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A Primer on Regulation and Trading in Switzerland

A Primer on Regulation and Trading in Switzerland

 “This shows once again how the traditional Swiss approach of having principle-based laws that give a lot of discretion to citizens and regulatory agencies are much more innovation-friendly than overly detailed European-style laws.”  

Luzius Meisser

Key Takeaways

  • Traditional banks require $10 million in equity. Crypto banks can apply for FinTech Bank License as of January 1, 2020. This license only requires $300,000 in equity. Startups that want to be licensed to trade security tokens require $1.5 million in equity.
  • Switzerland has already introduced the standards on Virtual Asset Service Providers (VASP), and it has done it more restrictively than the recommendations set forth.
We want to sincerely thank Dr. Martin Liebi and Silvan Thoma from PwC Switzerland for contributing this chapter.
Dr. Martin Liebi: Martin is director and the head of capital markets at PwC Legal Switzerland. Contact Martin for any further information and guidance: [email protected]  
Silvan Thoma: Silvan Thoma is manager in the Regulatory & Compliance Team of PwC Legal Switzerland. Contact Silvan for any further information and guidance: [email protected] 

Cryptocurrencies, which are based on distributed ledger technology, have gained importance in financial services in the recent past. This primer seeks to give an overview of the key obligations under Swiss regulatory laws related to:

  • Trading in cryptocurrencies
  • Initial coin offerings (ICOs)
  • Entities trading in cryptocurrencies
  • Anti-money laundering obligations

When Regulation Applies

Trading in cryptocurrencies is increasingly subject to regulation on multiple levels, namely:

  • Trading 
  • ICOs
  • Entities trading in cryptocurrencies
  • Asset management related to cryptocurrencies 

Table 1: Requirements for Swiss Licenses

Source: Martin Liebi, PwC

Payment tokens, exchange of cryptocurrencies into fiat money, custody wallets, banks, securities dealers, and asset managers are generally subject to anti-money laundering requirements, such as registration, supervision, and identification of counterparty requirements. Anti-money laundering obligations are the basic regulatory requirements that apply to most entities trading in cryptocurrency markets. Depending on their additional activities, they might require a license as a bank, securities dealer (Swiss version of an investment firm), bilateral organized trading facility (OTF) or asset manager, or a combination of these licenses. Switzerland is also planning to introduce a new license category in the near future, called fintech bank. Licenses are required in the cases listed below.

“FINMA – supervised institutions are thus not permitted to receive tokens from customers of other institutions or to send tokens to such customers.”  

  • Accepting client deposits, in particular when issuing OTC derivatives which are not securities, generally requires a banking license. The banking license is the highest regulated category of financial market participation. Cryptocurrencies and their associated private keys may be deposits under the Swiss Banking Act.
Critical Point: A bilateral systematic internalization is when brokers take clients’ trades on their own book. Brokers that engage in this type of activity are subject to higher regulation regarding transparency including the need to show the clients the quote prior to the trade. More information on the regulation of BSI can be found on FINMA website.

Trading in cryptocurrencies which are securities, either on behalf of clients or on one’s own account (if certain turnover thresholds are being exceeded), generally requires a securities dealer license. The licensing requirements also apply to the entity’s public issuing of derivatives. Bilateral systematic internalization of cryptocurrencies and related derivatives or financial instruments is subject to additional regulatory requirements under the Swiss Financial Market Infrastructure Act (FMIA). 

Critical Point: When a manager has the power of attorney to manage a client’s account at a bank, they do not need a license currently. This changes in the beginning of 2020. The new regulatory regime is called the Swiss Financial Services Act and Swiss Financial Institutions Act. The acts come into force on January 1, 2020; however, existing asset managers have up to three years to comply.

Asset management activities related to Swiss and foreign collective investment schemes regarding cryptocurrencies and related financial instruments generally require a license. The distribution of collective investment schemes and the representation of foreign collective investment schemes also require a license. Individual portfolio management and advisory activities are, under the current regulatory regime, not subject to a licensing requirement (except for AML registration). However, this is likely to change under the new regulatory regime planned to enter into force soon.

Critical Point: If a broker, such as Bitcoin Suisse, or a Crypto Fund, such as Incrementum’s Crypto Fund, wants to trade a Bitcoin call or put an option with a counterparty through an over-the-counter trade, they would agree on a price for the option, and then they would need to report this to FINMA and also show their collateral that they can use over time to prove their ability to sell or buy the coins, depending on what side of the option they are on. Natural persons do not need to report options trading positions.

Trading in derivatives based on cryptocurrencies that can be considered derivatives may be subject to multiple obligations depending upon the status of the counterparties involved, such as reporting and risk mitigation. For example, GenTwo’s structured products based on cryptocurrencies or Lykke’s platform that has coins that are linked to a colored coin, which is a small fraction of the underlying coin.

The Regulation of Cryptocurrency Trading

Categories of Cryptocurrencies

There is a rich variety of cryptocurrencies available. There is no generally recognized classification of ICOs and the tokens that result from them, neither in Switzerland or internationally. Switzerland does not yet have an established legal doctrine or case law on cryptocurrencies.

“In Switzerland, according to FINMA’s characteristic, an asset token represents assets such as participation in real physical underlings, companies, or earnings streams, or an entitlement to dividends or interest payments. In terms of their economic function, these tokens are analogous to equities, bonds, or derivatives.”  

Marcel Hostettler, Partner at MME Legal AG 

As we discussed in the January 2019 Edition of the Crypto Research Report, the Swiss Financial Market Supervisory Authority (FINMA) differentiates between three types of tokens. These are utility tokens, payment tokens, and asset tokens. This classification uses an economic approach, applying the concept of “substance over form,” meaning it is all about what the real purpose of the token is, after you scratch on its surface. That is why a token may have characteristics of multiple types of tokens and the classifications of tokens is not mutually exclusive. Asset and utility tokens could also be classified as payment tokens, which will then be referred to as hybrid tokens. In such cases, the requirements are cumulative and therefore more complex.

1.)     Trading in Utility Tokens

Utility tokens are tokens which are intended to provide digital access to an application or service by means of a blockchain-based infrastructure. For example, Timicoin is a utility token which enables access to a shared database for the exchange of health information. Utility tokens are currently not treated as securities by FINMA if their sole purpose is to confer digital access rights to an application or service when issued. There is no connection with capital markets, which is a typical feature of securities. Utility tokens will, however, also be treated as asset tokens if they also have an investment purpose when issued.

2.)     Trading in Payment Tokens

Critical Point: Some scholars argue that asset-backed stablecoins are securities similar to ETFs; however, other scholars argue that asset-backed coins, like the metal-backed Tiberius Coin, are not securities. Similar to physical ownership of a precious metal, a token is a representation of physical ownership that gives the owners the right to the underlying.

Payment tokens, commonly known as cryptocurrencies are tokens which are intended to be used, now or in the future, as a means of payment for acquiring goods or services or as a means of money or value transfer. Cryptocurrencies give rise to no claims on their issuer. Payment tokens are most similar to currencies. Given that payment tokens are designed to act as a means of payment and are not analogous in their function to traditional securities, FINMA currently does not treat payment tokens as securities.

3.)     Trading in Asset Tokens

Asset tokens represent assets such as a debt or equity claim on the issuer. Asset tokens promise, for example, a share in future company earnings or future capital flows. In terms of their economic function, therefore, these tokens are analogous to equities, bonds, or derivatives. FINMA generally treats asset tokens as securities. Tokens which enable physical assets to be traded on the blockchain also fall into this category, meaning that, for example, real estate companies which use tokens on a blockchain would have to deal with asset token regulations.

Table 2: FINMA Token Categorization System

 FINMA Token Categorization System

Source: Martin Liebi, PwC, * Hybrids consist of at least two categories of token-categories.

Asset tokens constitute securities if:

  1. they represent an uncertificated security (meaning that the security has no physical representation, either in the form of being printed on paper or being stored on a memory stick),
  • they represent a derivative (i. e. the value of the conferred claim depends on an underlying asset), there was a pre-financing or pre-sale phase of an ICO which confers claims to acquire tokens in the future.
Critical Point: The Lykke model and structured products from Vontobel, Leontec, GenTwo, and Amun represent derivatives on cryptocurrencies.
“It’s crucial for an ICO issuer to write a formal request to FINMA including the information required according to the ICO Guidelines and await the ‘no-action letter’ from FINMA before proceeding with the ICO.”  

Pascal Sprenger, KPMG 

All of the above require the token to be standardized and suitable for mass standardized trading. Being suitable for standardized trading means they are publicly offered for sale in the same structure and denomination or are placed with more than 20 clients insofar as they have not been created especially for individual counterparties.

In addition to regulatory requirements and obligations (see below), securities are subject to prospectus requirements under the Swiss Code of Obligations if they are analogous to equities or bonds.

4.)     Trading in Tokens That Are Derivatives

Trading in asset tokens that are derivatives is generally subject to the regulatory obligations applicable to conventional derivatives. These are the reporting obligation, risk mitigation obligations, and, at least in theory, the clearing obligation and the platform trading obligation under the Swiss Financial Market Infrastructure Act (FMIA). All of these obligations under the FMIA have been developed tailored to a bilateral relationship between two counterparties trading in derivatives.

Critical Point: It is, however, difficult to clearly identify the counterparties to tokens that are derivatives due to the decentralized nature of blockchain-based tokens and the anonymity of the holders of the tokens. Fulfilment of regulatory obligations applicable to derivatives can, thus, be cumbersome.

5.)     Initial Coin Offerings

Pre-Sales versus Pre-Financing

There are currently no specific financial market regulations in Switzerland that cover initial coin offerings (ICOs) explicitly. ICOs are, hence, currently treated in accordance with the generic categorization of tokens into payment, utility, and asset tokens. Thus, only asset tokens qualifying as securities are subject to treatment under financial market regulations and are, in particular, subject to the prospectus requirement if they are economically equivalent to a share or bond. The placement of securities and the issuance of securities in the form of derivatives, along with trading in securities, may be subject to licensing requirements (see below). Securities are also tokens that are put into circulation at the point of fundraising. Pre-financing is a situation in which the investors have the prospect of receiving tokens at some point in the future, while the tokens or the underlying blockchain remain to be developed. Tokens that are issued pre-ICO and which entitle investors to acquire different tokens at a later date are called pre-sales.

Figure: Number of ICOs per Month

Number of ICOs per Month

Source: Icobench.com, Incrementum AG

The Licensing of Entities Trading in Cryptocurrencies

  1. Asset Tokens
“Just like other financial industry service providers, crypto businesses can also apply for a membership with a self-regulatory organization (SRO). The idea is simple: Instead of getting a FINMA license themselves, crypto businesses become a member of FINMA-regulated SRO to prove compliance with Anti-Money-Laundering regulations and Swiss financial law.”  

Lucas Hofer, Writer at ICO.li 

1.) Registration with Self-Regulatory Organization

Payment tokens and utility tokens can be traded on a bilateral and multilateral basis just on the basis of a registration for AML (anti-money laundering) purposes with a self-regulatory organization. As long as the operator of such activities will be fully compliant with the applicable AML obligations, no other obligations will apply to such trading activities. The registration with a self-regulatory organization for AML purposes is for many operators the first step in the build-up process of their trading activities and can be done with little effort and costs.

2.) Registration as a Swiss Bank

Registration as a Swiss Bank

Banking License

The professional acceptance of public deposits generally requires a banking license, unless an exemption applies. Generally, all liabilities qualify as deposits. This is also true for derivatives that do not qualify as securities, for example, because they are tailor-made and not appropriate for mass trading. Professional acceptance of public deposits generally means more than 20 depositors or public promotion of the willingness to accept deposits.

Critical Point: Unlike most other regulatory sandboxes globally, Switzerland has a static sandbox where companies can try and test new business ideas without triggering a licensing requirement. However, you cannot pay interest or invest these assets on the deposit of under 1 million CHF.
Critical Point: If there is an investor deposit with a crypto broker and the money is only there for 60 days, then this does not trigger a licensing requirement for the crypto broker. This exemption also applies to brokers that take public deposits for security transactions, such as buying or selling stocks.

There are currently different scholarly opinions on whether cryptocurrencies and the transfer of the private key qualify as a deposit. Even if considered a deposit, there might be multiple exemptions applicable, and thus no banking license would be necessary. Typical exemptions are:

Not qualifying as professional activity: Swiss sandboxes accepting deposits of up to 1 million CHF is not considered to be professional activity if these are not invested and not subject to interest payments and if the clients are pre-informed about the lack of FINMA supervision and deposit insurance.

  • Deposits with precious metals dealers, asset managers, or similar enterprises that are not subject to interest payments and made for the sole intention of settling transactions, as long as the settlement occurs within 60 days. Securities dealers benefit from a longer settlement period determined on a case-by-case basis.
Critical Point: If you are a very wealthy person with a family office, you do not need a license to invest in cryptocurrencies because there is no third-party counterparty risk. The bank or family office is investing in cryptocurrencies with their own skin and not the skin of someone else.

Non-qualifying deposits: Deposits are not public if deposited by banks or qualified shareholders having at least 10 % of the votes or the capital and related third parties and institutional investors having at least one person dealing full time with asset management matters (professional treasury).

FINMA treats cryptocurrency client dealers that engage in similar activities to client FX (foreign exchange) dealers as such. Client cryptocurrency dealers that accept fiat money for cryptocurrencies from clients on accounts and are themselves party to cryptocurrency transactions with their clients generally do require a banking license. This is not the case if an asset manager has sole power of attorney, allowing the management of cryptocurrency positions.

Critical Point: A Swiss FinTech license is similar to a Liechtenstein e-money license. A privileged deposit in Switzerland is a deposit of at least 100,000 CHF. In Liechtenstein, a privileged deposit is only 30,000 CHF.

(2) FinTech Banking License

On January 1, 2020, Switzerland will introduce a new licensing category called FinTech license that should put FinTechs, and in particular entities trading in cryptocurrencies, under more adequate supervision. The FinTech license will allow holding public deposits, e. g., in the form of payment tokens or utility tokens or fiat similar to a bank up to an amount of 100 million CHF. It will, however, not be possible to do business with these deposited assets, e. g., by lending them to third parties, and no interest can be paid on these public deposits. The deposited assets are, unlike a bank, not subject to the legal privilege of privileged deposits. On the positive side, the regulatory capital required is much lower than that required by banks (300,000 CHF as a minimum or 3 % of the public deposits).

“The Fintech license allows institutions to accept public deposits of up to CHF 100 million, provided that these are not invested and no interest is paid on them. A further requirement is that an institution with a FinTech license must have its registered office and conduct its business activities in Switzerland.”  

The Federal Council of Switzerland

The FinTech license allows also for additional alleviations, such as accounting rules according to the Swiss Code of Obligations. An entity wishing to receive a FinTech license will have to undergo a licensing process with FINMA.

(3) Obligations of a Bank

Obligations of a Bank

Assume you are the new CEO of a bank and you have the idea of entering the crypto market. These are the requirements you have to fulfill to trade tokens which are not securities.

  • Requesting a License

Dealers in cryptocurrencies that require a banking license have to file an application to get a banking license with the Swiss Financial Market Supervisory Authority, FINMA.

  • Organizational Requirements

Any bank needs to have a board of directors with at least three members and a separate management team. A bank also needs a compliance and risk management function as well as an internal audit function, along with the business function. The bank must implement an effective separation between the trading desk, credit business, settlement, and the control functions (risk and compliance). The outsourcing of internal audit, compliance, and risk management is generally possible. Any bank must also have an effective internal control system in place.

(3) Capital Requirements

Any bank must have equity of at least 10 million CHF and is subject to additional capital requirements depending upon its business activity and risk profile. Banks are also subject to special regulatory accounting rules.

(4) Notification Requirements

Banks have to inform FINMA about the fact that they are initiating operations in a foreign jurisdiction. Furthermore, the acquisition or divestment of subsidiaries, representations or branches in a foreign jurisdiction must be reported to and pre-approved by FINMA. FINMA must also be informed about qualified holders of shares in the bank and about any decrease, increase, or reaching of the related qualified holdings of 10 %, but also 20 %, 33 %, or 50 % of the capital and the votes.

(5) Pre-approval Requirements

Any foreign shareholders of a bank need pre-approval from FINMA. Any change to the organizational documents of a bank must also be pre-approved by FINMA. 

(4) Asset Protection

Privileged deposits of depositors are subject to special protection. Deposits in the name of the depositor up to an amount of 100,000 CHF are privileged claims subject to privileged treatment in bankruptcy. Banks must cover 125 % of their privileged deposits with Swiss and covered claims.

