start?

Stefan Wieler 

I’m currently director of the Board of Goldmoney, former BitGold. We used to be primarily a precious metal custodian and we have a platform which allows customers to open an account the same way you would open a PayPal account and then purchase precious metals, primarily gold, but also silver, platinum and palladium, in a very efficient and cost effective way. Basically, we are a custodian and we provide a platform for you to trade. But there is no third-party risk with us because the metal is held on customer accounts. I would say the unique feature of what we offer is that you can pay using your precious metals, i.e. you can transfer within the network. You can pay via a MasterCard, et cetera, and the end goal is that you can pay everywhere with the gold directly, therefore we allow merchants to accept precious metals as a form of payment.

For context I’ll give you a bit of background on Goldmoney. The company was founded about 17 years ago by James Turk, and in the beginning they only offered custodial services. In 2014 Joshua Crump and Roy Sebag founded a company called Bitgold that developed the platform that allows Goldmoney’s current payment feature. That company did an IPO in 2015 and I was a Series A investor. I was still working for an energy hedge fund; I’ve been a commodity analyst for all my life, mostly on energy.

Shortly after the IPO, Bitgoldpurchased Goldmoney, merged the two companies and called it BitGold. From the start BitGold accepted cryptocurrencies as a form of funding your account. Clients would send us Bitcoin and Ethereum and we would sell those right away on an exchange and purchase metal for the client. And recently we started offering cryptocurrency storage on the platform. Right now we offer cold storage the same vaults we store metal and our customers seem to love it. Consequently, in the last seven weeks of 2017 we had about $22 million worth of sales. At the moment we only do Bitcoin and Ethereum, but this will change.

We are also working on a custody solution for institutional investors called Blockvault. The product allows for a full audit with an external audit company like we currently do for gold and other precious metals. For example, KPMG will be able to count the inventory of a client’s cryptocurrencies without being able to read the key, which is essential. We can store it in the same vaults we store precious metals and it will be fully insured. We should be ready by the end of the second quarter 2018 to launch this service. I’m a director on the Board of BlockVault.

Demelza Hays

Thank you. It’s interesting to hear that there are institutional grade vaults coming now for cryptocurrencies. That is really a unique selling point.

Stefan Wieler 

We are not the first to offer cold storage in a vault in Switzerland. There are other companies that are doing that in Zug. But those companies simply put a server in a vault and if your cryptocurrency is on that you can’t audit it. It’s like a memory stick. What we are working on is a way that an external auditor can audit the entire inventory. That’s the only way you can get insurance.

Demelza Hays

Let’s move on to Oliver; would you kindly introduce yourself?

Oliver Völkel 

My partner and I, Arthur Stadler, have a law firm in Vienna. We specialize in cryptocurrency and blockchain technology related fields of law. My background is banking, finance, capital markets law and I’ve done a little transaction work in the past. Somehow cryptocurrency related law fits nicely into the spectrum of legal fields that I have dealt with in the past. We are advising a big number of Austrian and international clients, and also banks, on cryptocurrency related matters. I can’t tell you much about our clients, but by way of example we have helped with initial coin offerings in Austria to establish it as a new form of financing.

Demelza Hays

Wonderful. I think it is public knowledge that you helped the first Austrian ICO HERO, isn’t that correct?

Oliver Völkel 

Yes, that’s correct.

Demelza Hays

How much did they raise?

Oliver Völkel 

They raised about US$2 million.

Demelza Hays

Okay, wonderful. I guess there are more projects in the pipeline?

Oliver Völkel

Correct. In fact there are huge projects in the pipeline from internationally well-known corporates and firms who are acting on the global stage. Very soon we will announce a new ICO that we are doing for an internationally known television company. This seems to be a new way to raise funds.

Demelza Hays

Wonderful. Thank you so much for taking time to join us today, Oliver. To conclude, Max, would you like to introduce yourself?

Max Tertinegg: 

Yes, sure. We started our company Coinfinity in 2014 and personally I’ve been involved in the crypto space since early 2011. Consequently, I’ve seen a couple of highs and lows in the crypto scene. Our company is a crypto coin broker with different sales channels. We started with the first Austrian Bitcoin ATM in our office in Graz and then expanded to around 30 ATMs all across Austria. We have a voucher project which is called Bitcoinbon where you can buy Bitcoin vouchers at about 5,000 points of sale in Austria. We have a web platform with a few tens of thousands of users where you can buy and sell cryptos. In 2018 we are focusing on developing a private banking department for high net worth individuals because we see a lot of demand for this service.

Demelza Hays

Excellent. Bitcoin Swiss, which is a brokerage in Switzerland, began with ATMs, and I found it surprising that they are applying for a bank license now in Switzerland but at the same time they sold their ATM network. I always thought it would be cool if I could have a crypto bank account and then go to a Bitcoin ATM and withdraw from my account directly. But that doesn’t exist quite yet.

Max Tertinegg:

Yes, and also just to add a note to this. There is a big problem with Bitcoin ATMs regarding banks and co-operations with banks, because banks just hate cash because cash is the tool for money laundering. Therefore, if you have cash coming in or going out of your crypto business it’s really hard to do co-operations with banks. This might be a reason why they sold the crypto ATM network.

Mark Valek: 

Are you guys applying for a bank license?

Max Tertinegg:

No, not yet, but just today I talked to Oliver about maybe getting a Zahlungsdienstleisterlizenz for Austria to do some payment processing, but not for a banking licence, not yet.

Demelza Hays

Very good. Thank you so much to all of our advisers for joining us today. I guess we can go ahead and begin the discussion. To open the board, I would like to talk about the market tanking the past month. We’ve had about a 50% decline in Bitcoin and we’ve had an even further decline in the total market cap of all the cryptocurrencies, and I would like to know if any of you have any reasons for this development.

Max Tertinegg:

I think there is one very obvious reason; the market was too overheated. There was a really big disconnection between prices and everyday usage and technology developments. What we have seen repeatedly over the last couple of years is that the market gets hyped up to a point where it’s not sustainable. I am personally very happy that we have had this correction because now we can focus more on technology and on development of coins.

Oliver Völkel

I heard a rumour that there were a couple of big exchanges in the past that were influencing the price to go up on a very unsustainable level. I have no idea if that’s true or not. I also heard a rumor that regulators had something to do with the crash due to their concerns about cryptocurrencies. However, in my opinion I don’t think that a single country’s regulator matters much for the global cryptocurrency market.

Stefan Wieler

There is one thing that is fascinating about the main cryptocurrencies; they have a very strange supply function, which you won’t find in nature. For example, let’s compare Bitcoin to a commodity because I think cryptocurrencies are commodities.

For a traditional commodity you basically deploy more capital, you put more energy in it, you put more labor and time in, and at some point in the future you’ll get more out of it. The price incentivizes you to produce more. Cryptocurrencies, for obvious reasons, don’t function that way, which makes cryptocurrencies inherently volatile. And you don’t really have a supply and demand function where the price can really impact supply at all, it can only impact demand.  

Crypto miners were making huge margins, which were not sustainable. There is nothing in our economy over the past couple of thousand years that would have had these margins. There is no margin like this that has been sustainable, unless it’s a government monopoly. I therefore think this is a very healthy correction. I don’t know what triggered the sell-off, but I think this is a sustainable business for the future, not just some pump and dump bubble thing like tulips.

Ronald Stöferle

Great thoughts. The market was obviously overheated, and I think there were various indications of that. Looking at investor behavior people were just trying to rush in as fast as they could. This is obviously a sign of an overheated market. It’s worth pointing out that  cryptocurrencies is a retail-led market. Other markets are usually led by institutions, and the institutions come in first, and retail comes in last. How do you guys see this institutional side of the equation? Are they coming late? Are they coming at all in a significant matter? I think the capacity and potential is much higher from that side.

Stefan Wieler

We talked to some of the institutional guys. I would make a distinction between traditional institutional investors and the players that are in the crypto space right now, which at this point are so big we have to consider them institutional. Look at who is holding most of the coins; it’s a very small group of people that controls the mining space and owns a lot of the assets. But I think what you are referring to is the traditional institutional guys, which from what I know, are few. I know some institutional investors that are completely private, that run their own money. I know personally that they’re actually in this space for a very, very long time but they do not invest client money in this. I think that’s something that is still missing in the space and that’s because you don’t have proper custody at the moment. That’s why these companies cannot invest in cryptocurrencies directly. They therefore invest in companies that are involved in the crypto space, for example our company. So you don’t have these traditional money managers actively investing in the space the same way they’re actively investing in the equity markets. It will be interesting to see what happens when that market develops, e.g. if it takes out some of the volatility.

Ronald Stöferle

Thanks, Stefan. Mark, Oliver, anything to add on that point?

Oliver Völkel

From a legal perspective large institutional investors, pension funds or banks, would perhaps be interested in cryptos, but they have a strict regime of capital requirements. EU requirements prevent them from investing in all sorts of assets. So from a legal perspective this could also be a reason why we don’t see much involvement of institutional investors yet, at least in the European Union.

Ronald Stöferle

Do you think, Oliver, that there would be at least some leeway for big institutions, insurance companies, pension funds etc. to have an allocation to cryptos if they are classified as a new, alternative asset class?

Oliver Völkel

The problem is not so much the legal classification of the asset class, but rather what an investment in such an asset class would entail for the capital structure of the bank, pension fund or the institutional investor. To give you a brief overview, the capital requirements regulation stipulates that you have to have a certain amount of Tier 1 or Tier 2 capital and the way you calculate how much capital you need is by multiplying your investment with the risk factor. The less risk something has, the less equity you need for an investment. If the calculation for cryptos shows that you need 100% security deposit it simply is not interesting for any institutional investors because it’s a very expensive investment. They would rather invest in something less risky and do a lot more investments, because the equity requirement is lower. I think this is the reason we don’t see much investment from banks or institutional investors.

Stefan Wieler

Currently you don’t even have hedge funds being as active as you would think, considering the potential upside and high volatility. This is not even because of regulatory reasons, but because they don’t want to. To quote somebody we talked to: “I cannot give some kid $50 million to have some data on a server somewhere in a garage in Silicon Valley”. So even hedge funds, who can do what they want with their capital, are not as invested as they want, or not invested at all, because they don’t trust the crypto space. They don’t trust this thing and they don’t trust themselves being technologically savvy enough to have it in their wallet and put it in the safe.

Demelza Hays

Excellent point. Private keys get hacked very frequently, as we saw with a cryptocurrency company in Liechtenstein called Aeternity, They were attacked during the parity hack and I think they lost approximately $20 million within a matter of seconds. Getting hacked is definitely a risk.

Ronald Stöferle

It seems that the factor preventing cryptocurrencies becoming more institutionally accepted is primarily an infrastructure problem. Would you agree with this conclusion?

Stefan Wieler

Yes, I think that’s what we’re hearing when he talks to major players. Currently they are all pointing out that infrastructure is a big issue. And obviously there’s also still a lack of a rigorous regulatory framework

Demelza Hays

The media is reporting that Bitcoin lost 50% of its value since December 2017, but it is interesting to consider that in January 2017 Bitcoin was at $1,000 and now it’s at $8,000. So we still had a 700% annual increase despite a 50% drop in the past month. And I guess another question for that topic is do you see this trend changing? What is your outlook for the first and second quarter of 2018?

Max Tertinegg:

I’m driven from a technological perspective rather than from an investor’s perspective. We recently made the first lightning transaction on a Bitcoin ATM worldwide in our Bitcoin ATM in Graz, which was really awesome to see, that you can send Bitcoin without hitting the blockchain with very low fees at a fraction of a second. This promise of a lightning network that has been floating around for the last two or three years will come into existence in the next couple of months. I think that this will be a very big factor. This development will give a much bigger usage or utility to the whole Bitcoin network because currently I would say 95% of all people who use Bitcoin are using it as a form of investment, but not as a form of payment. So the payment system character of Bitcoin hasn’t been very big. But with the dawn of the lightning network I think that we will see an explosion in cryptocurrency payments and this will on the other hand give Bitcoin a much bigger value. I’m not sure if this will happen by the end of the year but my outlook is very promising. So I think that Bitcoin easily could rise to $50,000 this year.

Ronald Stöferle

Great, Max, then just to put on my investment hat, so long Bitcoin, short Bitcoin cash?

Max Tertinegg:

Yes. Yes, definitely.

Ronald Stöferle

Okay. Thank you.

Demelza Hays

Stefan or Oliver, do you have an outlook for 2018?

Oliver Völkel

I would actually refrain from giving any outlook because I am not confident enough in my ability to predict the market. So I really can’t add to this.

Stefan Wieler

I’m glad I’m not the only one. I just don’t know. I used to work for investment banks and I had to make an oil price forecast and I always hated that part of the job because you were almost by definition wrong. But with proper analysis, you can identify what drives the price of a commodity and if you did a good job, you can – more often than not – say in which direction it will go. With Bitcoin I have absolutely no idea what is driving the price at the moment. I can see cryptocurrencies having amazing utility as it develops, but currently I would say 99.9% is for speculation, it’s really not used as a form of payment at all. And it is not used like money at all. Nobody that is not printing or not mining it can pay their employees in cryptocurrencies because your labour cost can basically go up tenfold overnight. But as it becomes a form of money I see how the utility of this thing goes up. Over the long run I think the way is clearly up, but what happens over the next quarter or two, I just don’t know. My big philosophical view is that in the end it’s an alternative form to fiat currency the same way gold is. Because I’m very bearish on the fiat currency system I believe that anything that is an alternative to fiat currency will go up in fiat currency terms over time.

Demelza Hays

Definitely. So all three of you work with cryptocurrency in your professions; are you seeing an increased interest from potential clients?

