XRP and Ripple

August 21, 2019

“XRP Recently in Green, But Outsized Risks Prevail. XRP’s recent rally is unlikely to endure, in our view. Ripple’s litigation risks and the prospect of XRP being classified as a security were largely ignored over the past three months as XRP staved off the effects of the broader crypto-price collapse. This stalling has helped to make XRP the second-largest asset of its kind by market capitalization.”

Bloomberg Crypto Outlook

Key Takeaways

Ripple Labs Inc. claims that they are not the creators of the coin XRP. However, the company Ripple Labs Inc. has earned over $890 million in revenue from selling XRP coins on the market. In June 2019, the company Ripple moved 1,000,000,000 XRP from their escrow account to the market, which could generate approximately $300 million more in revenue from selling XRP.
Ripple was created by Jed McCaleb, the creator of Mt. Gox. McCaleb has since sold most of his 9 billion XRP coins, and he has abandoned the project. McCaleb now is the leader of Stellar and owns approximately 1 billion lumens.
The coin XRP does not need to be used by the Ripple Network for settling transactions. Various investment reports value XRP at close to zero in worth, and XRP could be an unregistered security in the US.

Soaring 3000 %, XRP was one of the ultimate high-flyers during the 2017 crypto boom. At USD 0.31 the cryptocurrency lost 89 % since its all-time high of USD 3.31 in January of 2018.[1] Ripple has been on the Forbes Fintech 50 List for three years in a row by Laura Shin; however, Shin recently changed her position on Ripple and XRP. In episode 39 of the Unchained podcast, Shin discusses the main problems with Ripple and XRP.[2] We highly recommend the interview. The main questions that were discussed include:

What is Ripple?
What is XRP’s Elevator Pitch?
Is XRP an unregistered security?
Who owns and uses XRP?
Is XRP centralized?

We will be addressing these questions in this article.

Ripple Came Before Bitcoin

Most investors do not know this, but the concept for Ripple came in 2004 from Ryan Fugger, way before Bitcoin was created in 2008. However, the Ripple we know today, Ripple Labs Inc., was handed over in 2012 to Chris Larsen and Jed McCaleb.

Jed McCaleb (left) joined Ripple in 2011. Chris Larsen (right) joined the company in 2012.
Source: BitMEX Research.

If Jed McCaleb sounds familiar, it’s because he was the original founder of the infamous Mt. Gox Bitcoin exchange. When McCaleb sold Mt. Gox to Mark Karpelès, 80,000 Bitcoin were missing.[3] However, the contract of a sale stated that Karpelès could not hold McCaleb legally accountable. Years later, McCaleb’s login details for the backend of Mt. Gox were still valid, and they were used to hack into Mt. Gox in order to steal Bitcoin.[4] To this day, the perpetrator of those hacks remains unknown.

XRP Ledger, RippleNet, xCurrent, xRapid, and xVia

The first information to untangle is what exactly is XRP? XRP coins are accounting units in an open source distributed database called the XRP Ledger (XRPL). In contrast with XRP and the XRP Ledger, Ripple Labs Inc. is a company that provides a closed source software called RippleNet to companies, and Ripplenet contains a suite with three tools: xCurrent, xRapid, and xVia. The myriad of products and information surrounding the products befuddles investors and distracts them from understanding what XRP is. We briefly describe each of the three products in this section.

XRP Ledger

The XRP Ledger is a distributed ledger that stores information regarding XRP transactions and balances. The main question: Is XRP Ledger’s consensus mechanism decentralized? We searched for a comprehensive technological analysis of XRP’s consensus mechanism, but one does not currently exist. A plethora of articles exists online, with answers ranging from the XRP Ledger consensus mechanism is centralized to decentralized and everywhere in between. What is clear is that RippleNet’s xCurrent and xVia are not using the XRP Ledger, so they have centralized consensus.

According to the latest whitepaper written by Ripple Research by Brad Chase and Ethan MacBrough, to come to consensus on what transactions are valid and what transactions are invalid, the XRP Ledger uses the XRP Consensus Protocol, which is “a Byzantine Fault tolerant agreement protocol over collectively trusted subnetworks.”[5] Binance Academy explains in simple terms how XRP Ledger’s consensus works,

“The XRPL is managed by a network of independent validating nodes that constantly compare their transaction records. Anyone is able to not only set up and run a Ripple validator node but also to choose which nodes to trust as validators. However, Ripple recommends its clients to use a list of identified, trusted participants to validate their transactions. This list is known as the Unique Node List (UNL).

The UNL nodes exchange transaction data between each other until all of them agree on the current state of the ledger. In other words, transactions that are agreed upon by a supermajority of UNL nodes are considered valid and the consensus is achieved when all these nodes apply the same set of transactions to the ledger.”[6]

However, as BitMEX claims this entire process is unnecessary because, in order for a node to support a proposal for a new set of transactions, a node must download private keys from a server that is controlled by Ripple.[7]

“The software indicates that four of the five keys are required to support a proposal in order for it to be accepted. Since the keys were all downloaded from the Ripple.com server, Ripple is essentially in complete control of moving the ledger forward, so one could say that the system is centralised. Indeed, our node indicates that the keys expire on 1 February 2018…, implying the software will need to visit Ripple.com’s server again to download a new set of keys.”

According to BitMEX Research, XRP’s Ledger is unable to achieve distributed consensus:

“For example, one user could connect to five validators and another user could connect to five different validators, with each node meeting the 80% thresholds, but for two conflicting ledgers. The 80% quorum threshold from a group of servers has no convergent or consensus properties, as far as we can tell. Therefore, we consider this consensus process as potentially unnecessary.”

Another problem regarding the single point of failure aspect of XRP Ledger’s consensus mechanism is that there is no fee for validating transactions. This means there is no incentive for becoming a validator in the Ripple network. According to Ripple, institutional participants will be incentivized to run nodes at their expense for the health of the network.[8] For some, this assumption seems arduous: One could argue that large financial institutions will not run an XRP node because of potential legal recourse that could ensue. As Joe Kendzicky points out:

“Imagine the PR backlash a bank would receive if it came out that one of its UNL peers was a darknet market, and the bank themselves played a direct role relaying drug and money laundering related transactions.”[9]

In general, Byzantine Fault Tolerant consensus mechanisms are more centralized than Bitcoin’s proof-of-work and longest chain consensus mechanism. Since XRP Ledger’s is expected to migrate to a different consensus algorithm called Cobalt at a date that has not been determined yet, we will leave the discussion on consensus here and hope for an unbiased analysis of exactly how decentralized XRP’s consensus really is.[10] Moving on from the XRP Ledger is RippleNet, which is a closed source software that contains three main products: xCurrent, xRapid, and xVia.

xCurrent

xCurrent’s peer-to-peer structure is similar to the Lightning Network discussed in The Crypto Research Report March 2018 edition. If Bank A wants to pay Bank B with US dollars, but Bank B wants to be paid in euros, the xCurrent protocol layer could route the transaction. Bank A would submit a transaction to convert the US dollars to euros (in the form of an IOU) to a global order book. xCurrent then acts as a path-finding algorithm to find the cheapest route for the US dollars amount to be exchanged to euros.

One of the most interesting and at the same time most widely ignored features of Ripple are the fact that transactions on Ripple’s xCurrent software do not need to be denominated in the network’s native currency, namely XRP.[11] Contrary to common belief, the network can manage IOUs denominated in any type of asset.

“The use of XRP is totally independent of the Ripple network in general; that is, banks don’t actually need XRP to transfer dollars, euros, etcetera which is what many small investors might be missing when they are buying the token.”[12]

While the xCurrent protocol layer is currency-agnostic, there is a small transaction fee (~.00001XRP) to access the exchange.[13] This transaction fee is not collected by anyone, but rather destroyed once payed. The stated idea behind the fee is to prevent spamming on the network.[14] However, burning XRP also makes Ripple Labs richer. When the network burns the transaction fee in XRP, the remaining amount of XRP in existence are worth more because the supply is decreasing with constant demand, ceteris paribus. Since the developers and Ripple Labs own the majority of Ripple, each transaction fee makes the developers and Ripple Labs wealthier.

xRapid

xRapid is built on top of the XRP Ledger and can be used to settle transactions denominated in the native XRP token. xRapid is the only one of RippleNet’s three-suite software package that is built on top of the XRP Ledger, which means that as xRapid gains more adoption, there is more demand for XRP.

In order to use xRapid, banks or other participants either need to hold XRP reserves, as the bridge currency, on their balance sheets, or have dedicated liquidity lines operating on the xRapid layer, which is what the Ripple Lab Inc. would like to see because this would give value to XRP, of which they own approximately 60 % of currently. But why would banks just give away their wealth away to Ripple Labs by buying up XRP off of the open market in order to settle international payments? In order for banks to use xRapid, they would need to invest in XRP and potentially hold reserves of XRP. Why would banks accept the currency risk of holding on to XRP reserves in order to use xRapid, when they can just use a stablecoin or central bank cryptocurrency?

One reason is if the bank also owns XRP or is a private investor in Ripple Labs equity shares. One of the banks that is often cited as a user of XRP, Strategic Business Innovator (SBI) Remit Co. Ltd., is actually invested in the private equity shares of Ripple Labs Inc., and has a financial incentive to promote positive news headlines regarding the company and XRP because when more banks are shown as using XRP, then Ripple Labs Inc. earns more in quarterly sales revenue from XRP sales.[15]

xVia

Various YouTube videos and Twitter tweets state that Ripple is a competitor to the Society for the Worldwide Interbank Financial Telecommunications (SWIFT) network. However, many investors do not even understand how the SWIFT network works. Actually, SWIFT does not settle a single transaction. SWIFT is only a messaging system between banks and settlement systems, such as the Clearing House Interbank Payments System (CHIPS). xVia is the messaging application for RippleNet users that need to send invoices or other information to other users. This is the part of the technology that would compete with the SWIFT network.

Unlike SWIFT, Ripple Labs is an enterprise software company that has a negative customer acquisition cost because they can pay people in XRP to use XRP. In Ripple’s 2017 October market report, they explain that they offer a 300 % rebate on integrating the Ripple software.[16] The rebate is paid in XRP. This means that any costs that a firm has for integrating RippleNet into their system will be rewarded with a 300 % return. They seeded a $300 million accelerator fund that helps cover the costs of integrating RippleNet into existing companies.[17] They are willing to lend XRP to market makers at zero cost, which allows market makers to add millions in revenue to their bottom line.[18] Although, this encourages firms to work with the Ripple network and with XRP, some financial analysts say that Ripple’s free distribution of XRP to banks that are willing to experiment with RippleNet borders a bribe.[19] The current security problems that SWIFT has regarding fraud and hacks would be the same with xVia because xVia is part of RippleNet, which is closed source and has centralized consensus and is a single point of failure.

What is XRP’s Elevator Pitch?

Ripple and Libra are both effectively trying to become a global private central bank. The main investment argument made by XRP enthusiasts is that retail investors can front-run banks that eventually will adopt XRP for cross-border settlements. Since the banks will rush in and buy reserves of XRP to use as a bridge currency, the price will go up, rewarding early investors with an XRP appreciation. But why would banks give up their market share to XRP voluntarily? Banks currently settle international payments and incur a cost of approximately 20 basis points per transaction.[20] Ripple noted that their system could reduce settlement costs by six basis points, and an additional two basis points if XRP is used on the xRapid network.[21] As CEO and founder of Messari pointed out, Ryan Selkis, there is a negligible benefit of using XRP for cross border settlement compared to the cost banks will have to incur to hedge fluctuations in the exchange rate of XRP.[22]

Furthermore, the token XRP is volatile, which impedes its ability to compete with the US dollar as a global reserve currency. To manage XRP’s volatility, professional market makers ensure that sell walls in XRP order books on cryptocurrency exchanges are reduced when good news are released and buy walls in the order books are built-up when bad news are released.[23] This makes XRP less volatile than other cryptocurrencies that do not have professional market makers.

The addendum to this article discusses how interbank settlement works in order to explain the business of banks that Libra and XRP are both vying to takeover.

Is XRP an Unregistered Security?

The first important clarification is that XRP coins do not convey ownership because Ripple Labs Inc., is a privately-owned company with a valuation of USD 410 million.[24] Unfortunately, many retail investors falsely believe that if Ripple the company makes profits, their XRP coins will go up in value because they think of XRP coins as equity shares of the company’s balance sheet. XRP coins are not equity shares.

Despite the fact that XRP coins are not tokenized equity shares of Ripple Labs Inc., XRP coins can be considered investment contracts according to the Howey Test, which is a tool used by US regulators at the Securities Exchange Commission to determine if a company falls under their jurisdiction or not. Former Chairman of the Commodities Future Trading Commission Gary Gensler explained that Ripple coin is a security according to the Howey Test[25], and Ripple is facing their third security fraud court case in the United States.

Why is this?

This is because Ripple’s XRP coin sales are similar to an initial coin offering that never ends. Izabella Kaminska wrote that Ripple’s issuance of XRP is like an exchange-traded fund:

“It is entirely centrally controlled, operating more like an ETF unit than anything else since the issuer has the capacity to release or absorb (pre-mined) tokens in accordance with their valuation agenda. More egregiously though, the token plays little part in Ripple’s central business case.”

Figure 3: XRP Price Did Not Respond to Coinbase Listing.

Source: Coinmarketcap.com, Incrementum AG.

According to the latest Bloomberg Crypto Outlook, Ripple is at risk of being classified as a security.

“Ripple’s risk in suits by XRP buyers is a court ruling that XRP is a security, which would subject XRP to stricter SEC regulation that could curb transactions. Classification as a security could allow purchasers to rescind buys, would require Ripple to register or find exemptions for XRP sales, and would hinder XRP’s ability to be listed on U.S. virtual marketplaces, which have reportedly been reluctant to list XRP due to the risk of facilitating the sale of a potentially unregistered security.”

When Bloomberg’s report came out in 2018, the two largest exchanges in the US, Coinbase and Gemini, did not list XRP, despite Ripple offering an interest-free loan of $100 million worth of XRP to Coinbase and a $1 million direct payment to Gemini.[26] However, Coinbase did decide to finally list XRP on Coinbase Pro, formerly known as GDAX, earlier this year in February. They reportedly did not receive any compensation from Ripple in order to list XRP.

But Ripple Labs is now claiming that XRP does not belong to the company. During a hearing in front of the British Parliament regarding Ripple, Ripple’s Director of Regulatory Relations claimed that Ripple Labs Inc. did not even create the coin XRP.

“XRP is open source and it was not created by our company, so that existed as an open source technology. We created a company that was interested in modernizing payments and then began using that open-source tech to do so … We didn’t create XRP … What we do have is we do own a significant amount of XRP, it was gifted to us by some of the open-source developers that created it. But there’s not a direct connection between Ripple the company and XRP.”

Ryan Zagone,
Ripple director of regulatory relations

However, Zagone’s claim is strange given Ripple used to state explicitly on their website that they created XRP. This image was found on an Internet archive explorer because Ripple has removed this statement from their website.

Figure 4: Ripple Originally Claimed That They Invented XRP.

Most XRP Coins Are Owned by Ripple Labs

XRP coins were created all at once in the genesis block in 2012. This was possible because the protocol does not use proof-of-work mining. The initial distribution of the coins was extremely centralized, and still is centralized today. The creators kept 20 billion XRP coins for themselves (20 %). The remaining 80 % or 80 billion XRP were gifted to Ripple Labs Inc.

If you look closely at the XRP listing on Cointmarketcap.com, you can see that the circulating supply and the total supply are very different. This is because the company Ripple is forcibly keeping coins off the market. Ceteris paribus, when the supply of a scarce good is restricted given a constant level of demand, the price can be kept artificially high. If you imagine that the coins locked away are also worth $0.31 each, then XRP’s real market capitalization is closer to $30 billion.

However, the price of XRP would most likely decline if Ripple sold more than 1 billion per month, which is their stated limit on monthly XRP sales. Ripple the company was valued by investors as being worth $410 million, which begs the question: Why would investors value Ripple at $410 million when they own 60% of the outstanding XRP, worth approximately $8 billion in current prices? Overall, the fact that Ripple Inc. effectively controls a large part of the XRP supply opens up non-systematic risks unique to Ripple.

Figure 5: Ripple’s Real Market Capitalization Would Be USD 31 Billion.

In 2018, Ripple Labs decided to partly lock up 55 billion XRPs in an escrow-like account that releases 1 billion XRP per month to Ripple Labs Inc. to be used as they wish. The remaining XRP coins that Ripple owns are distributed “methodically” to incentivize market maker activity.[27] XRP’s official supply metrics are tracked on their homepage; however, some data is missing.[28]

Ripple has sold on average 300 million XRP tokens per month since 2016. This money goes directly to Ripple Labs’ revenues. In January of 2018, the creators of Ripple were billionaires.[29] Ripple’s executive chairman, Chris Larsen, owns 17% of the private company and controls 5.19 billion XRP. Larsen was estimated to be one of the richest men in the world worth $60 billion when XRP hit an all-time high of $3.31 in early 2018. Ripple CEO, Brad Garlinghouse, is estimated to have $10 billion in personal wealth.

Several of the 2018 court cases regarding Ripple are because of the escrow account. The news of the escrow account made the price shoot up, and many investors are claiming that Ripple Labs profited financially by manipulating the price and investors. However, the Ripple founders are notorious for selling large amounts of their Ripple coins. Jed McCaleb wrote online in May of 2014 that he was selling 9 billion of his XRP coins.

“I plan to start selling all of my remaining XRP beginning in two weeks. Because I have immense respect for the community members and want to be transparent, I’m publicly announcing this before I start. So just fyi… xrp sales incoming.”

The price dropped by 60 % following his post. He has now moved onto his third project, Stellar, which is like Ripple but with smart contracts. In 2015, McCaleb got into trouble for trying to sell more Ripple on Bitstamp than he was allowed to.

All of Ripple Labs Inc. shenanigans has led to 16 court cases in the United States and multiple encounters with regulators in other countries. Table 1 outlines the major cases that Ripple Labs has fought in the US.

Table 1: Court Cases and Fines Involving Ripple.

Source: Legal databases, User brjXRP17 on xrpchat.com

Who Owns and Uses XRP?

The 100 most active XRP wallets own an estimated 97 % of the existing XRP. Dogecoin creator, Jackson Palmer, created the website arewedecentralizedyet.com and showed XRP as being by far the most centralized coin. McCaleb’s project after XRP, Stellar, is also very centralized.

Figure 6: Ripple is Considered to be Centralized.

However, Palmer received so many messages from XRP users that he removed XRP from the website entirely.

Figure 7: XRP Army Attacked Are We Decentralized Yet Website Owner.

The XRP Army

After Demelza Hays expressed her disapproval of XRP on Twitter, she received nearly a thousand comments in favor of XRP, including several harassing comments that attacked Demelza personally. It is well known among crypto Twitter that the “XRP Army” is one of the most toxic communities. Although the community includes many real XRP supporting enthusiasts, the XRP Army benefits from automation and thousands of inauthentic accounts—that ultimately function to create the illusion of a larger, more robust community than is reality. Collectively, the XRP Army engages in “coordinated inauthentic behavior” (this activity violates Twitter Rules; more specifically, around platform manipulation).

Figure 8: Twitter Accounts that Commented on Demelza’s Tweet.

The XRP Army is notorious for attacking accounts which share anything that opposes the narrative they are pushing. One of the more frequent targets of their attacks has been Geoff Golberg, a social media manipulation researcher and founder of SocialCartograph, a social media mapping firm. Geoff dissected the XRP Army in great detail in this August 2018 post. His research has helped surface social media manipulation across the world, including that of India’s Bharatiya Janata Party (BJP; link 1; link 2), and, more recently, People’s Mujahedin of Iran (MEK; link), among others. More on his work may be found here.

Specific to the XRP Army, Geoff has received death threats simply for posting data-driven analyses that highlight how the group violates Twitter Rules. In the case of the MEK, Geoff’s research has even resulted in him being doxed. Doxxing is the process of attacking someone online with private details of that person’s life.

Figure 9: Many Twitter Bot Accounts Suspended Since Posting

(Note @ceramika74, which has since been suspended).
Source: @geoffgolberg

In addition to @ceramika74, there are several other XRP-focused accounts from this dataset that have been suspended since the data was collected (December 2018). Here are a few examples:

Figure 10: Many Twitter Bot Accounts Suspended For Being Fake.

One common tactic employed by the XRP Army, according to Golberg, is to create XRP-focused sockpuppet accounts (personas) around locations (cities, states, countries). Their goal, effectively, is placing XRP-branded billboards all over Twitter to create the illusion that the XRP community is larger – and more geographically represented – than is reality. Examples include @XRP_Europe, @XRP_Norway, and @XRP_Spain_Army (to name a few). Then you have accounts on Twitter that do not even try to hide that they are a bot just retweeting XRP whale tweets like @XRPRetweeter.

Twitter’s Platform Manipulation and Spam Policy states that “you may not use Twitter’s services in a manner intended to artificially amplify or suppress information or engage in behavior that manipulates or disrupts people’s experience on Twitter.” One such tactic employed by the XRP Army, states Golberg, are inauthentic engagements—more specifically, engagements (follows, retweets, likes, replies) that “attempt to make accounts or content appear more popular or active than they are.”

The first step to determining if the accounts are fake or not is to see if they were all created in and the around the same time period. The second step is to look at the patterns in the bio section. Many of the bots will contain the same words in their bio section, in the case of XRP, the main word to contain for a bot is XRP. This helps bots find which other bots they should follow and retweet from. The second step is to see how often they tweet. Some accounts tweet on average of 700 tweets a day, which is about once every two minutes. The next step is to look at the clustering of accounts. This means that all accounts are only following and retweeting posts from other accounts within their group, and they are not following or retweeting posts from other non-XRP related Twitter accounts. For example, a normal person that likes XRP should also be following a certain percentage of famous Bitcoiners accounts or regulators in their country. However, Twitter bots will only follow and retweet what they are programmed to follow and retweet. The final step is to go on to the Twitter profile and actually looking at their feed for signs that they are fake.

Conclusion

As the US dollar’s reserve status becomes increasingly challenged, more and more banks will lose their USD correspondent bank for settlement, and there could be demand for an alternative reserve currency and global private bank. Many articles online claim that large banks will use XRP as a global bridge currency or reserve currency to settle international transactions. However, banks can create their own native assets to settle transactions on the network with as well. Although settlement times and fees for Ripple transactions are lower than Bitcoin or Ethereum’s, banks will prefer to settle in whichever cryptocurrency establishes itself as a global reserve currency. Lightning network on top of Bitcoin, proof-of-stake coins, directed acyclic graph coins such as Byteball and Iota, and masternode structures, like Dash, are all attempting to make fast, reliable, and cheap transactions in order to become global stores of value and medium of exchange. However, all of these are volatile and will not be used as units of account, which is a requirement of a global bridge currency.