Critical Outlook: Securities are also subject to privileged treatment in the event of bankruptcy. Therefore, the question is how cryptocurrencies will be treated in the future in this regard.

  • Trading in Cryptocurrencies Which Are Securities

Great, your crypto bank worked out well and you met all the requirements. But that is not enough for you. As CEO of crypto bank, you are now eager to enter the market for cryptos which are tokenized securities.

Trading in cryptocurrencies that are securities requires the trading entity to be licensed as a securities dealer. Securities are standardized, certificated (existing in physical form), and uncertificated (not existing in physical form) financial instruments suitable for mass trading. They are, thus, either offered publicly in a similar structure and denomination or placed with more than 20 clients, unless they are being created specifically for individual counterparties.Don’t worry, you don’t need such a license for trading in utility and payment tokens!

A security can trigger multiple legal consequences when being traded. These consequences are:

  • Persons professionally trading in securities will potentially have to apply for a license as a securities dealer (the Swiss equivalent of an investment firm or broker/dealer).  
  • Facilities allowing for the multilateral trading of securities require a license as a stock exchange or multilateral trading facility (MTF) or must be reported as an organized trading facility (OTF).
  • Facilities allowing for the bilateral trading of securities must be operated by a duly licensed operator (the Swiss bilateral version of an OTF, which replaces the systematic internalizer in the EU).

1.) Current Regulation of Investment Firms Professionally Trading/ Executing Security Tokens (Securities Dealer Act)

Organized Trading Facilities (OTFs) Regulated by the Swiss Financial Market Infrastructure Act
Organized Trading Facilities (OTFs) Regulated by the Swiss Financial Market Infrastructure Act

Your friend Daniel is a securities dealer and you chose him as a cooperation partner for your bank. But dealing cryptos that are securities means you have to meet several requirements:

(1) Swiss-based Securities Dealers

Professional trading in securities typically requires a license as a securities dealer granted by the Swiss Financial Market Supervisory Authority, FINMA. The detailed requirements and licensing process depend heavily upon the place of domicile of the securities dealer and the business activity pursued. A Swiss domiciled securities dealer is any legal entity or partnership that professionally sells or buys securities either:

  • on its own account on the secondary market with the intent of reselling them within a short period of time (own-account dealers and market makers)
  • on behalf of third parties (client dealers)
  • by publicly offering securities to the public on the primary market (issuing houses)
  • by professionally creating derivatives and offering them publicly on the primary market (derivative house)

Table 3: Which Security Tokens Dealers Need and Additional License

Which Security Tokens Dealers Need and Additional License

Source: Martin Liebi, PwC,

“The true game changer is to get an OTF license from FINMA here in Switzerland.”  

Richard Olsen, Founder of Lykke

“Own account dealers” (see below) and “issuing houses” (see below) have to be primarily active in the financial sector at an individual and group consolidated level. This means that the main business activity of a group must be in the financial sector. Even sizeable securities trading activities of treasury companies within a group that is pursuing a primary business purpose other than a financial activity are, thus, not subject to the licensing requirements of a securities dealer if the securities trading is closely related to the group’s business activity (e. g., treasury departments of industrial companies). This does not, however, apply to market makers and client dealers, who will have to apply for a license even if the group’s main business activity is not a financial activity.

FINMA Licensing Categorization System

  • Trading on One’s Own Account (Proprietary Trading)

Securities dealers trading on their own account will only become subject to a licensing requirement if they pose a systematic risk to the financial system. That is why their gross annual turnover in securities must be at least 5 billion CHF. They typically do not have any clients. Securities dealers trading on their own account generally act in a professional capacity and on a short-term basis. Key aspects of trading on one’s own account include trading without instructions from third parties and taking on risk, which is primarily market risk. In the context of a clearing situation it can, however, lead to a counterparty risk if clients do not advance money to settle the securities.

Trading on a short-term basis means the active management of securities to achieve gains from short-term fluctuations in prices or interest rates within a short period of time. Long-term investments in securities and, in particular, the holding of securities until maturity are not deemed to be trading on one’s own account.

  • Trading on One’s Own Account (Market Makers)

Market makers trade publicly in a professional capacity in securities, on their own account and on a short-term basis. They trade publicly because they offer the securities to anybody. They set a firm bid and ask for prices on an ongoing basis or on request (request for quote).

  • Trading on Behalf of Third Parties (Client Trading)
“August 27, 2019. Sygnum and SEBA have both been granted a banking and securities dealer license from the Swiss Financial Market Supervisory Authority (FINMA). This is the first time this license has been awarded to digital asset specialists.”  

Greater Zürich Area Magazine

Client dealers handle securities in their own name, but on behalf of clients, in their professional capacity. A professional capacity is assumed if the securities dealer maintains accounts directly or indirectly or acts as a custodian for more than 20 clients.

Whether the securities dealer is dealing on account for the client or on his/her own account is determined based on economic considerations, namely who is bearing the risk of the transaction. If the client is bearing the economic risk, trading activities over the nostro accounts of the securities dealer are deemed transactions on behalf of the client. Client dealers maintain accounts for the settlement of the transactions for these clients or with third parties or keep these securities for themselves or for third parties in their own name.

There are exemptions when no licensing requirement is triggered, such as if all clients are Swiss. Asset managers and investment advisors are not deemed to be securities dealers if they are acting based on a power of attorney, unless they purchase or sell securities to their clients using their own account or securities deposits.

  • Placing Cryptocurrencies as Securities (Issuing Houses)

Securities dealers in the form of issuing houses place cryptocurrencies as securities issued by third parties on a professional basis at a fixed price or for commission and offer them to the public on the primary market. A key criterion for whether the placement of cryptocurrencies as securities on the primary market is an activity of a securities dealer is thus whether it is “public.”

An offering is public if it is addressed to an unlimited number of people, in particular by via advertisements in the media, prospectuses, or other electronic means. Offers of securities are made exclusively to qualified investors such as domestic and foreign banks and securities dealers or other enterprises under government supervision, shareholders and partners with a significant equity interest in the borrower and parties affiliated and related to them, and institutional investors with professional treasury departments, meaning the employment of one person on a full-time basis managing the company’s assets, are not considered. An offering is deemed to be “public” even if securities have been placed with fewer than 20 people, but the offering has been addressed to an unlimited number of people who do not have to be exclusively qualified investors.

  • Creating Cryptocurrencies as Derivatives (Derivative Houses)

Derivatives houses create cryptocurrencies in the form of derivatives, meaning financial instruments whose value is derived from an underlying. They handle this professionally themselves and offer them on the primary market on their own account or on account of a third party. A placement of derivatives with less than 20 clients after a public offer still qualifies as public offer. A placement of derivatives with less than 20 clients does not trigger the requirements of a securities dealer.

Security Token Derivatives?
Many investors erroneously believe that exchange-traded funds in traditional markets like stocks and bonds are derivatives. They actually are not considered derivatives. Rather, they are a separate category of securities similar to mutual funds. Unless they use leverage to enhance the performance over the underlying asset such as the ProShares Ultra S&P 500 ETF seeks to provide investors with returns that equal twice the performance of the S&P 500 index. That is an example of an ETF that is a classified as a derivative.   Also, there are investment contracts that qualify as a derivative but not as a security – at least in Switzerland. For example, a tailor-made over-the-counter call option is a derivative but not a security. In the European Union, this is normally still considered a security.     

(2) Foreign securities dealers

Foreign securities dealers are entities that either: 

  • possess an equivalent license abroad, or
  • apply the expression “securities dealer” or an expression of similar meaning in their corporate name, business purpose, or documents, or
  • conduct trading in securities.

Foreign securities dealers, meaning entities that are not domiciled in Switzerland, are generally subject to the same requirements as Swiss-domiciled securities dealers, unless the law sets forth different obligations. Securities dealers that are actually managed in Switzerland and execute their transactions mainly out of Switzerland must incorporate in Switzerland and be organized according to Swiss regulations. They will be subject to the regulatory requirements of a Swiss securities dealer. Securities dealers organized under Swiss law are deemed to be under foreign control if a foreign person indirectly or directly holds more than 50 % of the votes or has a material influence on the securities dealer in any other way.

(3) Obligations of a Securities Dealer

Daniel, the security dealer, now clearly knows what forms there are and he is certain about how his firm’s work is seen from a legislative point of view. But still he needs to know what exactly he must do to build up a fully compliant service. Here are the steps he must follow:

(1) Applying for a License

Anyone falling within one of the categories of a securities dealer mentioned above has to apply for a license with the Swiss Financial Market Supervisory Authority, FINMA.

(2) Organizational Requirements

The securities dealer must have a board of directors and a management team. There must be an adequate separation between trading, asset management, and administration. The securities dealer must also establish an internal control system consisting of compliance, risk management, and internal audit. An external regulatory audit firm must also be appointed. It is possible to unify some of the control functions with a specific person.

(3) Capital Requirements

Any securities dealer must have fully paid-in minimal capital of at least 1.5 million CHF. Any shareholder indirectly or directly holding more than 10 % of the capital or the voting rights of a securities dealer or that may in any other way influence the business activities of the securities dealer must meet FINMA’s fit and proper criteria. The provisions applicable to banks regarding their own capital and accounting generally also apply to a securities dealer. Privileged deposits of clients are subject to enhanced protection.

(4) Reporting, Information, and Approval Obligations

Any securities dealer will have to comply with multiple reporting, information, and approval obligations on an ongoing basis. Any change to the preconditions for granting the license, but in particular the articles of association, regulations, material change of business activity, management, board of directors, and external audit firm, as well as build-ups, investments, and divestments of foreign operations, must be pre-approved by FINMA.

Any indirect or direct acquisition or sale of a stake in a securities dealer reaching, exceeding, or falling below the thresholds of 20 %, 33 %, or 50 % of the capital or the votes must be reported to FINMA.

(5) Exception: Algorithmic and High Frequency Trading

Participants in Swiss trading venues that are engaging in algorithmic or high frequency trading activities are subject to enhanced recording requirements and their systems must ensure adequate functioning even in stress situations.

Organized Trading Facilities (OTFs) Regulated by the Swiss Financial Market Infrastructure Act

(1) Bilateral Trading in Cryptocurrencies

Trading arrangements in derivatives or financial instruments related to cryptocurrencies can be an organized trading facility (OTF) that is subject to special regulation. An OTF is, in Switzerland, the catch-all facility for many other trading setups encompassing bilateral and multilateral as well as discretionary and non-discretionary trading activities in both securities and financial instruments, meaning any other financial instruments used for investment purposes while not constituting securities. The Swiss OTF offers a lot of flexibility, which makes it a highly suitable platform for cryptocurrency trading. 

An OTF is any trading facility that:

  • is governed by a set of rules that is standardized and binding to participants,
  • allows for the conclusion of contracts within the scope of application of these rules,
  • enables the initiative to trade to come from the participants.

An OTF can only be operated by a bank, securities dealer, trading venue, facility recognized as a trading venue or a legal entity within a financial group that is controlled directly by a financial market infrastructure and is subject to consolidated FINMA supervision. Unlike under MiFID II/MiFIR, a systematic internalizer is not a special category of investment firm/securities dealer but is either a bilateral OTF or a securities dealer if the related requirements are met.

Critical Point: Credit Suisse and UBS are examples of entities that have OTF licenses. Pre-trade transparency means that the bid and ask spread must be disclosed to the client prior to the trade. Many cryptocurrency brokers are trying to get an OTF license.

The operation of an OTF is also subject to requirements that ensure orderly trading, transparency and investor protection, such as best execution requirements in the case of discretionary trading. Any operator of an OTF must issue rules and regulations and appoint an independent control function that monitors compliance with these regulations. Pre-trade transparency is required in the case of bilateral and multilateral liquid trading, meaning at least 100 trades on average per day over the last year. Post-trade transparency is only required in the case of multilateral trading. Anyone operating an OTF or intending to do so in the future must report this fact or intent to the Swiss regulator FINMA.

After having reviewed bilateral trading systems, in the following part different multilateral systems will be described.

(2) Multilateral Trading in Cryptocurrencies

“Unlike under European law, the Swiss law OTF category serves as a rather wide catch-all category.”  


Cryptocurrencies can be traded on a multilateral basis based on multiple organizational setups depending upon the legal nature of the cryptocurrencies traded and the trading mechanism.

1.) Multilateral trading in Payment and Utility Tokens on the Basis of an SRO registration

Payment tokens and utility tokens can be traded on a multilateral basis, meaning the simultaneous exchange of bids between several participants and the conclusion of contracts based on non-discretionary or discretionary rules, simply based on a registration with a self-regulatory organization (SRO) for AML purposes.

2.) Multilateral Trading in Asset, Payment, and Utility Tokens

(1) Stock Exchange

The highest regulated entity for trading in cryptocurrencies on a multilateral basis is the stock exchange. A stock exchange means an institution for multilateral securities trading where securities are listed, whose purpose is the simultaneous exchange of bids between several participants and the conclusion of contracts based on non-discretionary rules. A stock exchange can admit to trading payment token and utility token.

Stock exchanges are regulated according to the principle of self-regulation in Switzerland. This means that the law gives certain guidelines and determines certain obligations that must be complied with on a mandatory basis. The operator of a multilateral trading operation has, however, the discretion to determine the organization and the rules applicable to the trading activities of the stock exchange as a default.

A stock exchange must have multiple bodies, such as the admission board, the reporting office, the disclosure office, a trade surveillance office, the regulatory board, the sanctions commission, and the appeals board. It must also have a board of directors, a management, a compliance function, a risk function, and an internal audit function. The organization must be appropriate in terms of staffing and organization to operate a multilateral trading operation. In particular, there are also certain obligations regarding the features and the resilience of the trading system and the IT system, such as pre- and post-trade transparency, algorithmic trading, and guarantees for the orderly trading.

(2) Multilateral Trading Facility

A multilateral trading facility (MTF) means an institution for multilateral securities trading whose purpose is the simultaneous exchange of bids between several participants and the conclusion of contracts based on non-discretionary rules without listing securities. An MTF differs thus from a stock exchange only in so far that securities are not listed on an MTF. Payment token and utility token can, next to securities, also be traded on an MTF.

The organizational requirements and the required staff are almost identical to the ones required for a stock exchange. The only real difference results from the fact that securities are not listed on an MTF but admitted to trading.

(3) Organized Trading Facility

An organized trading facility (OTF) is an establishment that allows, next to the bilateral trading in securities or financial instruments for the exchange of bids, also for the multilateral trading in securities or other financial instruments whose purpose is the exchange of bids and the conclusion of contracts based on discretionary rules or the multilateral trading in financial instruments other than securities whose purpose is the exchange of bids and the conclusion of contracts based on non-discretionary rules.

An OTF must either be operated by a licensed bank, securities dealer or the authorization or recognition as a trading venue. The law requires some obligations regarding conflict of interests, transparency, and orderly trading. Within these guidelines, the operator of an OTF has, however, a vast discretion to self-regulate the OTF.

(4) DLT Trading System

“The Swiss proposal can be seen as confirmation of the positive attitude of the Swiss government towards DLT and strikes a good balance between self-regulation, supervision, and alleviations for smaller marketplaces.”  

Martin Liebi, PwC

The Swiss lawmaker is planning to introduce soon a new category of multilateral trading facility specifically made for DLT-securities amongst many other key legal changes addressing pressing needs (such as, but not limited to the bankruptcy treatment of crypto assets and a new category of securities called DLT securities etc.). The key differentiating features of this license category will be that one license covers the entire trading and post-trading (settlement and custody). Although a similar setup like a stock exchange is required, FINMA can on a case-by-case basis relieve the license holder from certain requirements depending upon the risk profile and the scope of activity. Participants can be either natural persons or licensed entities.

Anti-Money Laundering Obligations

Cryptocurrency Activities Subject to Anti-Money Laundering Supervision

Cryptocurrency Activities Subject to Anti-Money Laundering Supervision

1.) Payment Tokens

The issuing of payment tokens constitutes the issuing of a means of payment subject to this regulation as long as the tokens can be transferred technically on a blockchain infrastructure. This may be the case at the time of the ICO or only at a later date.

2.) Utility Tokens

In the case of utility tokens, anti-money laundering regulation is not applicable as long as the main reason for issuing the tokens is to provide access rights to a non-financial application of blockchain technology.

3.) Exchange of Cryptocurrency into Fiat Money 

The exchange of a cryptocurrency for fiat money is subject to AML requirements.

4.) Custody Wallet

The offering of services to transfer tokens if the service provider maintains the private key is a financial intermediary activity subject to AML requirements.