Stefan Wieler

Yes, definitely. We allow people to hold cryptocurrencies on the platform. We have only offered storage since November and it has gone absolutely through the roof. We only offer Bitcoin and Ethereum at the moment and we actually haven’t launched BlockVault yet. What we offer right now is simply cold storage in a secure vault. As I mentioned we sold about 22 million coins in the last seven weeks of 2017, we facilitated about $22 million of sales. If you scale that up to a full year it equates to about $150 million, which is already a tenth of coin base. The interest probably has come off a little bit during the sell-off, but it’s still very good. Given what happened with the price, the interest has been stellar.

Demelza Hays

Wonderful. Oliver or Max?

Oliver Völkel

What’s very interesting is that in particular German corporations are moving to Austria to do crypto business in Austria, to headquarter their businesses here and then try to go back to Germany with their services because it’s simply much easier here in Austria to do cryptocurrency related business because of the regulation and laws that apply in Austria compared to Germany. Also, we have seen a shift in the structure of who is actually trying to get advice from us because in the past couple of months we have seen a lot of private investors who have fallen for scams and who are trying to find recourse now, which is quite difficult due to the nature of cryptocurrencies, if they are gone they are usually gone. But I’ve heard from well-informed circles that the law enforcement agencies already have quite sophisticated methods of tracing cryptocurrencies. But I think this is a sign that we need to do more educational work in the public to bring closer to people the dangers that are associated with using cryptocurrencies. But for some people if they are dealing with cryptocurrencies, it doesn’t feel like real money. That’s why they spend it more loosely or they don’t really think about it that much. And also cryptocurrencies are associated with giant profits in a matter of months. The most ridiculous promises that are made online don’t actually scare people; they really believe it. I have therefore seen an increase of individual clients who have fallen for such scams. If it continues it has the potential to damage the whole effort that we put into this to make cryptocurrencies become more mainstream. I think this is something we should all work together with to try to avoid.

Demelza Hays

Yes, that’s a great point. I was thinking the other day about how the saying “10X”. 10X wasn’t really a saying before the cryptocurrency market existed. The next question that I wanted to move on to was the relationship between cryptocurrencies and gold.

Stefan Wieler

Philosophically gold and cryptocurrencies are linked, because they are an alternative to fiat currencies. Gold fulfills this role because it’s a store of value, it’s a unit of account and it’s a form of exchanging value. Gold is a better store of value than fiat currencies because fiat currency hasn’t really been a stellar store of value, at least for a long time. The idea of cryptocurrency is similar to that, moreover it is outside of the banking system and it is not controlled by a government in the sense that you cannot just print it. That said a lot of gold supporters hate cryptocurrencies and vice versa. Gold and cryptocurrencies are two different forms of money that at the moment exist side-by-side and both have a similar promise; if the fiat system completely implodes you are not going to lose your savings. But they obviously work very differently. The most important cryptocurrencies don’t have a proper supply curve like gold has, so you can’t really make more if you want more or need more. Then obviously also if you’re a speculator, cryptocurrencies are great, if you’re a speculator in gold, that actually is not really a good deal, because gold just preserves your value. So if you look at it over 100 years it just buys you roughly the same things. So you’re not really getting rich with gold at allBut if gold goes to $10,000, it’s because the USDhas collapsed.

But with cryptocurrencies, those gains were possible, so it’s a very, very different world. There has been an argument that the sell-off in gold in late December was somehow linked to the rise of cryptocurrencies, that bigger investors sold gold to buy cryptocurrencies. I cannot confirm that. I don’t think that happened at all. Now on the way down, gold hasn’t done anything at all. So gold actually caught up to probably where fair value was before the cryptocurrency sell-off started, and then during the entire sell-off it’s been almost flat. So there is really no link between the two.

Demelza Hays

Those are good points. I know a few people that realized gains in the cryptocurrency market and invested in gold in mid-December.

Stefan Wieler

Cryptocurrencies  opened up the discussion among millions of people for the first time in several generations about what money is. 2008 didn’t do the trick, and gold going from $200 to $1,800 and back to $1350 didn’t do the trick either, but cryptocurrency seems to have done the trick, that people are actually starting to think about what money actually is Once you actually start thinking about what money is you instantly lose confidence in fiat currencies. I can imagine that people who realize gains on cryptocurrencies buy gold. We’ve seen it since we started the business; people actually send us cryptocurrencies and buy gold with it. One reason might be because it might be the easiest way for them to send us money, but the other thing could also be that they just want to realize their gains, and rather than holding it on a bank account, they’re holding precious metals with us.

Ronald Stöferle

Something I loved when I found out about the cryptocurrency space was that people were actually asking the question: “what is money? What are the advantages or the disadvantages of fiat money, and what are the advantages of gold?”

I also like that people in the crypto space come from a more technical side and that they are finding out more about the monetary system. But it seemed that during the mania so many people rushed in and didn’t care about those topics at all. They were mostly buying because of rising prices, fear of missing out and so on. So I think that the discussion in the crypto space changed. I think there are major similarities between Bitcoin and gold, but there are also major differences.

If you just compare the size of gold to the crypto space, gold is well valued at roughly 7 trillion at the moment, while the cryptos’ market value is around $400 billion. I think the most important difference is first of all the liquidity, gold is traded at roughly $250 billion a day, as we all know mostly on the futures market, so it’s not physical trading or physical gold trading taking place, while Bitcoin as I’m reading now, is trading at roughly $2 billion. I’m not sure if that amount is accurate, but in a nutshell liquidity is a huge difference. And I think there’s still very little overlap with cryptocurrencies and gold on the sources of demand and supply. This is something that I told James Turk three years ago when he was on a panel at a big mining conference in Zurich. The whole gold community hated this new competition coming up. I love the fact that James Turk embraced the idea of competing currencies and actually was very open when it came to this new form of technology because money is basically a technology, nothing else.

Stefan Wieler

Liquidity is actually a very interesting question; how much of the $2 billion do you think are people basically moving cryptocurrency from one wallet to the other, i.e. it’s not really traded?

Max Tertinegg: 

Actually it’s not $2 billion, but rather around $20 billion.

Mark Valek: 

Can you elaborate on the $20 billion, how much you think is actually real and how much is just basically a number?

Max Tertinegg: 

It’s a question of what is real. So it’s more real than maybe the gold volume, because there’s no, or very little, paper Bitcoin. On the contrary there’s paper gold and real gold and currently we are in a situation where we only have real cryptocurrencies. So in that sense, it’s more real than the gold volume. But on the other hand if I have an exchange with a 0% fee, I can do 10 million a day trading volume without any cost. I therefore don’t think you can draw too many conclusions from these numbers.

Demelza Hays

I think that’s a great point. The OTC markets are estimated to be much larger than the exchange markets for cryptocurrencies. For example, Bitcoin Suisses has a prop book of approximately $3 billion and they’re settling their own trades within house and they don’t report any of the transactions to any type of data repository. The total global daily volume is much higher than what is reported on coinmarketcap.com.

Stefan Wieler

I think the point that Ronni made about liquidity is definitely valid. Gold, for now, is still a way more marketable commodity than Bitcoin, for instance. But I think it’s also quite an achievement already that it has come so far and volatility and marketability probably go hand-in-hand to some extent. My outlook is that if this monetization process continues it will lead to falling volatility and increasing marketability, or higher liquidity.

Demelza Hays

To conclude on the gold topic, we are not sure that crypto is bringing more absolute money into gold, but I think we can be sure that the median age of gold investors is decreasing.

Max Tertinegg: 

Yes, that’s a good point. I think it brings interest for a completely new generation. Anecdotally, everybody I know from my Wall Street days have Bitcoin, and some Ethereum. They all say it’s their insurance policy. And they all understand gold as well in that form. So gold used to be their insurance policy, now Bitcoin is their insurance policy. And I agree with Ronni, I think the overlap is relatively small. But this could change if you have more companies like Goldmoney, and if gold and cryptocurrencies become much more fungible, which it really isn’t at the moment at all.

Demelza Hays

That’s an excellent point. I read in the news recently that Perth Mint is looking at backing a cryptocurrency with gold, and I know there’s been a few other projects where they’ve had difficulties with custodianship, but I think it’s an interesting idea to try to make gold easier to use digitally .

Stefan Wieler

A gold-backed cryptocurrency will obviously be very different to what we have right now because with a gold-backed currency there is an element of trust, which obviously is the whole idea of cryptocurrencies; that you don’t need to trust anybody. So the minute you need somebody to store your gold, you need to trust that institution. But why would you do that? Why would you have something like a blockchain which is all about trust, but then you have to trust the company anyway to store your gold?

Ronald Stöferle

That’s a great segue to the last topic we want to discuss, which is the legal aspect and regulation. Oliver, you said from your point of view as a lawyer, it is really exciting to be in this space because you can actually influence legislation and new laws. I’d like to know if you think financial market authorities and governments underestimated the crypto space initially, but with the rapid price developments in the last couple of months they might be more open to it? I think proper regulation of the sector might turn out to be a big advantage, especially as it creates some sort of security for market paricipants. I’d love to hear your thoughts on the most recent developments, and also where you’re expecting the legal side to be a couple of months or years from now.

Oliver Völkel

What we have to keep in mind, and let me stress this point, there is really no regulation-free space. No matter where you look, there is always a law that you can apply to something. The same is true for cryptocurrencies. The fun part of doing the legal work is that you can influence legislation. People want cryptocurrencies to become more secure; I have said before, with regard to initial coin offerings, that it’s not the Wild West. There are regulations that you have to adhere to, and if you don’t, either you fall under the capital markets law which is quite severe since there’s criminal punishment looming ahead of you, but also if you’re creating just regular token, there’s legislation you have to adhere to, which would be the consumer rights directive, for example. So there is no law-free space, so to speak.

That’s my first remark. The second thing is that in early 2017 regulators were extremely interested in cryptos; they were more cooperative with giving you their legal point of view. They don’t really do that anymore, or if they do, they simply give you a short sentence and that’s it; end of discussion. So from my point of view, it has been a little bit more difficult to deal with the regulators. I have only heard in the news that Germany and France were proposing, or will be proposing, a regulation draft. I have unfortunately not had access to this draft. It’s a huge piece of legislation that could influence the whole industry.

A second piece of legislation that will pass soon is the update of the fourth anti-money laundering directive, which will for the first time include a definition of what a cryptocurrency actually is. But this piece of legislation only applies to a small area of law, or a small area of the industry, namely people who are selling, purchasing and selling cryptocurrencies, or wallet providers. These will be covered and they will also have to adhere to anti-money-laundering rules in the future. So those are the two major developments that I see in the future. And from an Austrian point of view I can give you an interesting update, which is not at the legislative level but on the executive level. The Austrian financial authorities, recently released a note to all the finance centres in Austria where they say that a price increase would fall under capital taxation, which is actually wrong and which really raises tricky questions and difficult legal questions because it puts the burden to battle any wrong decisions of the finance centre on the people

Demelza Hays

If I could just ask, in what sense is it wrong? Because I think that other countries such as Switzerland consider crypto to be subject to a capital gains tax.

Oliver Völkel

It’s certainly wrong, in Austria at least, if you are selling cryptocurrencies and you are doing this either as a private person or as a small entrepreneur, then it would fall under your regular income tax, any price increase, or any gains or any profit that you have achieved from it, and not under capital gains.

Demelza Hays

I see, okay. Yes, that’s the case in Switzerland, it’s only professional investors that go over certain thresholds. So in Austria, retail traders  have to pay that tax as well?

Oliver Völkel


Ronald Stöferle

I’d like to hear from Max, because he told me once that it was really hard to get a bank account for his company and I know that his business is really growing quickly. So I’d like to hear a bit more from Max regarding his most recent experiences regarding legislation and the legal side.

Max Tertinegg: 

I unfortunately still have to report the closing of our bank accounts. But I think this will get better once we have this fifth anti-money-laundering directive in national law, because the banks will have clear regulations. So currently people are sitting in compliance offices in banks and are not really sure what this whole crypto thing is. At the end of the day they are people responsible for the relationship with companies like us. So I don’t blame them, but it’s still hard for us to develop proper banking relationships. On the other hand, I have to say that there is a small number of very interested, mostly private, banks who actively are seeking co-operation with us. In the meantime I think we have six different working bank accounts, but we only use them for specific purposes.

There is interest from the banks but still the whole banking scene is very rough. Recently the Austrian financial market authorities sent a letter to all of the Austrian banks informing them that they should do more research into money coming from exchanges or companies like ours. I can also unfortunately report that many of our clients get their money frozen by the banks, e.g. if you want to sell 100 Bitcoins to us and you get a large amount of Euros, then you might be in the unfortunate situation that your money gets locked up for four to six weeks, until all the documentation is done. The problem is that the people in the standard banks just don’t know how to handle these cases. There is no proper expertise. I hope this will get better by the end of this year, but who knows?

Ronald Stöferle

Okay, thanks. Great. We’re getting close to the finish. Does anyone want to add anything?

Max Tertinegg: 

I wanted to congratulate you on your crypto research report, I think it’s very good.

Demelza Hays

Thank you very much, Max. We’re looking forward to a good second edition coming out in late February, early March.

Mark Valek: 

Sponsorship’s still open.

Demelza Hays

Yes, sponsorship is still open. We are looking for more sponsors to help us create better quality content and hire more thinkers and writers.  If you think of anyone or any firm that may be interested in sponsoring the report, please have them email us at [email protected]

Ronald Stöferle

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Introduction to the Blockchain Technology and Cryptocurrencies

Introduction to the Blockchain Technology and Cryptocurrencies

“Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.”