Bottomline, XRP will be competing with Apple Pay, Facebook’s Libra, JP Morgan coin, and all of the other proof-of-authority ledger monies that will be directly competing with the US dollar. However, all of the other global reserve and bridge currencies have a stable value. There is absolutely no reason to use a medium of exchange that is volatile like XRP for interbank settlement. XRP’s purchasing power is not backed by any reserves. When Facebook announced Libra, the stock price of Facebook went up, not the purchasing power of Libra. The purchasing power of Libra is expected to be stable because the Libra coin is not meant to be an investment. XRP will most likely not reach its stated goal of becoming a bridge currency, but that does not mean that XRP does not have any use case. XRP can be used as a digital store of wealth that is similar to a numbered 1980’s Swiss-style bank account, although, there are probably better technologies out there for that application like Monero, Dash, and Bitcoin.

A lot of members of the crypto community have received large payments of XRP from Ripple Labs Inc. in order to test XRP; however, this also may incentivize these members of the community to be quiet regarding XRP’s myriad of problems. Ripple Labs Inc. is also attempting to make inroads into Switzerland by inviting politicians and high-net-worth individuals to special events, such as the dinner at the Dolder Grand that occurred in early summer 2019. The strategy may even remind readers of the original formation of the US Federal Reserve on Jekyll Island in November 1910.[30]

Addendum: How Financial Transaction Settlement Works

The cross-border payment market is estimated to settle USD 180 trillion every year in volume.[31] To put this huge number into perspective, the entire annual economic production of Switzerland, as measured by the GDP, is USD 0.705 trillion.[32] According to Ripple research, cross-border payments are estimated to cost senders and receivers of cross border payments USD 1.6 trillion per year.[33]. For example, PayPal charges a fee of 2.9 % for payments plus an additional transaction fee will be charged for international payments, which is the spread in exchange rates that accrues to market makers. These costs for consumers translate into to profit centers for banks and financial intermediaries. Recent entrants like TransferWise or Revolut offer international transfers to retail investors at substantially lower costs, but the field of traditional payments is still dominated by long-established banks with little transparency and close to no competition.

How a Domestic Transaction is Settled

If UBS has an account at the SNB, this is referred to as a nostro account because it means “our” account at “their” bank. Nostro is also referred to as “Due from Bank Account” in accounting terms. As shown in Figure 11, UBS has nostro accounts showing up as credits on their balance sheet because this is UBS’s money held at other banks. In contrast, UBS’s nostro accounts show up as vostro accounts on each of the other bank’s balance sheets, and this why it is shown as debit or liability. In contrast, vostro means “our” or “Due to Bank Account” in accounting terms.

Imagine that Alice is a customer of Bitcoin Suisse (and Bitcoin Suisse’s July 2019 application for a Swiss banking license is approved), and she has a bank account with a balance of 500 CHF. If Alice wants to send 100 CHF to Bob’s bank account at Falcon Private Bank, then Bitcoin Suisse’s balance sheet would show their nostro account with Falcon Bank being debited 100 CHF, which means their assets are being decreased. Falcon Bank’s balance sheet would show Bitcoin Suisse’s vostro account as debited 100 CHF as well because this is 100 less of a liability for Falcon Bank to Bitcoin Suisse. The complimentary transactions would appear on Falcon Bank’s balance sheet in order to finalize the transaction.[34]

Figure 11: An Expensive Way to Settle a Domestic Transaction.

However, this is a very expensive way to settle a domestic transaction because this means that each bank has to have an account with cash deposits at every single other bank. This opens the bank to counterparty risk in the case that the bank where their account is can go bankrupt. The liquidity also has an opportunity cost. Instead of just leaving the cash deposits idle in a bank account at another bank, the bank could be using that money to earn interest from lending.

Instead of a bilateral model, all banks could just have one bank account at the central bank as shown in Figure 12.[35] This would reduce the counterparty risk and liquidity required each bank.

When a domestic bank has an account at the central bank, this is called a correspondent bank. When a domestic bank does not have an account at the central bank, then they are called a respondent bank. Settlement at the central bank between correspondent banks occurs in two main ways. The first is DNS systems, which settles transactions at the end of the day, for example, CHIPS in the US. The second is real-time gross settlement systems (RTGS), which have instantaneous settlement. An example of an RTGS system is Fedwire in the US.

Banks that have an account at the domestic central bank (correspondent banks) can charge fees to lower status banks (respondent banks) that need to use a clearing bank to access RTGS/DNS systems. This introduces substantial fixed costs, transaction fees, and time delays, which is why payments are both costly and slow.

Figure 12: A More Efficient Way to Settle a Domestic Transaction.

How an International Transaction is Settled

Banks can open a branch in a foreign country by getting a banking license in that foreign country or if a bank does not want to deal with the cost associated with getting a banking license in a foreign country, then a bank can open an account with a bank in a foreign country or open an account domestically with a bank that has a branch in foreign country.

For example, UBS can have a nostro account denominated in Swiss francs at the SNB in Switzerland, but they can also have a nostro account at Citibank in the US denominated in dollars. Both are “our” accounts at other banks. UBS can also use SNB’s nostro account at the Federal Reserve in the US to clear US dollar transactions.

There are several different ways that a foreign transaction can occur. First, it is important to understand that dollars do not leave the US during a foreign exchange transaction. Instead, all that happens is basically accounting wizardry.

The most common way to settle a foreign exchange transaction is for an international bank to have branches in two different countries. When the international bank receives $100 in their US branch, they make a liability and show the $100 as an amount payable in the future to the home branch of the bank in Switzerland. In the Swiss branch of the international bank, they credit the accounts receivable for the Swiss franc amount of the $100 at the spot rate, which, for example, could be 98 CHF.

Until the bank closes the accounts payable, the bank has exposure to currency risk from the spot price of the exchange rate changing. If the Swiss branch needs the Swiss francs right away, then the bank must settle the accounts payable in their American branch with the accounts receivable in their Swiss branch. In order to close the accounts payable, they must go to the foreign exchange market and sell their $100 and buy the CHF. When the Swiss branch buys CHF, this means that a counterparty bank is willing to sell them CHF. For example, if Citi Bank in Switzerland wants to sell 98 CHF Swiss francs to UBS for $100, then Citi reduces the asset side of their balance sheet by 98 CHF.

The SNB reduces its liability to Citi by subtracting Citi’s account at the SNB by 98 CHF. SNB shows UBS’s bank account as having more CHF in it after the sale, and that represents a new liability for the SNB to UBS of 98 CHF. On UBS’s own balance sheet, they use the recently purchased Swiss francs to clear out their accounts receivable on the asset side and simultaneously increase their reserves on the asset side. The New York branch of UBS clears out the Accounts Payable, since it has now been paid and they must reduce their asset side of $100 in reserves because they sold the reserves to Citi. This shows up on the Federal Reserves balance sheet as $100 less in liabilities to UBS and $100 more in liabilities to Citi. Citi show their asset side of their balance sheet increase by $100 in the capital account.

This is an example of a swap, and each bank is dealing with the central bank in their domestic country for final settlement. No Swiss francs or US dollars actually leave the country.

About 85 % of all global transactions are settled in US dollars through the Federal Reserve System in the US. Therefore, the Federal Reserve is not only a central bank for the US, it is also a central bank for the whole world. Citi Bank is able to charge foreign exchange fees to settle an international transaction even if they do incur any fees themselves because they have bank accounts in foreign currencies all around the world. However, the fees that Citi incur are somewhat justified from the fact that Citi has to keep liquidity tied up in foreign currencies available for settling transactions, which has an opportunity cost. This is the market that Ripple Labs Inc. argues that XRP can disrupt. However, XRP would need stable purchasing power, and Ripple would need to be a lender of last resort. In order for XRP to really gain adoption as a bridge currency, that would mean that we also need to trust XRP and Ripple Labs Inc. more than we trust the US dollar and the Federal Reserve.

[1] See “Why XRP’s Price Didn’t Explode After Coinbase Listing,” Charles Bovaird, Forbes, March 1, 2019.

[2] See “Ripple’s XRP: Why Its Chances of Success Are Low” [Podcast], Laura Shin, Unchained, May 8, 2018.

[3] See Cracking Mt. Gox: Investigating one of the biggest digital heists in digital history – from the outside, Kim Nilsson, WizSec, 2018.

[4] Ibid.

[5] See “Analysis of the XRP Ledger Consensus Protocol,” Brad Chase and Ethan MacBrough, Ripple Research, February 21, 2018.

[6] See “What is Ripple?,” Binance Academy, December 24, 2018.

[7] See “The Ripple Story,” BitMEX Research, BitMEX, February 6, 2018.

[8] See “Technical FAQ,” XRP Ledger Developer Portal, 2018.

[9] See “Ripple (XRP) Analysis,” Joe Kendzicky, Medium, May 4, 2018.

[10] See “Analysis of theXRP Ledger Consensus Protocol,” Brad Chase and Ethan MacBrough, Ripple Research, February 21, 2018.

[11] See “What is Ripple?,” Binance Academy, December 24, 2018.

[12] See “What is Ripple?,” Shawn Gordon, Bitcoin Magazine, n. d.

[13] See “Transaction Cost, “XRP Ledger Developer Portal, 2018.

[14]See “Reserves,” XRP Ledger Developer Portal, 2018.

[15] See “Ripple’s XRP: Why Its Chances of Success Are Low” [Podcast], Laura Shin, Unchained, May 8, 2018.

[16] Ibid.

[17] Ibid.

[18] Ibid.

[19] ibid.

[20] See “The Cost-Cutting Case for Banks,” Ripple, February 2016.

[21] Ibid.

[22] Ibid.

[23] See “Bitcoin $11,000 Next? Stock Market Crash, Whale Dump Recovery, BITMEX Manipulation” [YouTube video, minute 21:30], Ivan on Tech, May 19, 2019.

[24] See “Ripple’s Chris Larsen: Meet the Richest Person in Cryptocurrency,” Laura Shin, Forbes, February 7, 2018.

[25] See “Former CFTC Head Says Big Cryptocurrencies Could Be Classified as Securities,” Camila Russo, Bloomberg, April 23, 2018.

[26] See “Ripple’s XRP: Why Its Chances of Success Are Low” [Podcast], Laura Shin, Unchained, May 8, 2018.

[27] See “Market Performance,” Ripple, 2018.

[28] See “Market Performance,” Ripple, 2018.

[29] See “Who is the ripple founder?,” Joshua Warner, IG, January 22, 2018.

[30] The Creature of Jekyll Island, G. Edward Griffin

[31] See “Blockchain In Banking: 14 Possible Use Cases,” Sam Mire, Disruptor Daily, October 17, 2018.

[32] See “Switzerland GDP,” Trading Economics, 2019.

[33] See “The Cost-Cutting Case for Banks,” Ripple, February 2016.

[34] For the best explanation of a domestic transaction see “Flow of Money – Payment System” [YouTube video], Wayne Vernon, October 1, 2015.

[35] For the best explanation of a foreign exchange transaction see “Flow of Money – Foreign Exchange” [YouTube video, Wayne Vernon, September 17, 2016.

Libra: The End of the State Money Monopoly?

Mark Valek

August 15, 2019

Libra The End of the State Money Monopoly

“Money is an honest ledger that individuals use to keep track of real wealth, defined as productive assets. Sorry Facebook but real wealth doesn’t include ‘bank deposits and short-term government securities. That said, thank you Facebook for widening the conversation about what money really is. That is a true service to society. Libra is the first denationalized ‘money’ that billions of people in the world will encounter.”

Caitlin Long

Key Takeaways

Libra is challenging the US dollar. If every Western depositor were to move a tenth of their bank savings into Libra,its reserve fund would be worth over USD 2 trillion, making it a big force in financial markets.
Libra is viewed critically by many economists, politicians, and public intellectuals. Their concerns revolve around privacy, trading, national security, and monetary policy. The Libra Association based in Switzerland will be responsible for managing the financial reserves that back the currency, and this will always be a single point of failure that makes it more centralized than Bitcoin.
Although many state officials have a negative perspective on Libra, Facebook’s digital currency could turn out to be a boon for government, since Libra could funnel third-world savings into first-world debt. That is why Libra is a wolf in sheep’s clothing.

Will we witness the end of state money monopoly during our lifetime? Andreas Antonopoulos recently gave a speech in Scotland about how the next decade will witness competition between three types of money: state money, corporate money, and decentralized cryptocurrencies.

Over the past decades, the state money monopoly has rarely been called into question. In the 1970s, Nobel laureate Friedrich August von Hayek articulated the idea of competing, non-state currencies in his book The Denationalization of Money. For a long time, Hayek’s ideas were regarded as theoretical thought experiments far removed from economic and political reality and, therefore, received no broad public attention. Five decades later, however, with the advent of the Internet and the development of Bitcoin, we are returning to the debate. The phenomenon of cryptocurrencies has led the broader public to focus on the issue of money, what is money and how to create the optimal money?

What Do We Know About Libra ?

Facebook announced that they will be launching a cryptocurrency named Libra. In collaboration with 28 large companies including PayPal, eBay, Visa, Mastercard, and Uber, Facebook has raised USD 280 million and hopes to raise USD 1 billion in total before the launch of the coin in 2020. What is called the Libra Association is projected to reach one hundred different members, which are supposed to be geographically dispersed through the globe. None of the members shall have more than one percent of the votes within the system – not even Facebook. The conglomerate of companies will base their operations in Geneva instead of the USA because of Switzerland’s friendliness towards the blockchain technology. Facebook has plans to integrate a wallet called Calibra on the Facebook messenger applications and on WhatsApp, which combined has over 1.7 billion users around the world. At the same time, Calibra is set up as a regulated subsidiary to ensure there will be a separation of social and financial data. This way, Calibra is aiming not to share customers’ account information or data with Facebook unless the subsidiary is to prevent fraud or comply with certain regulations.

Figure 1: The Founding Members of Libra.

On the more technical side, Libra is structured as an open-source project, allowing all sorts of developers to read, build, and provide feedback.^{^[1]} As marketed, this open-source protocol will go by the name of Libra Core, while the Libra network is supposed to be powered by what is called the Libra Blockchain. The latter will be using Merkle trees and a Byzantine Fault Tolerant (BFT) consensus protocol, both of which are technologies associated with the blockchain technology. Nevertheless, Libra will neither be using blocks nor a chain, but rather a single data structure that records the history of transactions and states over time.^{^[2]}

The Libra network is referred to as a permissioned blockchain. Unlike Bitcoin, the Libra network is not open for anyone to run a node. As for now, members must be given permission to connect their servers in order to record and validate transactions on the network. Only in the future, the Libra network is supposed to be transitioning to a public blockchain, according to Facebook. This obviously is a bold statement to make. If Libra will be able to pull this off and become a permissionless system, it’d be really one of a kind. If history tells us anything though, chances of the Libra project becoming decentralized are rather weak. In this context, Nic Carter, partner at Castle Island Ventures and cofounder at Coinmetrics, with great irony pointed to a famous quote by Friedrich Engels talking about state become obsolete at one point in time:

“The interference of the state power in social relations becomes superfluous in one sphere after another, and then ceases of itself. The government of persons is replaced by the administration of things and the direction of the processes of production. The state is not ‘abolished’, it withers away.”^{^[3]}

As we know today, things have turned out quite the opposite from what Engels imagined. And even if Libra should succeed in becoming more decentralized over time, there remain central points. After all, as long as Libra will be tied to a basket of reserves, there’s always the need for a third party to manage the reserves, which would mean the project would at least have one point of centralized control.

How Libra Could Change the World

The most interesting aspect of this new medium of exchange and its basket of reserves is that the value will not be pegged to the US dollar, which means that it will have a floating exchange rate with the dollar. The currency’s value will be backed by a basket of assets including currencies and bonds from all over the world. Facebook’s stock responded kindly towards this news with a 4 % increase on the day of the announcement as shown in the figure below. Regulators in the US and Russia have already expressed their concerns regarding the currency and rightly so. As longtime Bitcoin enthusiast and CEO of Shapeshift Erik Voorhees has expressed, the fact that Libra is not backed by the US dollar alone, will have profound implications. As Erik envisions, Libra could arguably become a medium-term replacement to any single government fiat currency because it is a conglomeration of many different fiat currencies, which makes it into a more diversified asset.^{^[4]} In our age of currency wars, this could be a very desirable feature going forward.

Figure 2: Price Hike of Facebook’s Stock in Response to Libra.

**Source: Yahoo Finance, Incrementum AG.**

Since the media depicted Libra as a fierce competitor to banks – it is interesting that no single bank has been announced as one of the 28 founding members. Since this is also a competitor to the US dollar, it was no surprise that politicians reacted in a negative tone towards Libra.

For the banks, the Libra project could indeed become a nightmare. In terms of reaching customers, Facebook is way beyond what even the biggest banks like JP Morgan, Citibank, or Goldman Sachs, could ever reach. If every Western depositor were to move a tenth of their bank savings into Libra, its reserve fund would be worth over USD 2 trillion, making it a big force in bond markets.^{^[5]} This would certainly affect banks badly, since they would see their deposits shrink, which could then trigger a panic over their solvency. In our world of today, banks have become too big to fail. A competitor like Libra that could seal their fate and be the nail in their coffin, doesn’t come over unnoticed. In a quest to critically assess the newly planned digital currency, economists, politicians as well as other technocrats have turned their attention to Libra.

Above all is the US government, which is taking Libra quite seriously. In a letter from the US House of Representatives to Mark Zuckerberg, Sheryl Sandberg and David Marcus, the representatives openly express their concern about Libra being a direct rival to US monetary policy and the US dollar.^{^[6]} Consequently, Zuckerberg and his associates were requested to agree to a moratorium on any movement forward on Libra, so issues regarding privacy, trading, national security, and monetary policy issues could be discussed.

First paragraph of the US Committee on Financial Services’ letter to Facebook.
Source: Crowd Fund Insider, see reference no. 6.

As always, this is only one side of the coin. In fact, there are also many reasons why the US government should support Facebook’s Libra. The main one being the ability for regulators to access information regarding financial transactions if necessary. As such Libra has already been described as Facebook’s GlobalCoin, since it could enable a global techno-panopticon that could be used by governments around the world to monitor people’s financial affairs.

What sounds bad from a Libra user’s perspective, could, be bullish for Bitcoin in the long run. This could bring the world one step further towards Bitcoin and co., with the next decade witnessing a fierce competition between centralized currencies like Facebook’s Libra, Apple Pay, Google Pay, and decentralized currencies like Bitcoin. Interestingly enough, the genie of private money is out of the bottle. Politicians and other functionaries will have to come to acknowledge that the future will be a future of competing monies – there is nothing anybody can do to stop it.

Two Scenarios for Regulators

Bitcoin is not even used by 1 % of the world’s population, but Bitcoin is ruffling the feathers of the top 1 %. Even the highest political bodies will have to get used to being increasingly confronted with this issue.

Scenario One: Governments are Really Against Libra

Various high-profile US officials have raised concerns about Libra. In June, the chairman of the US Federal Reserve, Jerome Powell, spoke at a hearing before the US Senate in which he was asked several times about privately issued currencies such as Facebook’s Libra, but also about decentralized cryptocurrencies, such as Bitcoin. Powell stated, “Libra raises serious concerns regarding privacy, money laundering, consumer protection, financial stability.” Because of a whole lot of open regulatory questions, the project “cannot go forward” without having clarification on matters concerning regulations and the law in general. This is also why the US central bank had already met with Facebook representatives before the announcement of Libra and set up a working group to work tête-à-tête with the tech giant.

Taking the same line was Treasury Secretary Steven Mnuchin, signaling concerns that Libra could be a criminal’s tool for money launderers and terrorist financiers. Counterarguments pointing out the fact that the US dollar is by far the most laundered currency in the world were played down by Mnuchin referring to the fact that the US anti-monetary standards are among the strictest in the world. The treasury secretary’s message was clear: Regulators will do everything to protect the stability and integrity of the overall financial system from abuse through private monies. As he stated, they will make sure that Bitcoin doesn’t become the equivalent to Swiss numbered bank accounts.^[7]

From a more skeptical perspective, it could be said that concerns about money laundering and terrorist financing are just a pretense. What politicians and other state officials are really worried about is losing their monopoly power over money, which enables them to buy votes from voters by promising “free” stuff and then quickly turning on the printing presses. But to camouflage their plea for money they don’t have, officials disguise their criticism as a lack of trust vis-à-vis Facebook and their endeavor to launch a private currency.

However, the regulators seem to have come to grips with what the new development of corporate money and cryptocurrencies really means. There’s a high chance that the regulatory screws will be tightened going forward, which will affect cryptocurrencies like Bitcoin as well.

Scenario Two: The US Government Figures Out That This is Good

Rahim Taghizadegan of Scholarium in Vienna cleverly pointed out that western governments should actually be in support of Libra. Since Libra will hold a significant amount of western government debt and their currencies, this can actually facilitate an enormous redistribution of wealth from the Asia, the Middle East, and South America to the western world. Since each Libra will be fully backed, this means that Libra can tap into global household savings and use those savings to buy US and European government debt and fiat currency. Along the same lines, Pascal Hügli, a journalist from Switzerland and frequent contributor to this report, has described Libra as a sort of tool allowing the first world to extend its expansionary monetary policy to the third world. In his view, Libra is one more attempt at keeping our fading era of paper money from coming to an end – an end that is inevitable and is slowly but surely ushered in by the new digital age accompanied and fostered by Bitcoin and things coming from it!^{^[8]}

So contrary to current political opinions, Libra could actually turn out to be a life buoy for the dollar by propping it up for another decade while Facebook quietly siphons of savings from households in South America, Africa, and Asia and into the coffers of the US government via bond purchases. Since third world savings would be funneled into first world debt via government securities, the governments’ respective currencies, especially the dollar, would appreciate, or at least not depreciate as quickly as would absent Libra. Although it is true that the Libra Association isn’t bound to back Libra with US treasuries, there is a realistic chance that Libra and US government will go hand in hand to negotiate a win-win deal for both of them.

[1] S“Libra will be open-source under an Apache 2.0 license, allowing developers to read, build, provide feedback, and take part in a bug bounty program. Testnet is launching soon. Mainnet will be launched in 2020.” [Tweet], Larry Cermak, Twitter, June 18, 2019.

[2] See “Your Guide to Libra,” VerumCapital, 2019.

[3] Quote tweet], Nic Carter, Twitter, June 18, 2019.

[4] See “Thoughts on Libra (and my first tweetstorm!): first, zoom out for a second and realize how far this industry has come. The biggest companies in the world are now launching cryptocurrencies. BOOM.” [Tweet], Erik Voorhees, Twitter, June 18, 2019.

[5] See “Weighing Libra in the balance. Facebook wants to create a global currency,” The Economist, June 22, 2019.

[6] See letter of the House of Representatives to Mark Zuckerberg, Sheryl Sandberg and David Marcus, July 2, 2019.