5.) Banks, Securities Dealers, and Asset Managers

Securities dealers and banks duly licensed by FINMA are financial intermediaries. They are subject to the requirements of Swiss anti-money laundering provisions. Any other trading activities not subject to a license as a securities dealer are not subject to the Swiss anti-money laundering regulations (unless they concern a payment token). Asset managers of individual portfolios are also subject to anti-money laundering supervision but are not subject to FINMA authorization.

Obligations of Entities Engaging in Cryptocurrency Activities Subject to Anti-Money Laundering Supervision

1.) Registration With a Self-Regulatory Organization or with FINMA if not FINMA-Supervised

Financial intermediaries not supervised by FINMA must register with an AML self-regulation organization or directly with FINMA. They will then become subject to the client and beneficial owner identification and transaction surveillance requirements set forth in the applicable directives of the self-regulation organization.

2.) FINMA-Supervised Entities

“Swiss Federal Council continues to monitor developments around blockchain/DLT.”  


Banks and securities dealers have to comply with the verification of the identification requirements of contractual parties and the establishment of the identity of the controlling person and the beneficial owner according to the Agreement on the Swiss Banks’ Code of Conduct with regard to the exercise of due diligence (CDB16). Compliance with these requirements is audited by the external auditor on an annual basis.

3.) General Obligations of All Financial Intermediaries Subject to AML Obligations

(1) Identification of a Contractual Party

Financial intermediaries undertake to verify the identity of the contracting partner when establishing business relationships. The execution of transactions involving trading in securities must exceed 25,000 CHF in the case of an account opening.

(2) Establishment of the Identity of Controlling Persons and Beneficial Owners
Critical Point: Form A is used to disclose the beneficial owner or if you go to a bank counter at LGT and you try to exchange a certain amount of euros and Swiss francs above a certain threshold, then you need Form K. 

If an operating legal entity or partnership has one or more controlling persons with voting rights or capital shares of 25 % or more, these are to be identified in writing. Controlling persons are those natural persons who effectively have ultimate control over the company. Whether these persons exercise control directly or indirectly via intermediate companies is irrelevant. A controlling person must generally be a natural person. The contracting partner must confirm the name, first names and actual domiciliary address of the controlling person in writing or by using Form K.

The financial intermediary requires from its contracting partner a statement concerning the beneficial ownership of the assets. Generally, the beneficial owners of the assets are natural persons. If the contracting partner declares that the beneficial owner is a third party, then the contracting partner has to document the latter’s last name, first name, date of birth, and nationality, along with his/her actual domiciliary address, or the company name, address of registered office, and country of registered office using Form A.

(3) Business Relationships and Transactions with Increased Risk

Financial intermediaries have to determine business relationships and transactions that are subject to increased risk. The initiation of such business relationships and the execution of such transactions are subject to enhanced due diligence requirements. Such business relationships must be approved by the management.

(4) Organization

Financial intermediaries must establish an organization that allows for efficient compliance with the applicable anti-money laundering regulations and, in particular, has to designate a dedicated anti-money laundering function. New products must be checked by the securities dealer for their compliance with the applicable regulations. Securities dealers must establish an effective mechanism for the surveillance of transactions and business relationships based on an IT system.

4.) Regulatory Requirements Regarding Payments on the Blockchain

Switzerland has already implemented the FATF standards on virtual asset services providers (VASP). These apply to crypto exchangers, wallet providers, and trading platforms. FINMA has made it clear that information regarding the person giving the payment instruction and the beneficiary must be submitted in case of a payment made on the blockchain like in any other payment made between banks (e. g., SWIFT). Any such payment must also be made between two entities registered for AML purposes (unlike the FATF recommendations that allow also for payments between non-AML-registered entities). Payments are only possible between two clients of the same AML-registered entity or between wallets of the same client held with the AML-registered entity. Payments to third parties outside of the scope of influence of the AML-registered entity making the transaction must be identified like an own client (identity, beneficial ownership, and actual transaction power) by means of adequate technical measures. In case of exchanges fiat-vs-payment tokens and the involvement of an external wallet must the exchanging entity check who has the power to transact about the wallet by means of adequate technical measures.

This more restrictive implementation of the FATF-VASP standards will force wallet providers to become registered for AML-purposes to allow for the execution of payments. Such registration can be done on a voluntary basis with an SRO for AML purposes in Switzerland. It will also require an exchange of information between the two entities executing the payment because there is yet no system available that can transmit the data required for the identification of the contractual party and the beneficial owner.

Tokenizing the Swiss Franc with Armin Schmid of Swiss Crypto Tokens

Tokenizing the Swiss Franc with Armin Schmid of Swiss Crypto Tokens

“Useful groundwork has already been done in all these areas in Switzerland. But the time for pioneers is over: Switzerland now has to take the next step in the development of DLT, morphing from the much-vaunted ‘Crypto Valley’ into a fully-fledged DLT nation.”

Avenir Suisse, Blockchain after the Hype Report

Key Takeaways

  • Crypto Francs (XCHF) is fully backed by physical bank notes and there is no negative interest rate. Storage costs make 100 % backed circulating bearer instruments not possible unless the issuing company charges subscription and redemption fees as well.
  • Swiss Crypto Tokens has issued more than 10 million XCHF on the Ethereum blockchain using the ERC-20 token smart contract.
  • Swiss Crypto Tokens does not see Swiss National Bank Coin as competition, as the underlying private blockchain and purposes are fundamentally different.

Everyone Can Hold Digital Swiss Francs Now

The most common form of stablecoins are fiat-backed and fiat-pegged stablecoins. For this edition of the Crypto Research Report, we interviewed Armin Schmid from Swiss Crypto Tokens (SCT) AG that issues the Crypto Franc (XCHF) to answer a few unanswered questions from our readers. The tokens themselves represent an underlying transferable bond based on Swiss law.

Source: Bitcoin Suisse
Source: Bitcoin Suisse
Armin Schmid joined Bitcoin Suisse in April 2018 as Head Strategic Projects. In July 2018, he became CEO of the newly founded daughter company Swiss Crypto Tokens AG. Armin previously worked for eBay, PayPal, and SIX Payment Services. He holds a Master in Materials Engineering from ETH Zurich and an MBA from University of St. Gallen.

Each ERC-20 token represents a zero-coupon Crypto Franc bond. Swiss Crypto Tokens is “borrowing” money for one month from investors. In exchange for borrowing the money, Swiss Crypto Tokens issues a stablecoin to them as a type of receipt. If the token is not returned before maturity, the token rolls over to the next bond period free of charge. When the XCHF ERC-20 is sent back to Swiss Crypto Tokens and the customer is fully onboarded with KYC & AML documentation, the Swiss francs are redeemed. Swiss Crypto Tokens burns the XCHF ERC-20 token and does not further trade it.

  • Are all Crypto Franc (XCHF) ERC-20 tokens fully backed with reserves?

Armin: All holdings (currently more than 10 million CHF) are backed 100 % in physical banknotes, that’s right.

  • If you stored this cash in a bank, would you have to pay negative interest rates on this money?

Armin: Most probably yes. Banks usually have a certain threshold, where they don’t charge, but at this level, they would charge negative rates for business customers. This might be different for private customers. But especially with this volume in cash, no investments = full -0.75 % interest would apply.

  • Current setup: XCHF > Swiss Crypto Tokens AG > banknotes in bunker
  • If stored on bank account:  XCHF > Swiss Crypto Tokens AG > bank XYZ

We would announce any changes to the interest rate 3 months in advance. So token holders have the chance to redeem them, so they do not have to pay negative interest. This is just a nice feature that we announce early. The goal is to keep the interest rate at 0 %.

“Volatility has become an obstacle to the wider adoption of cryptocurrencies. In general, an effective currency should at least function as a medium of exchange and a store of value.”  

Armin Schmid, CEO Swiss Crypto Tokens AG
  • Is this why you write “The interest rate for the next 3 months of the bond issuance is set at 0 %.” Why would Swiss Crypto Tokens need to charge a negative interest rate on the bond if the money is stored in a vault outside of the banking system? 

Armin: Storing banknotes is not free: Vault, insurance, cash handling, monthly auditing by Grant Thornton of SCT have running costs. The idea is to make up for losses with issuance & redemption fees.

The bank notes belong to Swiss Crypto Tokens and the XCHF product. XCHF token holders know that we have the assets stored in a bunker and have this audited on a monthly basis by Grant Thornton.

  • If interest rates go up, will SCT pay a positive interest rate or will this be a profit margin for BS in the future? 

Armin: Based on the prospectus, we would not pay positive interest rates. And yes, this would be our margin.

Figure: Swiss Interest Rate Since 2000

Swiss Interest Rate Since 2000

Source: OENB, Incrementum AG

  • Why did you need to make this into a bond? 

Armin: If you’re not a bank and you’d like to accept money from customers, there are only a handful of exemptions based on Swiss law. Bond with prospectus is one of them.[1]

  • Is there a subscription fee?

Armin: Yes.

  • Is there are redemption fee?

Armin: Yes.

  • Is there a transaction fee?

Armin: (No – only GAS Fee from Ethereum Network.)

  • Is there a management fee?
SCT Fee Overview

Armin: No.

  • How many redemptions have you had?

Armin: 2 major redemptions with 5 million CHF volume in total.

  • Is it open to retail investors? What is the minimum investment?

Armin: Any customer segment is welcome. We have lowered the threshold for issuance from Swiss Crypto Tokens to 1,000 CHF. For lower volumes, we recommend using exchanges like Bitfinex, Ethfinex, IDEX or Uniswap, where XCHF can be traded against Bitcoin, Ether, Dai or USD. 

  • The ERC-20 tokens can be traded freely as any Swiss-based bond can be traded peer-to-peer with anyone. The target customers are Swiss investors. If a customer outside Switzerland wants to invest, Swiss Crypto Tokens must look at each case one-by-one and each investor needs to do KYC/AML with Swiss Crypto Tokens in order to invest. Is this correct?

Figure: Number of Stablecoins Launched Per Year

Number of Stablecoins Launched Per Year

Source: Blockdata.tech, Incrementum AG

Armin: Swiss bond = Swiss customers, any other customer is welcome, and we would check individually. We would like keep the website setup simple, not to request from each visitor to identify themselves: Where are you from? What are the legal requirements for country XYZ? Are you a qualified investor? …

“It is very difficult to determine which is a better mechanism to achieve stability but what we do know is this — the race for a truly decentralized, stable and transparent cryptocurrency is alive and well, and this will be a welcome solution to many of the problems inherent in the market currently.”

Armin Schmid, CEO Swiss Crypto Tokens AG
  • Do you have a whitelist of people who can hold the coins?

Armin: No.

  • What happens if someone loses the private key to their tokens?

Armin: No recovery, the token is 100 % linked with customer wallet.

  • Does Swiss Crypto Tokens have a backup of the private keys? 

Armin: No, no backdoors, no freezing of funds.

  • Is the ERC-20 token considered a security in Switzerland?

Armin: Based on Swiss law (FINMA), the underlying bond is clearly seen as an asset token, a security.

  • If the SNB launches a private ledger token that represents Swiss francs, what will this mean for the Swiss Crypto Tokens’ Crypto Franc (XCHF)? 

Armin: Crypto Franc is a token issued on the public blockchain Ethereum. If SNB would launch a CHF stablecoin on a private blockchain, it is not different from a centralized ledger. Only limited participants would be able to use it. E. g., banks. SIX Digital Exchange (SDX) have announced to work with SNB but only for settlement of SDX internal transactions. So, I see it as a completely different product from the current Crypto Franc (XCHF).

[1] https://www.admin.ch/opc/de/classified-compilation/20131795/index.html#a5.

How Crypto Brokers and Funds Source Liquidity

How Crypto Brokers and Funds Source Liquidity

 “If you contact multiple desks to source your trade, you are leaking a lot of information to the market, and desks will often ‘pre-hedge’ ahead of consummating the trade. That is very expensive as it amounts to legal ‘frontrunning’ that will move the price against you.”

David Weisberger, CoinRoutes

Key Takeaways

  • There are two main ways that large-scale investors such as high net worth individuals, crypto brokers, and digital currency funds execute large trades in the cryptocurrency space. Agency models attempt to get the best price via smart-order-routing, but are prone to slippage from the benchmark price, generally charge a commission and usually pass on exchange fees and other transaction costs. In contrast, principal models shift execution risk away from the investor, but need to be financially compensated in order to do so, meaning that transaction costs will be incorporated into a spread between what is obtained in the market and then shown to the client.
  • Crypto hedge funds are outperforming Bitcoin in bear markets. Since BTC normally holds over 50 % of the crypto market capitalization, 66.7 % currently, it is commonly used as a benchmark for market performance. Most of the funds have a high beta with Bitcoin (~0.75 or higher) but have realized fewer losses in 2018 (-46 % average for funds vs. -72 % for BTC).

When an investor wants to buy $100 million worth of Bitcoin, how do they actually do it? What are the steps that they follow and the risks that they need to keep in mind? This article covers what crypto funds are and how they source liquidity, who the players are, including B2C2, Grayscale, Galaxy Digital, FalconX, Tagomi, SFOX, CoinRoutes, Omniex, Caspian, and Koine, what their strategies are, and how much they manage.  

Four Models for Sourcing Liquidity

“Statistical arbitrage has been a widely adopted trading strategy among traditional asset classes for quite some time.”  

Gabriel Wang, Aite

Large investors want to make sure that their own orders do not move the price. This price of Bitcoin fluctuates based on the global market of supply and demand for Bitcoin on exchanges on over-the-counter markets. Imagine an exchange such as Kraken is quoting at a bid-ask spread of $10,000 on the bid side and $10,010 on the ask side. Let’s say that the bid side has a buy wall of $10 billion at various strike prices and the ask side has a sell wall of 1 million Bitcoin at various strike prices. If an investor comes in and wants to buy $1 million worth of Bitcoin, what is the best to execute their trade so that they do not lose out to slippage, the spread, and transaction fees?

There are two main ways that whales, such as high-net-worth individuals, crypto brokers, and crypto funds, execute large trades in the cryptocurrency space. Agency models are risky because the exchanges and brokers can easily front-run investors. In contrast, principal models shift execution risk away from investors and need to be financially compensated to do so. Agency brokers needs to be compensated as well. The difference is that an agency broker will trade with principal-at-risk brokers, and will offer wider (i.e. worse) prices in order to reap their financial reward. So cryptocurrency investors that go directly to principal-at-risk brokers can receive better prices for their cryptocurrency investments, especially if they connect to more than one principal-at-risk broker.

1.) Account with Exchanges and/or OEMS (Order & Execution Management System) platforms

The most common method that retail investors use is the agency model with multiple accounts at several exchanges. This is called an agency model because the investor is the principal and they are relying on an agency to execute their trade for them. For example, when the investor wants to buy, they simply send their money to an exchange and buy at the spot price.

First, the investor will lose money because of slippage, which is the price that the investor saw the ask at and the price that the trade was actually executed at. For example, they might have clicked “buy” when the asking price was $10,010, but in their account,  they notice that the price they actually got was $10,012 because the price changed slightly in between the time he clicked and the time the trade was received and executed. This occurs often with highly volatile assets like Bitcoin and can result in significant losses in the aggregate for high frequency traders.  There are two main causes of slippage:

  • Technical Architecture of the Exchange: The website should optimize the number of page loads per millisecond and have servers that have stable and rapid response to site traffic. This enables transactions to occur at high speeds, which enables traders to mitigate the risk of significant price changes.
  • Liquidity on the Exchange: Low liquidity means that orders will not be filled for a single price. Instead, large orders will be distributed over several smaller orders, with an increased price for each tranche of the order.

In addition to currency risk from slippage, this model also has counterparty risk because they must trust the exchange. As long as their assets are on the exchange, either fiat or crypto, they risk losing their 100 % of their wealth if the exchange goes bankrupt.

In this model, how do investors know which exchange is offering the best price?

“With $130 trillion of assets under management worldwide, institutional investors could have a huge positive impact if they moved even a tiny fraction of those funds into crypto, whose market cap remains under $300 billion.”  

Gerrit van Wingerden, Caspian

There are three main companies in this space that help investors determine which exchange has the best price using routing protocols that consolidate liquidity.