Marc Andreesen

This chapter focuses on the basics of the blockchain technology and the financial infrastructure that has developed in this space over the past eight years. Keywords such as blockchain, cryptocurrency, Bitcoin, cryptocurrency exchange, altcoin, and initial coin offering are defined.

The terms blockchain, cryptocurrency, and Bitcoin are becoming increasingly relevant for finance. In 2008, a research proposal was released on an online forum called “Bitcoin: A Peer-to-Peer Electronic Cash System” by a mysterious programmer(s) going by the pseudonym Satoshi Nakamoto. Although the basic idea of a blockchain data structure had existed for several decades, this was the first time that blockchain technology had been combined with peer-to-peer (P2P) networking, cryptography, and distributed computing. In 2009, the developer of Bitcoin released the first version of the Bitcoin software protocol. During the first few months, programmers from around the world worked on improving the software code. By the end of 2009, the Bitcoin software was robust, open-source, and free. Anyone could download the software and begin sending transactions to other people.

The foundation for the blockchain technology was laid when the first Internet was created in California in 1969. Today’s widespread adoption of the Internet enables billions of users to engage in P2P networks that share files and information.

In a similar way to the Internet, Bitcoin’s P2P software is comprised of “nodes” that broadcast information about transactions to other nodes on the network. However, simply having a P2P network would not be sufficient for building decentralized digital money. The next part of the puzzle came when cryptographers discovered asymmetric encryption in the 1970s. Asymmetric encryption fundamentally changed the way people can share private information. Today, governments, banks, insurance companies, and many other firms use encryption tools for applications such as storing sensitive customer data and enabling secure online payments.

Fast-forward a decade and the last piece of the puzzle was developed: blockchain. Up until this point, changes to digital data could not be chronologically ordered without relying on external timestamps. Although a seemingly small inconvenience, the inability to timestamp data made it possible for counterparties to change, add, and delete digital files without leaving footprints. The blockchain data structure enabled internal timestamping for the first time. From this point forward, governments and companies could digitally track every single change made to each data file.

Following these information technology discoveries, the first attempts at digital cash were made. American inventor David Chaum designed DigiCash, an electronic cash system that was based on cryptographic algorithms in 1983. In 1997, Adam Back, a British cryptographer created HashCash that used encryption tools to block email spam. In 1998, Wei Dai and Nick Szabo released b-money as well as bit gold, respectively. All failed to gain significant adoption.

Then in 2008, the creator(s) of Bitcoin combined P2P networking, asymmetric cryptography, and the blockchain data structure to create a transparent and secure global monetary system. Cryptocurrencies and the blockchain allow users to generate units of currency and transfer funds without intermediaries.

The rigor of the underlying technologies provides evidence that this is not a scam or ponzi scheme. However, the adoption of this technology depends on several factors independent of the technology itself. Government regulation and consumer preferences will play key roles in the success of the blockchain. For example, government regulation has the power to either crush or support this nascent technology. In addition to government regulation, consumer preferences are a crucial determinant of the use of blockchain-based money. If consumers prefer “sound” or commodity monies such as gold or government monies such as the euro, then the blockchain technology may not become the global decentralized money that Nakamoto had envisioned. On the other hand, not everyone has to agree on using the same currency. Instead of completely replacing the commodity and fiat monies, cryptocurrency may become a third option with unique advantages and risks.

The remainder of this chapter provides an in-depth review of the blockchain technology, cryptocurrencies, and the financial infrastructure that has developed over the past eight years. The first section on the blockchain technology lays a foundation for the economic and technical features of this data structure. The second section explains how the technologies cryptocurrency and blockchain are inherently inseparable. The third section describes the top five cryptocurrency coins in detail. The penultimate section sheds light on the terms initial coin offering and token generating event. This chapter is concluded with an overview of the financial intermediaries including exchanges and brokerages that facilitate trading markets and provide liquidity for the cryptocurrency ecosystem.

a. The Blockchain Technology

“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.”[1]

Satoshi Nakamoto

The blockchain technology refers to a collection of digital methods for storing identical data in multiple locations. The blockchain technology, also called the distributed ledger technology (DLT), was popularized in a white paper released in 2008 by a covert author under the name of Satoshi Nakamoto.[2] A blockchain can be thought of as a database that stores the amount of accounting units held by each user.[3] Users can receive and spend their account units, referred to as cryptocurrencies, with an encrypted password, referred to as a public-private key pair. Since 2008, over 1000 different blockchains and corresponding cryptocurrencies have been created.

A blockchain is a collection of information that is not held by one entity but rather distributed across all computers in the network known as nodes. Due to the redundancy of data storage, blockchains are enormously expensive to operate and they are slow. Each computer around the world that stores a copy of the database must agree to each change made to the database before the network can process new data entries. Despite the setbacks, blockchains harness unparalleled computing power and security, which provide users with services that cannot be provided by any other technology. The Bitcoin blockchain is an example of a peer network node data storage system that continuously grows as transactions are broadcasted and verified by the network. Storing identical data in multiple locations provides security benefits and latency drawbacks compared to storing data in one location.

In information science, the former method is referred to as distributed computing while the latter is referred to as single point of failure (SPOF) storage. A centralized database that has a SPOF can be easily hacked and sensitive data can be compromised, changed, deleted, or altered. In contrast, data stored in computers located in different geographic regions throughout the world makes an adversary’s job exponentially more difficult. Distributed computing commonly uses two fictional characters, Alice and Bob, to illustrate concrete use cases of the technology.

To understand how a basic blockchain transaction works, imagine that Alice is a customer at a coffee shop and Bob is the owner of the coffee shop who is selling Alice a nice cup of coffee. Instead of using cash, Alice wants to send one digital coin to Bob in exchange for the physical coffee that she ordered in Bob’s coffee shop. If Bob happens to have the digital coin software, also referred to as a “cryptocurrency wallet,” on his phone, Bob can easily open the software on his phone and accept a payment from Alice by scanning the QR code shown on Alice’s software on her phone. Alice will instantly see her account debited by the amount that she specified, and Bob will see his account credited with the same amount. For Alice and Bob, their work is done. Bob’s phone will get a beep sound that signifies to him that Alice’s transaction has been broadcast to the P2P network of computers around the world that are actively listening for new transactions.  The individuals or groups of individuals that operate the computers that listen to transactions are often referred to as miners. Using special hardware, miners create blocks containing a list of transactions that have been broadcasted to the network by users. Next, blocks are added one after the other in a chronological order, creating a chain, hence, the name, blockchain. Once the miners hear Alice’s transaction Bob’s wallet, they will add this transaction to a list of transactions stored in a “candidate” block. A candidate block is a block that has not been confirmed in the blockchain. Before confirming the candidate block and the transactions inside of it, the miners compute hashes until they find a desirable number that is less than a specific number set by the software protocol. In the Bitcoin protocol for example, miners must find the right “nonce”, or arbitrary number, that produces a hash lower than the difficulty target set by the software. The hash that is lower than the difficulty target becomes that specific block’s identification number. The first miner to find a hash that is lower than the given difficulty target will receive a reward and the transaction fee that Alice paid to the network when she broadcasted her payment. After approximately ten minutes, the transaction will be confirmed by all of the computers in the network, and there will be no way for Alice to complete a chargeback on the money that she sent to Bob. Although, Satoshi Nakamoto created the blockchain technology to facilitate decentralized currency, entrepreneurs are constantly innovating and creating new applications of the blockchain technology. A famous blockchain enthusiast, Vitalik Buterin, built a blockchain-based decentralized contracting platform called Ethereum in 2014. More recently, start-ups are using the blockchain technology to decentralize lending markets. For example, the German company eSports.com is accepting cryptocurrency investments to crowdfund the capital required to launch their business idea. Similar to the Internet decentralizing information, blockchain technology is decentralizing money, contracting, and capital.

b. Cryptocurrencies

The past few years have witnessed an explosive growth of Google searches and social media posts about the blockchain technology and cryptocurrency. However, people aren’t only searching for these terms. Over 600 applications were filed in the U.S. for blockchain and cryptocurrency related patents during 2016 and the beginning of 2017. Mainstream interest in cryptocurrency began in 2014, when the price of the most famous cryptocurrency, Bitcoin, soared for the first time to over 1,000 USD per Bitcoin. The exponential growth garnered worldwide attention and became the main topic at FinTech and finance conferences. Following this rally, over 400 books on the topic of cryptocurrency were released on Amazon.com. Amazon responded by creating a new book subcategory, “Digital Currencies,” which feature several best sellers.

Cryptocurrencies are a medium of exchange and store of value like currencies; however, they have no physical or digital existence. Instead, cryptocurrencies are account amounts held in a digital ledger that can be transferred to other users. The term cryptocurrency is really a misnomer because there is no such thing as a cryptocurrency with an identification number such as token number “1234567.” In fact, none of the cryptocurrency coins have unique identifiers because a cryptocurrency is not actually a coin in the traditional definition of the term. Rather, each cryptocurrency account name is linked to a certain number of cryptographic accounting units, and these accounting units have been given the name cryptocurrency.

The terms cryptocurrency and blockchain are used interchangeably due to the inability of separating these technologies. Bitcoin is the name of one cryptocurrency and blockchain. Ethereum is another. Ripple is another. There are over 1,000 different cryptocurrencies.[4] Different cryptocurrency coins use different incentive structures to encourage computer nodes around the world to listen to new incoming transactions. The first successful implementation of a blockchain and cryptocurrency was Bitcoin. However, different strategies for verifying transactions within a decentralized network have given rise to different cryptocurrencies such as Litecoin, Nxt, Monero, and Bitcoin Cash.

c. Bitcoin

“Bitcoin is the beginning of something great: a currency without a government, something necessary and imperative.”

Nassim Taleb

After attempts at making a private virtual currency had failed for 20 years, Bitcoin emerged amidst the 2008 global banking crisis. The creator of Bitcoin, unknown, was determined to create a decentralized, private, and secure way to transfer value online, which did not rely on trusting sovereign entities, central banks, or financial intermediaries.[1] After being ridiculed as money for computer nerds and a conduit for illegal activity, investors are finally beginning to take notice of Bitcoin and the underlying technology, the blockchain. During November of 2017, the price a Bitcoin breached $11,000 per coin as shown in Figure 1.

Bitcoin was the first and is still the most popular cryptocurrency and use of the blockchain technology. This system allows participants to send accounting units that store value, referred to as Bitcoin, from one user’s account to another user’s account without intermediaries. As a cryptocurrency, Bitcoin is a store of value and a medium of exchange combined in one.

Bitcoin has a fixed supply capped at 21 million and the currency’s inflation rate is programmed to decrease by half about every four years. Daily, around 1,800 Bitcoin are released onto the market. This rate will half to 900 Bitcoin per day in 2020, and then to 450 Bitcoin per day in 2024. According to estimates, Bitcoin’s last coin will be mined in the year 2140 A.D. At the time of this report, approximately 16.5 million Bitcoin have been mined. The finite supply gradually enters the market according to a mathematical algorithm that releases approximately 12.5 Bitcoin into the network’s supply of Bitcoin every ten minutes. The inflation rate therefore decreases over time according to the algorithm until every unit of the finite supply has been released into the economy.

Since Bitcoin was launched in 2009, the transactions on the network have doubled every year. Figure 2 shows that that the Bitcoin network averages hundreds of thousands of transactions every day. The Bitcoin network is gaining in popularity as a payment system because transactions of any amount can be sent at anytime of the day to any place in the world.

Although blockchain transactions do exist in physical servers, Bitcoin are not physical or even digital coins. Instead, a Bitcoin is a chain of electronic signatures that represents units on a digital ledger. Network users can trade and store these fungible accounting units by debiting the account controlled by one participant and crediting the account held by another participant. An individual that creates a Bitcoin wallet can transfer accounting units to other users by digitally signing a private key on a transaction. The combination of several innovations from distributed computing and cryptography form the basis of the Bitcoin ecosystem, including the blockchain and the Bitcoin protocol.

Satoshi Nakamoto’s invention was the first system, which effectively solved the “double-spending problem” and thereby enabled a safe peer-to-peer payment system. Double-spending is the digital version of counterfeiting fiat currency or debasing a physical commodity money, such as gold. In the aforementioned example, Alice could attempt to pay two people, Bob and Charlie using the same coin by duplicating the string of bits that represents the coin with serial number 1234567.[6] Centralized payment systems, such as PayPal, solve the double-spend problem by using a centralized mechanism of validating real transactions. In computing terminology, a centralized solution to the double-spend problem is called an example of an SPOF because if PayPal’s server is jeopardized, the entire system fails.

Instead, Bitcoin relies on the “proof-of-work” consensus mechanism to achieve decentralized consensus. Proof-of-work is an incentive structure in the Bitcoin software that rewards miners with transaction fees from users and with a pre-defined number of Bitcoin for successfully adding a block to the chain of previous transactions. The proof-of-work protocol timestamps the transactions recorded in the blockchain. The correct blockchain is always the blockchain with the longest history of proof-of-work computing. Using the simple rule to always mine on the longest blockchain ensures that miners all add transactions to the list of transactions that has received the highest amount of computing resources. Network agreement on the state of transactions eliminates the potential to double-spend the same coin without the presence of a central clearinghouse.

Bitcoin vs. Gold

The 2017 In Gold We Trust report provides a thorough introduction to the topic of Bitcoin and gold in the chapter, In Bitcoin We Trust? Due to the positive feedback and curiosity that the chapter piqued, a more in-depth analysis of these two assets is elaborated on in this section.

Originally, Bitcoin and the underlying blockchain technology were designed to replicate the characteristics of gold, which make it uniquely suited to be money. However, Bitcoin constitutes an unparalleled asset class and can be a fundamental part of wealth management from the portfolio diversification perspective. For the past eight years, Bitcoin’s daily returns have had a low to slightly negative correlation with gold. The main reason is that Bitcoin and gold have different use cases and different risks. However, from a portfolio construction point of view, one must be aware of the extremely high volatility, which this asset class exposes.