[7] See “Are you saying cash has never been used for illicit purposes, @joesquawk asks in response to Mnuchin’s concerns about #btc ‘We are going to make sure that bitcoin doesn’t become the equivalent to swiss numbered bank accounts’ says @stevenmnuchin1” [Twitter Video], Squawk Box, Twitter, July 18, 2019.

[8] See “You Don’t Want to Help Bank the Unbanked!,” Pascal Hügli, Medium, June 26, 2019.

In Case You Were Sleeping: Facebook Edition

Nikolaus Jilch

August 9, 2019

In Case You Were Sleeping Facebook Edition

“In an age of unlimited fiat currency printing, all value flows to scarce assets – and Bitcoin is the scarcest liquid asset in history.”

Robert Breedlove

Key Takeaways

Bitcoin’s price crossed USD 13,000 on July 10^th, and trading volume is up 20% compared to the monthly average year-to-date. All signs indicate that we are firmly back in bullish territory.
Trump finally put in his two cents about Bitcoin on Twitter. He is not a fan of it. After all, Bitcoin and Libra challenge the US dollar’s status as a global reserve currency. Interestingly, the chairman of the Federal Reserve System took a slightly more neutral view and described Bitcoin as being used as a “speculative store of value” similar to gold.
The NYSE’s sister-company Bakkt finally launched the beta of their Bitcoin-settled futures. This is expected to put further buying pressure on the Bitcoin market. Public launch is expected later.

Is Crypto Spring finally here? Bitcoin prices have experienced a remarkable recovery since April. Many new projects are springing up, existing ones are bearing new fruit. And then there’s Mark Zuckerberg and his plan for a Facebook coin.

The NYT Indicator

Sometimes it’s uncanny how closely markets and the media are connected. We’ve seen this time and again in asset classes like gold. When the shiny metal lands on the cover of the local tabloid, it’s time to sell. There’s something even better in the crypto sector. Perhaps the best-known newspaper in the world provides the most reliable indicator for Bitcoin prices: The New York Times.

On January 13^th, 2018, the Times marked the final end of the last bull market with the wonderful headline: “Everyone Is Getting Hilariously Rich and You’re Not.” The first picture shows two crypto fans in Bitcoin and Ethereum pullovers. The price of Bitcoin was still USD 14,600. In the three weeks following the article, the price plummeted by almost 60 % and briefly even dropped below USD 6,000.[1]

A little over a year later, the New York Times strikes again. This time it goes in the other direction. The newspaper reported, “Smart Money knows that crypto is not yet ready,” on April 2^nd, 2019.[2] The pessimistic article came just one day after the Bitcoin price jumped more than 20 % in a matter of hours. One may forgive the editors of the Times for not simply withdrawing the article that had been researched over the long term. On April 2^nd, there was also general confusion as to what had actually happened in the markets the day before.

After all, the sudden jump from around USD 4,000 to more than 5,000 came at a time when most analysts were predicting a continuation of the bear market and new lows. The mainstream media, which had already mostly forgotten about Bitcoin, even attributed the price jump to an April fool’s joke. In fact, on April 1^st there was a rumor making the rounds on social media that the US Securities and Exchange Commission had approved two Bitcoin ETFs – in an alleged “emergency session” nonetheless.[3]

But this obvious fake was by no means the reason for the sudden rise in the Bitcoin price. In fact, it was probably a single mysterious buyer who had invested the sum of USD 100 million in the cryptocurrency on several exchanges within a few hours. Specifically, the exchanges Coinbase, Kraken and Bitstamp were used, as Reuters reported. Whether an individual investor or an institution stood behind the order, we still do not know. But we do know the consequences.[4]

A Strong Sign of Life

After more than a year in a depressing crypto winter, especially Bitcoin but also some altcoins have awoken. In the months that followed, prices went steeply uphill. Even the USD 6,000 mark, where the price remained on its way down for a long time, did not prove to be major resistance. As we write these words, the price hovers just above USD 10,000. The chart technicians are now arguing whether we are already in a new bull market or just seeing a sharp bear market rally. With the price having reached the price of over USD 13,000 on July 10th, things seem to become ever more obvious that cryptoassets are back on bullish territory. But should we really be in a bull trap, new lows would be possible despite the returning euphoria. Some, like Tyler Jenks of Lucid Investments, still think it’s likely that the Bitcoin price could fall to USD 1,000.

His colleague Leah Wald brought the example of historical sugar prices into play to support this theory.[5] In the mid-1970s they had risen dramatically. Then the bubble burst, just like Bitcoin’s. A few years later there was a sudden rise, all indicators were bullish, and the price almost reached its all-time-high, just to collapse a second time and mark a new low.

Will Bitcoin be similar? Or do we actually already see the return of the bull market for the crypto space? The fact that the whales, the really big players on the Bitcoin market, bought almost half a million Bitcoin in the nine months before the price increase, is a hint but no proof yet. From their point of view, they obviously took advantage of favorable prices, but they can sell again just as well if the rally loses momentum.

In the long run, we are still in the accumulation phase, say Tuur Demeester and Michiel Lescrauwaet of Adamant Capital. In a paper they took a very close look at the market and found some reasons for cautious optimism.

“We believe Bitcoin is in the last stage of this bear market: the accumulation phase. The current sentiment has recovered from capitulation and the blockchain shows us that Bitcoin HODLers are committing for the long term again. This is confirmed by our drawdown and volatility analyses.”

“While lower prices are still possible, Bitcoin’s fundamentals are gaining momentum. Embraced by Millennials, its ecosystem is developing at rapid clip, both as a decentralized bottom-up disruptive technology, and as an uncorrelated, highly liquid financial asset for institutional portfolios around the world.”[6]

As always with these things, we’ll only be smarter after the fact. Demeester and Lescrauwaet published their analysis in mid-April, assuming a medium-term trading range of USD 3,000 to 6,500. Values that we have already left behind since then. The two experts expect Bitcoin to experience its “Windows moment” in the next five years, i. e. to establish itself globally as a financial asset and as a payment network. The enthusiasm of millennials for new technologies and the growing skepticism towards traditional banks are the decisive drivers.

The Facebook Moment

But they’re not alone. A certain Mark Zuckerberg also wants to enter the crypto business. Maybe we won’t experience a “Windows moment” this time but a “Facebook moment”? Hardly any other large company seems to have such ambitious crypto plans as Facebook does. When details became known at the beginning of May, the Bitcoin price rallied immediately. The market seems to regard the push as positive.[7]

So, what’s it about? For one year now, Facebook has been working on the Internet giant’s entry into the area of payments and money. Zuckerberg wants to enter payments, e-commerce, and even banking. In India, pilot projects are already underway in which WhatsApp users can use the app for payment transactions. That makes sense. Particularly in emerging markets, the introduction of new money technologies is often easier than in developed industrial countries. You can also bring customers into the financial system who don’t even have a bank account yet. But that’s just the first step.[8]

According to media reports, Zuckerberg wants to build a whole digital economy around his social media services. Libra is supposed to act as a bridge and payment channel. Billions of users will be able to buy directly from influencers via Instagram, and dealers will be able to advertise products directly on WhatsApp.

In mid-June, the Wall Street Journal reported that Facebook had meanwhile brought 27 renowned partners on board for the project. Visa, Mastercard, PayPal and Uber among others will each provide at least USD 10 million as members of a consortium. Ultimately, however, Zuckerberg wants to have 100 companies in the consortium and collect a billion US dollars, which will serve as a reserve for Libra. Apparently, the currency is not going to be tied to the US dollar, but to a basket of currencies and low volatility government securities. That would give the coin its own price while staying relatively stable. The payment platform Stripe, the travel website Booking.com, and the South American trading platform MercadoLibre will also cooperate with Facebook on Libra.[9]

What is clear is that Facebook will have no direct control over the coin. They want to cooperate with other consortium members on a Blockchain, whose rules are fixed. This could lead to broader acceptance and trust in the long term. It looks as if Facebook wants to use the blockchain technology to provide its users with a cheap and fast way of payment that they can trust. As Zuckerberg said, “Sending money must be as easy as sending a photo.”[10]

A stablecoin makes sense, of course, because the wild volatility of cryptocurrencies like Bitcoin is a deterrent for the average person. The fact that Libra is tied to a basket of currencies and not to the US dollar also reflects the global orientation of Facebook, which is growing fastest outside the western industrialized countries.

Whether this push is positive for Bitcoin, as some analysts and investors expect, remains to be seen. Many Bitcoin fans have pointed out that if you look at Facebook’s plans, you can’t speak of a cryptocurrency at all. Others argue that the global acceptance of new currency forms should be strengthened by the project in any case. Be that as it may, the Zuckerberg project meets the demands of many young people for new, affordable alternatives to the traditional monetary and financial system. In a later chapter in this report, we will analyze the Libra project a little more in detail.

Adoption, Adoption, Adoption

Back to the “Windows moment.” The old lady Microsoft always has been very open to real cryptocurrencies like Bitcoin. Already in 2014, it was possible to use the digital coin in the X-Box-shop.[11] The option was abolished around the bubble at the end of 2017, because Bitcoin as a payment system suffered under the burden of its own popularity. It was simply too slow and the price too volatile. But Microsoft has not lost sight of the issue.

In mid-May, the company presented a project designed to give users control over their own login data and thus their identity on the Internet. A closed blockchain or a solution based on Ethereum is not used. No, Microsoft relies on the oldest and most secure blockchain of all: Bitcoin.[12]

And another household name from the US now accepts payments via Bitcoin: the telecom giant AT&T. However, AT&T was not the only telecommunications company to announce that they will be working Bitcoin. The Taiwanese electronics company HTC announced that the next model of their Exodus 1s phone will contain an entire Bitcoin full node.

This does not mean, however, that Ethereum is being left behind. The opposite is true. The second largest cryptocurrency has always been popular with companies due to its flexibility. But, so far, hardly any application based on Ethereum has achieved broad use – unless you count the ICO boom, which would never have been possible without Ethereum.

On the Forbes list of the 50 largest companies that do something with blockchain, more than half work with Ethereum. These include names such as Anheuser-Busch, British Petroleum, Comcast, Amazon, Foxconn, Google, HTC, Intel, Samsung – and a long list of banks, from Citigroup to BNP Paribas.

The consulting giant EY unveiled its “Nightfall” project in mid-April. This software is designed to help EY’s corporate customers use the Ethereum blockchain. 200 developers have been working on the product for over a year. EY thinks of areas of application such as supply chains and transactions.

EY doesn’t want to make any money directly with “Nightfall” either. The platform is provided free of charge, a license is not necessary. EY’s blockchain chief Paul Brody explains:

“We want to maximize adoption and community involvement, we want people to adopt it, and adapt it, and improve it. If we retain ownership, people may not invest that much time and energy in something they might not control. The cleanest way to make everybody use it is just to give it away with no strings attached. A year of coding work. This is a million dollar’s worth of stuff we’re giving away.”[13]

“Nightfall” will run on Microsoft’s Azure Cloud and integrate with SAP’s enterprise software. EY is particularly keen on getting as many industries as possible to use open blockchains in order to take full advantage of the technology. A series of private blockchains of individual companies would only create silos and stand in the way of growth. Also, the treatment of tokens has been considered a lot, says Brody:

“We have made a big investment in the token technology. We built a special kind of token, which is ERC 721-compatible, to separate a physical asset from the legal ownership of that asset.”[14]

S&P 500 on the Blockchain

Another extremely exciting project based on Ethereum aims to link the old and the new financial markets. The platform UMA (Universal Market Access) has created USStocks, an ERC20 token that reflects the American stock market. More precisely, it reflects the 500 largest companies by market capitalization. In other words: “USStocks” is an index fund tracking the S&P500 equity index. Until a few weeks ago, it was tradable on the decentralized DDEX platform ‒ with the stablecoin DAI. In the meantime, however, the experiment was terminated.[15] They just wanted to show what was possible and draw conclusions from it, according to UMA in a blog post. The smart contract had been well received. But early crypto entrants are often uninterested in “traditional” markets for ethnical or financial reasons. The UMA experiment was somewhat short at eight weeks.[16]

A central problem, however, is that people who do not have access to the US stock market today usually do not have access to the crypto markets either. So, it will probably take some time before the cost advantages of the blockchain world can be transferred to the “normal” financial market. However, we will monitor developments very closely here, because it is precisely these cost advantages that could ultimately give many people access to financial markets that have hitherto been excluded.

We also expect the traditional market to move faster and faster towards Bitcoin and cryptoassets. Fidelity Investments aims to provide access to its institutional clients as soon as possible. The demand is certainly there. According to a survey by Fidelity, 22 % of institutional investors already hold cryptocurrencies. And almost half (47 %) believe that digital assets have a place in their portfolio. Among the investors surveyed were foundations, pension funds, and family offices, according to Fidelity.[17]

The long-awaited Bitcoin futures from the crypto project of the ICE exchange, which is also behind the New York Stock Exchange, are also due to start soon. On July 22^nd, the test operation starts. In a statement, Adam White, the COO of Bakkt:

“This is no small step. This launch will usher in a new standard for accessing crypto markets. Compared to other markets, institutional participation in crypto remains constrained due to limitations like market infrastructure and regulatory certainty. This results in lower trading volumes, liquidity, and price transparency than more established markets like ICE’s Brent Crude futures contract, which has earned global trust in setting the world’s price of crude oil.”[18]

Bakkt also wants to become an important custodian for digital assets, and they took out an insurance policy of USD 100 million to calm investors’ fears of losing their assets, for example, through hacks. These are certainly ambitious plans. If the start of the Bakkt futures goes well, we believe that Bitcoin will be able to further establish itself as an asset class ‒ and will rise in standing for traditional investors.

Closer to home, the parent company of one of our premium partners of the Crypto Research Report, GenTwo in Switzerland, launched an actively managed investment certificate (AMC) platform with CAT Financial Products. The platform allows Swiss asset managers to launch regulated certificates that can invest in all financial asset classes including cryptocurrencies. Information about the platform can be accessed on GenTwo’s Blog, where Demelza Hays also regularly contributes articles. Her latest article, “The Pursuit of Optimal Money,” explains why neither Bitcoin nor gold make good monies. Instead of being digital cash as the original whitepaper wrote, she argues Bitcoin is digital gold. To subscribe to GenTwo’s blog in order to receive exclusive new articles by Demelza and other authors, signup at g2fp.com/blog.

The Central Banks are Haphazard

All the positive news about price and adoption should not obscure the fact that there are also shadows where there is light. The controversies around Bitfinex and Tether do not come to an end. The New York State Attorney General accuses iFinex, the parent company of Bitfinex and Tether, of misusing USD 850 million from the reserve of the stablecoin Tether, which is tied to the US dollar. iFinex denies all allegations as unfounded.[19]^,[20]

Binance, the world’s largest crypto exchange, also has problems with the authorities in the US and, therefore, now wants to set up a regulated, US-centric exchange.[21] In addition, there was a hack, and the perpetrators were able to steal USD 40 million worth of crypto.[22] But neither the controversy surrounding iFinex nor the problems at Binance have had any effect on the price rally since April.

This also applies to the many attempts to damage Bitcoin and the crypto space from the outside. Veterans like economist Joseph Stiglitz continue to argue that states and central banks will one day intervene to avoid jeopardizing their currency monopoly. Stiglitz is particularly aggressive. “I think we should ban crypto currencies,” he said in early May. And then:

“I’ve been a great advocate of moving to an electronic payments mechanism. There are a lot of efficiencies. I think we can actually have a better regulated economy if we had all the data in real time, knowing what people are spending.”[23]

So, it is not the technology that bothers him but the fact that it is not controlled by the state. This is, of course, the core of the idea behind Bitcoin: a currency and monetary policy that cannot be influenced by individual states or central banks.

Many Bitcoin supporters also argue that it is not possible to simply ban Bitcoin. Such attempts have always failed in the past. But some are still trying. China wants to ban mining again.[24] And in India, even a prison sentence of up to ten (!) years is being considered for the owners of cryptocurrencies.[25] This, of course, is in stark contrast to the plans of Silicon Valley and Wall Street, which still have a lot to do with Bitcoin and Blockchain.

Another attack against Bitcoin was leveled by the US president himself, Donald Trump. On Twitter he openly declared:

“I am not a fan of Bitcoin and other Cryptocurrencies, which are not money, and whose value is highly volatile and based on thin air. Unregulated Crypto Assets can facilitate unlawful behavior, including drug trade and other illegal activity…[26]

Alongside his knock against decentralized cryptoassets, he also commented on Facebook’s “virtual currency” Libra. In his statement, he made it crystal clear that if Facebook wanted to become a bank, they would have to seek a new banking charter and become subject to all banking regulations – no different from all the other banks. At the end of his little Twitter thread, he then portrayed the US dollar as the only real currency, which would be dependable and reliable, making it stronger than ever before. So, with all of his very provocative Twitter comments, he really managed to trigger the Bitcoin Twitter community, while he might have also caused some really cognitive dissonance within liberal and green left-wingers: Should they now be of the same opinion as their arch-enemy or rather side with a new digital currency that is oftentimes pictured as one great pollutive counter force in the struggle for a better climate?

Interestingly, Bitcoin’s price did not suffer a significant decline after arguably the most influential person in today’s world issued a public statement slamming Bitcoin. Many Bitcoin enthusiasts take this as a sign of Bitcoin’s resilience and antifragility.

As far as the introduction of digital currencies by central banks is concerned, we are not getting anywhere fast. Central banks are notoriously slow. And their experts still seem to be uncertain whether the technology makes sense at all. The well-known Bitcoin opponent and head of the Bank of International Settlements, Agustin Carstens, recently warned against the introduction of digital central bank currencies. If citizens can store their money via blockchains operated by a central bank, they could withdraw money from the traditional banking system, which would be dangerous.[27]

But the European Central Bank (ECB) expresses it best. According to a recent paper, a digital euro could either help or harm the economy. The consequences could simply not be assessed. In addition, much would depend on the design of the currencies. The ECB writes:

“Depending on its specific features, central bank digital currency could either allow monetary policy to reach a wider range of economic actors more directly or weaken the tools available to the issuing central bank for the conduct of its monetary policy.”[28]

The negative opinion of states and central banks can be observed in Russia. The head of the central bank, Elvira Nabiullina, said at the end of May:

“We are generally opposed to cryptocurrencies being launched into our monetary system. We do not see the possibility that cryptocurrencies could act as monetary surrogates.”[29]

Ironically, Nabiullina said in the same conversation that Russia would at least consider using a gold-covered cryptocurrency of another state. But so far, only a handful of central banks are seriously considering whether to introduce digital currencies. We assume that this process will continue for many years to come.

Long Live the King!

With all this negative publicity the world was taken by surprise, when the Federal Reserve Chairman Jerome Powell compared Bitcoin to gold. Testifying before the Senate Banking Committee Powell stated that Bitcoin is used more as an alternative to gold, sort of like a speculative store of value.

Another watershed moment, indicating that officials and politicians are not all hostile to and clueless about Bitcoin, was when Congressman Patrick McHenry made another remarkable statement during one of the hearings:

“The world that Satoshi Nakamoto, author of the bitcoin white paper, envisioned is an unstoppable force. We should not attempt to deter this innovation … those who have tried have already failed.”[30]

But that was not the only praise Bitcoin got from representatives of Congress. It was Warren Davidson, who made the rather trenchant statement that “There’s Bitcoin and the there’s shitcoin[31]“. While even among crypto-friendly bankers, out of decency, the term “shitcoin” is oftentimes avoided to actually describe just that, it’s all the more astounding that in Congress, where such a wording would be least expected, representative call a spade a spade!

While there is still a lot of negativity, there are also some very enlightening and favorable assertions coming from public intellectuals, which might go to show that at the margin people are waking up to crypto and understand what Bitcoin all is about in the first place. Projects such as the Facebook join Libra, the Bakkt futures, the Fidelity platform for institutional investors and experiments such as the Ethereum-based equity fund will have far more significance for the sector in the short and medium term than the statements and experiments of the central banks. That’s also the opinion of long-term bull Mike Novogratz. “I feel better than ever about Bitcoin,” he recently told Bloomberg. The co-founder and CEO of Galaxy Investment Partners has admitted to having been overly optimistic in the past. But nevertheless: Bitcoin has proven itself in the meantime and functions as a value store, like gold, he said. According to Novogratz, other cryptocurrencies must find their niche and sustainably occupy it. Or to put it another way: The king is dead, long live the king!

[1] See “Everyone is Getting Hilariously Rich, And You’re Not!,” Nellie Bowles, The New York Times, January 13, 2018.

[2] See “Amid Bitcoin Uncertainty, ‘the Smart Money Knows That Crypto Isn’t Ready,’” Nathanial Popper, The New York Times, April 2, 2019.

[3] See “Bitcoin mysteriously rocketed above $5,000 – and one theory pins the rally on an April fool’s gag,” Trista Kelley, Business Insider, April 2, 2019.

[4] See “Bitcoin jumps 20 percent, mystery order seen as catalyst,” Tom Wilson and Tommy Wilkes, Reuters, April 2, 2019.

[5] “Is it still possible for BTC to hit the phase 1 line? Even though indicators are now bullish, there is historical precedence. Yes, one example is sugar.” [Tweet ], Leah Wald, Twitter, May 21, 2019.

[6]See “Bitcoin in Heavy Accumulation,” Adamant Capital, April 18, 2019.

[7] See “Facebook is reportedly looking for allies to support its planned cryptocurrency payment service,” Salvador Rodriguez, CNBC, May 2, 2019.

[8] See “Facebook in Talks to Build Ecosystem for Planned Stablecoin: WSJ,” Yogita Khatri, CoinDesk, May 3, 2019.

[9]See “Facebook’s New Cryptocurrency, Libra, Gets Big Backers,” Anna Maria Andriotis, Peter Rudegeair and Liz Hoffman, The Wall Street Journal, June 13, 2019.

[10]See “WhatsApp at Facebook F8: ‘Sending Money Should Be As Easy As Sending Photos’ – Mark Zuckerberg,” Trisha Jalan, Medianama, May 2, 2019.

[11] See “You Can Now Buy Xbox Games With Bitcoin,” Dan Kedmey, Time, December 11, 2014.

[12] See “Microsoft Wants To Protect Your Identity With Bitcoin,” Gregory Barber, Wired, May 14, 2019.

[13] See “Auditor EY Unveils Nightfall, An Ambitious Bid to Bring Business to Ethereum,” Anna Baydakova, CoinDesk, April 16, 2019.

[14] Ibid.

[15] See “Announcing US Stock Index Token, Powered by UMA and Dai,” Hart Lambur, Medium, March 27, 2019.

[16] See “USStocks: Learnings and Next Steps,” Allison Lu, Medium, May 15, 2019.

[17] See “Fidelity is reportedly about to offer cryptocurrency trading for pros within a few weeks,” Maggie Fitzgerald, CNBC, May 6, 2019.