  • CASPIAN. Backed by Novogratz’s Galaxy Digital Capital and offshoot of Tora Trading Services from the traditional equity space, Caspian provides a single user interface software that allows investors to see the order books on 30 spot crypto exchanges and seven crypto derivative exchanges.[1] A large order, called the parent order, is broken down into child orders, or slices of the order, that can be executed within the software at various exchanges in order to try to get the best price. The company raised $16 million in fall of 2018 in a pre-sale of their token called CSP. The coin’s all-time high was on its first day of exchange trading on April 8, 2019 at $0.019 and its all-time low is set newly almost every day with the latest prior to publication of this report being on October 24, 2019 at $0.005. The year-to-date return is -73.68 %.
  • OMNIEX. Founded by ex-State Street senior VP for emerging tech, Hu Liang, Omniex is an order- and execution-management system for trading. Although they are very similar to Caspian, they have one difference – which is, they are crypto native.[2]
  • COINROUTES. Recently invested in by Bitcoin Suisse for an amount of $3 million, CoinRoutes plugs into the APIs of 35 exchanges, aggregates the information, and then allows investors to access these 35 exchanges by simply accessing just one software. CoinRoutes has a patent pending called Smart Order Router that allows clients to retain complete control over their exchange keys and wallets.[3]

Figure 7: Caspian Return on Investment Since Launch

Caspian Return on Investment Since Launch

Source: Coinmarketcap.com, Incrementum AG

The main problem with non-custodial cryptocurrency trade optimization routing software is that investors will have to open up several accounts on several exchanges because routing software do not take custody of the coins. They simply allow traders to trade where the traders have already done KYC/AML and made deposits of collateral. Not only is it a hassle to KYC/AML on 30+ exchanges, but there is the opportunity cost of keeping liquidity on many exchanges. By avoiding custody of assets, this software also avoids having to apply for money services business (MSB) licenses at the federal level and money transmitter licenses (MTLs) at the state level in each state where the software company sells their product.

2.) Agency Model – Account with Broker

The second type of agency model is where investors only open up one account with a broker instead of 30 accounts with various exchanges. Brokers such as Bitcoin Suisse in Switzerland or BitPanda in Austria would typically take custody of the coins and execute the investor’s order by sourcing liquidity from their network of counterparties and their own internal order book. This is considered an agency model because the broker is acting on the behalf of the fund or high-net-worth individual (HNWI).

Do Selfish Brokers Increase the Overall Credit Risk?  
Although reducing the broker’s counterparty risk by paying after receiving sounds appealing, this arrangement actually increases the overall systematic risk of the entire market.  For example, imagine that Tagomi wants to buy $100,000 from Kraken and Tagomi has an agreement with Kraken that Kraken will send the 10 Bitcoin to Tagomi first and then Tagomi will send the money. Now imagine that Tagomi receives the 10 Bitcoin but then goes bankrupt before sending the $100,000. This leaves the exchange empty handed with losses of $100,000 that they may try to socialize over all of their clients’ accounts, leading to a downward pressure on the price of Bitcoin overall.
Now imagine the opposite, Tagomi buys $100,000 worth of Bitcoin from Kraken and Kraken makes Tagomi send the funds upfront by posting collateral. Now, if Tagomi goes bankrupt, the exchange is fine because they have the funds already. The only clients that will suffer are the clients of the broker that went bankrupt. The impact is localized to the investors that took on the risk in the first place in this model. The common model in traditional FX is settling through a central clearing company. An example of such a company is the CLS. Centralizing settlement helps to eliminate a risk called the “Herstatt Risk”, which is named after the Bank Herstatt fiasco. Bank Herstatt failed to deliver their side of the settlement. There is no CLS in crypto, because it would be centralized (by definition) and therefore goes against the ethos of crypto. Therefore, brokers and banks in the cryptoasset industry often use the first model when the credit risk of the exchange is larger than the credit risk of the broker or bank. Credit risk determines who will have to post collateral first. The reason some brokers have this privilege is because their trading volume and credit worthiness makes them an important client for the exchange. Therefore, this option is not available to retail traders. Retail traders must first post collateral on the exchange, and then the exchange will deliver cryptocurrencies. Another option that is quickly becoming a standard is delayed settlement with 1–2 basis points charged per extra day of settlement.

The largest firms in this space are Tagomi and SFOX. SFOX even has Federal Deposit Insurance on fiat deposits with them up to $250K. Since brokers take custody of client funds, they normally need to be licensed. For example, in the US the common licenses required for this activity include MSBs and MTLs.

There are two main ways that brokers and exchanges handle the counterparty risk of cryptocurrency trades:

  • Exchanges send the cryptocurrency to the broker prior to the broker paying the exchange for the cryptocurrency.
  • Brokers post collateral or pay for the cryptocurrency prior to the exchange sending the cryptocurrency.

Brokers can have contractual agreements with exchanges that state that the exchange must send the cryptocurrency first to the broker before the broker sends the fiat to the exchange in order to pay for the cryptocurrency they bought. Essentially, the broker wants to ensure that they have received the cryptocurrency in their wallet before they settle the trade with the exchange by sending the money.

Some firms are trying to become institutional brokers, such BCB Group in the United Kingdom and Falcon X in the US. The idea is to offer the lowest spread possible on trades without slippage. The model heavily relies on the network effect and is a race to connecting the disparate exchanges and agency OTC desks. By selling at cost, these companies hope to build a network that they can later sell peripheral services to, such as derivatives, margin trading, and lending. Currently, many startups are entering into this market.

Entrance from a traditional institutional broker such as State Street Corporation or Northern Trust would bring much needed legitimacy to the entire cryptocurrency market. However, clarity on the insurance of custodied assets would need to come first. Insurance firms such as Lloyds, Aon, and Zurich are dappling in cryptocurrency products; however, the market is immature. For example, BitGo’s $100 million insurance policy with Lloyds only covers cold storage meanwhile, other insurance policies only cover hot storage insurance.

3.) Principal Model – Client-Facing Market Maker

Some market makers face clients directly and use their own principal to take the other side of the client’s trade. However, market makers are in business to make money and may have directional bias (wanting to either go long or short) based on their view of the crypto market.  For example, if an investor is buying Bitcoin and the market maker is also wanting to be long, the sell quote from the market maker will likely not be advantageous for the investor. In this model, quotes shown to the client can be attractive if they line up with the market maker’s positioning, but might not be of great quality otherwise. As long as a client is connected to more than one principal-at-risk broker, the investor can benefit from the inside spread of all their principal-at-risk brokers. Clients will periodically see great prices as / when their brokers are “axed” (meaning they have a position, long or short, and are therefore skewing their prices to flatten). The barriers to entry are quite high for firms looking to become a market maker, because they require large balance sheets that they can use to offer bid-ask spreads on exchanges and to OTC clients.

In this category is B2C2 in the UK. They are a market maker that also has an OTC desk that faces clients. They aggregate the price of a cryptocurrency from many exchanges, and then internally create a price for that cryptocurrency. Once they have their internal price for the cryptocurrency, they create bids and asks around that price on exchanges, and they quote these bids and asks to clients. For example, the current price of Bitcoin on Kraken Pro is $6,120.40 with an ask of 6121.5 and bid of 6,119.10, then this would put the spread at $2.40 or .03% or 3 bips. Since B2C2 is plugged into the APIs of several exchanges, B2C2 may calculate that their internal price is $6,123.5. They will then offer a bid – ask spread around this price on Kraken Pro. If their internal price is wrong, then their principal is at risk of loss.

4.) Principal Model – Trading Desk or Bank

A bank acting as a principal means that they execute a trade with their client directly, taking the execution risk on their books. In turn, they would hope to warehouse or lay off that risk via another trade. This is the same service provided by market makers in model 3, but instead of the service being provided by market makers, the service is provided by banks and trading desks at large prime brokers.

Future Outlook of Principal-Agent Models in Liquidity Sourcing

The way financial intermediaries source cryptocurrency liquidity is rapidly evolving, but the market increasingly resembles the historical development of foreign exchange and equity markets.

“The spot FX trading industry is rapidly heading toward an agency-only trading model, but for the time being principal spot FX trading models are still widely utilized.”  

Solomon Teague, Euromoney

In traditional foreign exchange markets, large trades occur in over-the-counter markets instead of on exchanges. This is because the largest foreign exchange traders on exchanges, such as the world’s largest banks, have access to information regarding the depth of order books, and they can make well-informed trades against small banks, brokers, and trading desks.

Agent models are not a bad option for investors, as long as the aggregate order book that the broker has access to is deep and the bid-ask spread is low. For example, the US equities market averages spreads of 20 basis points. However, cryptocurrency markets have high spreads and order books with fake liquidity created by wash trades in order to manipulate investor perceptions.

Insights from seasoned foreign exchange traders can help startups in the cryptocurrency space professionalize their services and prepare the market for institutionals. We greatly thank Glenn Barber from FalconX, Dan Fruhman from BCB Group, and Simon Heinrich from B2C2 for sharing how crypto brokers source liquidity in this edition of the Crypto Research Report.

Who Needs to Source Liquidity?

Agents that execute trades on the behalf of their clients need to source liquidity, so that is primarily cryptocurrency funds and brokers.

Cryptocurrency Funds

Crypto Funds is a catch-all term to refer to a type of investment fund which pools capital from multiple investors with the goal of investing in a variety of crypto assets. There are several types of legal investment vehicles that fall under this category and several legal investment vehicles that do not follow under this category but are still labeled as cryptofunds by misinformed media outlets.

Crypto Hedge Funds

For regulatory reasons, the main category of cryptocurrency funds are still cryptocurrency hedge funds. The main goal of these funds is to outperform the cryptocurrency market as a whole in the long run. It is worth noting that traditional hedge funds (e. g., ones not invested in crypto) have generally failed to consistently outperform traditional index funds. They are often based in Cayman, British Virgin Islands, or Switzerland.

PricewaterhouseCoopers (PwC) reports[4] that the median fees collected by crypto hedge funds are a 2 % management fee (annually, based on the total investment) and 20 % performance fee (annually based on the profit realized). At the same time, the average with the traditional hedge funds is 1.3 %/15.5 %.[5] Despite the higher average fees and the recent crypto bear market, PwC reports that the crypto hedge funds grew over three times in assets under management (AUM) in 2018. 

PwC further reports that on average crypto hedge funds outperformed Bitcoin in 2018. Since BTC normally holds over 50 % of the crypto market capitalization, 66.7 % currently, it is commonly used as a benchmark for market performance. Most of the funds have a high beta with Bitcoin (~0.75 or higher) but realized fewer losses in 2018 (-46 % avg. for funds vs. -72 % for BTC). The exception seems to be quant funds, which have both a positive return (+8% and a negative beta -2.33); however, this is explained in the report with the fact that the majority of those funds had early investment in initial coin offerings (ICOs) and managed to exit some of those positions in the first half of 2018.

Here are some of the largest players in the cryptocurrency hedge fund arena:

  • Pantera Capital is one of the largest crypto investment firms with investments across five cryptocurrency funds (Venture Fund, Digital Asset Fund, ICO Fund, Bitcoin Fund, Long-Term ICO Fund). Current assets under management (AUM) are around $450 million, due to the recent crypto winter, although they previously had $700 million. The investments range from VC investments in blockchain companies, including some big ones (like Ripple, Zcash, Civic, Harbor, Bitstamp) to investments in ICOs (like Wax, OmiseGo, 0x, Funfair, FileCoin). There is a minimal investment requirement of $100,000. According to NewsBTC, the fund has recorded a 40 % loss since its inception and a 72 % loss year-to-date.[6]
  • CoinCapital is even more restrictive, looking for individuals with a net worth over $2.1 million. Similar to Pantera Capital, this fund invests in a combination of blockchain startups, ICOs, and cryptocurrencies. It holds a portfolio of over 40 cryptocurrencies, including the major ones – Ethereum, Litecoin, Bitcoin, Ripple, and Dash. The fund does not report AUM and fees; however, third-party sources report that they are currently raising $25 million from accredited investors under a 2/20 fee structure.[7]
  • BitcoinsReserve was a specialized crypto hedge fund in the field of arbitrage. Like many cryptocurrency hedge funds, they have already gone out of business. Essentially, they looked for inefficiencies (price discrepancy) on the price of cryptocurrencies across different exchanges and leverages this to realize profit.
  • General Crypto is a smaller crypto hedge fund with $25 million in assets. The firm takes a venture capital approach to investing. Its main focus is coins that offer solutions to real-world problems. For instance, General Crypto is invested in Golem due to its decentralized computing capabilities and Ripple because of its international wire transfer technology. 
  • Bitbull is a cryptocurrency hedge fund that invests in crypto assets and startups. In essence, this is an umbrella fund which offers various options, including BitBull Fund, a crypto fund of funds, and BitBull Opportunistic Fund, which directly invests in crypto assets. The fund of funds operates under a 1/10 structure with $100,000 minimum investment and a 10 % hurdle. The standard fund is a classic 2/20 with $25,000 minimum investment. The strategy employed in the standard fund is described as “Opportunistic; current focus is market-neutral volatility strategy.” Both funds are only open to accredited investors.
  • Brian Kelly Capital Management currently manages over $50 million in assets and provides its investors with a three-pronged approach: buy-and-hold with 50 %, ICOs for 20 %, and actively manage the remaining 30 %. Investments in the BKCM consists primarily of cryptocurrencies like Bitcoin, Ethereum, Litecoin, Ripple, Zcash, and Stellar. Additionally, the fund invests in more risky tokens like Golem, Siacoin, and Augur.[8]
  • Ember Fund can be thought as more of an advisory service rather than a traditional hedge fund. The fund offers portfolio rebalancing and optimization strategies which are not carried out by the fund itself but supplied as tips to its customers. There are both pre-defined portfolios and customer-defined ones. Currently supported currencies are BAT, BCH, BTC, DENT, ENJ, LTC, TUSD, and XRP. A customer can have up to three portfolios. The fund charges a fixed fee of 1.5 % on every trade.
  • Prime Factor Capital was the first crypto hedge fund approved as a full-scope alternative investment fund manager by the Financial Conduct Authority, according to Bloomberg. There is no information publicly available regarding the firm’s investment strategy. The team is comprised of former employees from Blackrock, Legal & General, Goldman Sachs, and Deutsche Bank.

Index Funds

  • Grayscale Bitcoin Trust (GBTC) is a publicly listed company, holding its assets in Bitcoin and thus allowing traditional investors to have exposure to BTC without buying it directly. GBTC is basically “a single-asset index fund” which runs at a premium (around 22.5 %), in addition to annual fees of two percent. The price of Bitcoin is up 123 % year-to-date, and the Grayscale Bitcoin Trust (OTC: GBTC) is up 143.3 %. Currently, Grayscale Bitcoin Trust is up over 2,700 % since its inception in 2015.

Figure: Grayscale Premium Roughly Constant Over Time

Grayscale Premium Roughly Constant Over Time

Source: Grayscale, Incrementum AG

AIF- and UCITS-Regulated Cryptocurrency Funds

  • Postera’s Fund is regulated in Liechtenstein and based in Germany. The fund invests in a wide range of cryptocurrencies and for professional investor’s only.
  • Crypto Finance’s Fund is regulated in Liechtenstein and based in Germany. The strategy is long-short on a single asset, Bitcoin, with a cash buffer. This fund is for professional investors only and is the one of the best performing funds of the year that are based in Liechtenstein.

Products that are not funds but are often called funds are exchange-traded products, such as Amun tracker certificate that is actually a bond and not a fund. Other products that are not legally fund structures include all of the cryptocurrency-based certificates issued by companies, such as Bank Vontobel and GenTwo Digital. Although cryptocurrency certificates have similar fees and trading strategies compared to cryptocurrency funds, the legal distinction mostly refers to whether the assets are held on a balance sheet of a bank and who is liable if the assets get stolen or hacked.

[1] Information retrieved in October 2019, from Caspian’s website.

[2] See “Omniex Adds Additional Top-Tier Institutional Crypto Clients And Launches Executable Streaming Prices To Fuel Growth Of Institutional Crypto Trading,” Omniex, July 16, 2019.

[3] Information retrieved in October 2019, from CoinRoutes’ website.

[4] See 2019 Crypto Fund Hedge Report, PwC & Elwood, 2019.

[5] See “Hedge funds see fee increases in 2018,” Charles McGrath, Pensions&Investments, January 30, 2019.

[6] See “Pantera Capital’s Crypto Fund Reports 40.8% Loss Since Launch,” David Babayan, News BTC, 2018.

[7] Information retrieved in October 2019 from Security Token Network’s website.

[8] See “Top 10 Crypto Hedge Funds: Investment Guide,” Tom Alford, Total Crypto, October 9, 2018.

Bitcoin vs. Gold – a Fictitious Debate

Bitcoin vs. Gold – a Fictitious Debate

Since we have been quite involved with the topics of Gold and Bitcoin for several years, we have already held several discussions on the subject of investing in Gold and Bitcoin. In the form of a (fictitious) debate between a proponent of gold investments (XAU) and a proponent of the cryptocurrency Bitcoin (BTC), we want to dialogue some frequently discussed points such as the similarities, differences and opportunities of these two forms of investment.