Bitcoin is entirely digital, and therefore, does not exist in a physical form like gold. Also, in contrast with gold, Bitcoin does not have industrial applications. Instead, demand for Bitcoin comes from people around the world who demand a fast, private, and appreciating asset. Like gold, Bitcoin is scarce. Throughout history, 5.6 billion ounces of gold have been mined. In comparison, 16.5 million Bitcoin have already been mined, and the inventor capped the total amount of Bitcoin at 21 million. Also, similar to gold, Bitcoin is a store of value and a medium of exchange combined in one. However, the cryptographic and digital nature of Bitcoin makes it inherently both easier to transfer and harder to find than gold.

The scatterplot in Figure 4 shows the monthly returns of gold plotted against the monthly returns of Bitcoin. The y-axis represents Bitcoin and the horizontal axis gold. During the past eight years, Bitcoin’s monthly return ranged from positive 465% in November of 2013 to negative 40% in September 2011. During the same time, gold’s volatility was much lower. Gold’s largest decrease in return of 14.5% occurred in June of 2013, while gold’s largest increase of 13.9% occurred in January of 2012. The black trend line shows that the historical monthly returns for Bitcoin and gold are primarily uncorrelated.

However, Bitcoin does not win a unanimous vote compared to gold. Unlike gold, the risks associated with Bitcoin are uncertain. Gold’s track record is 5,000 years, while Bitcoin’s is only a couple of years. The value of the Bitcoin network relies on the Internet and the geographic dispersion of computers around the world that maintain the network and history of transactions. Loss of the Internet would cripple the Bitcoin blockchain. Due to the different risk and return profiles, Bitcoin and gold constitute two distinct asset classes. A growing body of academic research increasingly suggests that a diversified portfolio should only be 1 to 2% in Bitcoin.[7]

d. Alternative Cryptocurrencies

Bitcoin’s novel combination of distributed computing, encryption, and open-source programming inspired the creation of over 1,000 cryptocurrencies. In 2011, Bitcoin was the only currency and therefore held 100% of the cryptocurrency market’s capitalization. Today, Bitcoin’s share of the cryptocurrency market has fallen to less than half. In addition to Bitcoin, cryptocurrencies such as Litecoin, Dash, Ethereum, and Bitcoin Cash are attracting traditional investors to this new digital asset class. Upon closer inspection, each of the top ten cryptocurrencies attempts to solve a different problem. Incrementum has created a cryptocurrency classification system to enhance investor proficiency of this asset class.

Our classification system has three subclasses of cryptocurrencies:

  • Money: Medium of Exchange or Store of Value
  • Infrastructure
  • General Purpose

For example, Bitcoin, Litecoin, Dash, and Bitcoin Cash are part of the money subclass because these digital tokens compete with fiat currencies such as the U.S.  dollar, euro, and renminbi. This subclass offers fast, private, and “permissionless” payments. Each of the money cryptocurrencies has a unique monetary policy. For example, the total supply of Litecoin is four times the total supply of Bitcoin. Also, Dash offers more privacy compared to Bitcoin or Bitecoin. Bitcoin cash focuses on increasing the number of transactions that can be processed per second.

In contrast, cryptocurrencies such as Ethereum, Lisk, and IOTA are infrastructure coins. Instead of competing with fiat money, the subclass of infrastructure tokens enables decentralized contracting. For example, marriage contracts, cosmetology licenses, and seal of approval certificates can be issued and publicly stored on the Ethereum network. The final subclass of cryptocurrencies includes all of the remaining cryptocurrencies. These coins solve unique problems that are not related to money or infrastructure. For example, Augur is a decentralized prediction market that is built on the Ethereum infrastructure. Another coin, TenX, is a credit card that allows users to spend cryptocurrencies where credit cards are accepted.

These three subclasses; money, infrastructure, and general purpose, make up the super class of cryptocurrency assets. In the same way that stocks are highly correlated with other stocks, the subclasses of cryptocurrencies are also highly correlated. However, the correlations between cryptocurrencies provide evidence for the cryptocurrency classification.

Each cryptocurrency has different applications and different risks, which should be considered when making investment decisions. The table below shows the correlation of the excess daily logarithmic returns between Bitcoin, Litecoin, Dash, and Ethereum. As the cross-correlation matrix shows, Bitcoin’s excess daily logarithmic return correlation with other cryptocurrencies from the money subclass is higher than with Ethereum, which is a cryptocurrency in the infrastructure subclass. This indicates that Bitcoin is competing more with Litecoin and Dash compared to Ethereum. As shown in row 2 and column 1 of the matrix, Bitcoin’s return correlation value of 0.56 with Litecoin means that Bitcoin is more correlated with Litecoin than with Dash or Ethereum. Overall, all of the cryptocurrencies are correlated positively; however, there is statistical support for a classification system based on the application of each cryptocurrency.

Incrementum focuses on the subclass of money and infrastructure cryptocurrencies. From the money subclass, the highest market capitalization coins include Bitcoin, Litecoin, Dash, and Bitcoin Cash. From the infrastructure class, Ethereum is leading the way. To provide a better understanding, a summary for each of the four alternative cryptocurrencies is available below.

 1) Bitcoin Cash

Similar to Bitcoin, Bitcoin Cash is a cryptocurrency from the money subclass. Bitcoin Cash was created on August 1, 2017 during a hard-fork[8] of the original Bitcoin cryptocurrency. With a value of approximately $1,400 per coin and 16.5 mi  llion coins in circulations, Bitcoin Cash has a market capitalization of $23 billion.

2) Litecoin

Litecoin was announced as an alternative to Bitcoin in 2011. In the cryptocurrency market, Litecoin is often referred to as “silver” and Bitcoin is referred to as “gold.” Litecoin is considered to be silver because the Litecoin network can process transactions four times faster than the Bitcoin network. Also, the total supply of Litecoin is 84 million while Bitcoin’s supply is capped at 21 million. This four-fold increase in cryptocurrency units means that the inflation rate of Litecoin is higher than Bitcoin.

3) Dash

Invented after Bitcoin and Litecoin, Dash focuses on privacy and pseudonymity. Prior to being rebranded as Dash, this cryptocurrency went by the name Darkcoin. Dash developed new methods for reducing the traceability of transactions by mixing many transactions together before sending them to the final destination. The process of mixing blurs the identity of the original sender. To increase privacy further, Dash does not have a publicly available ledger. Recently, the developers of Dash have made successful efforts to increase merchant acceptance.

4) Ethereum

Unlike Bitcoin Cash, Litecoin, and Dash, Ethereum is an infrastructure cryptocurrency that enables “smart” contracts – digital contracts that automatically execute preprogrammed agreements. Similar to the Bitcoin network, the thousands of Ethereum nodes around the world maintain the Ethereum network. The Ethereum infrastructure provides a platform where decentralized applications can be built and operated by anyone. Ethereum smart contracts operate without downtime or censorship. Smart contracts work with the Ethereum network’s native cryptocurrency referred to as ether. With approximately 94 million ethers and a price of $460 per token, Ethereum’s market capitalization is approximately $44 billion.

e. Initial Coin Offering or Token Generating Event

Currently, there are over 1,000 actively listed cryptocurrencies, and every week a few more cryptocurrencies are released to the market.[9] When a group of developers is ready to launch their new cryptocurrency, they can have an “initial coin offering” (ICO) or “token generating event (TGE)”.[10] In 2017, ICOs raised over $1.7 billion in investment capital. For example, the French developers behind the cryptocurrency Tezos raised $232 million in July of 2017. The month prior, Bancor raised $150 million. In fact, out of the 25 highest crowd-funded projects in all of history, 18 of them are blockchain companies.[11]

The term ICO is based on the term IPO, which stands for initial public offering. However, initial public offerings are fundamentally different from initial coin offerings. Therefore, what is called an ICO in the cryptocurrency world is not exactly a parallel concept to an IPO. An ICO is more of a crowdfund whereas the first day the token is launched on an exchange is the IPO because you cannot easily trade your tokens during an ICO. Instead, investors have to wait until the token is launched on an exchange. Therefore, the more fitting equivalent of a stock IPO is the first day a token is launched on an exchange. However, the comparison does not fit exactly because firms that go to IPO usually have a history and a track record for investors to research. In contrast, many of the firms going to ICO now do not have a history.

According to the PWC report, Considering an IPO (2012) firms have to pay $3.7 million to go to IPO.[12] In contrast, ICOs can cost close to nothing to conduct. Instead, the development team that performs the ICO often has “no skin in the game”. Developers and entrepreneurs, who are sometimes not even incorporated in any geographic location, can launch an ICO without involving an underwriter, receiving the appropriate green lights from regulators, or paying the costs associated with the traditional framework. Due to no barriers to entry for investors or for firms, ICOs should not have the systematic underpricing pattern that stock J. Ritter reported on IPOs in 1991.[13]

Underpricing refers to the fact that the price of a firm’s stock share is signifi cantly lower during the initial public offering compared to the closing price of the share on the first day of secondary market trading. Using data on the past 50 years, Professor Ritter has found that stock IPO prices have been 16.8% lower during the IPO on the primary market compared to the price on the secondary market at the 3-year anniversary of the IPO. This equates to approximately $125 billion being earned by IPO investors instead of going to the firms. Several explanations have been given for the cause of the underpricing. A major cause has been attributed to the conflict of interest between the investment banks that underwrite the IPO and the firm going to IPO. By artificially decreasing demand with eligibility requirements that limit investment, investment banks can secure low prices for themselves and their clients. When secondary markets open, investments banks and their clients are often able to realize instant gains because of the systematic underpricing.

The only coins that have at least three years of data provide empirical evidence that ICOs have systematic overpricing. Overpricing refers to a higher closing price on the first day the token is traded on an exchange compared to the closing price on the three-year trading anniversary of the token.

Figure 11 shows that only 5 out of the 21 ICOs in 2013 and 2014 had a positive return on the first day of trading on an exchange. These five coins were Mastercoin, Bitshares, Counterparty, Maidsafe, and Qora. The main takeaway is that most cryptocurrencies are immediately dumped on the market the moment the coins are traded on an exchange. Even the second largest market capitalization coin, Ethereum, lost 73% in value the day it was launched on an exchange. Currently, little research has been done on the cause of this phenomenon.

Figure 12 shows that the exchange adoption returns do not improve by the third-year anniversary of the coin. Only 5 out of 20 had a positive return between their opening price on the day of exchange adoption and the closing price on their third-year anniversary of being traded.[14] The five coins were Mastercoin (165%), Bitshares (984%), Maidsafe (3,262%), Storj-x (10,061%), and Nubits (2%).

However, the limited amount of data available on 2013 and 2014 means that inferences made are not statistically significant. The cryptocurrencies that went to ICO in 2013 and 2014 may not representative of the entire population of cryptocurrency ICOs. Since less than 30 coins went to ICO in total, the central limit theorem does not apply. As more data becomes available, further analysis should be applied to check the sign of the average return on ICOs and ICO three-year anniversaries.

As a final caveat, the cryptocurrency market has changed rapidly since these coins went to ICO. If a price pattern does exist and investors determine the pattern, then the pattern will change. For example, if the price always increases after the ICO then investors will try to invest during the ICO phase. If a large number of investors invest during the ICO phase in anticipation of post-ICO gains, then the ICO price may become overvalued.

f. Financial Infrastructure

As shown in Table 1, financial infrastructure is maturing in the cryptocurrency market. Private banks are beginning to offer customers cryptocurrency bank accounts. Start-up companies, such as the Tenx in Singapore, are issuing credit cards that can be filled with cryptocurrencies. Companies such as Bitcoin Suisse in Switzerland are operating cryptocurrency automatic teller machines (ATMs) that dispense Bitcoin for Swiss francs and accept Swiss francs for Bitcoin. Cryptocurrency exchanges, such as Bitfinex and Poloniex are paying interest on “cryptocurrency deposits.” Wallstreet “quants” are building algorithms for trading bots that take advantage of arbitrage opportunities on different exchanges. Large players are negotiating special pricing with cryptocurrency exchanges and miners. The cryptocurrency market even has an equivalent of the traditional underwriter. Cryptocurrency brokers and law firms offer underwriting for initial coin offerings and charge a percent of the capital raised during the ICO. Finally, legal licenses are being granted to a handful of firms that satisfy regulatory requirements. This section outlines the basics of cryptocurrency exchanges, over-the-counter markets, and brokerages.

1) Cryptocurrency Exchanges

A cryptocurrency exchange is a website where investors can buy and sell cryptocurrencies for other cryptocurrencies or for fiat money such as USD and EUR. Cryptocurrency exchanges are generating the highest revenues during the cryptocurrency boom. Coinbase, the biggest exchange in the U.S., has a valuation of over $1 billion.[15] Gemini is an exchange made by the Winklevoss Twins, who sued Mark Zuckerberg over the ownership of Facebook. However, Gemini is only open to U.S. based cryptocurrency traders. The six most important exchanges on an international basis include Kraken, Poloniex, Bitstamp, Bitfinex, and Bittrex, and GDAX owned by Coinbase.


Kraken is a cryptocurrency exchange that has its headquartered in San Francisco, California. The exchange has been in business for six years, and has the largest daily trading volume for the Bitcoin/euro pair. The exchange offers trading in several fiat currencies including USD and EUR and several cryptocurrencies including BTC, ETH, ETC, DASH, GNO, ICN, Litecoin, MLN, Monero, REP, Ripple, Zcash, and Stellar. Kraken has fees ranging from 0.05 – 0.50% per trade depending on the trader’s volume and the cryptocurrency they are trading.