[18] See “Putting Bakkt’s Bitcoin Futures to the Test,” Adam White, Medium, June 13, 2019.

[19]See “Bitfinex Used Tether Reserves to Mask Missing $850 Million, Probe Says,” Paul Vigna, The Wall Street Journal, April 25, 2019.

[20] See “Bitfinex and Tether respond to NYAG in court saying that there is no ongoing fraud, and no victims,” Larry Cermak, The Block, May 6, 2019.

[21]See “Binance Says It’s Launching a US Exchange With FinCEN-Registered Partner,” Nikhilesh De, CoinDesk, June 13, 2019.

[22] See “Binance Suffers $40 Mln Hack, Crypto Community Outraged After CZ Suggested Bitcoin Rollback to recover Funds,” Alex Dovbnya, U.Today, May 8, 2019.

[23] See “Joseph Stiglitz: ‘We should shut down the cryptocurrencies,’” Andrew Davies, CNBC, May 6, 2019.

[24] See “China Plans to Ban Cryptocurrency Mining in Renewed Clampdown,” Edwin Chan, Bloomberg, April 9, 2019.

[25] See “Exclusive: India Proposes 10-Year Jail For Cryptocurrency Use, May Introduce Its Own Digital Currency,” Nikunj Ohri, Bloomberg, June 7, 2019.

[26] [Tweet], Donald Trump, Twitter, July 11, 2019.

[27] See “Bitcoin Critic Warns Against Central Banks Issuing Own Tokens,” Catherine Bosley, Bloomberg, March 22, 2019.

[28] See “Digital Euro Could Either Help or Harm Economy, ECB Paper Says,” Carolynn Look, Bloomberg, May 17, 2019.

[29] See “Bank of Russia may consider gold-backed cryptocurrency,” Russian News Agency, May 23, 2019.

[30] See “’There’s Bitcoin and Then There’s Shitcoin (Libra).’ Congress Finally Gets It,” Ben Brown, CNN, July 18, 2019.

[31] Ibid.

John Tromp: Making Computer Science Great Again

Demelza Hays

April 30, 2019

“PoW (Proof-of-Work) makes for a fairer coin distribution as everyone has to compete on equal terms. A constant reward, resulting in linear emission, extends this fair competition across all times.”

John Tromp

Key Takeaways

Cuckoo Cycle is memory-bound Proof of Work mining algorithm that tries to find a cycle within a particular type of graph, a bipartite graph.
There are a few projects that are implementing Tromp’s Cuckoo Cycle mining algorithm. MimbleWimble, the privacy preserving Blockchain protocol also makes use of Cuckoo Cycle. Aeternity, the unicorn Blockchain project based in Liechtenstein is using Cuckoo Cycle, and the hot privacy coins like Grin.
MimbleWimble is a privacy preserving blockchain protocol implementation and gets its name from the Harry Potter fictional book series.

John Tromp from Cuckoo Cycle

John Tromp (1) is the inventor of the Cuckoo Cycle (2) mining algorithm, and its variants (Cuckatoo Cycle and Cuckaroo Cycle). He is also a core developer of the privacy focused blockchain Grin (3), which makes use of the MimbleWimble (4) protocol, a privacy preserving blockchain protocol. MimbleWimble implements his Cuckoo Cycle (5) mining algorithm. In addition, Tromp is known for having created a mining software implementation, or solver, of the Equihash (6) mining algorithm for Zcash (7). Tromp is one of the most intelligent computer scientists in the crypto space. Tromp has a PhD from the University of Amsterdam in Theoretical Computer Science and has an exceptional knack for bringing that theory into reality with practical algorithm implementations and computer code. Not only is he one of the brightest minds, he is also one of the humblest.

What is Cuckoo Cycle?

According to Tromp, Cuckoo Cycle is memory-bound Proof of Work mining algorithm that tries to find a cycle within a particular type of graph, a bipartite graph. In the case of Cuckoo Cycle, memory-bound means that the rate of solutions a miner can achieve depends on the memory bandwidth of the miner, as opposed to the amount of memory, or the amount of processing power of a miner. A graph, in simple terms, is a set of points connected with lines. A bipartite graph is two sets of points, where there are no lines between points within that particular set, only lines connecting points across the two different sets. When the lines across sets form a cycle, or in other words a loop, that cycle is known as a bipartite graph.

Tromp compared Cuckoo Cycle to Bitcoin’s Hashcash (8) mining algorithm and described Cuckoo Cycle as more of a stronger “Proof of Work” than Bitcoin’s Hashcash, which claims to be “Proof of Work” because of the tremendous amount of work that must be computed in order to find a solution. Instead Tromp described Hashcash as more of a “proof of luck” than a Proof of Work. For a miner to solve the Cuckoo Cycle Proof of Work, the machine must find a cycle of length 42. Once a cycle is found, an additional filter of the Hashcash algorithm is applied to the result from the found cycle. According to Tromp, Cuckoo Cycle miners calculate the speed of a machine by its measured graph rate, as opposed to the hashrate measurement used for calculating the mining speed of hardware for Blockchain’s such as Bitcoin and Ethereum. Hashrate is simply, how many hashes per second a miner is able to compute. The graph rate is, how many graphs that are able to be computed per second. Tromp further described fidelity, which is the probability that a miner will find a cycle of length 42, so Cuckoo Cycle miners measure the speed of their hardware using a combination of graph rate and fidelity to determine their mining speed.

Cuckoo Cycle Variants

The original whitepaper (9) for Cuckoo Cycle was written in 2014. Since then, there have been many new developments made with Cuckoo Cycle. Tromp originally thought Cuckoo Cycle was “ASIC resistant” Proof of Work. ASIC resistant simply means that an ASIC programmed for calculating Cuckoo Cycle would not necessarily give a miner a competitive advantage against other forms of mining, for example, compared against a GPU miner. However, Tromp created has now created two different variants: one variant of Cuckoo Cycle, called Cuckaroo Cycle, is ASIC resistant, another, known as Cuckatoo (10) Cycle, is ASIC friendly. There are at least two cryptocurrency mining machine manufacturers creating ASICs for Cuckoo Cycle Blockchains, in particular, for a blockchain known as Grin. Those two companies are Obelisk (11) and InnoSilicon (12).

What Coins Use Cuckoo Cycle?

There are a few projects that are implementing Tromp’s Cuckoo Cycle mining algorithm. MimbleWimble, the privacy preserving Blockchain protocol also makes use of Cuckoo Cycle. Aeternity (13), the unicorn Blockchain project based in Liechtenstein is using Cuckoo Cycle, and the hot privacy coins MWC and Grin (14) are implementing the Cuckoo Cycle.

There is even a research proposal named cuckoo-http (15) that is experimenting with Cuckoo Cycle to limit denial-of-service attacks against web servers. (16)

MimbleWimble

MimbleWimble is a privacy preserving blockchain protocol implementation and gets its name from the Harry Potter fictional book series. According to the official MimbleWimble documentation (17), “MimbleWimble as an idea was released anonymously. It’s a blockchain with Proof of Work but almost nothing else”. The first implementation of MimbleWimble was proposed by an anonymous online persona known as Ignotus Peverell, which is also the name of a fictional character from the Harry Potter series, thus following a similar anonymous origin to Bitcoin as being created by the anonymous Satoshi Nakamoto.

Grim

This first implementation of MimbleWimble eventually became known as Grin. Tromp was particularly excited about MimbleWimble and Grin and their decision to use Cuckoo Cycle as the mining algorithm. Tromp eventually became a core developer and contributor to Grin. Tromp described the coin emission model of Grin (18) to be of particular interest to him as he felt it had many advantages over other Blockchain’s coin emission models. However, we have a slightly different view. Grim has no hard cap on the coin supply, which makes it not scarce, and therefore, no different from other infinitely inflationary fiat currencies.

John Tromp, Making Computer Science Great Again

We asked Tromp how he felt to have such an influence of spawning an entire ecosystem within the mining industry. He humbly downplayed the significance he has actually had within the blockchain community but from where we’re viewing from, he has been very influential and is well respected Computer Scientist by many in the crypto space. When we asked Tromp about his perspective of the cryptocurrency mining industry, he described mining as a very tricky business and noted that many people have regretted getting into mining rather than just outright buying coins, and that novices should take note of this information before considering getting into the mining business. He also suggested that in order to succeed, one must understand the risks with running a mining operation as well as understand the need for having access to cheap long-term power contracts. With that said, we look forward to learning about future developments with Cuckoo Cycle, it’s variants, and the many up-and-coming blockchain projects such as Grin that are making use of Cuckoo Cycle.

(1) See https://tromp.github.io/
(2) See https://github.com/tromp/cuckoo
(3) See https://grin-tech.org/
(4) See https://github.com/mimblewimble/grin
(5) See https://github.com/mimblewimble/grin/blob/master/doc/pow/pow.md
(6) See https://en.wikipedia.org/wiki/Equihash
(7) See https://z.cash/
(8) See https://en.wikipedia.org/wiki/Hashcash

(9) See http://hashcash.org/papers/cuckoo.pdf
(10) See https://www.grin-forum.org/t/cuckoo-cycle-weakness-and-possible-fix-cuckatoo-cycle/738
(11) See https://obelisk.tech/products/grn1.html
(12) See https://www.innosilicon.com/html/a9-miner/index.html
(13) See https://aeternity.com/
(14) See https://www.beam.mw/
(15) See https://css.csail.mit.edu/6.858/2019/projects/kaza.pdf
(16) See https://github.com/AnimatedRNG/cuckoo-http
(17) See https://github.com/mimblewimble/docs
(18) See https://github.com/mimblewimble/docs/wiki/Monetary-Policy

When the Tide Goes Out…

Nikolaus Jilch

April 30, 2019

“Only when the tide goes out do you discover who’s been swimming naked.”

Warren Buffett

Key Takeaways

Bitcoin’s price recovered 63% from its low of $3,125 in December. JP Morgan, Fidelity, Nasdaq, Goldman Sachs, Swissquote, Vontobel, and Twitter are preparing the drinks and food for guests in preparation of a new bull market.
Investors have historically priced in each Bitcoin halving 458 days prior to the halving. We are currently about 400 days away from the May 2020 halving.

New bull market gains even more momentum if negative interest rates are charged on personal bank accounts held by retail investors as recommended by the International Monetary Fund.

It’s still chilly in cryptoland, but with the Twitter founder and the bosses of Fidelity and Nasdaq, the circle of Bitcoin fans is getting bigger and bigger. Even JP Morgan is doing crypto now.

Back to the Roots

What’s the purpose of Bitcoin This question is often answered with far reaching visions. The word “revolution” is often used. “Blockchain” of course. But sometimes a news item surfaces that makes things much clearer. Bitcoin’s purpose is to give financial sovereignty; not for a state or a company, but for the smallest of all minorities: the individual.

In February, the International Monetary Fund once again raised the question of how negative interest rates could be implemented in the event of the next recession. You should know that conventional monetary policy has only one answer to a crisis: cheap(er) money, i.e. lower interest rates. But since the great financial crisis we have reached a limit. If the interest falls below zero, someone has to pay. Either the banks or their customers, the savers. They can tolerate negative real interest rates. It’s not so obvious. But when it comes to actually losing money from their account, they get restless. This has not yet happened for private individuals, but it has happened for companies in Europe. Their reaction: they started stashing cash in vaults.(1)(2)

In the next crisis, when the negative interest rates become even more extreme and also hit private customers, they will react similarly, according to the experts of the Monetary Fund. Their “solution” is to massively restrict the use of cash in order to make it more difficult to escape expropriation through interest rate policy. Ironically, they even want to introduce an “electronic currency”. With that in place, negative interest rates can be easily implemented according to economists. At the same time, they have in mind a two-tier society.
Anyone who wants to pay cash in the supermarket could do so – but with a penalty
surcharge. This “nudging” will herd us all into the clutches of the state electronic
monetary system that they have in mind.(3)

Luckily, nothing is eaten as hot as it is cooked. These ideas are neither economically sound nor politically feasible. But the proposal should serve as a warning to us. By now it should be clear why Bitcoin is here to stay. Why it’s needed. It’s the antidote to such crazy ideas. Bitcoin makes it possible to get out of a system that is becoming increasingly hostile towards the users.

Of course: Bitcoin is still young. The extreme volatility is a deterrent. The technical difficulties, the hacks, scams and criminal cases as well. All these are growing pains that are to be expected when building a completely new, alternative monetary system. The Crypto Research Report has been documenting these developments for almost two years now and our sister report, In Gold we Trust has been covering cryptocurrencies since 2014. We offer an alternative explanation to the mainstream media’s fixation on Bitcoin’s price.

The falling price since January 2018 has curbed Bitcoin’s attractiveness and the crypto winter is still underway. The industry is bleeding. More and more companies have to reduce their staff. We are not even talking about the big and small investors who have lost a lot of money – at least on paper. The comparison with the dotcom bubble is certainly fitting. Too many people have invested too much money in ambitious projects that have often failed to deliver on any of their promises. But where there’s shade, there’s also light. And we can see some big rays shining through. But first we have to talk about the shadow.

How Long Will This Bear Market Last

According to Coindesk, Bitcoin is officially in the longest bear market in its history.(4) However, this is very hard to estimate. Since December 2017, when the price of one Bitcoin briefly rose to $19,764, the price fell for 360 days before reaching its most recent trough at $3,125 in December of 2018. Shortly after, Bitcoin actually surpassed $4,000, realizing a gain of over 29.92%. Although, the price dropped down shortly afterwards. Defining a bear market by a percentage loss or gain in cryptocurrencies is difficult because of the strong volatility associated with the asset class. Talking about stock markets usually the beginning of a bear or bull market is defined by losses or gains of 20%, respectively. Empirically, Bitcoin has only had three downturns that lasted more than three months, and each saw a loss of over 80%. In contrast, Bitcoin has only had several bull markets with returns over 1000%, but only two of them lasted longer than five months. In the Crypto Research Report, we define a bear market as a drawdown of over 30%. We define a bull market as a gain of 30%. Therefore, we have officially begun a new Bitcoin bull market.

The crypto winter saw a maximum drawdown of 84%. In contrast, the first bear market lasted only 163 days. This was in 2011, when the price fell from $31.50 to $2.01, which equates to a loss of 93%. Between 2013 and 2015, prices fell by 86%. Although we are hopeful that the movement from $3,125 to the current price around $5,000 is the beginning of a new bull market, we will only know in hindsight whether or not the tide has come back in. However, a hint may lie in the Bitcoin’s monetary policy.

Every 210,000 blocks, the reward the miners receive per block is halved. This roughly corresponds to a four-year cycle. Observers pay very close attention to the schedule, because the so-called “halving” is regarded as an important indicator of price movement. There is only little experience so far, since there have been only two such “halvings”. But they show that the price has always risen in the months before the actual event. Specifically, the Bitcoin price found its bottom in the first bear market exactly 378 days before the first halving. And in the second bear market 539 days before the second halving.

This equals an average of 458 days, and we are currently approximately 400 days from the next halving. The next halving will probably take place towards the end of May 2020. If the pattern observed so far is confirmed, the bottom should occur somewhere between December 2018 and May of 2019. So far so good, but again: in retrospect, we’ll be smarter.(5)

A Tragic Story Traverses the World

Since the megaboom at the end of 2017, no Bitcoin story has been as present in the mainstream media as the one about the mysterious death of Gerry Cotten. The founder and CEO of Canadian crypto exchange Quadriga CX died unexpectedly at the beginning of December on a trip to India. Complications with his chronic bowel disease were given as a cause of death. Quadriga had money problems before, after their bank had frozen nearly $26 million of their funds. But what followed Cotton’s death was much worse. His widow told the Canadian authorities that Cotten had used his encrypted laptop to handle all the finances of the exchange. And that, despite the involvement of experts, she has not yet succeeded in cracking the laptop.(6)

As a result, almost $140 million in client funds are no longer available. It is understandable that major customers now want to take legal action. There is also wild speculation within the community. After so many cases of frauds and rip-offs that the crypto world has seen in the past months, the distrust is enormous. Is Gerald Cotten still alive? Does his wife pretend she doesn’t have access to the money? There are more than 20,000 Bitcoin and a number of Altcoins missing. The Reddit community watches the well known Quadriga wallets with eagle eyes.(7)(8)

On a meta-level, the case underlines two things: crypto exchanges are a damn bad place to store your coins. If you don’t want to take responsibility for your own funds, you should fall back on professional providers of custodianship solutions that are insured by regulated insurance agencies.(9) Or even stay away from cryptoassets altogether. Quadriga was not the first and probably not the last case in which an exchange did not deal professionally with its customers’ funds. Many exchanges have experienced rapid and tremendous growth. Their systems did not always grow with them. Scaling problems affect not only the blockchains themselves but also the infrastructure of the market.

When the tide goes out…

“Only when the tide goes out do you discover who’s been swimming naked.”
Warren Buffett

It was to be expected that scams and half-baked projects would be uncovered and disappear in a bear market. This is what happened in the “normal” market after the great financial crisis in 2009. But now a second wave is also hitting the crypto sector. A phase that was also to be expected: it is shrinking. Jobs are being cut from companies that want to slim down for winter so that they can still exist at the end of the crypto winter.

The most prominent case is probably ConsenSys. This “decentralized company” serves as a kind of umbrella fund for around 50 Ethereum projects, which Ethereum co-founder Joe Lubin himself has selected. Lubin announced in December 2018 that 13 percent of the 1200 employees will leave the company and that the entire project will be restarted as “ConsenSys 2.0”. This also fits in with the plans to rebrand Ethereum as “Ethereum 2.0”

Lubin himself is considered one of the richest men in the scene because he has a large amount of ETH at his disposal. But that is not enough to keep ConsenSys running in the form of 2017 and 2018. According to Forbes, the “decentralized company” consumes about $100 million a year. And developers report that they never had to present a business model to get money. All it took was a thumbs up from Uncle Joe.(10)

Even the Chinese crypto giants Bitmain and Huobi are not getting off scot-free. Bitmain is the world’s largest manufacturer of mining hardware. The company will experience “some adjustments in the workforce”, according to a press release. Followed by a phrase that is often used in bad times. Bitmain says that they want to concentrate again on “their core business”. Bitmain denied rumors that more than half of the employees had to leave.(11) Bitmain also closed a research center in Israel and fired 20 employees there. Huobi, one of the world’s largest exchanges, also announced that it would “optimize” its workforce. The employees with the worst performance would have to leave. Bitmain had almost 2600 employees in its prime, Huobi more than 1000.

Other prominent victims of the bear market were the decentralised social media platform SteemIt and the NEM Foundation, which is behind the cryptocurrency XEM. SteemIt had to reduce staff. The NEM Foundation slipped into a real bankruptcy – only to ask the community for the equivalent of $8 million in order to be able to continue until February 2020. AKA, in order to make a “restart”. That’s a very popular word in the scene at this stage: restart. Soon it’ll all be “2.0.”

“Downsizing is a natural cycle in new, rapidly growing industries and blockchain is unfortunately no exception.”

Jehan Chu

Jehan Chu, the co-founder of Kenetic Capital in Hong Kong said in an interview with the South China Morning Post “We have also seen this with the Internet in the early 2000s. But this period has also produced some companies that are today the largest in this sector. I’m looking forward to a better, more focused version 2.0 of the blockchain industry.”

Admittedly, this is a dream for the future. At the present time, we must tighten our belts in Europe too. In the famous Crypto Valley in the Swiss city of Zug many cutbacks have already been announced. During the boom, too many start-ups had generously hired people who they can no longer afford or want to pay. Shapeshift, which is based in Switzerland, let about 37 employees go – a third of the workforce.(12) Locally, Crypto Finance in Switzerland had to lay off seven staff members mostly coming from their sales team.(13) In Liechtenstein, the Binancesupported exchange LXC is rumored to be having major problems.

Some crypto projects, such as Hosho’s Smart-Contract auditors, had to reduce up to 80 percent of their employees to get through the cryptowinter.(14) But there are also success stories: Blockdaemon, for example, which hosts nodes for blockchains, had a good year: “This is the most productive phase we have ever been in,” said CEO Konstantin Richter. Many start-ups have to step on it to deliver what they promised – and they are turning to service providers such as Blockdaemon: “The projects now have to show what they are made of. The time is up of raising a lot of money and talking a lot of talk.” Some investors are even happy about the cryptowinter. Many projects that were previously overvalued can now be entered at more reasonable prices.(15)

A State Cryptocurrency?

Bitcoin was originally invented to offer people an alternative to state currencies. Therefore, we are sometimes very surprised when the crypto fans absorb every message of an alleged “state crypto currency” as if it were honey. Especially since the nations in question are often a little questionable. We are not talking about the “electronic currency” that the IMF experts have in mind, but about Venezuela and Iran. The allegedly planned “crypto rial” is currently fascinating the media. In Venezuela, it was the Petro. The motivation is the same for both countries: they want to avoid US sanctions. Neutrally speaking, that is understandable. But the “Petro” of Venezuela can be considered a grandiose by most accounts.

Be that as it may, Iran is allegedly in talks with eight states from Europe and Africa (including Switzerland, Austria and Russia).(16) The content of the talks is whether international transactions could be carried out with cryptocurrencies. At the same time, there are reports of a “crypto rial” that may be linked to gold. Iran has been cut off from the international monetary and banking system for months. Europe, on the other hand, has a strong interest in circumventing the new US sanctions. and maintaining trade relations. Even an own agency was founded, the INSTEX. It is intended to facilitate trade between European countries and Iran. At the same time Tehran signals to consider everything that could harm the “great Satan” USA.(17)(18)

Against this background we ask ourselves: Why does it need a “crypto rial”? Is this all about propaganda? Misinformation? Which European country, which Russian company should accept such a new coin? If Tehran were really serious about using cryptocurrencies, wouldn’t the Iranians immediately resort to Bitcoin? Especially since the First Mover would have enormous advantages in such a scenario. As long as no such plans are known, we will not take the news from Iran too seriously. A “crypto rial” would probably have the same success as the “Petro” from Venezuela. None at all.

The Swedish plans for an E Krona are of course different. They are to be taken quite seriously. Especially since Sweden is a test laboratory for the “cashless society”. But here, too, we are still years away from implementation. And if it comes in the end, it will be a kind of cash substitute on a blockchain basis, not a cryptocurrency with its own monetary policy.(19)

Meanwhile in Europe, central banker Ardo Hansson has attracted attention – as a harsh critic of cryptocurrencies: “I think we will come back in a few years from now and say how could we ever have gotten into this situation where we believed this kind of a fairy-tale story”, Estonia’s central bank chief said in January. Crypto currencies are a “complete nonsense” and will probably disappear, says Hansson.