BTC: Dear GOLDBUG, I am pleased that we have met here today. I am quite curious if I can convince you that there are some parallels between gold and Bitcoin, and that Bitcoin definitely has a place in the market or will become much more important.

Gold has fascinated humanity for thousands of years
gold statue

Source: Unsplash.com

XAU: Thanks for the invitation! As you know, as a rather conservative investor I am very critical of the crypto world, but I am always open to a good argument.

BTC: This is a good basis on which we can build our conversation. Let us start by discussing the differences and similarities between Bitcoin and gold. What are your thoughts?

XAU: That’s a great idea! While I did notice that there is a huge trend towards digitalization these days, it stops with me when it comes to the investment of value. This is because gold is a precious metal. You can touch it and it has always imposed an almost mystical fascination on people– especially my wife.

BTC: Sure, but there is a fundamental difference. gold is a chemical element, it exists physically, it can be touched as you say, and admittedly it does have rather interesting properties. But Bitcoin on the other hand, is an open protocol that only exists digitally as bits and bytes. Bitcoin is ultimately a groundbreaking innovation and has managed to successfully give digital information scarcity for the first time!

Bitcoin is a relatively new technology. Is it becoming the gold of the digital world?
Digital Gold

Source: Unsplash.com

XAU: What does that mean?

BTC: For example, if you send someone an email, you are not actually transferring your own data. You send a copy of your data. Ultimately the data will be available to both you and the recipient afterwards. Until the invention of Bitcoin and the associated blockchain technology, it was not possible to make digital information definitively transferable, i.e. that it “goes from me to you and is no longer with me afterwards”.

XAU: Okay, I’m following so far. I can even concede that this is indeed a groundbreaking invention. But how do I know this transmission will work safely? Everything on the Internet is hackable!

BTC: The inventor of Bitcoin created a very intelligent reward system for the people involved in securing the network. These so-called “miners” fulfill the task of verifying that each transaction is valid and is only actually executed once. The same Bitcoin can never be spent twice simultaneously. With the computing power provided by the miners, they ultimately make the network secure. In return, for compensation they receive newly mined Bitcoins. The more Miners are involved, the more difficult it becomes for Miners to conspire to validate a fraudulent transaction.

XAU: Okay, I can imagine that Bitcoins can be transmitted relatively safely over the Bitcoin network. I have never transferred a Bitcoin, but surely someone by now would have noticed if a secure transmission was compromised?

“Bitcoin is considered to be hack-proof because the Bitcoin blockchain is constantly being monitored by the entire network. Therefore, attacks on the blockchain itself are highly improbable.”  


BTC: Exactly! Since the network was established, every single transaction has been transferred securely.

XAU: Still, why exactly would Bitcoin prevail? There are supposedly thousands of such cryptocurrencies in existence today! Whereas the element gold only exists once, guaranteed!

BTC: Well, I have to admit, 100% I can’t rule out the possibility that there won’t be another crypto currency at some point.

XAU: You see!

BTC: Regardless of this, since the launch of Bitcoin, the likelihood of another cryptocurrency becoming established as a store of value has already decreased significantly. This is primarily due to the enormous spread of its network and thus the high level of Bitcoin security. The computing power that secures the Bitcoin network is now gigantic. No other cryptocurrency has even come close to achieving similar computing power. This can be observed by looking at Bitcoins hashrate.  

Figure: The Development of Bitcoin’s Hashrate

Bitcoin Hash Rate Coinwarz

Source: Coinwarz.com, EH/s Stands for Exahash per Second.

XAU: Okay, so you’re claiming I can transmit Bitcoins safely and securely on the blockchain because the most processing power is behind the Bitcoin network. But this security method is extremely power consuming! Isn’t that a disaster in these times of global climate change?

“If the Bitcoin system were a country, its electricity consumption would put it in 43rd place in the world – between Switzerland and the Czech Republic, and the trend is growing.”  


BTC: I’m sure we could spend a very long time debating this specific topic, but I think the most important point is that the electricity used to produce Bitcoin is often excess electricity that would otherwise be wasted.

XAU: What do you mean? The power used to operate the Bitcoin network must be taken from someone else!

BTC: It is well known that electricity is very difficult to store and can only be transported over long distances with huge losses in power. To mine Bitcoin economically, it is essential to use the cheapest sources of electricity. These are usually remote hydroelectric power plants, as there is often no way to store the electricity. Therefore, many of the Bitcoin farms are located in Scandinavia and Iceland, for example. In both of these places there is large surplus of electricity and it is cheap to use hydroelectric power. Various electricity suppliers have already recognized this and are using Bitcoin mining in some cases to deal with the surplus of electricity. In places with electricity shortages you couldn’t even consider mining, because the electricity prices are too high making mining not cost effective. Even at an average electricity price point it is still not possible to mine economically!

XAU: Wow, I really didn’t know that. Still, why invest in Bitcoin now? With gold, I know there’s a finite amount on earth. So, gold will always be worth something. But Bitcoin is so speculative. And it pays no interest, either.

Figure: Stocks of Bitcoin and Gold Compared with Future Outlook – An Indicator of Inflation

Bitcoin versus Gold Inflation

 Source: Incrementum AG

BTC: Okay, let’s get this straight. Both gold and Bitcoin are two investments that yield no interest. Both are “unproductive” assets whose value originates in the investment itself. Shares are invested in order to participate in the success of the company. Or, via government bonds, one participates to a certain extent in the development of the entire economy.

XAU: I understand your argument, but I would still not consider gold and Bitcoin to be equivalent. This is because gold is strong and stable. Gold is only available in limited quantities and is therefore valuable. Every year the amount of gold mined grows very steadily by about 1.5 percent. Even after large price increases, mining companies have not been able to expand their production significantly. Central banks, on the other hand, have been siphoning off vast amounts of money since the financial crisis, amounts that I can no longer even imagine because of the many zeros. Surely, they will go bankrupt at some point!

BTC: On that point we are in complete agreement. The number of Bitcoin cannot be increased arbitrarily at will! Gold and Bitcoin could therefore be two ways of protecting against the dangers of the central banking system.

XAU: But with digital currencies, you could also add the numbers zero and one to somewhere in the code and thus create new “currency”.

BTC: [Laughs] I’m so glad you brought that up. You’re kind enough to play into my hands. In fact, Bitcoin will become even “stronger” than gold over time, because the maximum number of Bitcoins available is exactly 21 million. That’s all there is, and that’s all there will ever be, the Bitcoin protocol stipulates this. Every four years the inflation rate of Bitcoin is therefore halved. In May of this year, Bitcoin’s inflation rate will fall roughly to that of gold and in the future Bitcoin will be even “stronger”, even less inflationary than gold. See also the different stock-to-flow ratios in comparison [chart on the next page, Figure 5]. Simply changing a few numbers in the code is absolutely impossible. There would have to be a 95 percent approval of the miners to do this. But Bitcoin thrives on the fact that it is a scarce commodity, so broad approval for such a change is almost impossible.

Figure: Various Stock-to-Flow Ratios in Comparison

Bitcoin and Gold Stock to Flow
Bitcoin and Gold Stock to Flow

Source: Incrementum AG

XAU: But what about the opportunity then to just create a new cryptocurrency? I’ve heard that one could basically just copy Bitcoin, and everyone could create their own version. Isn’t that called hard fork? Wouldn’t that just double the maximum number of Bitcoins in seconds?

What is a Hard Fork?  
Simply put: a fork is the further development of a software. A hard-fork, i.e. a backward-compatible change to the rules on the blockchain, results in a blockchain becoming two blockchains. At the time the hard fork is published, the blockchain users have to decide whether they want to stay with the old blockchain or whether they want to switch to the new one. This decision must be made actively. A hard fork always leads to a split, but the blocks remain the same until the split. A detailed explanation can be found on the Crypto Research Report’s website under the following Link.      

BTC: Technically, while this sounds quite simple in theory, it is extremely unlikely that a copy of Bitcoin would be widely adopted:

First of all, the survival of a new cryptocurrency depends on whether there is any interest in it at all. Why would Bitcoin investors, who probably also trust Bitcoin because the system has limited inflation, want to switch to a new cryptocurrency system? There has to be added value here. If there is not, the hard fork will be very difficult. This has been seen with all Bitcoin hard forks so far. Secondly, the Miners who secure the system would have to go along with it and make their computing power available to the new Bitcoin version in the future. But the Miners don’t do that, because they have a far greater incentive to mine the most valuable asset. Without high computing power this “new version” of Bitcoin would be very insecure and thus is not an attractive investment.

XAU: Okay. You know, I keep hearing that Bitcoin has a scaling problem. If you want to use it as a widespread currency it’s way too expensive, right?  

The “Scalability” Problem of Bitcoin
Bitcoin’s current version allows for a maximum of seven transactions per second. If Bitcoin really wants to be used as a means of payment in the long term, at some point that rate will be too little.  

BTC: You are correct, there is currently a scaling problem that is caused by the size and decentralization of the Bitcoin network. There is a trade-off between the security of the network and the speed of transactions. One perspective is that Bitcoin does not have to become a mass payment medium to be valuable. This is true for gold as well. The smaller the quantity of gold, the higher the transaction costs in terms of the price difference between buying and selling. It is questionable whether one should really invest in gold if one only wants to buy 1 gram of gold. With larger quantities of gold, the transaction costs are hardly significant. From a cost perspective, gold is therefore well suited as a store of value for larger investment amounts. Bitcoin can be viewed in the exact same way. From a cost point of view Bitcoin is store of value for larger amounts, i.e. digital gold, but it admittedly can be a volatile one.

XAU: Interesting. But Bitcoin’s ultimate claim was to be the advanced electronic payment system. Is that now unfulfilled because of this scaling problem?

BTC: Quite correct. The title of the so-called white paper was even “Bitcoin: A Peer-to-Peer Electronic Cash System”. And there are intensive efforts to fulfill this claim. There are various approaches to enabling more transactions per second. Hard forks are just one approach, which we have already seen with Bitcoin Cash, for example. Other possibilities exist in the areas of off-chain transactions, such as the Lightning-Network. There, transactions outside the blockchain are processed quickly and securely. In any case, thousands of programmers worldwide are working on the solution to this issue. There is an incredible amount of human capital behind this, which is also responsible for the fact that the hurdles that have been overcome so far have been handled quite effectively. If the scaling problem is actually still being resolved, it would not only be digital gold, but also a strong digital currency! So, another difference between gold and Bitcoin is that Bitcoin can be used as a means of payment and a store of value at the same time. This is a huge advantage of Bitcoin over gold, because gold is hardly suitable as a means of payment.

XAU: Well, I must strongly object here. In the days of the classic gold standard, gold was indeed used as a means of payment! Today’s central banks tend to overlook the period from 1870-1914, when there was slight deflation and very high growth rates. But I think that is a different debate. In any case, I don’t understand why you, as a Bitcoin fan, keep talking about Bitcoin being a store of value like gold, considering the high level of volatility?

BTC: I think I have already been able to give you some solid arguments, such as limited inflation or the security of the system through the hashrate. I would also like to highlight the fact that Bitcoin is still in its early stages. The market capitalization as of January 9, 2020, at $ 144 billion, is only a fraction of that of gold. The significant price fluctuations are therefore also offset by an exorbitantly high potential profit. In fact, Bitcoin is an extremely asymmetric asset class, as Bitcoin either succeeds in the medium term and asserts itself as a global digital store of value or – for whatever reason – fails and becomes worthless.

Figure: Comparison of Market Capitalization Gold vs. Bitcoin 2013 – 2020

Bitcoin versus Gold Market Capitalization

 Source: Incrementum AG

XAU: Hmmm, I never thought of it that way. Bitcoin has a different payout profile than gold. I mean, gold really can’t drop to zero, or do you disagree with me on this point?

Figure: Number of Months of Different Returns of Bitcoin and Gold

Bitcoin versus Gold Monthly Return Distribution

Source: Incrementum AG

BTC: No, we are in agreement on this! Gold cannot become worthless. But the appreciation potential of gold is of course limited, since gold is known to everyone. Bitcoin is still extremely small and very young. The Internet has only been around for 30 years and Bitcoin for only 10 years. The vision is that Bitcoin will become the universal and digital value standard in an increasingly digitalized world. Very little of this has been taken into account so far. Why shouldn’t the central banks hold digital assets in 10 years? They are already thinking about digital currencies today, why shouldn’t they invest in “digital gold” at that point in time? When Bitcoin becomes established as the strongest digital currency, the central banks will hold Bitcoin as a currency reserve in addition to gold. I don’t think that’s so far-fetched. The world is changing!

XAU: Okay. Assuming you have piqued my interest, what would your investment advice be? I’ll tell you one thing right off the bat. I certainly won’t sell my gold, at least not all of it!

BTC: There are indeed crypto enthusiasts who swear by cryptocurrencies and have invested all their savings. This is of course extremely risky! On top of that, things usually turn out the way they’re supposed to! They buy in euphoria and sell in panic. But it is precisely the asymmetric payout profile that makes a small addition of Bitcoin interesting. And the high volatility can be used to your advantage through rule-based rebalancing!

XAU: Well, it seems that Gold and Bitcoin are more alike than one might think, don’t they? Together the two asset classes form a thoroughly dynamic duo.

In Case You Were Sleeping: Banking on the Blockchain

In Case You Were Sleeping Banking on the Blockchain

“Bitcoin will do to banks what email did to the postal industry.”

Rick Falkvinge

Key Takeaways

  • Coinbase is estimated to control about four percent of all Bitcoins, which would amount to more than 850,000. The asset manager Grayscale, provider of the “Bitcoin Trust,” manages around three billion USD in crypto assets. At BitGo, it’s two billion USD.
  • PayPal has already withdrawn from the Facebook Libra consortium. Visa and Mastercard are also shaking in their boots. Heads of the Bank of England and European Central Bank have expressed grave concerns regarding Libra. The project appears to be at a standstill for the moment.
  • US authorities are investigating a German company that offered an alleged gold-backed cryptocurrency called “KaratGold Coin.” The company had previously sold gold products – and had been the subject of repeated warnings from authorities in Canada, the Netherlands, and Namibia even before entering the crypto space.   
  • Demand for Bitcoin is slumping. The number of addresses from which users send Bitcoin to the major stock exchanges BitFinex and Binance is falling. However, demand for Altcoins has slumped even more. Altcoins never left the 2018 crypto winter.

Libra Meets Resistance Everywhere

“We believe that no private entity can claim monetary power, which is inherent to the sovereignty of Nations.”  

French and German Governments

While Bitcoin is gladly dismissed and smirked at by politicians and central bankers, they immediately took Libra seriously. This is interesting because the founders of Libra were strongly inspired by Bitcoin and Ethereum and have borrowed heavily from these projects.[1]This makes sense, too. Where else should they look for ideas and concepts for a cryptocurrency? Be that as it may, there is obviously great fear on the part of the state when it comes to private competition on the currency market.    

France, the USA, and China are particularly active. All for different reasons. Paris put Libra on the global agenda during its time chairing the G7 group and set up a working group on stablecoins.[2]Central bankers from all over the world openly show their skepticism. Mark Carney, the head of the Bank of England, said that Libra would have to submit to the “highest regulatory standards.” The head of the European Central Bank ECB, Mario Draghi, who has since retired from office, expressed himself in an almost identical manner. The finance ministers of France and the USA also voiced grave concern.   

The state actors have two main problems with Libra: Facebook’s market power and the impending loss of the state monopoly in the money market. Facebook can access a network of more than one billion users on its own. In addition, more than 20 partner companies are involved in the Libra consortium. A huge starting advantage. “I think that’s really what’s gotten the regulators quite in a furor about what’s happening around Libra, as opposed to bitcoin,” said Zennon Kapron, founder and director of consulting firm Kapronasia, to CNBC. Governments could gradually lose power over monetary policy if Libra ever goes live.[3]

“U.S. lawmakers are calling for Facebook to halt Libra development.”  

The Block Crypto

And it’s not just about interest rates and inflation expectations but about tough power politics, says Kapron: “Right now, the U.S. dollar has a lot of power, and the U.S. government has a lot of power because oil is priced in U.S. dollars. And, the U.S. government controls which banks can interact with the U.S. dollar, so using that sphere of influence, they’re able to really control the direction of global economics and the global political situation.” Experienced crypto investors should be perplexed by these words. How come the same state actors haven’t been as nervous about Bitcoin? Was it not Satoshi Nakamoto’s stated intention to undermine the state currency monopoly?    