Unlike Kraken, Bitstamp, and Bitfinex, Poloniex is a cryptocurrency exchange that does not allow fiat deposits and withdraws. Therefore, customers must purchase cryptocurrencies from other sellers and then deposit cryptocurrencies on the exchange before they can begin trading. Poloniex has fees ranging from 0.00% – 0.25% per trade depending on the trader’s volume and the cryptocurrency they are trading.


Bitstamp is a cryptocurrency exchange headquartered in Luxembourg. The exchange has been in business since 2011. The exchange offers trading in several fiat currencies including USD and EUR and several cryptocurrencies including BTC, ETH, LTC , and Ripple. In 2015, Bitstamp was hacked for approximately 19,000 Bitcoin, and the exchange shutdown services for one week.


Bitfinex is a cryptocurrency exchange headquartered in Hong Kong. The exchange has been in business since 2012, and the exchange has the largest daily trading volume for the Bitcoin/USD pair. The exchange offers trading in USD and several cryptocurrencies including BTC, ETH, ETC, DASH, Litecoin, Monero, IOT, Ripple, and NEO. In 2016, Bitfinex was hacked and a value of $72 million was stolen. By April of 2017, all customers had been paid back for the hack.


Bitfinex is a cryptocurrency exchange headquartered in the USA. Bittrex was founded in 2014. Like Poloniex, Bittrex is a cryptocurrency exchange that does not allow fiat deposits and withdraws. Therefore, customers must purchase cryptocurrencies from other sellers and then deposit cryptocurrencies on the exchange before they can begin trading. Bittrex has a fee of 0.25% per trade regardless of the coin or the volume being traded.


The Global Digital Asset Exchange (GDAX) is owned by Coinbase, which is registered in San Francisco, California. Coinbase has been in operation since 2012, has over 7 million registered users, and operates in 32 different countries. Coinbase is one of only three firms that has received the New York BitLicense, which entitles them to provide services to New York persons. GDAX offers BTC, ETH, and LTC. GDAX is a cryptocurrency exchange that allows USD, EUR, and GDP deposits and withdraws. GDAX has fees ranging from 0.1% – 0.25% per trade depending on the trader’s volume and the cryptocurrency they are trading.

2) Over-the-Counter Markets

Over the counter (OTC) markets in the cryptocurrency sphere refer to websites that allow buyers and sellers to make customized contracts with one another. A major reason for the popularity of OTC markets for cryptocurrencies is that personal identification is often not required. The most famous OTC markets include LocalBitcoins.com based in Finland and Bitcoin.de based in Germany. Many transactions on OTC markets include no fees. However, OTC markets also offer optional escrow services that customers can elect to pay for. For example, LocalBitcoins.com charges 1% of the amount in escrow.

3) Cryptocurrency Brokerages

In addition to cryptocurrency exchanges and 0ver-the-counter markets, the cryptocurrency ecosystem has the equivalent of traditional investment banks like Goldman Sachs. In the crypto world, brokerages are the new investment banks. They help new cryptocurrency companies launch initial coin offerings by setting up escrow accounts, clearing qualified investors, and settling trades. Brokerages charge a percentage of total revenue earned by the ICO. Brokerages also offer customized service for high-net-wealth individuals who want to gain exposure to cryptocurrencies. This service is paid for by the spread between the price that the brokerage buys or sells the cryptocurrency at on an exchange, and the price they charge the customer. The largest brokerage in Europe, Bitcoin Suisse in Zug, Switzerland has a monthly turnover of $150 million. Other brokerages include Coinfinity in Graz and BitPanda in Vienna.

Conclusion: Cryptocurrency Financial Infrastructure is Maturing

 In conclusion, cryptocurrencies and the blockchain technology are becoming everyday words. The cryptocurrency market has grown from a market capitalization of $0.00 in 2010 to over $430 billion in 2017. The absolute return of over one million percent has driven interest in this technology. The interest has attracted great minds and investors into the space. Today, the market is maturing into an efficient market with updated versions of traditional financial intermediaries. Exchanges, brokerages, derivatives, and credit cards are developing for the cryptocurrency market.

However, the impact that these technologies will have on the world is still unknown. The open-source nature of public blockchain software allows anyone to use Nakamoto’s inventions for the development of new technologies. At the same time, if governments decide that permissionless blockchains are too revolutionary, governments may try to limit further innovation.

At each step of development in the cryptocurrency market, the Crypto Research Report hopes to be your go-to-guide for critical analysis. The constantly evolving cryptocurrency space needs a reliable source for up-to-date information, and Incrementum has accepted the challenge. We wish you an informative and educational read through our inaugural report. The rest of this edition includes exclusive interviews, statistical analyses of different cryptocurrencies, and helpful insights on frequently asked questions.

Also, we invite you to look for each subsequent edition of The Crypto Research Report. Over time, the CRR aims to become a leading authority on cryptocurrency and blockchain investments for financial market participants and institutions. We look forward to understanding the investment potential of these exciting new technologies together!

We welcome your feedback: [email protected]

[1]Nakamoto, S. (2009, February 11). Bitcoin open source implementation of P2P currency.P2P foundation. The Foundation for Peer to Peer Alternatives. Retrieved from http://p2pfoundation.ning.com/forum/topics/Bitcoin-open-source

[2] Nakamoto, S. (2008). Bitcoin: A Peer-to-Peer Electronic Cash System. Retrieved from https://bitcoin.org/bitcoin.pdf

[3] Unlike normal databases, public blockchains are not owned by a central entity.

[4] Coinmarketcap.com

[5] Lo, S., & Wang, J. C. (2014). Bitcoin as Money?. Federal Reserve Bank of Boston Current Policy Perspectives, 2014(4). Retrieved from https://www.bostonfed.org/publications/current-policy-perspectives/2014/Bitcoin-as-money.aspx

[6] This is a simplification of the double-spend problem in cryptography. As previously mentioned, each Bitcoin does not have a unique serial number.

[7]  Hong, K. (2016). Bitcoin as an alternative investment vehicle. Retrieved from https://link.springer.com/content/pdf/10.1007%2Fs10799-016-0264-6.pdf and Brière, M., Oosterlinck, K. & Szafarz, A. Virtual currency, tangible return: Portfolio diversification with bitcoin. Journal of Asset Management (2015) 16: 365. Retrieved from: https://doi.org/10.1057/jam.2015.5

[8] A fork in the blockchain occurs if the protocol is been upgraded, but not all users agree on the changes. The existing chain of transactions is split into two paths. One path which follows the new, upgraded blockchain, and one path which continues along the old path.

[9] Coinmarketcap.com

[10] ICO and TGE have the same meaning. In order to make ICOs look less like IPOs, some law firms, such as MME in Zug, recommend for developers to avoid traditional finance terms that may signal to authorities that cryptocurrencies are securities. Some developers do not do an ICO. Instead, they rely on Airdrops, Hardforks, or Initial Minings.

[11] The Cover Card (2017, July 13).18 Of The Top 25 Highest-Funded Crowdfunding Projects Are Blockchain Startups. Forbes. Retrieved from https://www.forbes.com/sites/thecovercard/2017/07/13/18-of-the-top-25-highest-funded-crowdfunding-projects-are-blockchain-startups/ – 29d3359f619a

[12] Strategy& Formerly Booz & Company, & pwc. Considering an IPO? The costs of going and being public may surprise you. Retrieved from https://www.strategyand.pwc.com/media/file/Strategyand_Considering-an-IPO.pdf

[13] Ritter, J. R. (1991). The long-run performance of initial public offerings. The Journal of Finance46(1), 3–27.

[14] Ethereum had to be dropped from the analysis because only two years of trading data are available.

[15] Peterson, B. (2017, Aug. 10) Bitcoin exchange Coinbase confirms its unicorn status with $1.6 billion valuation. Business Insider. Retrieved from http://www.businessinsider.com/coinbase-now-unicorn-valuation-series-d-funding-2017-8

Constructing a Cryptocurrency Index

Constructing a Cryptocurrency Index

The world of cryptocurrencies has seen a plethora of coins appear during the past five years. In total, the cryptocurrency market has reached a number of more than 1000 tokens and a total market capitalization[1] of about USD 260 billion[2] as of November 2017, as the following chart shows.


Total Market Capitalization

This amounts to an increase of more than 1,200% from what the crypto market was worth just twelve months ago. With these numbers in mind and Bitcoin continuing to outperform many traditional assets, it comes as no surprise that private and institutional investors long for cryptocurrency exposure.

Some companies have started offering cryptocurrency funds that focus on Bitcoin, such as the US-based Bitcoin Investment Trust sponsored by Grayscale Investments. More recent cryptocurrency funds, such as the one by Incrementum that will be launched soon, are investing in a basket of cryptocurrencies in order to provide diversification benefits for investors.[3] As the article “U.S. Regulated Bitcoin Derivatives: Blessing or Curse?” in the inaugural edition of the Crypto Research Report points out, even option and futures trading will soon become available for Bitcoin. The number of investment vehicles is growing almost as quickly as the market itself.

The central question that investors ask, however, remains the same as with any other traditional asset class: How can I profit the most from the developments in this market? How can I hedge positions, reduce risks, and implement sophisticated investment strategies?

The choice of the right investment strategy differs with each individual and their specific goal. A portfolio destined for a down-payment on a house is most likely going to look different from one that is supposed to finance a private pension one day.

A reasonable strategy for private investors looking for consistent long-term gains is so-called indexing. Indexing refers to the allocation of assets in a portfolio so that the portfolio’s performance matches that of an index.[4] This approach has been recently popularized by the financial expert Gerd Kommer. In his comprehensive work on indexing, Kommer states that more than 75% of all equity and pension funds fail to outperform a correctly selected benchmark (i.e. the market) in the long run.[5] This situation can be further illustrated by the S&P Indices Versus Active (SPIVA), which measures the performance of actively managed funds against their relevant S&P index benchmarks. The most recent SPIVA U.S. scorecard showed that during the one-year period ending December 31, 2016, 66% of large-cap managers, 89% of mid-cap managers, and 86% of small-cap managers underperformed the S&P 500, the S&P MidCap 400, and the S&P SmallCap 600, respectively.[6] The chances of outperforming the market diminish further as we increase the time frame under scrutiny. During the five-year period ending December 31, 2016, 88% of large-cap managers, 90% of mid-cap managers, and 97% of small-cap managers underperformed their respective benchmarks.


With over a thousand cryptocurrencies to choose from, picking the winners and losers has become increasingly difficult. Source: Steemkr.com

To counter such bleak prospects for investors, Kommer suggests a radical cost optimization strategy based on passive investing, buying, and holding. While active investing is driven by the desire to outperform – or beat – the market, indexing enables investors to invest with the market, not against it. After all, the market is a dynamic process, which is spontaneous and highly complex, comprising billions of people with an infinite range of goals, tastes, valuations, and practical knowledge.[7] Individual investors cannot consistently yield better results than the market because no one can aggregate and understand all of the individual knowledge possessed by each market participant.

However, there are problems associated with passive investing as well. First of all, performance patterns change constantly. Some periods, active managers outperform passive managers and vice versa. Passive investments rely on bull markets to produce gains. In comparison, active managers can make manual decisions in a bear market. Once again – diversification – even on the level of management strategy appears to provide the highest return for a given level of risk.

Designing a Cryptocurrency Index

Keeping in mind the empirical and theoretical considerations highlighted above, we aim to develop a cryptocurrency index that tracks the entire cryptocurrency market. A professional index will give market participants a quick, concise impression of the direction of the relevant market segment or asset class. Primarily, an index serves as a benchmark and is a reference point for index investments. Most stock investors are familiar with ‘popular’ indices such as the German DAX, the Dow Jones, the British FTSE 100, or the SMI. Aside from these popular indices, there are lesser-known but often much more useful index families by specialized providers such as the S&P. The DAX index measures the performance of the 30 largest and most liquid companies on the German stock market, thus representing around 80% of the market capitalization of listed stock corporations in Germany.[8] The wider the index is, the less often its composition needs to be readjusted, which in turn reduces costs for index investments.

Currently, there are only a handful of cryptocurrency indices; unfortunately, these indices have disclosed very little to no information on their specific methodologies. In two articles published online, Thomas Ankenbrand and Denis Bieri from the Lucerne University of Applied Sciences and Arts briefly discuss several features of their Cryptocoin Index.[9] However, no academic papers on the theory and construction of a cryptocurrency index have been published yet.

So far, the most promising venture is the TaiFu index family provided by the Americans Tai Zen and Leon Fu, who started their service in June of this year.[10] The TaiFu index family is market-capitalization weighted and consists of three separate indices. The TaiFu 30 Index tracks the largest 30 cryptocurrencies on a daily basis. The TaiFu 30 Altcoin Market Index measures the theoretical market capitalization of the 30 largest cryptocurrencies on a daily basis, excluding Bitcoin or any hard forks of Bitcoin such as Bitcoin cash. The TaiFu Bitcoin Aggregate Index focuses on the total market capitalization of Bitcoin and all hard forked versions of Bitcoin that share the same genesis block that was created by Satoshi Nakamoto in January 2009.

The originators point out that there are two practical issues with their indices: (1) a real-world cost of slippage[11], commissions, and taxes and (2) the impracticability for investors to rebalance their portfolios on a daily basis. As Zen and Fu explain on their website, the indices were created “to help investors, reporters, hedge funds, institutions etc. gauge the health and ‘pulse’ of the cryptocurrency markets”.[12] Their indices are not made for actual investment purposes. Therefore, we have developed a different approach to composing a cryptocurrency index.