We need to point out that there are 19 national central bank governors and one ECB president in the euro zone.(20) These 20 people do not always agree and do not automatically speak for the Eurosystem when they express an opinion. It’s also not surprising that a central bank chairman, no matter which country, has nothing good to say about Bitcoin. Let us recall the IMF story we mentioned at the beginning of the report. Bitcoin is not only the enemy of state fiat money, but also hinders the implementation of extreme monetary policy elements. But it is a pity, nevertheless, that an ECB man is so derogatory. For the economists of the ECB were the first of a large central bank to deal with the advantages and disadvantages of Bitcoin in detail as early as 2012. It would be a pity if such a differentiated point of view from a serious source was forgotten, because the bosses prefer to make pithy remarks. That is why we recommend that everyone read the two ECB reports on Bitcoin. These come from a time when the central banks did not yet see the cryptocurrency as a threat, but as an enrichment.(21)(22)

Support is Increasing

Economists and central bank leaders who reject Bitcoin are truly no new phenomenon. What is striking, however, despite the ongoing bear market, is that the number of celebrity names that openly support Bitcoin is growing strongly. There’s Twitter’s CEO Jack Dorsey who said in a podcast,

“I believe the internet will have a native currency and I don’t know if it’s bitcoin. I think it will be bitcoin given all the tests it has been through and the principles behind it, how it was created. It was something that was born on the internet, was developed on the internet, was tested on the internet, and it is of the internet.“(23)

Dorsey even went so far as to say that in the end the world knew only one currency, and that Bitcoin was that currency. The timeframe he has set for this unique revolution is very ambitious: Ten years, maybe faster. Of course, Dorsey is also behind Square and its Cash App, where Bitcoin can be traded. Like all other proponents (and opponents), he therefore has a certain self interest. Dorsey also recently confirmed that he wants to integrate the Lightning Network into his cash app as soon as possible.(24)

Not only the Twitter founder, but also another social media giant is playing with the idea of integrating cryptocurrencies into his apps. We are actually talking about Mark Zuckerberg. He already said at the beginning of 2018 that he wants to deal more closely with cryptocurrencies. It was a New Year’s resolution back then. What has come of it now? Less than a year later, reports appear that Facebook is developing its own cryptocurrency to enable money transfers via WhatsApp.

This is not about Bitcoin, but about a stablecoin that is supposed to be pegged to the dollar. In any case, Zuckerberg is fully in line with the trend. The competition of Kik and Telegram is also tinkering with its own currency. And in China, WeChat has long since dominated the market for mobile payment.(25)

We also can report remarkable news from Samsung. It has equipped its new top smartphone, the Galaxy S10, with a crypto wallet.(26) This is a big step towards user friendliness for Bitcoin. And the South Koreans are also putting massive pressure on Apple. In any case, it seems appropriate, because in South Korea cryptocurrencies are still extremely popular despite the crypto winter.(27)

Preparations are also underway by the major financial institutions. Vontobel and Swissquote from Switzerland have both just introduced custodianship solutions for banks and asset managers. Bank Vontobel says it is the first in the world to meet all the standards of financial institutions and regulators. The product is called Digital Asset Vault and enables other banks and asset managers to offer their customers the purchase and sale of cryptocurrencies. Vontobel positioned itself early on as a Bitcoin-friendly bank and has been offering a Bitcoin certificate for some time, enabling traditional investors to bet on the Bitcoin price.(28)

In March, Fidelity Investments wants to follow up and enter the market with its own solution for the storage of Bitcoin and other cryptocurrencies. Fidelity’s CEO, Abigail Johnson, is a supporter of Bitcoin and has repeatedly advocated making digital assets available to a wider range of investors. It’s convenient that she’s in the executive chair of a giant in the financial industry. Fidelity is currently testing the technology with a small group of investors and their own employees. They want to start with Bitcoin, then follow up with Ether. Fidelity is one of the largest fund providers in the US with $7 trillion in assets under management, and they already work with 13,000 financial institutions. If this company gives its customers access to Bitcoin once, you can confidently call it a game changer.(29)

Nasdaq boss Adena Friedman also outed herself as a Bitcoin fan in early 2019. “Cryptocurrencies can still become the global currency of the future,” Friedman wrote in a blog post in the run-up to the World Economic Forum in Davos. Cryptocurrencies “deserve the chance to take a sustainable future place in our economy.” Bitcoin’s invention is “great evidence of human resourcefulness and creativity”. The ups and downs of Bitcoin’s price are due to the classic life cycle of a new invention and are no longer worrying, according to the Nasdaq boss. But the well-known technology exchange has a lot of catching up to do.(30)

More than a year after the introduction of Bitcoin futures, Nasdaq still has no such product on offer. We already reported in our last report that Nasdaq wanted to introduce such a system soon. Little has happened since then. It almost seems as if players like Nasdaq and the Bakkt project (of ICE, the operator of the New York Stock Exchange) are taking their time because they don’t want to risk embarrassment of launching a flop in the middle of the crypto winter. Only when prices recover can they be sure to receive full attention for their new products. After all, the Nasdaq boss’s comments show that the path is clear, it’s only a question of timing.

Speaking of Bakkt, on December 31, 2018, the new digital assets platform raised $180 million in investor funds. Among the donors were the Boston Consulting Group and Microsoft’s Venture Capital Arm, M12. A company called Horizons Ventures has also joined. Behind this one is a certain Li Ka-shing. The billionaire is number 23 on the global list of the super-rich. But Ka-shing is no stranger in the Bitcoin scene. He invested in BitPay with Horizon Ventures in 2013 and in Blockstream in 2016.(31)

Most recently, Jeremy Allaire, CEO and co-founder of the crypto company Circle, said in an AMA session on Reddit: “In my view, crypto is a much more significant and disruptive innovation than the web, and its impact on society, politics, economics, governance will be far, far greater for humanity over time.” Circle was making waves last year when the startup bought the established crypto exchange Poloniex. The company is also behind the Stablecoin USDC, which is operated jointly with the Bitcoin giant Coinbase. But what makes Circle special: None other than Goldman Sachs is heavily invested in Circle. Rumor has it that Circle is Goldman’s crypto experiment.(32)

And then shortly before the editorial deadline of this issue, an almost unbelievable message fluttered in: JP Morgan is the first large bank to develop its own cryptocurrency. Even if Jamie Dimon, the boss of JP Morgan, is known as a particularly vocal Bitcoin opponent. Admittedly, JPM Coin is not a competitor to the number one cryptocurrency Bitcoin. Instead, JPM is supposed to be a cheap vehicle for money transfers between banks and companies. Therefore, JPM Coin is more of a competition for Ripple than for Bitcoin.

The JPM coin is a currency tied to the dollar, i.e. it is a stablecoin. The idea seems to be to make it easier, faster and cheaper for large corporate customers to move dollars around the globe. “Pretty much every big corporation is our client, and most of the major banks in the world are, too,” says Umar Farooq, who heads the blockchain projects at JP Morgan. “Even if this was limited to JPM clients at the institutional level, it shouldn’t hold us back.”[33]

Spring setting in?

So, there is also a lot of good news from the sector, despite crypto winter, layoffs, and deaths. We suspect that the recent low of $3,125 is the trough of the last bear market, and that we are actually beginning the next bull market. However, we will only be able to tell in hindsight if this premonition was correct. The well-known Bitcoin bull Mike Novogratz recently said,

“There’s 118 elements on the periodic table, and only one gold […] Bitcoin is going to be digital gold, a place where you have sovereign money, it’s not U.S. money, it’s not Chinese money, it’s sovereign. Sovereignty costs a lot, it should.”(34)

What does that mean for the price? Well, Novogratz, has often been wrong here. But for the sake of completeness: he sees $8,000 dollars as an acceptable value in the medium term, which would make sense if investors price in the 2020 halving. Since bitcoin’s inflation rate will half, a doubling of the value is what is required in order to keep miners online.

What we know: Mark Dow, a trader who opened his Bitcoin shorts at an almost perfect time at the height of the last bubble, closed this short at the end of 2018. As it looks today that was great timing. However, as we have just seen, there are good reasons to stay with Bitcoin. Not only because a number of institutional investors are thinking about entering positions and more and more prominent names are standing behind crypto currencies but because the original fundamentals of Bitcoin have not changed. The original use case for Bitcoin – i.e. its use as an independent, censorship resistant currency – is still intact, and we don’t know how many of the current competitors to Bitcoin really have a future.(35) To see that, we just have to look at Venezuela again. There, Bitcoin transactions have recently reached new all-time highs. People do not trust the already broken Bolivar or the state crypto currency Petro. They want Bitcoin. And they buy Bitcoin.(36)

Bitcoin is needed in a world full of crazy money experiments. We also know that Bitcoin as a currency and digital gold is still at the beginning of its life cycle(37). That technical innovations such as the Lighting Network will be needed to start the next phase. That the next halving, i.e. the halving for block rewards, is due in less than two years. The charts are already circulating on the web today. Bitcoin cycles slow down over time. In other words: The halving alone does not guarantee a new all-time high. But if Bitcoin continues to evolve as before, some calculations suggest that the price will be between $100,000 and $200,000 per Bitcoin by 2023.(38)

Is that a prognosis on our part? Not at all. A buy recommendation? No! But that is the basis for those who are continuing to work on the infrastructure even in a prolonged bear market and for those who plan to buy now – or at least soon, when the bottom is really reached, somewhere between $2,000 and $3,000 dollars. And it is also the reason why we will continue to document the development of this sector until 2020 and beyond.

(1) See “Bargeld soll in den Tresor statt zur EZB”, Handelsblatt, June 8, 2016
(2) See “Immer mehr Schweizer Firmen bunken Bargeldberge”, Die Presse, September 13, 2016

(3) See “Cashing In: How to Make Negative Interest Rates Work”, IMFBlog, February 5, 2019

(5) See “Bitcoin is Now Officially In Its Longest Bear Market Ever”, Coindesk, February 2, 2019

(6) See “QuadrigaCX Shutters, Claiming It Lost Access to Crypto Accounts After CEO’s Mysterious Death”, BREAKERMAG, February 1, 2019

(7) See “Digital exchange loses $137 million as founder takes passwords to the grave”, Arstechnica, February 2, 2019
(8) See “Zwei mysteriöse Todesfälle erschüttern die Bitcoin-Welt”, Die Presse, February 5, 2019

(9) Last Crypto Research Report we had a closer look at different custody solutions.

(10) See “Insiders Say ConsenSys Faces a Hurdle to 2019 Rebound: Joe Lubin’s Grip”, Coindesk, January 9, 2019
(11) See “China’s Bitmain Technologies and Huobi plan lay-offs as cryptocurrency crunch begins to bite”, South China Morning Post, December 26, 2018

(12) See “Schweizer “Crypto Valley”: Bitcoinkrise bringt viele Jobverluste”, Futurezone, February 1, 2019
(13) See “Swiss Crypto Firm Pares Staff”, Finews, February 5, 2019

(14 )See “Smart Contract Auditor Lets Go 80% of Staff in Crypto Winter Cutbacks”, Coindesk, February 1, 2019
(15) See “Crypto Winter Isn’t Fatal For All ‘Picks and Shovels’ Makers”, Bloomberg, January 16, 2019
(16) See “Talks with 8 countries over using cryptocurrency in monetary transactions going on”, TehranTimes, January 28, 2019

(17) See “Iran’s Crypto Experiments Are a Shield Against Trump’s Unilateralism”, BREAKERMAG, February 1, 2019
(18) See “Europa legt sich mit König Dollar an”, Die Presse, February 2, 2019
(19) See “Difference between e-krona and crypto-assets”, Sveriges Riksbank, October 18, 2018
(20) See “Virtual Currencies To Go Down as ‘Load of Nonsense,” Says ECB’s Hansson”, Bloomberg, January 7, 2019
(21) See “Virtual Currency Schemes”, European Central Bank, October, 2012
(22) See “Virtual currency schemes – a further analysis”, European Central Bank, February, 2015

(23) See “Twitter CEO Jack Dorsey Has Made A Bold Prediction About Bitcoin”, Forbes, February 4, 2019
(24) See “Square CEO Jack Dorsey Says Bitcoin’s Lightning Is Coming to Cash App”, Coindesk, February 11, 2019

(25) See “Facebook Is Developing a Cryptocurrency for WhatsApp Transfers, Sources Say”, Bloomberg, December 21, 2018
(26) See “Blockchain Goes Mainstream? Samsung Confirms Digital Wallet Integration for Galaxy”, Cryptovest, April 2019
(27) See “Cryptocurrency Was Their Way Out of South Korea’s Lowest Rungs. They’re Still Trying.”, The New York Times, February 10, 2019
(28) See “Swiss Multi-Billion Dollar Bank Vontobel Launches Regulated Crypto Custody”, Cointelegraph, January 14, 2019
(29) See “Fidelity Is Said to Plan March Launch of Bitcoin Custody Service”, Bloomberg, January 29, 2019
(30) See “„Potenzial zur globalen Währung der Zukunft“ – Nasdaq-Chefin outet sich als Bitcoin-Fan”, Handelsblatt, January 23, 2019

(31) See “World’s 23rd Richest Man Invests in Cryptocurrency Exchange Bakkt’s First Funding Round”, Cryptoslate, January 8, 2019
(32) See “Circle CEO Says Crypto Is a “Much More Significant” Innovation Than the Web”, BREAKERMAG, January 10, 2019

(33) See “JP Morgan is rolling out the first US bank-backed cryptocurrency to transform payments business”, CNBC, February 14, 2019
(34) See “Mike Novogratz: Bitcoin Will Be Digital Gold, “Sovereignty Should Cost A Lot””, February 13, 2019
(35) See “The Trader Who Nailed the Bitcoin Top Just Covered His Short”, Bloomberg, December 18, 2018
(36) See “Bitcoin trading in crisis-stricken Venezuela has just hit an all-time high”, CNBC, February 14, 2019

(37) See “The Original Crypto Bull Thesis, Revisited & Reinvigorated”, Zerohedge, January 2, 2019
(38) See “Bitcoin’s journey to the new peak will be longer this time”, Tradingview

Gold and Bitcoin: A Crypto Strategy, also for Institutional Investors

Mark Valek

April 30, 2019

Gold and Bitcoin A Crypto Strategy also for Institutional Investors

“Digital gold and physical gold make a highly interesting combination as a portfolio. Excess volatility is dampened by gold, while you still can participate in much of Bitcoin’s optionality.”

Mark Valek

Key Takeaways

Practical problems and structural hurdles have so far prevented most institutional investors from entering the crypto asset arena. A generally low level of expertise and exorbitant volatilities, among other things, were decisive factors in this wait-and-see attitude.
The two assets Gold and Bitcoin have partly similar characteristics but different patterns of price movement. In combination, volatility can be reduced disproportionately due to the diversification effect.

A rebalancing strategy with broad rebalancing bands and an option overlay can further improve the risk-adjusted return significantly and together this combination of assets represents an uncorrelated portfolio building block for a traditional portfolio.

Where are the Institutional Crypto-
Investors?

The crypto-community has been asking this question for a few years now. Given the last hype of 2016-2017, the interest in the young asset class has naturally increased dramatically even among professional investors. However, not many conventional investment vehicles were available for this class of investors during the boom time. This has changed in the meantime. Certificates, futures and regulated funds are now on the market. With falling prices, however, the appetite for the asset class has somewhat disappeared again. At least for now.

An announcement of the investment manager Morgan Creek Capital recently has attracted some attention (1): its Blockchain Venture Capital Funds is backed by USD 40 million coming from traditional investors. These include two public pension funds, a university endowment fund, a network of hospitals and an insurance company. Nevertheless, investments by traditional institutions still seem to be rare.

In our view, this is due on the one hand to special features of the asset class, which cause practical problems for institutional investors. On the other hand, structural hurdles within the asset management sector are also responsible for the current reluctance of many institutional investors.

Practical Problems for Institutional Investors

The following practical issues can be identified in the context of digital asset classes:

► Legal (un)certainty
► Custody
► Liquidity
► Investable vehicles

These practical problems inherent to the new asset class are not trivial, but in our view, are already largely solved.

Legal certainty regarding crypto-assets is of course crucial for institutional investors. The rise of digital assets meant that a whole range of legal issues had to be identified and regulated. First of all, legislators and regulators – as well as the entire investment industry – had to become familiar with and understand the phenomenon of crypto-assets and where necessary create appropriate legal foundations. For a long time, it was unclear whether cryptocurrencies should be treated as securities, cash or commodities. Meanwhile, many regulators have decided that distinctions must be made. The Swiss authority FINMA, for example, has commented on this topic and has provided an important foundation stone for the classification of crypto assets with the FINMA ICO guidelines. For corporate financing Security Token Offerings (STO) have to be used instead of the Initial Coin Offerings (ICO), which were misused in the early years. In the case of STO the rights of investors are better protected. Apart from these rulings, legislators by now have decided on the tax treatment of cryptocurrencies and have thus solved the central elements of previously prevailing legal uncertainty.

Custody of digital assets is an essential issue. Traditional securities investments have a settled infrastructure that has grown over decades, which has now become a standard procedure for the seamless transfer and safekeeping of assets. The new phenomenon of digital asset management industry is once again facing challenges in terms of safekeeping. In particular, the phenomenon of “cybersecurity” is inherent in this context. In recent years, however, many companies have offered safe and professional solutions for this area. Some of them have already developed so far that they have been approved by the regulators of the European fund industry as safe custody solutions. In our last Crypto Research Report, we dealt with different custody solutions (2).

Cryptocurrency liquidity is also of great importance to institutional investors. They have to make sure that the large volumes they manage can be invested without significant impact on prices (slippage). The measurement of liquidity in this area, however, is problematic. Many large transactions are processed OTC (“over the counter”) and not through an exchange. As a result, existing liquidity is underestimated. However, when looking at exchange-traded liquidity, it is probably too high. The background is that crypto exchanges have an incentive to identify their own market share as high as possible. In any case, apart from the difficulties of accurately measuring liquidity it is remarkable how different the liquidity between the individual cryptocurrencies is. By far the most liquid is Bitcoin. For liquidity reasons Bitcoin is by far the most attractive for an institutional investor, perhaps even the only realistic form of investment within the crypto universe in the current market environment.

Investment products could not be found in the regulated area until a few years ago. Although in principle, a direct investment in cryptocurrencies would also be an option from the prevailing perspective, from the point of view of institutional investors there is much to be said for investing securitized securities in this asset class. Thus, the custody does not have to be dealt with independently. Furthermore, consolidating crypto-assets with the remaining portfolio values becomes a much easier task.

If anything, crypto-investment for institutional investors was originally only possible via moderately regulated offshore hedge fund vehicles, which often do not separate the depositary from the manager. In the meantime, investment in cryptoassets can be done through an increasing number of conventional investment products. For instance, already regulated blockchain and crypto-funds, certificates and ETPs have appeared on the market. Below some examples.

Blockchain & crypto-funds:
► Polychain Capital
► Pantera Bitcoin Fund
► Galaxy Digital Assets

Certificates:
► VONCERT on Bitcoin by Vontobel
► Tracker certificate on Bitcoin by Leonteq
► Bitcoin Tracker One – SEK (COINXBT – ETF type)

ETP:
► Amun Crypto Basket Index
► Amun Bitcoin ETP
► Amun Ethereum ETP

As we can see, many of the practical issues surrounding legal uncertainty, custody and investment products have already been defused or resolved. As far as liquidity is concerned Bitcoin is currently primarily suitable for institutional investors. Speaking of which, learn some of the easiest ways to buy Bitcoin, and be ready when there is an opportunity available.

Structural Hurdles within the Asset Management Sector

Even more relevant than the initial practical problems today are probably structural hurdles within the asset management industry, which slow down the entry of many players. This includes in particular

► The expertise and the decision-making structures within the asset management
► The extraordinary volatility of most cryptocurrencies
► The principal agent dilemma

Expertise and decision making structures within large organizations such as asset managers are highly relevant when it comes to the question of adding a new asset class into the investment universe. In principle, new asset classes do not often emerge during the career of a portfolio manager. The asset management industry’s last asset-class “revolution” was probably the spread of hedge funds in the late 1990s and early 2000s. At that time, endowment funds at universities in the US were among the first institutional investors regarding hedge funds as an own asset class. Only gradually institutional investors followed and introduced hedge funds or alternative investments asset classes.

Over the next few years, players in the asset management industry will gradually have to come up with answers to how they handle the phenomenon of digital assets. The majority of institutional investors will for the time being ignore or negate it. However, the longer crypto assets are in the market, the more professional investors will make strategic allocations in this area.

One of the reasons for the sluggish entry into established institutions is probably that crypto-affine individuals within the organizations tend to be younger while the decision makers tend to be older. Of course, a young person does not automatically have to be comfortable with the crypto phenomenon, but an affinity may be more likely because younger generations as “digital natives” are more likely to be in touch with the developments in the crypto-world and therefore better able to understand it. Even though there are counterexamples, there is one thing that catches your eye: young crypto-savvy employees repeatedly come up with suggestions and ideas about crypto-assets in the executive team of many traditional institutions, as conveyed at any rate by anecdotal accounts of their experiences.

In addition, as everywhere, even among the asset managers the average level of knowledge is still quite low. It takes time for the executive levels of these organizations to allocate resources to educate their staff or set up their own departments that are committed to cryptocurrency. The number of banks and asset managers that are dealing with the issue on a project-related basis is growing. Some entities have recognized cryptocurrency and blockchain technology as a strategic business and openly admit to it. These include banks such as Bank Frick in Liechtenstein, Falcon Private Bank and SEBA Crypto AG in Switzerland, SolarisBank and Fidor Bank in Germany, but also Fidelity Investments in the US.

One of the largest obstacles for institutional investors is the exorbitantly high volatility of most cryptocurrencies. Fluctuations in prices of up to twenty percent within just a few hours have been recurring in Bitcoin over the past few years, while other cryptocurrencies have shown even more excessive volatility. When US stocks dipped by just five percent in February 2018 Wall Street was already in turmoil. Handling such high price fluctuations is also difficult for institutional investors and poses some problems.

The volatility or risk weighting of a single position in the portfolio context can actually be easily managed by adjusting the portfolio weighting accordingly. A position with high volatility should correspondingly have less weight if one wants to control the influence on the overall portfolio. For risk-return reasons, rightskewed asset classes such as Bitcoin should be particularly attractive as an addition since a large impact can be achieved with a small positioning.

From the point of view of the responsible portfolio manager, however, despite all this there is a weighty reason against even a small position in the crypto sector: the principal-agent dilemma. (4) If well-paid asset managers do not manage their own capital, they have an incentive not to take higher risks on a single position, even if from a capital theory perspective these are endowed with attractive risk-return ratios despite high volatility. The motto is: even with satellite positions one does not want to justify oneself as “agent” with the “principal” for high losses if they become striking.

Gold and Bitcoin – Stronger Together?

Market timing is difficult for any asset class. With such a volatile asset class as cryptocurrencies, one would like a favorable entry and exit time all the more. In practice, however, it can almost be ruled out that investors choose the ideal deadline to make their investments or to realize the gains.