The answer is yes. But unlike Bitcoin, Libra has an address and backers that you can subpoena in Congress. And that’s exactly what’s happening. American senators of both parties have been extremely harsh on Facebook at public hearings on the subject. The tech giant with the ambitious crypto plans also offers an excellent target for politicians because of its battered image. Facebook is like a “little child playing with fire,” it was said in July. “Do you really believe that people should trust Facebook with their hard-earned money?” asked Sherrod Brown, the democratic senator from Ohio rhetorically. His answer: “I just think that is delusional.”[4]     

Facebook’s Libra manager David Marcus defended himself, assuring that Libra will not compete with government currencies and that the privacy of users will be protected. Senator Brown nevertheless urged Facebook to simply stop the development of Libra. Summarized in one sentence: States don’t like Libra (and Bitcoin) because they endanger the money monopoly.[5]    

There is more resistance. The banks are nervous too. Because – and this applies to Libra and Bitcoin – before cryptocurrencies can change the monetary system, they will endanger the banks’ business model. At a meeting between bank representatives and the US Federal Reserve in September, the banks stated: “Facebook is potentially creating a digital monetary ecosystem outside of sanctioned financial markets — or a ‘shadow banking’ system. As consumers adopt Libra, more deposits could migrate onto the platform, effectively reducing liquidity, and that disintermediation may further expand into loan and investment services.”[6]

“Bitcoin is still too unstable.”  


The bank representatives seem to have overlooked the part of the Libra white paper that describes the process of creating new coins. It is true that Bitcoin is indeed a completely independent monetary system. But not Libra, because its coins are to be covered by a basket of traditional assets. Put simply, the more money goes into the Libra system, the more traditional securities the Libra Foundation has to buy for its reserve. But the main message still stands: Banks don’t like Libra (and Bitcoin) because they endanger their business model.    

The Special Case of China

China goes one step further. The government also sees danger for the control over the Chinese population by the state. Bitcoin has long been targeted by China because the regime has a general fear of capital flight. The fact that the ongoing protests in Hong Kong have again boosted Bitcoins popularity in the former British colony has certainly caused little enthusiasm in Beijing.[7]

But China also has another approach. It is much more open than other countries to the idea of launching its own, state-issued cryptocurrency. Cash is generally frowned upon in this vast empire anyway. Such a state-issued cryptocurrency could further accelerate the path to a cashless society. A pleasant side effect from the point of view of the communist government in Beijing is that such a digital state currency would also facilitate the total control of the population. It could even be integrated into the Orwellian “Social Credit” system of the People’s Republic. In addition, China wants to curb the dominance of the dollar – but not by bringing in a new currency from American “production” like Libra. To sum up: China really doesn’t like Libra (and Bitcoin) because cryptocurrencies provide Chinese citizens with a way out for their capital.[8] 

The resistance against Libra is not without consequence. PayPal has already withdrawn from the Libra consortium. The credit card giants Visa and Mastercard are also becoming increasingly nervous in the face of political pressure. According to the Wall Street Journal, they recently refused to openly express their support for the project – even though they had already promised to invest millions in the Libra reserve.

According to the plan, Libra should start sometime in 2020. But from today’s point of view, at least delays are to be expected – if not a total derailment of the plans.    

King Bitcoin Rules Over Altcoins

For Bitcoin investors, this is all a sideshow, a distraction. But from the fate of Libra some important conclusions can be drawn for the future of the crypto sector. You can’t subpoena the makers of Bitcoin, but you can subpoena those of some other crypto projects. In addition, the Bitcoin price has always responded to major Libra-related news. There is a connection – even if it is perhaps only seen on the market.

“It is clear that Bitcoin isn’t a safe haven asset today.”  


The crypto market cooled off considerably recently. Prices for Bitcoin fell from around $10,000 to just $8,000 at the end of September. The climb that began in April has been slowed down – perhaps even stopped. The number of addresses from which users send Bitcoin to the major stock exchanges Bitfinex and Binance is falling, according to data from London-based analyst TokenAnalyst. This signals “a lack of retail interest in general currently in crypto,” said TokenAnalyst co-founder Sid Shekhar. “If we go by the ‘Bitcoin as safe haven in times of recession’ narrative, the number of new users/buyers should actually be increasing.”[9]

This is a sore subject for the crypto space. This year, Bitcoin has not succeeded in establishing its reputation as a “hard” asset. The story of the alleged “safe haven” may apply to individuals and families in crisis-ridden countries, such as Venezuela or Turkey. And in these countries, you can also see a strong acceptance of Bitcoin. But from a global market perspective, Bitcoin is certainly not on a par with gold today. Perhaps the asset is simply still too young and has to earn this status.    

There is definitely no danger for “King Bitcoin” coming from Altcoins at the moment. Alts experience a continuous bloodbath in 2019. The vast majority have already been unable to benefit from the Bitcoin rise – and now that the king is going downhill, the peasants have to suffer even more. Bitcoin’s market dominance in October was 66 percent – and thus at the level of March 2017. Anyone who looks at the market capitalization of Altcoins in isolation (i. e. without Bitcoin) will notice that the bear market was probably never abandoned here. There is no other way to put it: If this trend continues, a (partial) destruction of the Altcoin sector is to be expected. This would probably be a positive cleansing process for the market, as many scams and fraudulent projects are still running – disguised as Altcoins. But it can’t be good for crypto’s image.    

Figure: Eight Coins Make Up 90% of Cryptocurrency Market

Eight Coins Make Up 90% of Cryptocurrency Market

Source: Coinmarketcap.com, Incrementum AG

Figure: Bitcoin Dominance

Bitcoin Dominance

Source: Coin.dance, Incrementum AG

In any case, further reports on scams and warnings to investors are expected. In recent months, we have seen the implosion of the PlusToken pyramid scheme, which started in Asia (probably China). US authorities are meanwhile investigating a German company that offered an alleged gold-backed crypto currency called “KaratGold Coin.” The company had previously sold gold products – and had been the subject of repeated warnings from authorities in Canada, the Netherlands and Namibia even before entering the crypto space.[10]      

In the USA, three men are on trial who are said to have sold drugs such as MDMA, Ketamine, and Xanax for Bitcoin on the DarkWeb. That alone is certainly not newsworthy. But in the run-up to the trial, the court decided to release only two of the three men on bail. The alleged leader must wait behind bars for his trial. Why? He has considerable Bitcoin assets at his disposal – and that leads to a flight risk, the court says. In this context, the authors at The Block are asking: “When will criminals learn that Bitcoin is an open payment system that can be traced by anyone?” The answer to this question would also be of interest to us.[11]     

What Will BAKKT Bring to the Table?    

“Facebook’s alliance crumbles as the controversial digital currency loses important partners.”  


But it’s not all bad news. The professionalization of the Bitcoin market, which we have documented in detail in previous reports, continues to progress. In addition to players such as Coinbase and Fidelity, Bakkt plays a major role here. Bakkt is the crypto project of Intercontinental Exchange (ICE), the parent company of the New York Stock Exchange (NYSE). Apart from Fidelity’s entry into the crypto sector, there is probably no other project with more significance. The Bitcoin futures promised by Bakkt, which, unlike those of CME, are ‘physically’ settled, were eagerly awaited by the market. But the start at the end of September was disappointing. On the first day, Bakkt traded only 72 Bitcoin via futures. For comparison: On the first day of CME futures at the end of 2017, the figure was 5,298.[12]

Figure: BAKKT vs. CME vs. CBOE (Trading Volume on First Trading Day in Million USD)

BAKKT vs. CME vs. CBOE (Trading Volume on First Trading Day in Million USD)

Source: BAKKT, CBOE, CME, The Block, Incrementum AG

Figure: BAKKT Trading Volume Over One Month (In Million USD)

BAKKT Trading Volume Over One Month (In Million USD)

Source: BAKKT, CBOE, CME, The Block, Incrementum AG

Some observers, including JP Morgan analysts, even blame the weak start of Bakkt on the fall in Bitcoin prices in the preceding weeks. The reason: Miners and other owners of physical Bitcoin may have taken shorts to hedge against falling prices. Seen like this, the launch of Bakkt futures was indeed a self-fulfilling prophecy – but from the point of view of the shorter and not that of the broad market. We know that the expectations of the broad masses are rarely fulfilled in the markets in general and in the crypto markets in particular. The continuing dominance of the “dumb money” of retail investors plays an important role here.[13]     

“It’s too soon to write off Bakkt.”  

Wall Street analyst

We therefore consider it appropriate to think beyond short-term headlines and price movements. Bakkt is by no means just introducing futures or another crypto exchange. Instead, ICE is working on a complete solution for the professionalization of the Bitcoin markets. Put simply: They try to prepare the crypto market in such a way that institutional investors can also get involved. The futures are an important step, as Bitcoin’s pricing still takes place on the spot markets today, which is unusual for other assets or commodities. “What Bakkt fundamentally believes is that price discovery is going to happen in an end-to-end regulated market,” said Bakkt COO Adam White, “Most of that price discovery is happening in the spot market, but it is going to switch to the futures markets.”[14]But there is a second step that is at least as important from Bakkt’s point of view: Custodianship.

The question of professional storage of Bitcoin and other crypto assets on behalf of institutional investors remains unanswered. We have described this problem several times in previous reports. Actors such as BitGo, Coinbase Custody, and Fidelity are working on their own solutions. At Bakkt, the custody question is at the center. The main focus here is on the New York location, the connection to the NYSE and the experience in working with regulators. On Bakkt’s website, they say that they want to set a new standard in the custody of digital assets by using the tools that are also responsible for NYSE cyber security.[15]

If you look at the history of the Intercontinental Exchange and its surprising acquisition of the iconic New York Stock Exchange, you immediately see that an innovative and highly ambitious team is at work here. Bakkt is apparently intended to secure the dominance of the NYSE in traditional markets for the future. “You can’t ignore ICE,” writes Frank Chaparro on “The Block” – and he’s certainly right about that.[16]    

But in one crucial area, Bakkt is far behind other actors. The popularity of futures has increased significantly in recent weeks and the rather embarrassing first day has been forgotten. But companies such as Coinbase and BitGo have long had large amounts of physical Bitcoin in their “safes.” Bakkt’s still lagging behind. Chaparro suspects that Coinbase controls about four percent of all Bitcoins, which would amount to more than 850,000. The asset manager Grayscale, provider of the “Bitcoin Trust,” manages around three billion USD in crypto assets. At BitGo, it’s two billion USD.

No ETF Yet, but the Central Banks Are Printing Again    

With its “Trust,” Grayscale offers one of the few products that enable traditional investors to profit from Bitcoins price movements. Recently there has been a strong increase in interest from institutional investors, Grayscale said recently. For the first time in months, money did also flow into Altcoins again.

What is still not available is a Bitcoin ETF. The reasons for this do not shed a good light on the current crypto markets and also explain why Bakkt is aiming at the establishment of a fully regulated futures market. The ETF is like the Holy Grail for some Bitcoin investors. These exchange-traded funds allow investors to invest in virtually any market. For example, the launch of the largest gold ETF to date in the 2000s is often associated with the rise in the gold price since then. The logic is simple and also applies to Bitcoin: Whoever buys an ETF does not have to worry about the custody and security of his/her assets.

But the US Securities and Exchange Commission (SEC) rejected another ETF application in mid-October, that of Bitwise Asset Management. A month earlier, the SEC had done the same with an ETF application from VanEck. The SEC’s justification is a slap in the face for every Bitcoin fan: The applicants have stated that “95 percent” of the Bitcoin spot market could possibly be fake, according to the SEC: Moreover, it has not been possible for Bitwise to identify the “real” Bitcoin market or to prove that it can be distinguished from fraudulent or manipulative activities, the regulator stated. The application must therefore be rejected, according to the SEC.[17]     

It is therefore in the interest of all professional players in the Bitcoin sector to create a regulated crypto market as quickly as possible. What Bakkt and others are working on seems to be a basic prerequisite for the further development of Bitcoin and Co. Only when there is a transparent and legitimate market, which has also taken over pricing, will the authorities approve a Bitcoin ETF. It could be years before we see something like this. This would also explain why major players in the ETF market, such as Blackrock or Vanguard, have so far shown no interest in the Bitcoin sector. And this despite the fact that there is a permanent race for first place in the ETF market.

Investors who have already invested should also know that an ETF decision by the SEC is headline news but currently has no fundamental significance. The prices of Bitcoin, Ethereum, and other cryptoassets shot up after the negative decision in mid-October.

Easy Money is Good for Bitcoin    

Many analysts and investors are now looking primarily at the development of the global economy and monetary policy to determine where Bitcoin might go next. The recent easing by central banks in Europe and the USA is generally interpreted as positive for Bitcoin prices. “We know that loose monetary policy has always historically helped Bitcoin,” said Joe DiPasquale, head of BitBull Capital, to Coindesk.[18]Analysts of Deutsche Bank also see this trend continuing.[19]    

“There are only 3 million Bitcoin left to be mined.”  

Anthony Pompliano

It seems that Bitcoin returned to its roots in October. The cryptocurrency was introduced more than a decade ago as an alternative to government money when central banks announced the biggest easing in history to date. After a brief period of normalization over the past two years, fears of an economic downturn have led to a new round of easing. This inflation of the economy drives money into various asset classes: Stocks, real estate, gold and even Bitcoin.

It is, if you like, the global version of a trend that can be observed on a small scale in crisis countries. When their own currency weakens, people look for alternatives. Unlike Facebook’s Libra, Bitcoin has long since established itself as such an alternative. And even if the fundamental professionalization of the sector is likely to continue for a long time to come, many investors have long regarded Bitcoin as a serious asset that can flourish and prosper at least in an environment of cheap money – an environment that could be with us for many years to come.

This article has been sponsored by Jelvix, and they recently wrote an article on how to choose what blockchain APIs to pull pricing data from for blockchain projects.

[1] See” Libra White Paper Shows How Facebook Borrowed From Bitcoin and Ethereum,” Brady Dale, CoinDesk, June 18, 2019.

[2] See “Paris will Facebook-Geld stoppen,” Oliver Grimm, Die Presse, September 12, 2019.

[3]  See “Facebook’s dream of a global cryptocurrency raises political stakes — for the regulators themselves,” Elizabeth Schulze & Saheli Roy Choudhury, CNBC, August 25, 2019. 

[4] See “Libra’s Biggest Challenge May Be Facebook’s Tarnished Reputation,” Kurt Wagner, Bloomberg, July 16, 2019.

[5] See “Facebook’s Crypto Plan Called ‘Delusional’ as Senate Digs In,” Robert Schmidt et al. Bloomberg, July 16, 2019.

[6] See “American Banking Giants Sound Off Against Libra as Monetary Threat,” David Pan, CoinDesk, October 3, 2019.

[7] See “Hong Kong protests are accelerating bitcoin adoption,” Adriana hamacher, yahoo!finance, September 2, 2019.

[8] See “China’s Digital Currency Will Be Two-Tiered, Replace Cash: Binance”, William Foxley, CoinDesk, August 2019, 2019.

[9] See “Fewer People Are Sending Bitcoin to Largest Crypto Exchanges,” Olga Kharif, Bloomberg, September 5, 2019.

[10] See “‘Gold-Backed’ Crypto Token’s Promoter Investigated by Florida Regulators”, Leigh Cuen, CoinDesk, October 4, 2019.

[11] See “Defendant’s sizable bitcoin transactions cited in drug defendant’s bail denial order,” Nelson Rosario, theblockcrypto.com, October 6, 2019.

[12] See “Bakkt Exchange’s Bitcoin Futures See Slow Start on First Day of Trading,” Sebastian Sinclair, CoinDesk, September 23, 2019.

[13] See “JP Morgan Chase Pins Bitcoin Price Plunge on Bakkt and BTC Futures,” Daily Hodl Staff, THE DAILY HODL, September 29, 2019.

[14] See “Calling Bakkt a ‘crypto exchange’ misses the mark on what they’re actually doing,” Frank Chaparro, theblockcrypto.com, August 19, 2019.

[15] See “Bakkt.com – About”, Bakkt Staff, October 11, 2019.

[16] See “Calling Bakkt a ‘crypto exchange’ misses the mark on what they’re actually doing,” Frank Chaparro, theblockcrypto.com, August 19, 2019.

[17] See “SEC not convinced a ‘real’ Bitcoin market exists, denies Bitwise Bitcoin ETF,” Rakesh Sharma, Decrypt, October 10, 2019.