Two Ways to Track a Market

The same way a stock market index records changes in the value of an equity basket (or portfolio) that represents a specific market or segment thereof, a cryptocurrency index should model changes in the price of cryptocurrencies. The goal of the cryptocurrency index – henceforth referred to as Cryptocurrency Market Index, or CMI – is to provide a broad-based exposure to the crypto market, where no single cryptocurrency or specific group thereof dominates the index. Rather than being driven by microeconomic events that affect only one specific coin or type of coin, the CMI aims to fairly represent the diversity of the cryptocurrency market.

There are several different methods to construct an index. In general, indices can be categorized as either price-weighted or capitalization-weighted.[13]

1. Price-weighted: A price-weighted index holds assets in proportion to their prices. Price-weighted indices include an equal number of each asset in their basket; their weighting method is simple to understand and their daily value easy to calculate. If an index contains three stocks A, B, and C with current prices of $3, $8, and $10 respectively, the ABC index level is calculated as $21/3 = $7. Therefore, share A would have a weight of $3/$21 = 1/7 of the entire index.

2. Capitalization-weighted: The problems with the price-weighted index can be overcome by weighting the assets according to market value, which is measured by capitalization. In contrast with a price-weighted index, a capitalization-weighted index hold assets in proportion to their market capitalization. For example, if Bitcoin holds 60% of the entire market capitalization and Ethereum holds 20% then the portfolio allocation will have 60% of the funds invested in Bitcoin and 20% invested in Ethereum. The remaining 20% will be invested in the rest of the cryptocurrencies according to their proportion of the entire cryptocurrency market. The popularity of capitalization-weighted indices, such as the Laspeyres index, mostly comes from the fact that they are simple to understand and have a low turnover ratio. The latter results in decreased costs for the fund and increased returns for shareholders.[14]


Percentage of Total Market Capitalization

Nevertheless, capitalization-weighted indices harbor two problems. Firstly, in heavily concentrated markets they may be dominated by a few large constituents. In the case of cryptocurrencies, Bitcoin and Ethereum come to mind. Only when Bitcoin’s share of the cryptocurrency market started decreasing substantially in relation to altcoins such as Litecoin, Ripple, and Dash in March of this year as the chart illustrates, the construction of a capitalization-weighted index for the cryptocurrency market became feasible. Excessive risk concentrations occur in traditional market indices, too. For example, the two companies Nestlé and Novartis make up more than 40% of the SMI. For that reason, there is a need to

define a limit for the maximum weights for each cryptocurrency in the CMI. Secondly, there is a danger that cryptocurrencies with a small free float[15] may carry greater weight in the calculation of the index than they do in actual trading. A small free float will generally lead to increased volatility of the coin price, a wider bid-ask spread and reduced liquidity. It will take a transparent rules-based approach in order to prevent these problems from affecting the viability of our index. To keep up with the latest events in the rapidly evolving crypto market, rebalancing has to be given special attention. The CMI rebalances monthly to ensure a transparent and up-to-date index basket. All cryptocurrencies in the index are denominated in USD.

Risks Associated with the Index

As cryptocurrencies entered the financial world only recently, investors should be aware of specific types of risk associated with the cryptocurrency market. These risks naturally pertain to any index replicating the cryptocurrency market.

Two main risks exist: (1) extreme volatility in prices and liquidity and (2) uncertainty stemming from the regulatory framework around cryptocurrencies.

Due to the idiosyncratic nature of the supply of many cryptocurrencies and their largely speculative demand, prices change unpredictably. Bitcoin’s volatility mostly results from its built-in quantity commitment: variations in the demand for Bitcoin are accommodated almost entirely by variations in its price. When demand rises, there is virtually no quantity increase to dampen the rise in price; and vice-versa for a fall in demand. The lack of liquidity compounds the problem of fixed supply. Liquidity volatility can cause price distortions and in the worst case, investors may not be able to close or open a position.


Investors must choose between holding of their cryptocurrency investment in Bitcoin or building a diverse index of cryptocurrencies. The saying, “Don’t Put All your Eggs in One Basket” means that lack of diversification can result in total loss. Source: Unsplash.com

The second major risk pertains to government regulation and intervention. Until today, the legal status of Bitcoin – and other cryptocurrencies – varies substantially from country to country. While it is mostly tolerated by governments in the Western world, a considerable amount of countries has not issued a legal opinion on the matter yet or bans the use of it completely. Such regulatory uncertainties can affect the price: When regulators in China recently outlawed initial coin offerings (ICOs) by declaring them “an unauthorized and illegal public financing activity”[16], the price of Bitcoin dropped from almost $5,000 to only $4,300 in less than 24 hours.

A specific challenge for the Cryptocurrency Market Index will be potential errors in data sources or other errors that may affect the weighting of constituents of the index. Eventually, the calculation, publication of the index values or other changes deemed necessary might be subject to discretion of the index provider. As we pointed out above, the current cryptocurrency indices in existence have disclosed very little to no information on their specific methodologies.

Conclusion: Index Investing is a Viable Benchmark for Cryptocurrencies

The cryptocurrency market is rapidly evolving. The supply of cryptocurrency-related financial products has an equally large growth potential. The Cryptocurrency Market Index (CMI) is one step in the direction towards a more developed, investor-friendly cryptocurrency market. Indexing is a time-proven method that does not rely on data or theory. Investors who would like to gain a broad exposure to the cryptocurrency market can use the index as an allocation strategy or as a benchmark for active portfolio management.

[1] The market capitalization of a cryptocurrency is calculated by the price of a coin multiplied by the number of coins in existence. This is an estimate, however, because an uncertain number of coins are irretrievable in the network since users forget their private keys or send coins to the wrong addresses.

[2] CoinMarketCap (2017, 26 September). Cryptocurrency Market Capitalizations, CoinMarketCap. Retrieved from https://coinmarketcap.com/coins/views/all/

[3] Fonds Online Professionell (2017, September 4).Europäischer Kryptowährungsfonds vor Start, Fonds Online Professionell.Deutschlands Unabhängiges Magazin für Anlageberater. Retrieved from http://www.fondsprofessionell.de/news/uebersicht/headline/premiere-erster-kryptowaehrungsfonds-europas-steht-in-den-startloechern-136702/ref/2/

[4] Investopedia (2017). Indexing. Investopedia. Retrieved from http://www.investopedia.com/terms/i/indexing.asp

[5] Kommer, G.(2015). Souverän investieren mit Indexfonds und ETFs: Wie Privatanleger das Spiel gegen die Finanzbranche gewinnen. Frankfurt am Main: Campus, p. 9.

[6] Soe, A. M., & Poirier, R. (2016). SPIVA® U.S. Scorecard.S&P Dow Jones Indices. A Division of S&P Global. Retrieved from https://us.spindices.com/documents/spiva/spiva-us-year-end-2016.pdf

[7] Huerta de Soto, J. (2010).Socialism, Economic, Calculation and Entrepreneurship. Cheltenham: E. Elgar Publishing, p. 35.

[8] Deutsche Börse Group (2017). DAX – benchmark and barometer for the German economy. Deutsche Börse Group. Retrievedfromhttp://deutsche-boerse.com/dbg-en/media-relations/deutsche-boerse-spotlights/spotlight/DAX—benchmark-and-barometer-for-the-German-economy/2606404

[9] Ankenbrand, T., & Bieri, D. (2017, July 18). Cryptocoin Index. Linkedin.Retrievedfromhttps://www.linkedin.com/pulse/cryptocoin-index-thomas-ankenbrand/

[10] TaiFuIndexes (2017). Taifu Indexes – The World’s 1st Cryptocurrency Market Indexes. Cryptocurrency Market, LLC. Retrieved from https://taifuindexes.com/

[11] Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed. Slippage may occur during periods of higher volatility when market orders are used or in the execution of large trades.

[12] TaiFuIndexes (2017). Taifu Indexes – The World’s 1st Cryptocurrency Market Indexes. Cryptocurrency Market, LLC. Retrieved from https://taifuindexes.com/

[13] For further reading on indices, see Brentani, C. (2004). Portfolio Management in Practice.Amsterdam: Elsevier, 2004, pp. 55-67.

[14] This is a simplification of how to build a capitalization-weighted index. The two most common ways to design a capitalization-weighted index are the Laspeyres method and the Paasche method. The Laspeyres method generates a base-period quantity-weighted index by measuring the current period prices of the index constituents weighted at the base period relative to the base period prices of the constituents weighted at the base period. For our purposes, the Laspeyres method proves to be superior to the Paasche method because it facilitates comparisons over time and requires less data.

[15] Similar to stocks trading, we use the term free float to refer to the number of coins freely available to the investing public.

[16] Hackett, R. (2017, September 5). 7 Reasons Why China Banned ICOs. Fortune. Retrieved from http://fortune.com/2017/09/05/china-Bitcoin-blockchain-ico-ban/

Quarterly Review Q4 2017: ICOs: Money, Scams, and Big Hopes

ICOs: Money, Scams, and Big Hopes

Summer 2017 was the summer of Initial Coin Offerings. ICOs and token sales in the crypto sector have seen explosive growth. In 2017, more money has been raised in this market than through venture capital or angel investments. However, this new market is a minefield for investors. Although no ICO regulation exists at the moment, that could soon change. This chapter focuses on initial coin offerings, bubbles, scams, and – of course – regulation.

Who still remembers Pets.com? The rise and fall of this Internet company has become a symbol of the dotcom bubble at the end of the 1990s. The technological possibilities offered by the Internet fired up the imagination of investors quite a bit at the time. For a little while it was considered received wisdom on Wall Street that a good-sounding domain name was all it would take to guarantee success. Pets.com actually had more than just a domain name: it had a business concept, more than 300 employees – and an already existing network of storage facilities across the US. Amazon was an early investor in this provider of pet supplies. It seemed that nothing could go wrong. And yet, Pets.com eventually failed spectacularly.

The online store went public in 2000 – with great success. 82 million USD were raised on the first day. But a mere nine months after the initial public offering (IPO) it was all over: Pets.com was bankrupt. The famous domain name was later acquired by competitor Petsmart. Within just 268 days, the stock plunged from 11 USD dollars to 19 cents.


Pets.com with ticker IPET went from $11 to $0.19 per share within nine months. Source: CNN Money

Pets.com joined the game too late. Other web sites, such as social media forerunner TheGlobe.com, initially had outstanding success. The stock skyrocketed by 600% on its first day of trading. But reality would soon intrude: “The rules of the game changed as soon as we went public”, co-founder Stephan Paternot wrote in his book A Very Public Offering: A Rebel’s Story Of Business Excess, Success, And Reckoning, “It was not about developing our business model, but increasing shareholder value. We were doing well if our stock went up and badly if it went down.”

A mere 20 years later, history seems to be repeating. This time it is blockchain technology that stokes the imagination of investors. The ingredients are almost the same as back then: once again a new technology appears to offer seemingly revolutionary possibilities. Once again, no sphere of life seems likely to be untouched by it. And once again millions are rushing in as though nothing could possibly go wrong.

A New Market is Born

However, there are decisive differences as well. The blockchain sector based on the technology underpinning the cryptocurrency Bitcoin is to this day an almost hermetically sealed market. Companies don’t list on the stock exchange, they don’t conduct an IPO but an ICO – an “initial coin offering”. In contrast to the dotcom mania, an entirely new market has sprung up – which is to date de facto unregulated. Neither investment banks nor hedge funds are the driving forces of the mania but private investors who made a lot of money in recent years as the prices of Bitcoin and other cryptocurrencies massively increased.

Only recently, eight years after Bitcoin first surfaced, the interest of investment bankers and hedge fund managers has been piqued. Goldman Sachs analysts have been giving consideration to Bitcoin since July. Unconfirmed reports suggest that at least 70 different hedge funds are currently entering the market.

ICOs have grown explosively in number and success this year as well. Goldman Sachs states that more money was raised via these instruments since the summer months than internet start-ups received from venture capital firms and angel investors. The precise figures are open to debate though. Goldman Sachs estimates that around USD 300 million were raised in ICOs this July. The New York Times even reported a figure of USD 665 million, which various projects were supposedly able to raise in this month alone – referring to data collected by industry journal Tokendata.io.

These statistics are moreover distorted by the extreme price volatility in cryptocurrencies, as ICOs are not based on dollars but on Bitcoins or more recently increasingly ether as well, the currency of the Ethereum network. As a result of this, a company that made an ICO a year ago may possibly have more than a hundred million dollars in the form of ether coins at its disposal – provided it didn’t exchange the cryptocurrency for dollars right away. The only thing that can be stated with certainty is: this new form of initial funding for start-ups is currently undergoing a boom that surpasses anything we have seen in the blockchain sector up to this point.

What is an ICO Actually?

The term ICO is of course an allusion to the established term IPO. There are in fact a number of similarities between these fund-raising procedures. Both aim to collect money from investors who have become aware of a potential profit-making opportunity and are prepared to take risks. Two important differences were already mentioned: ICOs are mainly the domain of inexperienced retail investors. In addition to this, contrary to stock exchange listings, ICOs are neither precisely defined, nor are they regulated. Lastly, only very few ICOs actually involve the sale of stakes in a company in the form of shares, but rather so-called tokens, the exact purpose of which can vary widely. It therefore seems to make more sense to regard ICOs as a new form of crowd-funding rather than confusing them with traditional stock market listings.

The SEC and ESMA in Europe are closely watching ICOs. Source: Sean at deBanked.com

Often the people offering ICOs specifically stress that the process should be defined as a “token sale”, a “donation”, or a “crowd sale”. This is designed to prevent future problems with regulators. A number of the latter, such as the SEC in the US, have already signaled that they plan to examine ICOs closely in the near future. Should the sale of ICOs be equated to the sale of securities, the same laws and tax rules that apply to the stock market could be applied to them as well. Currently no binding rules exist. Many ICOs already exclude U.S.-based investors though in order to forestall potential future legal problems.