Here we want to introduce our proprietary investment strategy, which defuses the volatility problem or even converts it to the benefit of the investor. In order to achieve this, our strategy draws on an old wisdom in portfolio management: Rebalancing. More on that later.

We already discussed in last year’s sister report, the In Gold we Trust report, that gold and Bitcoin cannot be seen as enemies but rather as complementary friends. (5) At a philosophical level, the investment assets are very similar because:

► Their stock cannot be inflated and devalued by a central bank
► They are nobody else’s obligation (no counterparty risk)
► They are easily transferable
► They represent liquid assets outside the fiat system

In addition, both forms of investment are difficult to confiscate and have a good chance of succeeding in an environment of over indebtedness, impending negative interest rates and financial repression. To a certain degree, this also applies to other “payment tokens” or “store of value tokens”. This strategy can be implemented with gold and an index of store of value tokens instead of gold and bitcoin. This would ensure that potential competitors of Bitcoin are on the radar and in the investment strategy in the future. For the sake of simplicity, we will examine the combination of Bitcoin and gold below.

To a certain extent, this also applies to other “payment tokens” or “store of value tokens”. This strategy can therefore be implemented with gold and bitcoin or gold and an index of store of value tokens. Including other “store of value tokens” would ensure that potential competitors of Bitcoin are on the radar and part of the investment strategy in the future. For the sake of simplicity, we will examine the combination of Bitcoin and gold below.

The Diversification Effect

Despite these similarities, the returns of gold and Bitcoin show low and sometimes negative correlation. This situation is welcome for an investor because the fluctuation of a combined strategy is reduced.

Of course, the volatility and thus the price risk of a crypto strategy will change significantly if gold is added to the investment strategy. Since gold is subject to significantly lower price fluctuations, the overall volatility decreases as the share of gold increases. In addition, the low correlation due to the well-known diversification effect helps to reduce fluctuations disproportionately.

The Rebalancing Bonus

In addition to exploiting the diversification characteristics of gold and Bitcoin, this investment strategy allows unlike any other to benefit from the “rebalancing bonus”.

What exactly is the rebalancing bonus, and what is the best way to receive it? Price fluctuations cause portfolio components to change dynamically over time. Thanks to so-called “rebalancing”, shifts in the portfolio are balanced out by resetting the portfolio to the original, strategic asset allocation.

In order to benefit from the rebalancing bonus, a strategic allocation and a rebalancing method must be defined for both assets. For example, an institutional investor may choose to assign 30% to Bitcoin and 70% to gold as a strategic allocation, as this mix creates an overall risk that is familiar to professional investors. As a rebalancing method, one can either set a fixed time interval or make adjustments only on an ad hoc basis when predefined portfolio shifts are reached (see info box). Our comprehensive quantitative analysis has shown that event-based rebalancing is more useful, especially considering transaction costs. In the strategy presented here, we have provided a wide range of Bitcoin allocations between 15% and 60%. The method therefore calls for the strategic allocation (or the initial allocation) to be restored through corresponding buy and sell transactions as soon as the Bitcoin allocation falls below 15% of the total portfolio or exceeds 60% due to price fluctuations. In case Bitcoin develops better than gold, it has to be sold and replaced by gold and vice versa.

Various studies confirm that the more the asset classes fluctuate in value and the lower their correlation, the stronger the rebalancing bonus.(6) (7) This circumstance must be taken into account against the background of the high price fluctuations in Bitcoin.

In a comprehensive quantitative analysis, we tested this investment strategy in several variants. As the graph below shows, rule-based rebalancing can significantly improve the risk-return ratio. Correspondingly, the Sharpe Ratio could be consistently improved with the help of the rebalancing strategy, irrespective of the Bitcoin allocation. (8)

The fact that the risk-return ratio can be significantly improved with this strategy becomes particularly evident when considering the maximum drawdown as a risk indicator.

A drawdown in financial literature refers to the price loss that lies between a high and a subsequent low in a given period. The maximum drawdown is the total loss that an investor has to accept for a period after investing at the time of peak.

Additional Income through “Covered Call Writing” and “Put Writing”

In addition to the diversification effect and the rebalancing bonus, a third element allows the investor to profit from high volatilities and thereby further improve the strategy. To achieve this, one uses the options market, which already exists for Bitcoin. On exchanges such as Ledger X or deribit one can trade options for over a year. Options can be used as a speculative element, for hedging or generating yield. The decisive factor is whether you write options without holding the underlying (“naked”) or in combination with the underlying.

Covered call writing is a well known strategy that can be used to exchange the upside potential of a position (or part of a position) for a premium. If you have a position in the portfolio that you want to hold or even sell, you can write a call option on it and thus generate the option premium. In the worst case, you no longer benefit from the full upside of the underlying, but at least you still generate the premium.

Conversely, selling puts is a good way to build a position. In this case, a contract obliges you to buy an underlying at a certain point in time at a given price. In this case, you also receive the option premium for it. If you execute, you will receive a net purchase price (taking into account the generated option premium) that is more favorable than the one that you would have been able to obtain by purchasing the underlying in the normal way. If the option is not exercised due to the price movement, then you will collect the entire option premium and the contract expires. The risk of this strategy is that the option will not be exercised and the price later explodes.

The prices of the option premiums are based on the expected fluctuations of the underlying and the volatilities implied in the option prices. As the price of Bitcoin has an exorbitantly high volatility, the option premiums are correspondingly high. According to our calculations, assigning a 10% share of the portfolio to at themoney options would produce an annualized additional return of 10 to 15%.

Conclusion

Bitcoin and gold are similar in certain characteristics and can be an attractive investment strategy as a portfolio. By combining both assets, investors benefit on the one hand from the low correlation of both assets. On the other hand, they can use the volatility of Bitcoin to their advantage through a rule-based rebalancing and thus reap the rebalancing bonus. In addition, option strategies generate an interesting return by collecting option premiums. Overall, this approach allows for a strategy that, in view of its volatility, seems to be better suited for institutional investors than highly volatile pure crypto strategies.

(1) In December, we had the honor of holding an exclusive Advisory Board Meeting with Mark Yusko of Morgan Creek.

(2) See January 2019 Crypto Research Report: Crypto Concepts: Cryptocurrency Custody Solutions

(3) Average daily trading volume in March 2019

(4) See https://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem

(5) See https://ingoldwetrust.report/download/1373/?lang=en, pages 177 following.

(6) See “When Does Portfolio Rebalancing Improve Returns?”, HodlBot, October 26, 2018

(7) See “THE REBALANCING BONUS”, www.efficientfrontier.com

(8) Obviously past performance is no guarantee for future returns.

Cryptocurrency Mining in Theory and Practice

Demelza Hays

April 30, 2019

Cryptocurrency Mining in Theory and Practice

“The purpose of mining is not the creation of new bitcoin. That’s the incentive system. Mining is the mechanism by which bitcoin’s security is decentralized.”

Andreas M. Antonopoulos

Key Takeaways

Cryptocurrency Mining can be seen as global arbitrage on electricity prices. Mining firms can strike lucrative deals with energy providers in Switzerland, the U.S., and Scandinavia. To stabilize the capacity of networks, some energy providers are actually willing to pay miners to use electricity during off-peak hours of the day.
All three of the mining companies interviewed use 100% renewable energy for mining cryptocurrencies. Alpine Tech SA and Blockbase DWC-LLC have minimum investment amounts that are bar most retail investors. Unity Investment AG has a minimum investment of $100.
Before investing in a mining company, due diligence includes checking whether the mining pool software is secure with no backdoors and that the pool is actually capable of delivering the reward for allocating your computation resources to their pool. With cloud mining services, due diligence includes verifying that the data center exists, that the computer or computers that you are renting exist, and are solely dedicated to your exclusive use, and that their software is secure with no trap doors.

Introduction to Cryptocurrency Mining

As discussed in the chapter on consensus mechanisms in the June edition of the Crypto Research Report, decentralized networks need a strategy or algorithm for stopping double spends of digital information. Normally, people state that the two main consensus mechanisms employed by cryptocurrencies are proof of work and proof of stake; however, this is wrong.

Recently pointed out to us by Ed Thompson of Web3 in Zug, Proof of Work is not Bitcoin’s consensus mechanism per say. Agreement on the latest state of Bitcoin’s transaction history is based on the longest chain policy. Despite that subtle difference, mining is one of the most important aspects of Bitcoin as well as many other blockchains, because mining serves the purpose of creating a new block in a blockchain.

A block is very similar to a page in a financial ledger that documents the order of any debits and credits to its accounts, along with a third entry performed by an auditor, a miner, that commits these debits and credits to each address account. This is known as triple entry accounting, a significant innovation in accounting. Therefore, the entire blockchain (a chain of blocks), is like all the pages of a financial ledger.

In Bitcoin, a new block is created approximately every 10 minutes. This block contains the most recent set of transactions among Bitcoin addresses, that have been verified among the network of computers. The act of mining is performed by computers configured for mining. In Bitcoin, these miners perform a computation that is known as a Proof of Work function. This Proof of Work function is computationally difficult and requires many attempts by the computers in the network to discover the solution. The computers in the network compete to find the solution to this Proof of Work before the others. The computer that finds the solution before the others is rewarded with a reward of coins from the blockchain. This is how new coins are created and enter the ecosystem.

Mining Business Costs and Risks

With that said, there are real world costs associated with running a computer that performs these computations. These costs are in the form of depreciating hardware assets, electric bills, maintenance costs, labor, as well as many other costs. When the price of the cryptocurrency goes up, these costs can be manageable for sophisticated miners. When the price of a cryptocurrency goes down or flatlines, or if a serious mismanagement of expenses has been overlooked, there is risk in spending more in electricity and hardware than the amount you earn from the rewards of mining. Mining is a very risky business unless you have an enormous number of mines and can out compete others because of cost savings stemming from economies of scale. Even then, many miners suggest that buying cryptocurrency is more profitable and less risky than mining for cryptocurrency. The advantage to mining and earning a reward is that you know where the coins came from because they are being issued directly from the Blockchain itself. When you buy the coins, you might not know where the coins have been along their path before they got to you.

Bitcoin Block Reward Emission Schedule

Proof of work uses two main types of financial rewards to incentivize users to maintain the network: rewards and transaction fees. Before confirming a new block of transactions, the miners compute hashes until they find a desirable number that is less than a specific number set by the software protocol called the difficulty target.

In the Bitcoin protocol for example, miners must find the right “nonce”, or arbitrary number, that produces a hash lower than the difficulty target set by the software. This is called a hash-puzzle because the miner must add the nonce to the hash of the previous block in the blockchain. The computational output is a number which basically falls into a target space which is comparatively small in relation to the large output space of the entire hash function.(1) This number becomes that block’s identification number, which is used as an input in the next block’s hash puzzle. The first miner to find a hash that is lower than the given difficulty target will be entitled to “print” new Bitcoins and receive the transaction fees that the senders paid to the network when they broadcasted their payments. The first transaction of every block is a “coin-creation transaction”. The coincreation transaction allows the miner of the block to mint new Bitcoin and to send these new Bitcoin to his or her wallet. In 2016, the value of the block reward was about 25 Bitcoins. However, this rate drops roughly every four years and is currently 12.5 Bitcoins.

There are other variables that must be taken into account to determine the true emission schedule, for example, the number of computers and their total computation capacity. This determines how quickly a block is discovered but that rate is estimated to be every 10 minutes. The network self adjusts the block creation rate every 2016 blocks in order to account for increases or decreases in the amount of computation capacity among the entire network of computers competing to mine the next block.

Updating the Network

In Bitcoin, mining is how all new coins are created. Once the solution to the Proof of Work function is discovered, the computer that found that solution broadcasts their discovery to the network of miners. Once this broadcast is received, the other miners are tasked with crosschecking that solution for verification purposes. Once there has been enough verifications by other miners in the network, a transaction is said to be verified and becomes a permanent record within a block stored in the blockchain.

Security Layers and Known Attack Vectors

Another purpose of a miner is to act as a security layer for the network. There are many known attack vectors for Blockchain and other cryptocurrencies. In Bitcoin’s case, the 51% Attack is where an attacker or group of colluders gain control of 51% or more of the computation power performing the Proof of Work function. With this much computation power, an attacker could potentially begin unraveling the transactions that have been previously verified within a block. However, the attacker must start by attacking or unraveling the most recent block. Once the most recent block has been successfully attacked, each subsequent block which came before, would need to be attacked, and this attack only gets harder and more expensive for the attacker as they attack more and more blocks in the blockchain’s history.

Different Ways to Mine

In the early days of Bitcoin, miners would use regular computers, such as a laptop or desktop, and the calculations would be performed using code processed by the central processing units (CPUs) of that computer. When more sophisticated participants started mining, they saw opportunities to improve on how fast they could perform calculations by looking at solvers other than CPUs. This led miners to perform those same Proof of Work calculations using the graphical processing units (GPUs) of their computers. GPU’s are typically capable of performing this Proof of Work calculation orders of magnitude faster as well as being capable of performing multiple calculations simultaneously far beyond a CPUs capability. This eventually led to even more sophisticated technologists entering the space, and miners began using field programmable gate arrays (FPGAs) which are devices that are even faster than GPU’s. Finally, the market evolved into using application specific integrated circuits (ASICs) which are chips designed for the sole purpose of performing a single calculation, and in Bitcoin’s case, the Bitcoin Proof of Work function.

Mining Pools

The cryptocurrency mining industry started with hobbyists who thought mining Bitcoin was a novelty, as no one really knew what the future would hold for Bitcoin. From there, as the block rewards got harder and harder to earn, and hobbyists had a more difficult time earning a reward, we saw the introduction of a concept known as mining pools. A mining pool is where individual miners could contribute their resources to a pool of miners and if one of the pool members achieves the reward, that reward gets split amongst the members of the mining pool. As the stakes increased, we saw the market evolve yet again, where computer manufacturers, graphics card manufacturers, FPGA manufacturers, and ASIC Manufacturers, entered the space by building specialty products for performing cryptocurrency mining. We even saw cloud mining companies develop. Rather than building or buying your own cryptocurrency mining machine, or joining a cryptocurrency mining pool, one could just rent computing power from a company that purchases and maintains the mining machines on behalf of their customers.

Three Interviewed Mining Companies

To bring the theory of mining into practice, we interviewed three cloud mining companies, Alpine Mining SA, Unity Investment AG, and Blockbase Group DWCLLC. With that said, we rely on the companies and people that we interview to give us the facts from their perspectives. As writers of the Crypto Research Report, we must let our readers know that we began this article naively. We held the erroneous notion that not all mining companies were bad actors, and that every company was doing the best they could. Unfortunately, we uncovered very suspicious and concerning information regarding two out of the three mining companies interviewed. We are still presenting this article to you for your information; however, we want to clearly state that we do not endorse these companies, and we hope that each investor does an extremely thorough investigation if they are considering investing in mining companies.

Investigating cloud mining companies to invest in requires proper due diligence, which involves many factors and is not easy to perform or get right. If you lack the sophistication for performing due diligence, seek out those who are capable as well as trustworthy to perform the due diligence for you. Or choose a company that performs this due diligence in a public fashion using cryptocurrency industry best practices. This might include inspections of computer manufacturers to see their manufacturing processes, inspections of cloud mining facilities, inspections of any software code, database accounting to ensure the number of users matches up with the number of machines available, performing financial audits of the company bank accounts, verifying the reserves of the company’s cryptocurrency holdings, among many other things. Due diligence is not something to be taken lightly when evaluating making an investment. If you are considering an investment, never risk more than what you’re willing to lose. Now let’s move onto the first interview.

Alpine Mining Tech SA

Another company we interviewed was Alpine Mining SA.(2) We spoke with Ludovic Thomas (3), who is CEO and cofounder of Alpine Mining. In the interview, we discussed how Alpine Mining came to be, what services they offer, and how they fit into the cryptocurrency market.

According to Thomas, Alpine Mining is dedicated to their activities and is a team of young, ambitious people, and they strive to have the utmost in ethics and desire to maintain a solid reputation. Thomas and his business partner Christophe Lillo (4), who is CTO and cofounder at Alpine Mining, bootstrapped the company with their own capital and efforts. They started mining cryptocurrency for themselves and have been mining Ethereum since it was $0.30. They started their first cryptocurrency mining data center at a location in Gondo (5), Switzerland. Gondo is a very small municipality on the Swiss Italian border with only 40 residents. For years, the municipality of Gondo, was trying to attract companies to the area by offering extremely low electricity costs but this small municipality was unable to attract people to the area. Thomas mentioned that this municipality offered the lowest electricity prices in all of Switzerland and that’s what made them decide to set up their first data center in Gondo. They were able to power their cryptocurrency mining data center using the hydroelectricity produced from the local river in Gondo.

They soon realized that they would be unable to scale their operation further because the municipality only had one transformer and there was a limited amount of land for them to expand to. According to Thomas, the transformer provided a total of 1.2 megawatts and half of that was being used by the municipality.

When they first started out mining cryptocurrency, they focused their efforts on coins that were mineable with GPU’s. According to Thomas, Lillo used his technical skills to figure out how to optimize the GPU’s to perform above and beyond their default configuration. This is referred to as “overclocking”. They started out mining for themselves, but eventually opened up their mining operation to others, mainly Swiss customers. Because they chose Gondo as the location for their first data center, they received a lot of exposure in the news and ended up going viral within the French part of Switzerland.

What Services Alpine Mining Offers

2018 was a difficult year for many companies in the mining space. Many companies ended up shutting their doors and declaring bankruptcy. Luckily, for Alpine Mining, Thomas says they avoided such a tragic outcome with their business flexibility. In 2018, they transitioned into being a service provider offering to build cryptocurrency mining data centers for other companies. They signed their first contract with a Hong Kong based company called Diginex and were tasked with building out a first data center in Sweden for Diginex.

According to a press release (6) found on the Alpine Mining website dated May 2018 this partnership was projected to cost around $30 million.

Alpine Mining was tasked with sourcing all the hardware, finding the right locations for the data center, to build out the location for the customer, and to manage the location for the customer. In addition, they needed to assemble all the mining systems, set up and configure the data center with the appropriate monetary tools, and software to increase network efficiency.

This marked the beginning of their cryptocurrency mining data center development as service. According to Thomas, they are also extremely focused on hiring skillful people as they continue to develop their company. Thomas stated that at one point, they were managing 40,000 graphics cards mining various cryptocurrency’s such as Ethereum and Monero.

Conclusion

Alpine Mining is currently going through a transition phase and will most likely be renamed Alpine Tech. Thomas stated that they are still mining cryptocurrencies, but they are now working on creating blockchain solutions for other companies. Thomas mentioned that they will soon be working in collaboration with the university where many of their team members have graduated from. According to Thomas, that project is focused on Blockchain Artificial Intelligence, but the project is currently in stealth mode and Alpine Mining is not publicly announcing details about that project at this time. If you or your company is in the market for building out a cryptocurrency mining data center, you might want to consider reaching out to Alpine Mining to see if they are able to assist you with your needs.

Unity Investment AG

Unity Investment is a Swiss company developing a cryptocurrency mining solution (7). For this interview, we spoke with Richard Kobler (8), Senior Program Manager of Unity. Richard is very knowledgeable about the mining industry. During our interview, Richard walked us through what Unity Investment AG is, opportunities they see in the space and how you can learn more about them.

Beginnings of Unity Investment AG

The founder and CEO of Unity Investment AG is Sean Prescott (9). The Unity Investment office is based in Schindellegi, Switzerland, which is a 40- minute drive to Zürich city. Their mining facility is based in Jona, Switzerland.

When they first got started offering cryptocurrency mining services to their clients, the cryptocurrency markets were experiencing their all-time high prices. In December 2017, Unity Investment was offering their clients the ability to invest in units of mining machines. Richard described a unit to be a bundle of 10 cryptocurrency mining machines. So, when you became a client and you purchased a unit, you would have 10 cryptocurrency mining machines mining for you. In January and February of 2018, the market started to experience a selloff from the all-time highs and Unity Investments quickly realized that the cost of cryptocurrency mining machines started to drop and with that, their own prices had to drop. This put earlier purchasers of the units at a disadvantage to new purchasers of units at a lower price. This is when they began to think of ways to restructure their offering to clients so that it would be fairer to all purchasers, no matter when you decided to get started mining with Unity.

Mining Pool

This is how they came up with the notion of mining participation in a pool with other participants rather than the notion of a unit. For example, if a pool of participants comprised a total of 1 million CHF and each participant purchased 100,000 CHF worth of the pool, then each participant’s share would be 10% of the pool, and therefore, would receive 10% of the eligible mining reward that particular pool of participants earned. 30% of the total mining reward of the pool is allocated by Unity to reinvest into new machines, labor, infrastructure, and other costs, and the remaining 70% of the pool gets distributed to that pools participants as the eligible mining reward.

Being that Unity is based in Switzerland, they have figured out how to keep costs under control, mainly electricity, rent, and labor, and are able to operate as lean as possible. They run on renewable energy: 85% of that being hydroelectricity, 10% wind turbines, and 5% solar electricity. Switzerland is also known for having a stable regulatory environment as well as known for providing a very secure physical location close to the Swiss Alps. They have been able to negotiate fairly good terms with the power company, for example, and if they are able to increase their efficiency, they are able to claw back 30% of the costs of electricity that they use, and with very low taxes on the cost of electricity already, Unity appears to be in a great position to compete in this competitive market. According to Richard, there are also no taxes in Switzerland on mining cryptocurrency.

Unity only invests in ASIC powered cryptocurrency miners. They have a partnership with Bitmain and currently have around 1000 ASIC miners. The mining facility is 3000 M² and the machine inventory includes the Bitmain S9, L3, and A3. They have also placed orders for the S15. Having a range of machines allows them to mine various cryptocurrencies, including Bitcoin, Bitcoin Cash, and Litecoin – basically any cryptocurrency that is mined using the SHA-256 or Scrypt hashing function. In addition, Unity has engaged BDO AG as their auditor so that potential investors have more confidence in their operation. They also encourage all potential investors to come to their offices as well as visit there mining facility to see the operation.

The Unicrypt Platform

Unicrypt (10) is a product developed by Unity Investments that is an online portal that provides access for clients to their account as pool participants. Unicrypt also introduces a proprietary algorithm known as Proactive Mining (11). Proactive mining has been developed by Unity and is unique because every minute, the algorithm scans various blockchain’s and checks the prices of each blockchain that they support for mining, and based on a proprietary risk to reward ratio, the algorithm determines which cryptocurrency to mine at any given point in time. Once the algorithm has determined which cryptocurrency to mine, it sends instructions to each of the machines to mine that cryptocurrency.

Additional Businesses Outside of Mining

The Unicrypt platform has two other cryptocurrencies created by Unity. The first is the Unity Aurix Coin, and the second is the Unity ExaCoin. Aurix is purportedly backed by physical gold and all deposits are verified through auditors and stored securely in vaults; however, the amount of gold actually tokenized in these coins is unknown to us, and Unity Investment has not released any public documents regarding the quantity of physical gold stored in their vaults or the quantity of tokens that are backed the gold. ExaCoin is backed by Fiat, either CHF, USD, GBP, or EUR. These coins are ERC 20 tokens and investors are able to convert their cryptocurrency into either Aurix, ExaCoin, or both.