[18] See “Bitcoin Jumps to 3-Week High Near $8,600 as Fed Plans New Round of Reserve Increases,” Brad Keoun, CoinDesk, October 9, 2019.

[19] See “Bitcoin could be rising due to central bank easing, Deutsche Bank says | Street Signs Europe”, Jim Reid, CNBC International TV, June 26, 2019.

Introducing the Academic Blockchain Podcast


Listen Now to our exclusive interview with the Director of Economics at the Center for Aerospace and Securities Studies in Pakistan, Dr. Usman Chohan.

The Academic Blockchain Podcast is a weekly podcast where we interview academics regarding papers that they recently wrote on the topic of blockchain and cryptocurrencies.

In this inaugural edition, we discuss why Dr. Chohan believes that cryptocurrencies will be the future, and that stablecoins are just a short-term intermediary step. Dr. Chohan does not believe that stablecoins will be able to maintain their pegs in the long-term because:

  1. Stablecoins that are backed by collateral are not scalable. If a stablecoin like Tether has to store dollar reserves, then eventually Tether would need to own and store trillions of dollars in order to service the world’s demand for a reserve currency.
  2. Speculative attacks on coins that are unbacked can break the peg. This is what we saw when Thai authorities abandoned the US dollar Thai baht peg on July 2, 1997, and when the Bank of England broke their peg to the Deutsche Mark during the European Exchange Rate Mechanism (ERM) in 1992.

We discuss that Pakistan’s currency devalued from 10 rupees to 1 USD dollar in the 1980s to the current exchange rate of 150 to 1. We discuss why pegs fail, and why blockchain probably will not help currencies maintain their pegs.

We also discuss how the Triffin Dilemma is all about the trade-offs between short-term benefits and long-term costs when a country’s currency becomes the global currency. We discuss how the United Kingdom’s pound hegemony and the US dollar’s hegemony have not helped these countries in the long-run.

We also discuss how Saudi Arabia’s exclusive use of the US dollar for oil sales is keeping the entire economy running on dollars, and why any oil producing country that moves away from the dollar is a major target for US warmongering.

In the following weeks, we will be releasing our podcast with ConsenSys discussing their central bank digital currency white paper released during the World Economic Forum’s 2020 conference in Davos, Switzerland. On the lineup also includes an interview with Stanford University Professor Dan Boneh who recently wrote a paper on problems with MakerDao’s Oracle data.

Tomorrow our weekly newsletter comes out. The report compares the Corona virus and the 9/11 Terrorist Attack crisis in 2001. Both are Main Street crises that the Fed is responding to by lowering rates. In the newsletter, we discuss all of the actions that the Fed has done over the past two weeks.

We discuss how the Fed’s three newest collateralized lending programs and the daily $1 trillion dollars in repurchase agreements or “Repos” do not mean that the dollar is being devalued in the long-term. On the other hand, we discuss how buying securities outright is bullish for crypto. Sign up for the newsletter now to make sure you understand what the Fed is doing and whether or not the Fed’s actions will devalue the dollar and send crypto soaring.

Crypto Research Report Newsletter

Incrementum Recommended Books: Crypto Currencies and Blockchain

Incrementum Recommended Books Crypto Currencies and Blockchain
Incrementum's Book Review

Today, thousands of cryptocurrencies exist and even more books on the topic of cryptocurrencies exist. Determining which books are worth the read is almost as difficult as determining which cryptocurrencies to invest in. A book that we recently read called Kryptowährungen und Blockchains was published last year in March 2019 by Dr. Niklas Schmidt. This book has already had to be reprinted several times due to popular demand and the English version, Crypto Currencies and Blockchain is set to be translated and release by the end of this year 2020.

Das Buch Kryptowährungen und Blockchains von Dr. Niklas Schmidt

The book closes the gap by covering detailed insights about cryptocurrencies and blockchains for the German-speaking readership. It is comprised of three main characteristics: First and foremost, it contains about 400 Frequently Asked Questions (FAQs) that provide an easily digestible introduction to the subject without having to read the entire book– although we highly encourage the full read.

Secondly, the book covers a wide spectrum of topics in great detail from technological functionality & characteristics of the blockchain to its economic aspects & implications. Some examples of this include: Bitcoin’s price development, the disruptive effects blockchain has on various industries, and a legal overview covering civil, tax, accounting, corporate, labour, commercial, data protection, supervisory, money laundering and criminal law.

Thirdly, the content is practical in that it contains many real-life examples and anecdotes so the reader can have better context. Some chapters also offer helpful lists of the industry’s current wallets, exchanges, blogs, newsletters, and apps.

Overall, this book we recommend without restriction and a great resource for both beginner readers and those who want to acquire a deeper knowledge of Bitcoin and beyond.

A Physical and Digital copy of Kryptowährungen und Blockchains (German) can be purchased on the publisher Linde Verlag’s Website.

The English version will be released this year (late 2020).

Dr. Niklas Schmidt

The Stock to Flow Model: Mark Valek’s Exclusive Interview with “Plan B”

The Stock to Flow Model Mark Valek’s Exclusive Interview with Plan B

“I read the whitepaper regarding Bitcoin, was hooked and went down the rabbit hole.”

Plan B

Key Takeaways

  • When asked if the Bitcoin Halving is Already Priced In, Plan B Says “No.”
  • Plan B says that Bitcoin has done a 10x increase during the last halvings, and his model forecasts this trend to continue.
  • The largest critique of Plan B’s Stock to Flow Ratio Model is that it does not consider demand. Plan B answers this critique by saying that many famous financial pricing models including Capital Asset  Pricing Model and the Black & Scholes Model do not consider demand.

Plan B is blogging under a pseudonym. Who exactly is behind this baseball cap remains unknown. We also asked him some personal questions in this interview. His Twitter handle is: @100trillionUSD.

Plan B

Plan B, When Will You Show Yourself?

As explained in the previous chapter, we arranged an interview with the father of the “Stock-to-Flow Model”. Plan B says that Bitcoin is here to stay. He also expects the price explosion of Bitcoin to be foreseen by his model. Why he is so sure about this? How does he deal with critics? Will he ever take off his cap and show his face?

Mark: Plan B, almost a year ago the publication of your model really shook up the entire crypto community. How do you deal with all this attention you and your model have received? What have you experienced this past year?

  • Plan B: It has been a very interesting year since the publication of the article March 22nd 2019. The paper was well received and I gained valuable feedback from econometricians and math/stats people all over the world. I love the interaction with the community and the open source vision of sharing knowledge. I really enjoyed doing the podcasts. With 60k followers and a full-time job, I do have to make choices. It is almost impossible to read all the comments, DM’s (Direct Messages), Telegram messages, WhatsApp messages, emails, and I hope everybody understands. I want to keep focused on analysis, investing, and writing more articles.

Mark: Can you tell us, what you do for a living and why do you use a pseudonym?

  • Plan B: I am both an analyst & investor at an investment office of a large institutional investor in the Netherlands. As a team we invest $50+ Billion AUM. My main focus is on mortgages, loans, and structured finance. I do not want my employer to have any negative consequences from my Bitcoin “hobby”. Also, I consider it good operational security to remain anonymous.

Mark: Where did your interest in Bitcoin come from?

  • Plan B: If you have seen the movie The Big Short (2015), that was my life from 2007-2008: CDO’s (Collateralized Debt Obligations), ABS (Asset Backed Securities), and RMBS (Residential Mortgage Backed Securities) etc. The craziness of negative interest rates and QE (Quantitative Easing) forced me to rethink everything I knew about finance. So, I was actively looking for QE hedges in 2013 and found an article about Bitcoin on the website Zerohedge. I read the whitepaper, was hooked and went down the rabbit hole.

Mark: Why did you start to model the value of Bitcoin?

  • Plan B: I started modeling because I wanted to know what drives Bitcoin’s price. I noticed that there was a lot of technical analysis, but not much statistics / econometrics modeling. So, I tried to make a more fundamental model, based on Bitcoin value: it’s scarcity.

Mark: In our “In Gold We Trust Reports” we have been writing about the S2F ratio of Gold and Silver for many years. It’s great, that through your model, this concept of scarcity has been introduced to an even greater community. In terms of terminology, however, we prefer to talk about constancy, rather than scarcity when talking about SF (Stock to Flow). A higher SF ratio indicates a more constant quantity rather than a scarcer quantity of the good (as a higher scarcity indicates that the quantity actually goes down). Even though this is just a minor differentiation in terminology, we think that this could be helpful for a more intuitive understanding of the S2F concept. What are your thoughts in this respect?

  • Plan B: Unforgeable scarcity (Nick Szabo) is a well know concept in the Bitcoin community, so I see SF as a nice quantification of that concept. Frankly I think some people in the “commodity community” don’t have a very good definition of scarcity. For example, I talked to a lot of commodities investors that think platinum is scarcer than gold because there is less platinum in the world than gold. I prefer the definition of scarcity that relates production (flow) to stock. You could also interpret this as inability of producers to influence stock (and thus price): with oil producers have much influence, and with gold less. Maybe your definition of “constancy” is the same? This is something we should discuss further.

“The Drunk & His Dog” Analogy

The drunken sailor goes out with his dog on a leash, wanders around in a random fashion and the dog has to stay with him, but sometimes he is on the right, sometimes on the left, but he cannot go any further as he is on a leash.

You don’t know where the drunken sailor and the dog are going, but you do know they stay together.    

Mark: Could you please explain to us the analogy regarding “the drunk and his dog” again and tell us the meaning for our readership?

  • Plan B: The drunk and his dog story is a popular story to explain cointegration. Correlation is about how two series move together. Cointegration is about two series staying together. So, the drunk walks a random unpredictable path, and his dog too, but the distance between the drunk and the dog is predictable, it is never larger than the leash. So, without knowing where the drunk or dog are going, we can predict they stay together. With stock-to-flow and Bitcoin it is special case of course, because we know where one of the two is going: SF. Cointegration is used to test if correlation is spurious or real: no cointegration = spurious. SF and BTC are cointegrated, so they are likely (no guarantee) not spurious.

Why Current Prices of BTC Do Not Reflect the Predictions of the SF-Model

Mark: Are people too dumb to get it?
Plan B: No, it is enough if some people get it. Like with insider information, if only 10-100 get it, they will move the price. Dumb money is formally “noise” according to the EMH (Efficient Market Hypothesis), it is irrelevant.
Mark: Is it bad model?
Plan B:  I think the cointegration is real, so the model is good. So far, I have not seen anything better.
Mark: Are the ones that “get it” already invested?
Plan B:  Most will be invested, but I think that many who “get it”, also see the big risks such as government bans, a software bug, “the next Bitcoin”, death spiral, etc. These risks prevent them from going all in. Actually, this is true for myself as well: I am invested, but not 100%; if I knew 100% certain Bitcoin would go to $100k USD in 2021, I would go all in and even lend money.
Mark: Are the markets inefficient?
Plan B: No, the markets are efficient. Also, the $150 Billion Bitcoin market is efficient, as I have shown in the FX (Foreign Exchange) example in my article. Easy arbitrage between BTC/USD, BTC/EUR, and BTC/JPY markets is not possible.
Mark: Do people know about the model?
Plan B:  Enough people know about it. I have 60k followers on Twitter and many of them are investment bankers, quants, miners, venture capitalists, hedge-fund CEO’s, and CIO’s, etc. The SF model was featured in MSNBC and in Forbes.    

Mark: Your model has occasionally been criticized – that it only explains the Bitcoin price in reference to Bitcoin supply. If this is even possible, how do you incorporate demand?

  • Plan B:  People that use the demand argument probably don’t have a statistics or investing background. The argument is theoretically right (price is a function of supply and demand) but there are a lot of famous pricing models that do not use demand (or supply) as input and still give good predictions. Some examples of this are the CAPM (Capital Asset Pricing Model) and Black & Scholes model, as both price with only risk / volatility (standard deviation, etc). The demand argument is really based on ignorance.

Mark: Let’s now throw a new thought into the equation: The model tries to explain the price of Bitcoin in USD. We know, that measuring value in fiat money over time is difficult, as fiat currencies are designed to be permanently inflated. In our mind, the model implicitly does not take into account fiat money inflation. If say, – at least for the sake of a thought experiment – the USD would hyperinflate within the next years, we would expect the model to vastly underestimate the USD value of Bitcoins. What are your thoughts regarding the dollar-inflation in regard to SF model?

  • Plan B: It is true that the SF model doesn’t correct for inflation. If we would do that, we probably see not much difference anyway because from 2009-2019 inflation was low. And indeed, in my opinion the SF model predicts USD hyperinflation because Bitcoin USD does this 10x every 4 years. Many people have problems with this thought, but for me it is not an improbable scenario, given negative interest rates and what central banks are doing with QE: they are going full Zimbabwe in my opinion.

Mark: What is the deal with the artist you commissioned? (The artist is going to make an artwork out of the charts).

  • Plan B: The artist Petek was intrigued by the charts and she asked permission to paint it. It will be a unique painting with some special elements that are yet to be revealed. It is exciting to see that a lot of other people are inspired as well and are commissioning a similar SF painting. Her idea is that she will make a series of paintings using different colors and materials based on SF. I think Bitcoin is not only about programming and money but also about a movement and a revolution. Art and science are two sides of the same thing, they belong together.

Mark: What other projects are you currently working on?

  • Plan B: I am cooperating with other Bitcoiners on research and writing more articles. I am working together with some investment funds, also traditional institutes, finding ways to include an exotic investment like Bitcoin in the existing asset mix. Also, I am doing chain-analytics, crunching the 300GB blockchain to find more patterns that can give insights and be used for proprietary trading, that is really uncharted territory.

Mark: (When) can we expect an outing of Plan B?

  • Plan B: I think the chances of me going dark are higher than an outing. I have no desire to become a public figure. Especially when the model works, which I hope and expect of course. People that want to meet me know where to find me, through my network, and everybody can verify it is me by my cryptographic signature (like on the articles).

Let’s Hope Bitcoin Doesn’t Become Any More Decentralized

Let’s Hope Bitcoin Doesn’t Become Any More Decentralized

A common claim among bitcoin enthusiasts is that it is a “decentralized” method of making payments. Here are some notable outlets making this claim:

Investopedia: “Bitcoin offers the promise of lower transaction fees than traditional online payment mechanisms and is operated by a decentralized authority, unlike government-issued currencies.”

Business Insider: “Because bitcoin is decentralized, it’s not directly subject to market forces such as interest rates or currency debasement.”

St. Louis Federal Reserve: “Bitcoin is a decentralized recordkeeping system, with updating of the record of transactions in the blockchain.”

This is in addition to the hundreds of other websites, both professional and amateur, that assert that bitcoin is a decentralized system.

But a new working paper from economists William J. Luther and Sean Stein Smith is casting doubt on this characterization of bitcoin. Luther and Smith offer a new taxonomy of the different methods of processing payments: centralized, decentralized, and distributed. The differences may seem superficial, but the implications can be significant.

Before we begin defining and understanding the different systems, it’s best to review some basic concepts.

First, let us define a medium of exchange as a good which is acquired in order to be exchanged for another good. Second, let us define money as the most commonly accepted medium of exchange. Third, we must distinguish between the production of money and the verification of an exchange: the production of money is creating new monetary units and adding them to the system; the verification of an exchange (a.k.a., clearing or processing) is determining whether sufficient funds exist to fulfill a transaction. We can go further and define trust as the belief that a transaction will be verified before it actually is.

With those preliminaries out of the way, we can now proceed to understand the three different systems of payment.

A centralized payment system has all transactions going through a third party for verification. The “third party”, in practice, may be several distinct parties networked as a series, with one verifying the work of another in sequence. The key feature is, however, that if the third party is unable or unwilling to process a payment, the two parties in a transaction will be out of luck.

Under a centralized system, there is effective a monopoly on verification. No one other than the centralized authority is permitted to produce money or verify transactions. As such, all other users must trust the judgment of the central authority.

A decentralized system is one where there are many independent verification parties. As an extreme example, a system where every transaction has no intermediaries (like a barter system) is a decentralized system. But decentralization exists on a spectrum: a situation where there are dozens of independent firms competing for the privilege of verifying a transaction is also a decentralized system.

This was the case in the era of private coin production. In the days of commodity monies, any private person with access to a mint could create their own money. Producers would compete on the aesthetic and value-to-weight ratios of their coins. The economist George Selgin documented perhaps the golden age of private coinage, England of the 18th century, in his book Good Money:

The commissioning and issuing of commercial coins, which had been the preserve of a few industrial and mining firms, was taken up by all sorts of small businessmen – grocers, drapers, silversmiths, malsters, and pretty much anyone whose dealings generated a need for small coin. Well, not just anyone: even small-scale token issuers were almost always persons of good standing in their communities, whose token issues were generally modest in comparison with their capital and command of credit.