“It can be compared to Kickstarter”, said Julian Hosp in a private interview we conducted during fall of 2017. Together with three partners, the Austria-born entrepreneur has founded the start-up company TenX in Singapore. TenX has developed a prepaid debit card which can be connected with a cryptocurrency wallet on a smart phone. “We want to make cryptocurrencies spendable”, Hosp explains. TenX raised the equivalent of USD 80 million within seven minutes in a token sale it conducted this summer. A special decentralized structure was developed in collaboration with a law firm so as to make the token sale immune to legal challenges.


With an all-time high market cap of almost $9 million, Putin coin’s sole purpose is to pay tribute to Putin and the people of Russia. Source: Twitter.com/putincoinput

The token itself, which trades under the symbol PAY, has no purpose beyond its “kickstarter” function. Soon it is supposed to be possible to use it for payments via the TenX app and debit card. With respect to his opinion on ICOs in general, Hosp isn’t exactly mincing words, neither in his YouTube videos, nor in interviews: “95 percent are scams and pure rip-offs. It probably won’t be long before many of these projects go under. How many of them have actually a useful sphere of application?”

Beware of Scams

Analysts at Smith and Crown are listing several dozen upcoming token sales and ICOs scheduled to take place in the coming months: the ideas range from blockchain-based adult entertainment to the storage of wills – also on the blockchain. According to Smith and Crown, the history of ICOs can be traced back to 2013. At the time token sales were mainly organized through the Bitcoin Talk forum. The first ever ICO is said to have been conducted for the purpose of funding Mastercoin, a mega-protocol that was supposed to create additional features for Bitcoin. The Mastercoin ICO raised 1,000 Bitcoin. The cryptocurrency project NXT also originated via an ICO conducted through the Bitcoin Talk forum. In 2013 and 2014 numerous further ICOs followed, some of which were the work of scammers.


Floyd Mayweather in July became one of the first high-profile celebrities to endorse an ICO. Source: Twitter.com/floydmayweather

That is the other side of the coin, so to speak. The growing success of ICOs and the ever-larger amounts of money involved in these offers continue to attract numerous criminals to this day. In summer of 2017, the Enigma project became victim of an attack by hackers. The hackers altered the web site of the project and entered a false wallet address to which users were supposed to send money to purchase Enigma tokens. The damage reportedly amounted to half a million dollars. How big the long-term damage to Enigma’s reputation will be remains to be seen. The hackers took advantage of the hype accompanying the project and the greed of potential investors.

Similar events occurred also on occasion of the ICO of Israeli project Bancor, which raised more than 150 million USD in June 2017. In this case false wallet addresses were distributed via social media, causing quite a few gullible investors to send money to them that is now lost forever.

The Role of Ethereum

The reason why ICOs have gathered significant steam this year has a name: Ethereum. The number two cryptocurrency by market capitalization was itself created by a token sale. Bitcoin equivalent to “only” USD 18 million were raised at the time. Ethereum is more than a currency, it is a platform providing a blockchain other enterprises can use for their own purposes. Moreover, Ethereum offers a feature called “smart contract”, which inter alia makes it possible to automatically exchange ether tokens for other tokens. That is precisely what happens in a “standard” ICO. Users send their investment in form of ether coins to an ether wallet address and in return receive the tokens issued by the project they want to invest in. The ICO of Bancor took place on the Ethereum network and was so successful that the latter was overloaded for more than a day.


A typical blockchain product roadmap showing progression from idea to implementation. Source: OxFina.com

What purpose the different tokens distributed by their inventors serve varies widely. There are several attempts to create tokens that will make it possible to receive passive income – such as, for example, dividend payments. In view of the looming threat of market regulation, this trend was at the very least hampered of late. Other tokens, such as the one issued by EOS, which will leave its ICO up and running for an entire year, are merely placeholders for the “real” token that will be traded on the still-to-be-developed “real” EOS blockchain.

Similar to many ICOs, participants in the EOS ICO invest merely in an idea and a team, not a ready-made final product. Until the EOS blockchain is ready, the EOS token remains an ETH token, which trades on the ETH blockchain. The highly successful token of Thai company Omise is an analogous case. Omise distributed an Ethereum token by the name of OMG. The token has in the meantime become tradable as well. Omise ultimately wants to develop its own blockchain though and exchange the tokens at a later point in time.

Investors as a rule don’t necessarily have to purchase a new token during the ICO phase, as most of them quickly tend to become tradable at cryptocurrency exchanges. At this juncture one would do well to remember the remarks of the CEO of Globe.com. Similar to start-ups at the time of the dotcom bubble, the survival of new ICO-funded blockchain enterprises should actually not depend on the prices at which their tokens are trading. On the contrary: many have raised enough money to be able to pursue their work for years without funding pressures. Alas, then as now, investors definitely tend to judge a project’s success by watching prices. That leads to a situation in which communication and public relations appear almost as important as the actual technological progress that is achieved – particularly in cases in which several projects in a specific sector are working toward the same goal.

The First Large ICO Failed

Thus, several companies are currently working on building supercomputers based on blockchain technology, on the introduction of cryptocurrency debit cards, or the creation of blockchain-based cloud storage solutions. These are just three examples of spheres of application in which blockchain enterprises want to gain a foothold. A number of projects in the health care, travel and gambling sectors are underway as well. An additional complication is the question what role the token plays in a company’s business concept. It is, for instance, possible that a token has to remain relatively cheap in order to support a project’s functionality.

crypto market cap in perspective

As of December 2017, Facebook’s market cap is twice the size of the entire cryptocurrency market. Source: howmuch.net

Ether itself of all things is subject to a recurring debate in this context: is ether actually a currency, or is it rather the fuel that is burned on behalf of other projects? Moreover, in the case of some projects it cannot be ruled out that their developers will flood the market with additional coins through a new ICO, which would inflate the total outstanding amount of the tokens concerned. In view of the sheer confusion and complexity of the several hundred ICOs in the pipeline for this year and next, interested investors will have no choice but to engage extremely thorough due diligence wherever possible – and to rather pass on investments if it isn’t possible.

Just how dangerous an ICO investment can be is illustrated by the history of DAO. It was the first large-scale ICO on the Ethereum network, which raised around USD 130 million in May of 2016 already. Alas, hackers exploited a security flaw and were able to steal tokens valued at USD 50 million.

Regulatory Authorities are Coming

The event had two important consequences: a so-called hard fork of the Ethereum network was implemented in order to restore the stolen coins. Ever since, both Ethereum and Ethereum Classic exist. The DAO disaster was also the reason for the US regulatory agency SEC to begin a review of the issue. The wheels of justice grind slowly. In the summer of 2017, the SEC issued a statement asserting that the stolen DAO coins should have been registered as securities with the agency.

The importance of this decision has to be equaled with that of the CFTC to classify Bitcoin as a commodity, similar to gold. SEC decision could have an enormous impact on the blockchain industry. Currently ICO issuers are still careful and will rather circumvent the US market in order to avoid becoming a target for regulators. On the other hand, if tokens are treated as securities, an important door will be opened as well.

The reason is that a sufficient degree of market regulation is a precondition for an asset to become accessible to institutional investors, banks, hedge funds and other large financial market participants. A blockchain asset regulated by the SEC could one day also become acceptable as collateral in the capital markets, which would give the importance of cryptocurrencies a massive shot in the arm.

The same applies to the giant Chinese market. The PBoC recently “prohibited” the ICO business as practiced in recent years, which was followed by a brief panic that led to a sharp sell-off in Bitcoin. But even in Beijing the next step is likely to consist of issuing regulations specific to ICOs, which should ultimately boost confidence in the sector and help it to attract more investment.

Conclusion: enormous potential remains

It is therefore probably too early to dismiss the ICO-mania of the past two years as a bubble. Over the medium term there is undoubtedly a danger that the crypto-sphere could be struck by a medium-strength or even very strong earthquake, which could lead to a noticeable shift in the valuation of Bitcoin and other alt-coins. But the potential for the market to become much bigger seems quite obvious as well. Thus, the total market capitalization of all blockchain assets stood at less than USD 260 billion at the end of November 2017.

Although the market capitalization of cryptocurrencies has grown nearly ten-fold since last year, the market remains very small compared to traditional financial assets. The market cap of Apple alone is almost five times larger than the entire sector. The combination of a maturing market, the slow emergence of more specific regulations and the rapidly growing interest on the part of investment banks and hedge funds leads us to conclude that the blockchain mania probably still has a lot of room to grow – perhaps it hasn’t even really started yet. Only once the authorities have indeed leveled the regulatory playing field between blockchain assets and other securities will it be possible to truly compare the market to traditional financial markets.

The same applies to comparisons with the dotcom bubble: between 1997 and 2000 a total of 522 dotcom companies were listed, raising more than USD 43 billion in the process. On the day the Nasdaq Composite peaked it had reached a total market capitalization of USD 6.6 trillion – level that was of course hopelessly exaggerated. However, one must not forget that despite duds like Pets.com and Globe.com, numerous companies involved in this bubble later more than fulfilled their promise – such as, for example, Amazon. Amazon disrupted the retail business by offering an online shopping platform with customer reviews, fast shipping, and free returns. Similarly, the blockchain technology may change the way we store value and pay for goods ands services.

Investors in the late 1990s were not wrong with their assessment of the future – they were merely too early. The required infrastructure didn’t exist yet. If one uses the Internet as a model for the prospects of the blockchain and believes that this technology will have a comparable revolutionary impact, investors can take steps to hedge themselves to some extent against the risks associated with a bubble: they only have to buy the Amazon equivalents of the sector and avoid falling for empty promises. That is of course easier said than done.

U.S. Regulated Bitcoin Derivatives: Blessing or Curse?

U.S. Regulated Bitcoin Derivatives

Chicago Mercantile Exchange (CME) Group Inc. and the Chicago Board Options Exchange (CBOE) announced plans to launch a cash-settled Bitcoin futures product by the end of 2017. This chapter explains what cryptocurrency derivatives are, how investors are using them to trade, and how derivatives can impact the price of Bitcoin.


A regulated and liquid option market would signal to retail and institutional investors that this technology is maturing into a real asset class. Source: Unsplash.com

Bitcoin Futures: A Blessing or a Curse?

The spike in Bitcoin’s price after CME announced their new line of Bitcoin Futures may signal that market participants believe this is a blessing. The price of Bitcoin surged to a record high of over $6,400 Although that record was washed away by Bitcoin’s rally to over $8, 600 in late November, many financial analysts argue that Futures are a curse for Bitcoin. Dave Kranzler of Investment Research Dynamics thinks that futures can be used to manipulate the price of bitcoin. By allowing an infinite amount of fiat-dollar-based paper Bitcoin contracts to be issued with only a limited number of buyers demanding the contracts, the futures price will plummet. Kranzler even goes so far as to question Bitcoin’s hard cap, “So much for the idea that Bitcoin supply issuance is firmly capped”.[1]

However, one important caveat in this argument is missing. As Valentin Schmid of The Epoch Times points out, the futures are settled in cash. Effectively, these contracts are not futures. Instead, these contracts are derivatives that are based on the index price of bitcoin. Therefore, the futures are likely to have little to no effect on the price of the underlying in the long run.[2] If an infinite amount of fiat-dollar-based paper Bitcoin contracts are issued and supply outpaces demand, then the futures price will drop. However, this is not directly connected to the price of Bitcoin.

There is only way to ensure that the futures price converges to the spot price: Arbitrage. Imagine if futures are trading at a 20% premium to Bitcoin’s spot price of $8,000. This could be for a one-month contract ending on the second business day before the third Friday in January 2018. The investor can sell Bitcoin futures and buy physical Bitcoin on an exchange and wait for the settlement date, January 17, 2018.

If the spot price of Bitcoin goes up to $15,000, the investor’s physical Bitcoin will go up in value and the futures will go down in value. If the price of Bitcoin goes down to $4,000, the investor’s physical Bitcoin will go down in value and the futures will go up in value. The two positions create a perfect hedge where exposure is neutralized and profits are zero.

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Bitcoin could go through the process of monetization. Futures markets can push their price higher while reducing volatility. Source: https://twitter.com/TraceMayer

As more investors collect the risk-free profit, the price of physical Bitcoins will go up and the price of Bitcoin futures will drop, enabling the early arbitragers to gain at the expense of the later arbitragers. These arbitrage opportunities will create temporary changes in the demand and price of Bitcoin because the arbitrager will close their physical Bitcoin position after the Futures contract settles.

Another clairvoyant point by Schmid is that long term Bitcoin buy and hold positions are what drive the price of Bitcoin. The shorting FUD (fear, uncertainty, doubt) argument stems from the well-documented market manipulation of gold, silver, and fiat currency.[3] However, Bitcoin’s transparent blockchain makes market manipulation easily traced and detected. Gold is easier to manipulate because fractional reserves go unreported. Dumps of fractional reserve gold certificates lead to margin-calls being executed, which further suppress the price.

However, Bitcoin does not have a fake gold paper equivalent. Bitcoin paper cannot settle transactions on the Bitcoin network. Although the Bitcoin market is not immune to manipulation, the manipulation can at least be monitored routinely for suspicious behavior. Market manipulation in a transparent market can only achieve limited gains. If market manipulators do not behave, they will be left holding worthless Bitcoin as long term holders switch to less manipulated cryptocurrencies.