Conclusion

As with all things crypto, always do your own due diligence before participating in any project. We highly recommend for anyone interested to visit their mining facility, office building, and to meet Mr. Prescott and the rest of the team in order to begin proper due diligence on Unity Investment (12). Visits are by appointment only.

Blockbase Group DWC-LLC

For the final interview, we spoke with Vlado Stanic (13), the Founder and CEO of Blockbase Group DWC-LLC (14), which is headquartered in the United Arab Emirates, with mining facilities based in Sweden.(15) In the interview, we learned how Stanic got his start in cryptocurrency mining, the history that led to the creation of Blockbase Group, and also received insight into how their business operates.

Scrappy Startup to Large Operation

Stanic first learned about Bitcoin in 2013 and was turned on to the technology after reading the Bitcoin whitepaper. He started his first cryptocurrency mining company in 2015 based in Austria, by raising money from friends and family. Soon thereafter he partnered with his now Chief Technology Officer, Alexander Dietrich (16), who also provided startup capital. Together, they setup their first cryptocurrency mining company, named Techdisplay, which was based in Austria. Techdisplay’s first data center was setup near a hydroelectric power plant inside of a shipping container.

They got their start by filling the shipping container with custom built GPU cryptocurrency miners and began mining Ethereum. During this time, they also started onboarding their first cryptocurrency mining clients which allowed them to grow. They helped their customers figure out which GPU’s made the most economical sense and began buying GPU’s in bulk, anywhere from a few hundred, to 1000 to 2000 at a time, from hardware suppliers in both Hong Kong and Europe. They eventually ran into issues with keeping these rigs cool because running GPUs all hours of the day at its highest level of performance creates a tremendous amount of heat. According to Stanic, some of the GPUs caught fire because the heat was so great.

Techdisplay eventually grew from one shipping container to three shipping containers, and suddenly faced scalability limitations. Three shipping containers full of mining machines was the maximum number of containers the hydroelectric power plant was able to support with its energy production. These limitations were partly due to the winter months when the flow of water slowed due to freezing, causing the production of energy to drop. Stanic described that when the snow is melting there is a large flow of water which produces a lot of energy, and that the opposite occurs when everything is frozen. In order to keep growing they decided to explore their options.

In the quest for finding a more scalable solution, Stanic learned of Sweden, where the energy tax laws were beneficial compared to other parts of the world. Initially, Techdisplay had planned to move their shipping containers to Sweden. Stanic traveled to Sweden in February 2017 to investigate, then in March 2017, they set up Blockbase in Sweden, and by May 2017 they started their new mining operations. They eventually sold the shipping containers based in Austria, and the cryptocurrency mining infrastructure to another Austrian-based cryptocurrency mining company because moving everything to Sweden would have taken a great deal of effort.

Blockbase Mining-As-A-Service

For those who are familiar with KNC Miner, one of the original ASIC Bitcoin manufacturers, they had a mining facility based in Sweden. KNC Miner met the unfortunate fate of going out of business, but this unfortunate outcome became an opportunity for Stanic and Blockbase, as they were able to move into the facility of previously occupied by KNC Miner (17). One of the benefits of the Swedish mining facility of Blockbase, is that it also makes uses of hydroelectricity to power the data centers. According to Stanic, this energy is 100% clean and green energy.

The website describes Blockbase to be mining-as-aservice and lists that they offer three purchase options for potential customers interested in mining: “Order Miners in Bulk”, “Buy Hosted Miners”, and “Send us Your Machines”. For the first two purchase options, they source, setup, and configure all of the desired mining hardware for the client, and all of the equipment is owned by the actual client, not by Blockbase. If a client has their own mining machines, the client could send them to Blockbase for hosting, but the website lists a minimum quantity of 1000 machines.

For those who don’t have their own machines, one of the other packages available seem more appropriate. The website does mention on the pricing page (18) a minimum purchase of 30,000 EUR worth of mining machines and the “Standard” plan is priced monthly, with 58 EUR per kilowatt per month. If you pay by the half year, there is a 6% discount applied, with a rate of 55 EUR per kilowatt per month. If you pay by the year, there is a 13% discount applied, with a rate of 51 EUR per kilowatt per month.

As for their inventory, Blockbase offers a Canaan AvalonMiner 841 (19), which is an ASIC machine produced by the company Canaan (20), and this is used to mine Bitcoin. The website lists these machines as currently in stock. As for the power consumption of these ASICs, they consume 1290 watts, and produce a hashrate of approximately 13.6 TH/s. The other mining machine options available is a GPU Miner P 102 100 (21), used for mining cryptocurrencies such as Ethereum, Monero, and Zcash. These machines are listed to be on backorder and require a 50% deposit per machine. As for the power consumption of the GPU miners, they consume 1582 watts, and produce a hashrate of approximately 380 MH/s.

99% Uptime

Stanic described how Blockbase is different from other mining services in the space, in that they offer a 99% uptime guarantee. Mining machines do experience failure due to continuous and rigorous operation, and when a failure happens to a client’s machine, that client is exposed to downtime until the machine is fixed. Sometimes this could take weeks for a manufacturer to repair the machine if it is under warranty, and by this time, the client will most likely lose money on their investment because when the network difficulty increases and more mining machines come online competing for the block reward, the window for achieving profitability with a mining machine gets smaller and smaller. To fix this exposure to risk, and to guarantee a 99% uptime, Stanic described, for example, that they could purchase an additional 20% of machines, so that in case a machine goes down, they are able to replace the failed machines with a new machine quickly, so their clients are back online mining right away and experience very little downtime. Further, Blockbase has implemented an online portal that allows clients to connect their own cryptocurrency addresses for receiving their rewards, and the rewards are paid out daily.

Conclusion

Overall, Stanic seems very knowledgeable about mining cryptocurrency and Blockbase appears to have a great location in Sweden with a long mining history. For the most part, the pricing of the service seems out of reach for the hobby miners and seems more like a service for well-funded companies who are serious about getting into the mining space. Stanic and Blockbase welcomes all their potential clients to visit their facilities in Sweden to check out their operations, and anyone interested in doing so, should reach out to them through their website. Always do your own due diligence71 before making any investment decision.

No Room for Trust in A Trustless World

One of the greatest innovations of Bitcoin is being able to transfer digital money in a peer to peer fashion without having to trust a centralized intermediary. Many refer to Bitcoin as trustless, there is no need to trust person or entity, all that is required is to trust the computer source code, the math, and the cryptography behind the system. Being that the computer code is open source, this allows anyone in the world with a computer and internet access to perform an audit.

The moment a centralized intermediary comes into play in the cryptocurrency ecosystem, trust is required. Purchasing specialty cryptocurrency mining equipment, using a mining pool, or renting computation power from a cloud mining service requires extreme trust. With cryptocurrency mining equipment manufacturers, you must trust that the supply chains for sourcing the materials are in place, that the materials arrive on time and on budget, that the machines actually get assembled and delivered, that the software on those machines is secure with no backdoors, and that those machines actually perform as their supposed to, among many other factors. With a mining pool, you must trust that the mining pool software is secure with no backdoors and that they are actually capable of delivering the reward for allocating your computation resources to their pool. With cloud mining services, you must trust that the data center exists, that the computer or computers that you are renting exist and are solely dedicated to your exclusive use, and that their software is secure with no backdoors.

With that said there have been many companies who have been leading examples by following industry best practices that security conscious consumers would expect. There have also been many poorly managed cryptocurrency mining operations, bad actors, and outright scams. In the early days of Bitcoin, companies began popping up claiming they were going to manufacturer specialty computers or chips for mining Bitcoin or other cryptocurrencies and they would offer “presales” of their equipment on fancy looking websites with incredible statistics. After the “presale”, the company would suddenly disappear, leaving unsuspecting purchasers at a loss of their hard-earned Bitcoin or fiat currency. In addition, there were incidents with mining pools that were compromised, whether from insiders or from external hackers, and the miners who contributed their precious computation resources had to suffer the consequences and loses. There have also been cloud mining operations that claimed to have data centers full of specialty mining computers without actually having the number of computers, or even any at all at their disposal for their customers.

We would like to point out important information to those who are new to the cryptocurrency space. It is unwise to give someone access to your private keys. In the same thought pattern, unless you are in direct possession of or control over the cryptocurrency mining machine, and that machine has open-source software that has been audited or reviewed by the community passing a community credibility check, you are essentially giving someone else access to your private keys. Make sure you trust the service provider who manages your cryptocurrency mining machines for you.

(1) Narayanan, A., Bonneau, J., Felten, E., Miller, A., & Goldfeder, S. (2016). Bitcoin and Cryptocurrency Technologies. New Jersey: Princeton University Press.

(2) See https://alpinemining.ch/en/

(3) See https://ch.linkedin.com/in/thomasludovic1991

(4) See https://ch.linkedin.com/in/thomasludovic1991

(5) See “Cryptocurrency mining to restore Alpine village’s goldrush fever”, swissinfo.ch, January 10, 2018

(6) See https://alpinemining.ch/2018/05/14/communique-de-presse-mai-2018/

(7) See https://unityinvestment.ch/

(8) See https://www.linkedin.com/in/richard-kobler-0310252/

(9) See https://www.linkedin.com/in/seanprescott/

(10) See https://unicrypt.com/

(11) See https://unityinvestment.ch/#proactivemining

(12) See https://unicrypt.com/contact

(13) See https://zw.linkedin.com/in/techdisplay

(14) See https://blockbasegroup.com/

(15) See https://blockbasemining.com/

(16) See https://at.linkedin.com/in/alexander-dietrich-b90681154

(17) See https://blockbasemining.com/mining-farm-sweden/

(18) See https://blockbasemining.com/pricing/

(19) See https://blockbasemining.com/hardware-servers/asic-miners/

(20) See https://canaan.io/

(21) See https://blockbasemining.com/hardware-servers/gpu-miners/

(22) See “The Blockbase Mining Connections”, The Financial Telegram, June 30, 2018

Technical Analysis: Spring Awakening?

Florian Grummes

April 30, 2019

“Technical analysis is not the holy grail but the best approach to grasp the hyper complex markets at a glance.”

Florian Grummes

Key Takeaways

Technically, Bitcoin and thus the entire crypto sector was definitely in a bear market until the end of March 2019. Since the sharp outbreak of over $4,150 and the rise to $5,330, however, the situation is no longer quite so clear.
At the moment, the Fear & Greed Index is increasingly providing warning signals and indicates that market participants are too optimistic or greedy. At any rate, the ideal time to buy based on sentiment analysis is now clearly behind us.
As long as Bitcoin cannot regain the psychological $6,000 mark, any price recovery remains only a bear market rally below the decisive resistance zone.

Winter has had a firm grip on the crypto sector for over a year. However, we were able to see who was swimming naked when the tide went out. The last two months saw a bottoming out and respectable recovery. The price has already increased $2,200 from the low of $3,125. This is an increase of almost 70%. This recovery may merely be a temporary thaw. However, it could also be the beginning of spring.

Review

Last year, in the March 2018 edition of the Crypto Research Report, we suggested a further correction could occur and warned about a potential crypto winter, when Bitcoin was still trading at over 11,500 US dollars.(1) Since then, prices have ultimately only gone further south despite sharp and profitable counter-movements. With the failure of the round psychological mark of $10,000 at the end of April 2018, a series of even lower highs could no longer be stopped. Nevertheless, Bitcoin prices were able to remain above $6,000 during the summer. It was not until autumn that this extremely important support became fragile.

Technically speaking, Bitcoin has had a descending triangle/ bearish wedge (2) during the first 10.5 months of 2018. After bouncing off the support zone around $6,000 six times and at the same time establishing a series of lower highs, it was just a question of time before the support around $6,000 would break. Breaking such a strong support makes any market crash. A similar formation in the goldmarket occurred in 2013, when gold was priced around $1,520. The same is true in an uptrend as well. The more often a market runs against a resistance zone the less strong the resistance line becomes. This is similar to Bitcoin’s resistance around $1.000-$1.200. It took a few attempts before Bitcoin finally broke through that number to the upside. After that, the massive rally in 2017 really started to gain steam.

Further falling prices were also suggested by us in the October edition of the Crypto Research Report. (3) Consequently, after the $6,000 support was broken, Bitcoin’s price halved again. However, a non-laughable recovery of 70% has been observed since mid-December when Bitcoin hit its low of $3,125. Meanwhile, Bitcoin is trading around $5,000, and has completed its first bottom formation. However, Bitcoin will experience numerous resistances levels going forward!

Parallel to the bleak price development of Bitcoin, most Altcoins had lost between 80% and 100% of their peaks. Many projects have now been buried. Fraud, mismanagement, and lack of a good business model were widespread. Rightly so, utility coins garnered a shady reputation for the entire blockchain industry.

However, we are still convinced that the public blockchain technology has fundamental value as a non-confiscatable asset for wealth preservations. Highly motivated and specialized tech teams worldwide are still working in the background on the further development of numerous blockchain and crypto projects such as Blockstream’s Liquid, the Lightning Network, and Plasma. Therefore, the epic popping of the 2017 bubble could actually offer an enormous opportunity. Generally, small investors lack knowledge and discipline, and trade and invest very emotionally. They usually don’t have deep pockets and give up at the lows and buy at tops. Smart money, which is not necessarily institutional money, does the opposite: buying when prices are low and nobody is interested, while selling once everybody wants to buy. Strong hands have a plan and are patient. Right now, crypto markets are quiet, and investors can slowly accumulate during this depressed environment. To handle the volatility of the cryptocurrency market, a radically countercyclical approach is needed.

Is Bitcoin Dead?

Of course Bitcoin isn’t dead. Even though the first crypto currency has only existed for a decade, the Bitcoin has been declared dead countless times. During this period, however, the value of a Bitcoin rose from 0.003 US dollars to almost 20,000 US dollars in the meantime. Basically an incredible success story! And even at current exchange rates of around 5,000 US dollars, you still have to pay almost four times as much for a Bitcoin as for an ounce of gold.

The collapse of the crypto sector is weeding out the bad business models. A similar situation occurred after the bursting of the dotcom bubble at the beginning of 2000/2001. More than 75% of the tech companies founded during the Internet boom in the late 1990s went bankrupt. But some of the biggest and most powerful companies of all time emerged from the ashes: Amazon, Google and eBay, for example, not only survived the crash, but are now an integral part of our everyday lives. The share prices of these companies have increased more than a hundredfold in the last 15 years. The same can be expected for the cryptocurrency market over the next ten year.

Of course, the market capitalization of the entire sector, currently around $160 billion, is negligibly low compared to other sectors and is far removed from the almost $850 billion in January 2018. The daily trading volume, at just under $30 to 40 billion, is also 60% below its highs of December 2017. Many small investors either sold their crypto investments at high losses or are blindly holding onto their underwater positions. At any rate, speculative money has left the sector at the moment. This lack of speculative money can also be observed by the decline in blockchain conference participants throughout Switzerland. Conference organizers have to give free tickets away in order to fill the hall.

Market Sentiment in the Short and Medium Terms

The mood in the crypto sector reached an absolute low in mid- December. One tool for determining the exact trend reversal point is the Fear & Greed Index. The index reached a low of 10 in mid-December, which lasted several months. As in all asset classes, returns are based on the individual behavior of countless market participants. The vast majority of buying and selling decisions are made very emotionally. Medium-term turning points often observe extreme fear or blind greed. Mass psychology is an underlying factor drives prices in any market. At market tops like the one in December 2017/January 2018, everybody is bullish and invested. Exactly at this stage you can observe blind greed. At bottoms the contrary is true, everybody is afraid, depressed and has lost his beliefs plus sold his positions in blind panic.

Generally, sentiment analysis makes the following assumptions: extreme fear can be a sign that investors are worried. That could be a buying opportunity. When investors are getting too greedy, that means the market is due for a correction. The Fear & Greed Index consists of five different data sources and is calculated automatically on a daily basis. Values of 0 mean extreme fear, while the maximum value of 100 stands for extreme greed and exuberant optimism. The index is comprised of several variables. Bitcoin volatility makes up 25% of the index. An unusually high volatility is a sign of an anxious market, similar to the stock market. The market momentum or trading volume contributes a further 25% to the index calculation. Market sentiment on social media including keywords on Twitter, are weighted 15% in the calculation. Weekly surveys among crypto investors and the Bitcoin dominance compared to the more speculative Altcoins make up 15% and 10% of the index respectively. The index is rounded off with various Bitcoin search queries (Google Trends data), which provide the last 10% for index calculation. An example of this is the query “Bitcoin price manipulation”, which is clearly a sign of increased fear in the market.

At the moment, the Fear & Greed Index reads high optimism values, which could be a cause for concern. According to market sentiment analysis using the Fear and Greed index, the ideal time to buy based on sentiment analysis is already behind us. It should also be noted that an extreme euphoria can rarely be observed in a bear market. Should it arise, it must be interpreted as a good sell signal. If a market is in a bear market, which we are, then any rally/recovery will create too much optimism, which cannot be fully supported while the overall trend is still down. The most extreme number for this sentiment index was around 75, therefore, 51 is not extreme optimism but rather this is moderately too optimistic.

The Bitcoin Optimism Index (Optix) published by Sentimenttrader currently comes to a similar conclusion. Sentimentrader.com do not share their formulas; however, each measure is ranked against its historical norms to determine whether or not the current level is at an extreme. The Optix can go from 0 (maximum pessimism) to 100 (maximum optimism), though it generally stays above 20 and below 80. As with most contrary indicators, when sentiment gets extremely pessimistic, below 30, we would become alert to a possible reversal to the upside as expectations improve from very low levels. When sentiment is very high, above 70, then we would become concerned about a correction as expectations may have gotten too optimistic.

For bitcoin, the Optimism Index has worked best when using a moving average, such as 10 days. “There is curretly a neutral optimism indicator. The psychological low of the last mass panic was measured on December 14, 2018. The calculation is based on future volatility expectations, the average discount of an unspecified Bitcoin fund against its net asset value and general price behavior. Overall, the sentiment analysis recommends a wait-and-see approach in the short term.

Technical Analysis: Possible Price Targets and
Accumulation Zone

Technically, Bitcoin and thus the entire crypto sector was definitely in a bear market until the end of March 2019. Since the sharp outbreak of over $4,150 and the rise to $5,330, however, the situation is no longer quite so clear. On the one hand, the downward trend line of the last sixteen months was clearly broken and since the low of December, the share price has already risen by over 70%. On the other hand, the price continues to move clearly below the former support zone by $6,000 – 6,200, while the stochastic oscillator on the weekly and daily charts is completely overbought. As long as the Bitcoin cannot regain the psychological level of $6,000, any price recovery remains only a bear market rally below the decisive resistance zone.

At the end of March, the Bitcoin was able to free itself from its threeand- a-half months of soil formation on the daily chart. The rise above 4,150 US dollars resulted in massive short covers, which drove prices up almost vertically. The price target from the ascending triangle was in principle worked off at 5,330 US dollars.

As a further rising triangle is emerging in the very short term, the Bitcoin exchange rates could also rise to 5,700 – 5,800 US dollars in the coming days and weeks. However, the resistance around 6,000 US dollars is extremely strong and should by no means be underestimated.

Of course, the newly established series of higher lows is positive. The strongly overbought Stochastic Oscillator, on the other hand, is negative. In any case, the air is now getting thinner and thinner with every further rise.

The imminent setback should lead at least to the still falling 200-day line (4,575 US dollars). It is also possible that only the rising 50th day line will catch the reset. In any case, the constellation of the two moving averages indicates that there is still some need for consolidation overall.

The large picture therefore still lacks a clear trend reversal. In the months to come, an irritating sideways phase is more likely to be planned. Similar to the closing of the last bear market in late summer 2015, a final slip of less than 3,000 US dollars might even be 1,500 US dollars. Only then would the sector be ready for a new bull market. 2019 should therefore be a year of transition.

However, as soon as the Bitcoin manages a weekly closing price above 6,200 US dollars, all bearish doubts will be dispelled. Then we have to assume that the correction has already reached its final low in December and that the Bitcon is already in a new upward wave. In this case we have to buy every backstop (Buy The Dip).

(1) Technical Analysis: Is a Crypto Winter About to Start? Grummes (2018). Crypto Research Report, pg. 51

(2) See “Descending Triangle”, www.stockcharts.com

(3) The Network Effect As a Valuation Methodology. Hays and Zapke (2018). Crypto Research Report, pg. 42

Equity Tokens

Demelza Hays

January 15, 2019

“Fractional ownership is not unique to blockchain, in fact, it’s not even unique to this century. Joint ownership dates back to the Roman Republic, or the Dutch East India Company in more modern times. However, some assets classes such as commercial real estate and fine art continue to be characterized by high unit costs.

A typical retail investor cannot harness the resources required to buy a Manhattan high rise. The investor is left with two options: (1) Forego exposure to Manhattan commercial real estate in their investment portfolio, or (2) gain exposure through an intermediary, for example a publicly traded Real Estate Investment Trust (REIT), where it is often bundled with a portfolio of other buildings of varying quality and characteristics. Security tokens offer an efficient path to fractionalize a single high value asset.”

Stephen McKeon,
Professor University of Oregon

Key Takeaways

Equity tokens enable companies to raise equity using blockchain technology without locking up investors.
Issuers of securities tokens are seeking to access the large pool of institutional money that has not yet penetrated the crypto currency market. Institutional investors expect KYC/AML, data protection and see a hurdle in one of the core elements of the blockchain, namely its immutability.
In 2019 there will be a race between stock exchanges, which can offer the first regulated market for securities tokens.

The Austrian Financial Market Authority approved the first financial prospectus for a fully regulated tokenized security in the European Union in late November. The Financial Market Authority in Liechtenstein already approved Liechtenstein’s first security token in August. Mt. Pelerin, Tokenestate, and Securosys are also purportedly offering security tokens in Switzerland. This means that a cryptocurrency can represent legal ownership in a company or can represent other securities, such as certificates and bonds, if they also register as a security. Unfortunately, there are no cryptocurrency exchanges that are licensed to trade security tokens. However, equity tokens are not for the standard cryptocurrency investor. Instead, equity tokens are trying to access the large pool of institutional money that has not entered the cryptocurrency market yet.

Institutional Money-Steering Innovation

The public blockchain technology reduces the cost of raising capital, and this matters for small firms. One of the main benefits of trading digital assets on the public blockchain infrastructure is that anyone can issue a digital asset, and anyone can invest in a digital asset. This saves immense amounts of time and money for issuers who no longer need licenses, underwriters, or lawyers. The large cost of listing a company on a stock exchange erects barriers to entry for small and medium-sized enterprises (SMEs). The blockchain also removes the barriers to entry posed by regulations that limit investment possibilities for retail investors like grandma.