Selgin (2011, p. 123)

Of course, kings and other nobles have been exercising virtual monopolies on money creation for millennia. So, what had happened to cause a break in the centralized system? According to Selgin, the Royal Mint in England stopped producing low-value copper coins as a cost-saving measure, despite the fact that there was great demand for them. Conveniently, there were many copper mines that were willing to sell their raw metal to those private individuals who would go on to mint coins. As metals were the commonly accepted medium of exchange (otherwise known as money), anyone with access to metals who could fashion them into something attractive for consumers could create his own money. And as Selgin (2011) documents, they were indeed attractive:

The other thing most eighteenth-century tokens had in common… was their extraordinary appearance. According to Francis Klingender… the tokens displayed a unique ‘combination of intellectual vigor, social consciousness, and imaginative design’ (Klingender [1943], 46.) [Citation corrected.]

Selgin (2011, p. 133).

Under this system, the functions of producing money and verifying transactions are divorced. The mint buys the raw materials and produces the money. A person then makes a direct exchange with the producer for the money, with no third-party intervening. The person who now owns the money will get use it at a new transaction. The transacting parties themselves verify each transaction, while the producers focus on minting easy-to-verify coins. If the users of the coins lose their trust in a coin, they stop patronizing the producer and he or she goes out of business.

Since every step in this process involved only two transacting parties, these are all decentralized markets.  

Eventually, of course, the central powers took notice of what was happening and took over the money production process again. The initial excuse is to ensure safety of the parties. Then overtime more duties are assumed by the regulator. This is called regulatory creep. In the 1900s, regulatory creep led to the advent of the modern central banking system with the systematized backing of fractional-reserve banking (FRB). Under an FRB regime, while the central bank and government mint create so-called “base money” (cash and ex nihilo virtual deposits into the accounts of chartered banks), it is the private banks that end up generating most of the media of exchange in the economy. Each bank does this by lending out the deposits of their checking account depositors.

Since each bank makes the decision to expand the supply of money via loans of demand deposits, the system functions as a decentralized network of money producers. However, the verification of transactions is still centralized. Thus, the current monetary regime is a blended centralized-decentralized system.

That is, until the existence of bitcoin. Bitcoin is neither a centralized nor a decentralized system. Instead, it is a distributed system.

A distributed monetary system distributes the role of verifying transactions to everyone on the network. This is distinct from a decentralized system, where the power of creating and verifying money is split up among many people. A distributed system has a two-fold approach to verification: first, the entire network shares a ledger that documents every transaction that has ever happened; second, the network has a shared protocol or procedure for verifying an update to the ledger via some kind of consensus rule.

The principles of distributed monetary systems come from the world of distributed computing. The major innovation of bitcoin was that it was the first to recognize how distributing trust among the entire network can be an attractive method of transacting. In effect, bitcoin is a trustless payment network, as buyer and seller no longer have to trust each other or a third party. Instead, only trust in the faithful execution of the automatic protocol is required.

This removal of interpersonal trust is a giant achievement. Trade axiomatically makes us richer. But in order to trade, we must trust the person we are trading with. Historically, trade has been mostly within tribes, among family members or other closely-knit individuals where trust was high. Trust was the only way to exchange.

After intertribal and cross-regional trade was discovered, and exchanging with strangers became a common occurrence, the necessity of money became apparent: it is difficult to know what others want, but everyone will want money. Direct exchange gave way to indirect exchange, albeit decentralized. While money superficially looks like an inefficiency, it facilitated a much smoother market. A decentralized market does not require a fully trusting society, but just enough trust that you find it unlikely to be taken advantage of.

The early markets were decentralized. Buyers and sellers now only needed to trust each other in an exchange. Over time, as tribes settled down to form cities, kingdoms, and empires, centralization of trade in the form of government fiat money, government mints, and so on, became the norm. Trust from the counterparty was replaced with trust in the centralized authority. However, centralized authorities have tendencies to restrict trade on a whim, in the name of security, nationalism, or other infamous ends.

Bitcoin offers a way forward. There is no longer a need to rely on a mercurial central authority to verify transactions and create money, nor do you need high trust. By extending the scope of the market, many more exchanges can happen, creating more opportunities for innovation, cost-reductions, and other benefits of making a connection with other people.

Luther and Smith (2020, pp.14-25) do point out, however, there is more to bitcoin than its distributed payment network. Firstly, it is the governance of the protocol itself. Here, changes to the protocol must be arrived at via popular consensus among the developers and miners. We can describe the decision-making process as broadly decentralized, despite the fact that some mining pools are more influential than others. Secondly, there is also the issue of exchanges and e-wallets. As they are third parties that verify transactions, they are centralizing forces in the bitcoin space. 

The original bitcoin whitepaper does not mention “decentralization” at all. Instead, the system was called a “peer-to-peer distributed time-stamp server.” Why did a distributed system become mislabeled as a decentralized one? Perhaps because many have an intuition that the current regime is highly centralized; and since bitcoin is not centralized, it must be the opposite: decentralized. However, there is a third way of organization: distribution.

A distributed system is not the same thing as a decentralized system. Decentralized systems require high trust between buyer and seller; meanwhile distributed systems require all peers on the network to share and communicate with each other constantly. As such, distributed systems can offer less privacy than a decentralized system, wherein all exchanges are only between buyer and seller. Furthermore, distributing among a large number of participants the responsibility to store every transaction between every participant on the system, may prove to be more costly (in terms of storage costs, energy costs, and time to approve a transaction) than a centralized system where only one entity is responsible.

On the other hand, decentralized systems can be cumbersome, costly, and the degree of trust required to fulfill them can serve as a hinderance to trade. A move towards decentralization would mean more trust is needed to engage in an exchange, in addition to regulatory creep. By reducing the level of trust required to verify a transaction, bitcoin has the potential to open up trade among more strangers who otherwise wouldn’t trust each other. 


Luther, William and Sean Stein Smith (2020) “Is Bitcoin a Decentralized Payment Mechanism?” Social Science Research Network.

Klingender, Francis Donald (1943) “Eighteenth Century Pence and Ha’Pence.” Architectural Review 93: 41-46.

Selgin, George. (2011) Good Money. Independent Institute.

The “Plan B” – Model: The Holy Grail of Bitcoin Valuation?

Bitcoin and Gold Stock to Flow
Bitcoin and Gold Stock to Flow

“The high stock-to-flow ratio, the liquidity of the market, and its unique features as a monetary good set gold apart from all other asset classes and make it an efficient hedge against systemic market risk.”

In Gold We Trust Report 2011, Page 26

Key Takeaways

  • The “Plan B” valuation model for the development of Bitcoin’s price quickly gained worldwide attention. In it, the price of Bitcoin is modelled with the “stock-to-flow ratio”, a proxy for scarcity.
  • Historically, the stock-to-flow ratio was an almost perfect exogenous regressor for the development of the price of Bitcoin (R2 was 95%).
  • According to the model, the price of Bitcoin should rise to USD 55,000 after the next “halving” in May.

What is the Stock-to-Flow Ratio?

Since the article “Modeling Bitcoin’s Value with Scarcity” appeared on the online platform Medium in March 2019, it has already been translated into over 25 languages and will soon spread worldwide. But what exactly is it all about and what conclusions can be drawn from it? In the following article, we’ll explore these and other questions.

The basis for the entire model is the so-called “Stock-to-Flow Ratio”, a concept that interested readers of the Crypto Research Report and its sister report, the “In Gold We Trust Report“, have been familiar with for many years. For those who are not yet familiar with the concept or who would like to refresh their knowledge of it, please refer to the info box on the left.

The author of the article, who blogs under the pseudonym “Plan B”, dared to try to model the price of Bitcoin with the “Stock-to-Flow Ratio” (hereinafter SF). The concept, which was originally applied to gold and other precious metals, hit the Bitcoin scene like a bomb. How did it come about that a concept for commodities could be applied to a cryptocurrency?

The Stock-to-Flow Ratio
The stock-to-flow ratio is a ratio of two figures corresponding to raw materials, which can ultimately be used for price modeling.   The term “stock” refers to how much of a certain raw material is mined or would potentially be in stock if the entire stock was offered. In this concept, “flow” stands for the production quantity within a certain period, usually within one year. If you now compare these two figures, you will see relatively quickly that this can be used as a measure of the constancy of the quantity of raw materials.   An example: While the total amount of gold ever mined is about 190,000 tons (stock), the annual production is about 3,000 tons (flow). If you divide the stock by the flow, you get a stock-to-flow ratio of 63.3, which means that at the current production level, it would take more than 63 years to double the gold stock or rebuild the current stock. So, the larger the number, the more constant is the raw material that is examined. While the “stock” is a given size and grows yearly exactly around the “flow”, the “flow” depends on various factors, such as the rarity, the price and the difficulty of extracting the raw material.    

Bitcoin, Gold and Scarcity

Two main factors contribute to the value of gold–– the most important precious metal for investors:

1. The Relative Rarity

2. The Difficulty of Extraction or The Extraction of the Raw Material.

Similar to gold, Bitcoin is both scarce and expensive to extract. Therefore, an analysis of the price development of Bitcoin with the SF model, which was originally designed for commodities, seems to be reasonable due to its similarity to gold.

Figure: Bitcoin vs. Gold – Stock-to-Flow-Ratio

Bitcoin and Gold Stock to Flow
Bitcoin and Gold Stock to Flow

Source: Medium Original Article, ZPX, Satoshi & Co. Research

The Quantitative Valuation of “Plan B”

A special feature of the Bitcoin protocol is that the code already determines how the Bitcoins offering – and thus the stock to flow ratio – will develop in the future. 

The maximum number of Bitcoins is 21 million (maximum stock). The number of newly generated Bitcoins is also fixed (flow). However, the Bitcoin flow is not constant over time. Every 210,000 blocks the so-called “block-reward” is halved. This is the number of Bitcoins that the successful miner receives for its validation services. Miners currently receive 12.5 Bitcoins per block, but the next “halving” will take place in May of this year. From then on, only 6.25 Bitcoins per block will be “mined”.

By way of comparison, in the case of gold or silver, for example, it cannot be completely ruled out that one day a huge find will be made, and the flow will shoot up, because more can be mined.
The “Halvings” lead to: Inflation of Bitcoin getting smaller and smaller until it reaches zero, and an increasing SF ratio as the flow is halved.
Since Bitcoin is denominated to eight decimal places, the reward per block will arrive at 0 exactly after the 33rd “halving”. Based on a halving every four years, the last Bitcoin will therefore be mined in 2140.

Table: Development of the “Block Rewards”

Period Number of New Bitcoins per Block
Genesis Block – November 2012 50
November 2012 – July 2016 25
July 2016 – May 2020 12,5
May 2020 ~ May 2024 6,25
May 2024 ~ May 2028 3,125

Source: Incrementum AG

Plan B examined a total of 111 data points between December 2009 and February 2019 and determined the respective market capitalization of Bitcoin and the corresponding SF ratio.

Important Links:
Live BTC Stock-to-Flow:  
DIGITALIK: https://digitalik.net/btc
LOOKINTOBITCOIN: https://www.lookintobitcoin.com/charts/stock-to-flow-model/  
The Original Article: https://medium.com/@100trillionUSD/modeling-bitcoins-value-with-scarcity-91fa0fc03e25      
Because the S2F ratio is constantly increasing, time is already included in the model as an exogenous variable.

Then the author pulled the data and one thing was immediately apparent: The higher the SF ratio, the greater the market capitalization. If one regresses the rising stock to flow ratio with the logarithmic price time series of Bitcoin, one finds a surprisingly high explanatory value. The correlation can also be seen with the naked eye.

The natural logarithm was used. This makes it possible to show the correlation of both quantities linearly and thus opens up possibilities for a solid statistical investigation.

Figure : Plan B’s Infamous Graphic

Plan Bs Stock to Flow Bitcoin Model

Source: Plan B, Medium[1]

For the Number Crunchers: If one models the price of BTC directly by SF and converts the resulting formula In (Market Capitalization) = 3.3 * ln(SF) + 14.6 Then you get the law of potency: Market Capitalization = Exp(14.6) * SF3.3

In Plan B’s infamous stock to flow chart, the small dots represent Bitcoin’s historical price data over time. The large grey and yellow dots show the respective market capitalization of silver and gold and their respective stock to flow ratio. The regression suggests what can be seen with the naked eye: a statistically significant relationship between S2F Ratio and the market capitalization of Bitcoin. 

For the Number Crunchers: Test Data of the Regression: R2: 0.95 F-Test: 2.3E-17 P-Value: 2.3E-17

Plan B argues that the correlation is so strong that the dominant driver for the price must be scarcity, or SF ratio. However, the author also acknowledges that other factors such as regulatory measures, hacks, and other news have an impact on the price; therefore, not all the data points are perfectly in line. The fact that the S2F ratio of gold and silver also fits very well into the picture is a further validation of the model.

Since the “halvings” have such a great influence on the SF ratio, Plan B has color-coded the months until the next “halving” in the chart. Dark blue are the halving months and red are the points shortly after the “halving”. The current S2F ratio of ~25 will thus double to ~50 in May 2020, which is already close to the S2F value of gold.  Based on this model, the forecast market value for Bitcoin after halving in May 2020 is $1 trillion, which would correspond to a Bitcoin price of $55,000.

Further Models

 We dug a little deeper and found out that there were already several variants of the model that Plan B calculated:

Points of Criticism with the “Plan B” Model  
The model is based purely on the supply side (maximum number, Bitcoins per block, etc.) and does not take into account the demand for Bitcoins.Regulatory measures, possible hacks, etc., i.e. (largely non-quantifiable) control variables, are not included or built into the model.
•        Historical data is not a source of forecasts.
•       The statistical correlation between the SF ratio and the price of Bitcoin is not a causality, only a correlation.
•       If the model is correct, this should already be reflected in the prices.
•       At some point Bitcoin will become truly deflationary (the loss of BTC per year would exceed the annual mining production), resulting in a negative SF ratio. What happens to the price then cannot be predicted by the model. Lack of stationarity of the data. The high R2- value could be a consequence of the missing stationarity of the data.The empirical work of Plan B is not precisely documented, which makes it difficult to find methodological weaknesses.  

Another interesting model is the so-called “time-based model”, as it explains the increase in the value of Bitcoin over time with a different underlying causality. The model states that Bitcoin increases in value as more and more market participants know about Bitcoin, deal with it and take the step to buy it. The narrative for the increase in value is thus the adoption, but not the scarcity (S2F). The estimates of this model are more conservative, and it is assumed that the price of Bitcoin will not break the $100,000 barrier until 2021-2028.

Table: Bitcoin Price Development Model Overview

Model Original Model (Until Dec 2018)  “Additional Data Model” “Out of Sample” Model  Time-BasedModel
Value After the 2020-Halving 55,000 USD 60,000 to 9,000 USD 100,000 USD Between 2021 & 2028: 100,000 USD
    Special Feature The first rapidly spreading model for price evaluation of Bitcoin with scarcity as proxy. Supplements “The Original” with additional data (older and younger). Uses only data prior to November 2012, so no halving has occurred in the data set yet. The reason for the price growth in this model is the progressive adoption of Bitcoin.

Source: Incrementum AG, Plan B

The Law of Potency

“S2F and price are proportional and react and change proportionally.”  

Plan B, Stephan Livera Podcast November 2019

Definition: “A power law is a relation in which a relative change of one quantity leads to a proportional relative change of the other quantity – independent of the initial quantity of these quantities”.

Exactly such a law of potency emerges when one examines the regression of the “original model”: At each halving, the SF ratio doubles, and market capitalization increases tenfold – this is a constant factor. Plan B therefore suggests:

“The possibility of a power law with a 95% R2 over eight orders of magnitude makes me confident that the main driver of the Bitcoin value is correctly captured by the SF ratio”.


The stock-to-flow model has shaped the crypto year 2019 like no other development. The accuracy with which the model traces price developments of the past is outstanding. It was also possible to observe how the model drove additional researchers and critics to take a closer look at the price development of Bitcoin. In the medium and long term, this invested human capital will contribute to a better understanding of the crypto world and its adoption to a broader population. The partly heavily criticized Model from “Plan B” will have the opportunity to prove itself as a forward-looking achievement starting this May – and it deserves exactly this opportunity. 

[1] https://medium.com/@100trillionUSD/modeling-bitcoins-value-with-scarcity-91fa0fc03e25

[2] See Stephan Livera and Plan B, Nov 4, 2019