One Year Bitcoin Options Are Now Available

In addition to the futures market, the startup firm Ledger X has become the first Bitcoin options exchange in the U.S. In July of 2017, the Commodity Futures Trading Commission (CFTC) approved LedgerX’s application to become a Swap Execution Facility and a Derivatives Clearing Organization. The main offering is Bitcoin to dollar option contracts with maturities ranging from one month to one year. Other companies offering Bitcoin derivatives, such as Deribit and the Bitcoin Mercantile Exchange (BitMEX), have garnered significant interest from traders; however, their domiciles in the Netherlands and the Seychelles have limited their investor pool.


Price and Trade Volume History of Bitcoin

The approval of LedgerX in the U.S. represents a momentous step toward establishing an efficient cryptocurrency market that is patrolled by U.S. financial market authorities. As a global leader in financial technology, the CFTC’s approval may encourage governments in Europe and in Asia to follow suit.

In traditional financial markets, an option market is a valuable source of information about market sentiment. Option markets can also be used to hedge volatile asset classes. Applied to cryptocurrencies, options can be used to bet on the future spot price and build positions. This section outlines several ways that investors can use options to trade cryptocurrencies.

Betting the Price Will Go Up

If a trader is convinced that the price of Bitcoin will go up in the future, they can buy a position at the spot price listed on one of the several exchanges or they can buy a call option on an options market. A call option on cryptocurrency works the same way as a call option on stocks. A cryptocurrency call option will give the investor the right to buy a specific amount of Bitcoin at a date in the future. Typically, an American option will have an expiration date of one to six months while a European option only allows investors to exercise the contract on the expiration date. For example, imagine today’s spot price is $8,000 per Bitcoin. The investor can buy one Bitcoin today for $8,000 or they can buy a call option for $200, which will allow the investor to buy the stock at $8,000 in one month from now. If the investor buys for $8,000 today and the price goes up to $10,000 in one month from now, then the investor can realize a gain of $2,000 by selling the Bitcoin.[4]

On the other hand, if the investor buys a call option for $200 and the price goes up to $10,000 in one month, then the investor can exercise the call option and buy one Bitcoin at the price of $8,000. However, the investor will only realize a gain of $1,800 because the cost of the call option, equal to $200, must be subtracted from the gain of $2,000. At first sight, the first scenario sounds better. However, the higher return is accompanied by higher risk. In the first scenario, the investor must risk $8,000, whereas in the second scenario, the investor only needs to risk $200.

If the price had gone down instead of going up, the second scenario would have provided a higher return. Imagine if the price of Bitcoin had plummeted to $4,000 instead of going up to $10,000. In the first scenario, selling the Bitcoin will lock in a loss of $4,000. On the other hand, if the investor had used a call option then they would only lose $200. The investor only loses the amount that they paid for the option when the option is “out of the money.” Figure 15 is a graphical representation of the two hypothetical price movements.


Two Bitcoin Price Paths

Betting the Price Will Go Down

In contrast, bearish traders who think the price of Bitcoin will decrease can buy a put option. Put options can be useful if internal debates, scalability issues, or government regulations challenge the future prospects of the technology. A cryptocurrency put option will give an investor the right to sell a certain amount of Bitcoin at a specific date in the future. In traditional markets, investors can bet on the price of an asset going down by shorting the asset. Shorting a cryptocurrency would involve borrowing the cryptocurrency, selling the cryptocurrency, and then buying the cryptocurrency again at a later date in order to return the cryptocurrency to the lender.[5] However, in the absence of liquid lending markets, put options may be the only way to bet on the price of Bitcoin going down.

For example, imagine today’s spot price is $8,000 per Bitcoin; however, the investor believes that the price of Bitcoin is going to go down. Buying a one month European-style put option for the price of $200 would enable the investor to sell one Bitcoin at the price of $8,000 in one month from today. This option would be “in the money” if the price of Bitcoin is below $8,000 on the day of the option’s expiration. As in the previous example, if the price drops to $4,000, then the investor could sell his or her Bitcoin at the price of $8,000. The trader would realize a gain of $3,800 after factoring in the costs of the put option.

Instead of buying a put option, the investor could short Bitcoin. In order to short a cryptocurrency such as Bitcoin, the investor would begin by borrowing a specific amount of Bitcoin on a lending market, such as the Poloniex lending market. Lending rates fluctuate constantly, and most loan periods are two days; however, interest on a two-day loan rolled over fifteen times to create a thirty-day loan ranges from 0.2% to 0.3% Bitcoin.

With a spot price of $8,000, shorting a Bitcoin would cost between $16 and $24. After borrowing a Bitcoin at the current spot price of $8,000, the investor could sell the Bitcoin immediately at the price of $8,000. If the price of Bitcoin dropped to $4,000 after one month, then the investor could buy back in at $4,000 and return the Bitcoin to the lender. After subtracting the lending costs of $20, the investor would realize a gain of approximately $3,980.

Like buying a call option, buying a put option reduces your risk. To see how this works, imagine the price of Bitcoin had gone up instead of going down. In this scenario, the cryptocurrency shorter has an infinite amount of loss. If the price of one Bitcoin went up to $10,000 after thirty days, then the shorter would lose the amount they paid for borrowing the Bitcoin plus the difference between how much they sold the Bitcoin for and the new spot price. In total, the loss from shorting would be approximately $3,700. In contrast, the second scenario only entails a loss of $200. If the price of Bitcoin goes up instead of going down, then the investor only realizes a loss equal to the cost of buying the put option.

Unlike the CME and CBOE futures markets, LedgerX’s swaps and options are settled physically. In addition to call and put options on Bitcoin, physical settlement allows investors to build positions by writing put options. The options market also enables active trading strategies such as call spreads and straddles. Furthermore, the total number of open or outstanding options may allow investors to gauge market sentiment. In traditional option markets, an increase in the number of outstanding options is interpreted as a bullish signal. Current research by the Nobel Memorial Prize winning economist Myron Scholes is investigating the role that option markets can play in forecasting risk.[6]

Conclusion: Bitcoin derivatives are a milestone for the financialization of the crypto sector

In conclusion, Bitcoin has had a steady upward trend over the past seven years despite being one of the most volatile assets. Only other cryptocurrencies are more volatile than Bitcoin. U.S.-based Bitcoin derivative markets with physical delivery can actually reduce volatility in the price of Bitcoin, which was the original intention of derivative markets in the 18th century. Bitcoin derivatives can be used to forecast risk, build positions in Bitcoin, hedge positions in Bitcoin, and speculate on price volatility; however, futures with cash settlements can only have a temporary impact on the demand and subsequently the price of Bitcoin. The most valuable takeaway from derivative markets will be the implied risk information that can help investors make allocation decisions. Instead of shorting FUD and doomsaying, regulated and liquid derivative markets may signal to retail and institutional investors that this technology is maturing into a real asset class worth investigating.

[1] Kranzler, Dave. (Nov. 1, 2017). Will The New Bitcoin CME Futures Contract Benefit Gold? Investment Research Dynamics. Retrieved from: http://investmentresearchdynamics.com/will-the-new-bitcoin-cme-futures-contract-benefit-gold/

[2] Schmid, Valentin. (Nov. 18, 2017). The Ins and Outs of Bitcoin Futures Contracts. The Epoch Times. Retrieved from: https://www.theepochtimes.com/the-ins-and-outs-of-bitcoin-futures-contracts-2_2356514.html

[3] First Gold Halt of 2014. (Jan. 6, 2014). Nanex Research. Retrieved from: http://www.nanex.net/aqck2/4522.html

[4] This is a simplified analysis of an options trade that does not consider the Greeks and implied volatility. Delta, Gamma, Theta, and Vega play a major role in the return on an options trade.

[5] A detailed explanation of cryptocurrency shorting will be published in the next edition of the Crypto Research Report coming out in Q1 of 2018.

[6] Scholes, M. (2017). The Evolution of Investment Management. Lindau Nobel Laureate Meetings. Retrieved from http://www.mediatheque.lindau-nobel.org/videos/37263/evolution-investment-management

Taxation of Cryptocurrencies in Europe

The countries in Europe are following a decentralized approach to cryptocurrency regulation. The UK treats Bitcoin like a foreign Currency. In Germany, bitcoin sales do not incur a capital gains tax; however, if the investment is held for less than one-year German income taxes apply. Income taxes in Germany are progressive and can be up to 45%. Surprisingly, even Switzerland the land of cryptocurrency, taxes are levied. Swiss residents must pay income tax, profit tax, and wealth tax on their cryptocurrencies holdings. Fortunately, in all EU countries and Switzerland and Liechtenstein, cryptocurrency sales are exempt from the VAT. Although paying taxes is a real bummer, at least this extra revenue will make regulators think twice before outlawing bitcoin.

What do tax law and cryptocurrencies have in common? Most people don’t know the first thing about these topics. Moreover, the two subjects represent polar opposites from a cultural/ worldview perspective. In the eyes of many people tax law symbolizes excessive regulations imposed by a central government agency. This is in contrast to cryptocurrencies and the associated blockchain technology, which stand for a decentralized, unregulated and free society not under the thumb of a central power apparatus. The complexity of these two spheres increases if one attempts to integrate cryptocurrencies into the world of the tax code.


Cryptocurrency Tax Law by Country

Taxation of Natural Persons

The following examination provides a cursory overview of the tax treatment of cryptocurrencies with respect to both natural and legal persons in Liechtenstein. In closing a brief excursion on the question of whether private asset structures are allowed to invest in cryptocurrencies is presented.

Since January 1, 2011 the worldwide income as well as all movable and immovable property of natural persons whose domicile or place of habitual residence is in Liechtenstein, are subject to taxation in Liechtenstein.[1] A special feature in Liechtenstein is the integration of tax on wealth into income tax as well as the principle that a source of income is either subject to wealth tax or to income tax (preventing double taxation).[2]


The Bitcoin protocol combines “1” and “0” to produce instructions that computers can read. Even though cryptocurrencies are digital, governments are eager to levy taxes. Source: Unsplash.com

With respect to the tax treatment of cryptocurrencies this means that every natural person with unlimited tax liability has to declare holdings of cryptocurrencies at the beginning of every fiscal year and convert their value to their Swiss franc equivalent. At the same time, speculative gains from trading in cryptocurrencies are tax-free and do not have to be declared. This is not only very attractive in terms of the tax burden, but provides significant administrative relief as well. In consulting practice one rarely comes across

cases involving the simple purchase and subsequent sale of a cryptocurrency (traditional speculation), but one far more often sees the following types of transactions (which require extensive declaration and documentation efforts in other countries): for example, CHF are exchanged for Bitcoins, later on Bitcoins are exchanged for ether, and these ether are then used to take part in an ICO/TGE and one receives new tokens (or Bitcoins are used directly to, for example, pay a restaurant bill).


Warning: the tax implications of a buy and hold cryptocurrency investment may induce headache. Source: Amazon.com

The tax treatment of coin mining also raises interesting questions. In the author’s opinion, income from mining cryptocurrencies doesn’t represent a tax-free capital gain but has to be seen as a separate commercial activity. Consequently this activity is subject to income tax, which on the other hand is offset by tax-deductible expenses associated with it (e.g., IT-related costs, electricity costs, rent, etc.).

Taxation of Legal Entities

A far more complex picture emerges in connection with legal persons. Investment in cryptocurrencies is not subject to tax exemptions pursuant Article 48 SteG (Tax Act). This means that speculative income is taxable and has to be declared, thus profits and losses are subject to taxation (12.5% income tax).

With respect to the equity capital interest deduction, it should be noted that investment in cryptocurrencies does in principle qualify for the equity capital interest deduction, which reduces the effective tax burden. However, this is conditional on the investment representing part of a firm’score operating assets.


Bitcoin Farm in Gondo, Switzerland. Source: Alpine Mining/Ludovic Thomas

Investment in cryptocurrencies also constitutes a special challenge for corporate accounting. Customary accounting software is (currently) not able to recognize transactions in cryptocurrency terms. Moreover, the assessment of blockchain transactions requires solid technical understanding or an exceptional IT affinity.

Exclusion: Private Asset Structures and Cryptocurrencies

The term private asset structure (PVS/German: Privatvermögensstruktur) designates a special tax status for legal entities managing assets, which results in a PVS being exclusively liable for minimum income tax pursuant SteG Article 62 paragraphs 1 and 2, and not being subject to tax assessment. A crucial condition is that a PVS must not be engaged in any commercial business activity. This condition is fulfilled if it solely purchases, owns, administers and sells financial instruments as defined in Article 4, paragraph 1 (g) of the Asset Management Act, as well as participating interests in other legal entities, liquid funds and bank deposits. Since most cryptocurrencies as a rule cannot be subsumed under the term financial instruments, these cryptocurrencies would have to be classified as “other assets”.[3] Accordingly, investment in cryptocurrencies would be permissible under the following two conditions:

1. There must be no regular, active trading in them and
2. Cryptocurrency holdings must not be used beyond the status of passive ownership, and in particular not to facilitate detrimental economic activities.

Conclusion: Different Countries Treat Crypto Differently

For us at Incrementum, Mr. Langer’s article means that cryptocurrencies may exist in the digital realm but their tax implications are very real. Detection of cryptocurrency investments is difficult–to–impossible for government tax collectors. Although investments that stay in the digital world may go unnoticed for a few more months, the rising value will ring the alarm for tax agencies. Banks that receive large transactions will ask questions and report suspicious activity. Instead, investors are expected to honestly declare cryptocurrency income and wealth to authorities each year.

[1] Article 6, paragraph 1 SteG

[2] Article 15, paragraph 1 SteG

[3] For comprehensive details see for example: Langer, M. (2017). Mehr Mut für Beschwerden im Steuerrecht: Entscheidung des VGH zur PSV(“More courage for complaints with respect to tax law: decision of the Administrative Court”), LJZ,2017, 62.

If you want to understand how to arbitrage coins read this article on bitcoin margin trading explained here.