In addition to enabling financial inclusion in the market, the public blockchain technology allows investors to trade “shares” of companies for much lower fees with instant settlement times. This means significant savings for retail investors and smaller profits for stock brokers.

However, some investors, especially institutional investors, want features of the traditional capital market to be incorporated into the token market. Enter “Security Token”. Over the past few months, the term “Security Token Offering” (STO) has been growing in importance compared to initial coin offerings. There are three main problems institutional investors have with the Wild West of blockchain:

Not all cryptocurrencies follow the laws such as know-your-customer, anti-money laundering, sanctions, etc.
Large investors want privacy. They do not want transparent blockchains that allow outsiders to see their transaction amounts and destinations.
Public blockchain cryptocurrencies are impossible to retrieve if a private key is hacked or lost. Large investors will not want their shares of Visa stock being controlled by a private key. Instead, cancel and reissue features will be required before the security token market can gain adoption.

In order to manage these concerns, several companies are working on private blockchains that will allow equity tokens to be stored and traded. The Swiss stock market’s Swiss Digital Exchange (SDX) near Sihlcity is working on a pilot project that wants to tokenize four main groups of assets.

First, native tokens for SMEs that only exist on SDX will be issued, stored, and traded.
Second, tokenize existing securities on the SIX Swiss Exchange.
Third, tokenize non-bankable assets.
Fourth, tokenize cryptocurrencies, such as Bitcoin and Ethereum.

In addition to SDX, Daura, a partnership between MME and Swisscom, is also working on a private blockchain. Blockchains specifically designed for trading securities will have KYC/AML integration, privacy, and cancel and reissue features that allow the stock exchange owner or broker to reissue shares to companies that lost their private keys or were hacked. Blockstream’s LIQUID and Polymath are also both examples of blockchains targeting the security market. However, important legal issues, such as whether or not tokenizing a fund violates fund distribution rights, still need to be answered.

Define Token and Security

A token is a digital representation of value on a particular distributed ledger. Tokens can represent voting rights, ownership shares, bonds, and much more. ERC 20 smart contracts on the Ethereum Blockchain and NEP5 smart contracts on the NEO blockchain are currently being used to pay out company dividends and vote on managerial decisions. On the other hand, the definition of a security differs from jurisdiction to jurisdiction. In the US, a financial product is legally classified as a security if the four following criteria are met:

Investment of value
With an expectation of profit
In a common enterprise
With the profit to be generated by a third party

As mentioned in the next chapter, these criteria came from the 1946 Supreme Court case between a Florida citrus grower named Howey and the Securities Exchange Commission. In response, US cryptocurrency issuers are applying for Reg D. and Reg S. exemptions from security law. They are also exploring how Airdrops can circumvent security law.

However, Europe does not have any concept of the Howey test. This is because the US has common law where court cases set precedents for future judgements. In contrast, mainland Europe has civil law, which is a principle-based approach to law. According to Article 2 let. b FMIA in Switzerland, a security is defined as, “standardized certificated and uncertificated securities, derivatives and intermediated securities, which are suitable for mass trading.” Subsequently, FINMA has already reported that many cryptocurrencies are securities.[1]

Should I Tokenize or Securitize or Both?

Tokenization of assets existed before cryptocurrencies were created. They are called certificates. However, certificates cost money to set up and maintain. Unlike issuing an ERC token on Ethereum, certificate issuers must have a business structure that can legally issue structured products, and often certificates are limited to qualified investors. According to the Swiss Collective Investment Schemes Act (CISA) of 2006, a qualified investor is one of the following[2]:

Supervised financial intermediaries (such as banks, securities dealers and investment fund managers)
Supervised insurance companies
Public law institutions and pension funds with professional investment operations
Business enterprises with professional investment operations
Wealthy private persons (German: vermögende Privatpersonen) with CHF 2 million worth of financial assets, and direct real estate investments do not count!
Investors who have a written asset management agreement with a supervised bank, securities dealer or investment fund manager

One type of structured product is a certificate. A certificate can be a tracker certificate that tracks the value of an asset, or a certificate can be actively managed. The asset could be an IBM share or a cryptocurrency index, or a physical plane, for example. Bank Vontobel, for example, creates many certificates. A certificate is similar to a bond because it represents a predetermined payoff promise that the issuer gives to the investor. This means that the investors can read in the terms of conditions what they will get from the certificate when the certificate expires. For example, the promise could be that “In two years you get the performance of IBM shares.” However, certificates can be actively managed as well. Actively managed certificates (AMCs) can contain any type of cryptocurrency, including privacy coins, pre-ICO coins, and ICO coins. Investment managers can also employ riskier strategies than UCITS or AIF can such as shorting and taking leverage.

Certificates are like tokens in the sense that they can be used to securitize anything. The only difference is that certificates contain normal investor protections and they can be easily purchased through security brokers. Since they adhere to existing regulations, they have certain costs. Therefore, securitization of an asset using a certificate only begins to make sense for assets worth over ₣ 10,000. Unlike UCITS and AIF regulated cryptocurrency funds, such as Incrementum’s, structured products are exempt from the collective investment scheme regulations.

GenTwo Digital, a joint venture of GenTwo AG and Inacta, is a Swiss consultancy firm based in Zug. GenTwo Digital was founded by Patrick Loepfe, a previous Vontobel Deritrade specialist, and the Vice President of the Board or/and Managing Partner of Forstmann, Philippe A. Naegeli. In an exclusive interview with Patrick Loepfe from GenTwo, we discussed the innerworkings of how securitizing a cryptocurrency works. The company helps financial intermediaries, high net worth individuals, and family offices turn bankable assets, such as actively managed accounts and structured products, and non-bankable assets, such as art and cryptocurrencies, into tradable certificates with Swiss International Securities Identification Number (ISIN) numbers. An ISIN number is code that uniquely identifies a specific securities issue.

In Switzerland, obtaining an ISIN code for a security requires a prospectus, term sheet, and offering memorandum. In traditional finance, ISINs are used for stocks, bonds, funds, hedge funds, mutual funds, and other securities, whether for a private offering or going public with an IPO (initial public offering).

What GenTwo does is build a financial company for each investment manager, and then the investment managers can issue multiple certificates within the company. GenTwo’s issuing structure is a unique dedicated issuance vehicle in Guernsey. Once GenTwo sets up the special purpose vehicle company, investment managers can build structured products as they wish. The advantage of setting up a dedicated issuance vehicle is that issuers can have balance sheet control where liabilities are stored off the balance sheet. Normally, issuers risk balance sheet risk from holding assets on the active side and liabilities that can be impacted from operational issues. Instead, an SPV structure leaves only the assets on the active side of the balance sheet and the certificates on the passive side. Since the certificate tracks the value of the assets that are held on the active side, there is almost no risk of a default. For example, Bank Vontobel has an SPV in Dubai from which they issue their certificates. Julias Bär has a SPV in Guernsey, EFG has a SPV in Guernsey.

Certificates are not really competitors for tokens. Tokens can be issued by retail investors and anyone in the world can invest in them. At Incrementum, we suspect that one will not completely replace the other for the time being. Instead, some market participants will choose to invest in the regulated world and other market participants will choose to invest in the unregulated world. Many companies will raise capital in both markets. As Oliver Völkel said during the Crypto Christmas Market Outlook, the main problem with equity tokens is that a licensed exchanged where investors can trade these assets does not exist. 2019 will be a race for the first legal platform that can trade cryptocurrencies that represent securities.

[1] See Wegleitung für Unterstellungsanfragen betreffend Initial Coin Offerings, FINMA, February 16, 2018.

[2] See “Qualified Investors,” Swiss Fund Data AG, 2018.

Disclaimer: GenTwo is an official partner of the Crypto Research Report. None of the information you read in this article should be taken as investment advice, nor do the writers of the Crypto Research Report endorse any project that may be mentioned or linked to in this article. Please do your own due diligence before taking any action related to content within this article.

Legal Challenges for Blockchain-Based Capital Markets

Christian Meisser

January 14, 2019

Legal Challenges for Blockchain-Based Capital Markets

“Blockchain technology can achieve what governments wanted to achieve for a long time: a fair, secure and attractive capital market for start-ups, SMEs and investors.”

Christian Meisser, LEXR AG

Key Takeaways

Tokenization seems to be interesting for small and medium-sized enterprises, as the cost of raising capital via tokens is sometimes lower than on the traditional capital market.
The regulatory classification of whether an issued token represents a security has far-reaching implications and is of the utmost legal relevance. The assessment of whether a token is to be treated like a security under supervisory law is fundamentally different in various jurisdictions.

Capital Flows to the US

Start-ups as well as small and medium-sized enterprises (SMEs) are praised for being a driving force of economic growth. In principle, Europe offers excellent conditions for growth, with a mobile and well-educated talent pool, a huge domestic market, and modern infrastructure. Nevertheless, risk capital for start-ups is scarce and promising start-ups move abroad. According to a press release of the European Commission,[1] in 2016 venture capital providers invested only € 6.5 billion in the entire EU, just about one sixth of the € 39.4 billion invested in the US. According to the same release, only 26 European companies were regarded as “unicorns” at the end of 2017 (unlisted companies with a theoretical market capitalization in excess of $ 1 billion), while 109 such companies existed in the US and 59 in China.

Not only start-up funding but also financial market support for SMEs appears to be lacking. One reason why start-ups are left wanting is widely considered to be the lack of “exit” opportunities in the form of listings: in 2017, the number of European IPOs of SMEs was still down 50 percent from the time prior to the financial crisis.[2]

With public markets for SMEs weak, venture capital firms hesitate to invest in SMEs at all. While the EU tries to improve the situation with subsidies, harmonization of capital markets and mild deregulation, the world of start-up funding is fundamentally changing because of the blockchain technology. The possibility of transferring assets directly between two parties without intermediaries enables an enormous simplification of issuance and trading of capital market instruments. Thus, start-ups raised $ 5.5 billion worldwide in 2017 by issuing tokens in the framework of ICOs – and this year the total amount has already swelled to $ 14.3 billion.[3]

But not only primary markets (i.e., the initial issuance of ICOs) are thriving. Daily trading volume in tokens in secondary markets amounts to several billion USD.[4] Thus, blockchain technology has already furnished impressive proof of its application potential in capital markets. From the perspective of investors, it was evidently worth the risk – according to one study, the average return on investment on ICOs stands at 82 %.[5] However, the legal design of such tokens as this new technology emerges has received little attention so far and investors rarely enjoy enforceable rights. The trend is clearly moving toward issuance of so-called security token offerings: more and more ICO teams want to tie tokens to enforceable rights, which provide token owners with a legal position akin to that of shareholders. Thus, the vision of a capital market in which start-ups and SMEs are able to access needed growth capital without having to move offshore and which offers investors safe and simple access to diversification opportunities is coming within grasping distance.

This article presents legal challenges for effective blockchain-based capital markets in different countries by way of examples and in particular discusses the following subjects:

Challenges posed by the classification of tokens in financial market regulations
Legal preconditions for the issuance of security tokens
Legal framework conditions for trading in security tokens

Classification of Tokens as Securities

Classification of tokens within the existing framework of civil law is already quite difficult and the opinions of legal scholars differ widely: for instance, in Switzerland it is debated whether tokens are digital assets, contractual rights, or a special form of assets in their own right.[1] This represents a difficult task for regulators with respect to a legal assessment in terms of financial legislation. Obligations under financial market regulations with respect to the issuance and trading of tokens directly depend on their legal classification. For example, if tokens are classified as securities[2] under a specific legal order, public offerings of such tokens without an appropriate prospectus may make issuers liable to criminal prosecution. Accordingly, correct classification is quite important, but it is anything but trivial: not unlike a blank sheet of paper, tokens can be configured with any combination of rights and obligations, or in the framework of smart contracts even with complex, automated processes. Various countries are trying to meet this challenge in very different ways:

Classification of tokens within the existing framework of civil law is already quite difficult and the opinions of legal scholars differ widely: for instance, in Switzerland it is debated whether tokens are digital assets, contractual rights, or a special form of assets in their own right.[6] This represents a difficult task for regulators with respect to a legal assessment in terms of financial legislation. Obligations under financial market regulations with respect to the issuance and trading of tokens directly depend on their legal classification. For example, if tokens are classified as securities[7] under a specific legal order, public offerings of such tokens without an appropriate prospectus may make issuers liable to criminal prosecution. Accordingly, correct classification is quite important, but it is anything but trivial: not unlike a blank sheet of paper, tokens can be configured with any combination of rights and obligations, or in the framework of smart contracts even with complex, automated processes. Various countries are trying to meet this challenge in very different ways:

The approach that has been historically established in US case law is based on flexible rather than static principles, which makes it possible to adapt regulations to the countless different possible designs.[8] This is primarily based on the Howey Test and the term security is tied to whether “an investment in a common venture is premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.” Whether there is indeed “a reasonable expectation of profit” is sometimes questionable, particularly in ICO projects which refrain from according any rights to investors. Supervisory authorities can strengthen legal certainty by regularly publicizing relevant rulings.

The legal situation in the EU is more formal. The EU directive on markets for financial instruments (better known as MiFID, or MiFID II) has largely harmonized financial markets in the single European market; the term “financial instrument” was defined in Annex I, section C. Unfortunately, it remains essentially unclear under what circumstances a security token is actually classified as a financial instrument. The definitions in the directive refer to “old world” terms (i. e. before blockchain technology), which simply cannot accommodate the plethora of possible designs associated with tokens. The Malta Financial Services Authority has at least attempted to provide some clarity in the form of a financial instrument test.[9] Without practical examples, the definitions nevertheless exhibit a degree of abstraction that leaves market participants unsure if tokens are deemed to represent financial instruments in view of the multitude of possible configurations.

The Swiss financial market supervisory authority Finma has decided on a compromise in its ICO guidelines.[10] Similar to the method adopted in the US, a functional approach is used with respect to investment purposes. At the same time, formal criteria are taken into account as well, and essentially every token that represents an asset is considered a security token. Due to these comparatively clear criteria and the possibility of asking Finma to provide regulatory information on specific cases in advance, the legal situation pertaining to various token configurations can be easily assessed in Switzerland.

The tokenization of traditional securities, such as stocks or bonds, is the easiest to assess: The laws were written for these types of securities and issuers are unlikely to face surprises with respect to tax consequences either. In order to prevent the erection of inappropriate barriers to innovation in virtual worlds and the tokenization of real assets, a restrictive application of the various terms designating securities would be welcome. For example, if one were to tokenize tickets to an event, such tokens may already be regarded as securities in several countries: for one thing, a real asset is underlying the token, for another thing one may well purchase event tickets for investment purposes, i. e. in the hope of being able to sell them at a higher price at a later date. At the same time, it seems hardly appropriate to having to issue a prospectus or to trade such tokens on a regulated exchange.

Primary Market: Issuance of Security Tokens

From a technical perspective, the internet makes it easy to market token offerings globally, and cryptocurrencies allow investors to buy tokens globally. Expensive intermediaries such as investment banks are barely needed anymore. The rapid growth of ICOs demonstrates that such a global capital market offers highly attractive funding opportunities for companies. However, upon issuing security tokens one is faced with a patchwork of national regulations. The most important aspect in this context: potential prospectus obligations.

A prospectus is intended to provide investors with the information required to make an investment decision. What information precisely has to be included varies from country to country and ranges from (for the time being) a few pages in Switzerland to almost book-sized tomes in the US. Prospectus requirements in the EU are so demanding that small funding rounds are barely worth the investment of time and money needed to draw up and publish a company’s financial statements. As an illustration of the costs involved: according to the Official Journal of the EU, the cost of drawing up an EU prospectus for offers of securities to the public with a total consideration of less than € 1,000,000 is likely to be disproportionate to the proceeds.[11] And that is just the prospectus for the EU. For every additional country in which tokens are to be offered, one has to verify whether a prospectus needs to be published and/or has to be reviewed by the local authorities.

Prospectus obligations may be limited or waived entirely below a certain threshold and plans by a number of countries to raise such thresholds for prospectus publication obligations have to be welcomed in this context (in the EU to around EUR 8 million or in Switzerland to CHF 2.5 million). Further relief is to be provided by various exemptions, such as thresholds on the number of investors or the focus on professional or accredited investors. While prospectus obligations and restrictions on distribution represent barriers to security token offerings, there already exist numerous projects which are able to implement such offerings successfully and with legal certainty. Along with growing interest, the required know-how will spread in the marketplace and costs will be lowered further, not least through the use of legal-tech software for drawing up documentation in various countries.

Secondary Markets: Trading in Security Tokens

The most impressive efficiency gains are possible in trading. Thanks to smart contracts, so-called decentralized trading platforms can be built, which enable trading between two parties without any intermediaries or counterparty risks. The assets to be traded are safely stored via the smart contract, and once the required conditions are fulfilled, clearing and settlement takes place automatically on the blockchain. Infrastructure costs, such as centralized security depositories, security settlement systems, or banks, and counterparty risks disappear. It is simply not possible in such a system to be affected by a default such as that of Lehman Brothers.

A sensible function that remains in place consists of match-making platforms similar to those operated by stock exchanges or other trading platforms, which are in particular aimed at efficient price formation and the prevention of market abuse. From a regulatory perspective, risks, such as insider trading and market manipulation, remain extant in the blockchain world as well, and modern-day regulations are in essence applicable to trading platforms for security tokens. In the meantime, both established exchanges such Switzerland’s SIX[12] and blockchain enterprises in a number of countries have made public announcements regarding the development of security token trading platforms. As “old-world” regulations remain applicable, a license is necessary, which has so far not been granted in any (developed) country. Moreover, the focus of proposed or already implemented blockchain-related legislation in various countries is on cryptocurrency trading and on utility tokens – which has largely no effect on the regulation of security token trading venues. Nevertheless, advisory practices and press releases by numerous enterprises in the industry give cause for confidence that trading venues for security tokens will be established shortly. After all, for ICO teams the tradability of a token is an important criterion affecting its design.

Final Remarks

The consummate ease with which tokens can be issued, transferred, and equipped with automated payment functions could be the basis for an “internet of finance” – a new generation of financial markets in which even the smallest projects can quickly and safely obtain external funding without intermediaries. Imagine for example a small bakery in a village which can get funding for a new oven from its loyal customers by issuing a tokenized micro-bond with automated interest payment features, or a movie project which automatically pays out a share of its revenue to the community of fans that funded it with every download. The indirect interaction between capital seekers and capital suppliers makes not only large, global funding rounds possible but also promotes stronger relationships between small investors and their local economy.

Moreover, a blockchain-based, decentralized trading system provides greater stability and safety, as the absence of intermediaries removes potential points of failure and middlemen whose incentives are not necessarily aligned with those of investors. In order for this technology to achieve its full potential for creating an attractive capital market for companies and investors, existing regulations have to be applied with sound judgment and a sense of proportion. Luckily the legislative pendulum is currently swinging toward deregulation again, and more and more regulatory exemptions are planned, particularly for start-up companies and small and medium-sized enterprises.[13] However, in order to make it possible for unicorns and already successful companies to obtain adequate funding in their home markets, more than exemptions for small projects will be needed. In a global financial market characterized by mobile talent, courage on the part of regulators to open up and liberalize markets stands to be rewarded.

[1] See “EU: €2.1 billion to boost venture capital investment in Europe’s innovative start-ups” [press release], European Commission, April 10, 2018.

[2] See Building a proportionate regulatory environment to support SME listing [public consultation], European Commission, 2017.

[3] Figures according to Coindesk ICO Tracker, accessed September 19, 2018.

[4] Figures according to CoinMarketCap, accessed September 19, 2018.

[5] See “Digital Tulips? Returns to Investors in Initial Coin Offerings,” Hugo Benedetti and Leonard Kostovetsky, SSRN, May 20, 2018.

[6] See “Verfügungsmacht und Verfügungsrecht an Bitcoins im Konkurs” (“Authority to dispose of and right to dispose of Bitcoins in insolvency proceedings”), Christian Meisser, Luzius Meisser, and Ronald Kogens, Jusletter IT: online, May 24, 2018.

[7] The term security is used as an overarching term herein for all designations of a similar type used in different jurisdictions, such as stocks/bonds or financial instruments.

[8] See Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Securities and Exchange Commission, Release No. 81207, July 25, 2017

[9] See Guidance Note To The Financial Instrument Test, Malta Financial Services Authority, July 24, 2018.

[10] See Guidelines for enquiries regarding the regulatory framework for initial coin offerings (ICOs), Finma, February 16, 2018.

[11] See “REGULATION (EU) 2017/1129 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market (prospectus directive 3),” European Union, Official Journal of the European Union, June 30, 2017.

[12] See “SIX to launch full end-to-end and fully integrated digital asset trading, settlements and custody training” [press release], SIX Group AG, July 6, 2018.

[13] See “Fact Sheet Frequently asked questions: Easier access to financing for smaller businesses through capital markets” [press release], European Commission, May 24, 2018.

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John Tromp from Cuckoo Cycle

What is Cuckoo Cycle?

Cuckoo Cycle Variants

What Coins Use Cuckoo Cycle?

MimbleWimble

Grim

John Tromp, Making Computer Science Great Again

Back to the Roots

How Long Will This Bear Market Last

A Tragic Story Traverses the World

When the tide goes out…

A State Cryptocurrency?

Support is Increasing

Spring setting in?

Where are the Institutional Crypto- Investors?

Practical Problems for Institutional Investors

Structural Hurdles within the Asset Management Sector

Gold and Bitcoin – Stronger Together?

The Diversification Effect

The Rebalancing Bonus

Additional Income through “Covered Call Writing” and “Put Writing”

Conclusion

Introduction to Cryptocurrency Mining

Mining Business Costs and Risks

Bitcoin Block Reward Emission Schedule

Updating the Network

Security Layers and Known Attack Vectors

Different Ways to Mine

Mining Pools

Three Interviewed Mining Companies

Alpine Mining Tech SA

What Services Alpine Mining Offers

Conclusion

Unity Investment AG

Beginnings of Unity Investment AG

Mining Pool

The Unicrypt Platform

Additional Businesses Outside of Mining

Conclusion

Blockbase Group DWC-LLC

Scrappy Startup to Large Operation

Blockbase Mining-As-A-Service

99% Uptime

Conclusion

No Room for Trust in A Trustless World

Review

Is Bitcoin Dead?

Market Sentiment in the Short and Medium Terms

Technical Analysis: Possible Price Targets and Accumulation Zone

Institutional Money-Steering Innovation

Define Token and Security

Should I Tokenize or Securitize or Both?

Capital Flows to the US

Classification of Tokens as Securities

Primary Market: Issuance of Security Tokens

Secondary Markets: Trading in Security Tokens

Final Remarks

Premium Partners of the Crypto Research Report

Where are the Institutional Crypto-
Investors?

Technical Analysis: Possible Price Targets and
Accumulation Zone