Facebook’s Libra coin is meeting strong resistance from governments and central banks. But there is also a lot happening in the “traditional” crypto sector. Several players are laying foundations for a regulated market that could attract institutional investors. And Bitcoin reacted to the recent rounds of easing by central banks.
The year 2019 is slowly coming to an end. What was the best place for an investor’s money this year? Prices for Bitcoin have more than doubled since January – even though they have recently fallen sharply again. From April 1 to June 24, they rose by 250 percent – from just under $4,000 to just under $14,000. At the time this report was prepared, Bitcoin was priced at around $9,000.[1]
Figure 1:Almost 1 Million Active BTC Addresses Per Day
Source: Coinmetrics.io, Incrementum AG
“Facebook’s digital currency, Libra, is a mixed blessing for Bitcoin and other digital currencies.” Forbes
Forbes
Whichever way you look at it, Bitcoin beats the second-best asset of the year, namely US technology stocks, by far. This year, they have risen by about 30 percent. Even gold, which is experiencing a quite respectable year, is just up 17 percent. The broad S&P 500 index gained 21 percent. All this fades in comparison to Bitcoin’s growth by more than 140 percent – from $3,300 in January to about $8,200 per coin in October.
Figure 2: Non-Monetary Demand For Gold and Silver Declining (in Tonnes, 2010 – 2019)
Source: The Silver Institute, Refinitiv GFMS, Metals Focus, World Gold Council, Incrementum AG
Still the crypto space has been rather quiet lately. The rise in prices alone was not enough to satisfy the mainstream media hunger for new stories. In addition, Altcoins look rather bad at the moment. Take Ethereum, for instance. The second most important cryptocurrency rose by “only” 80 percent between January (around $100) and October (around $180). The focus of politicians and the media has for some months now not been Bitcoin or Ethereum but the Libra project initiated by Facebook.[2]
One almost has the impression that Libra has displaced Bitcoin from the podium of the most important crypto projects. Especially in the mainstream media, where many journalists have specialized in crypto. And they don’t seem to get enough of the drama around Libra. But: Libra does not yet exist. Worse still, the alliance around the project is already beginning to crumble. [3]
According to Szabo, Bitcoin is more secure that Ethereum.
The currency coins that Nick Szabo is interested in are Mimblewimble-based coins and some of the of the privacy coins including Monero, ZCash, and Dash.
Demelza Hays. Do you think Bitcoin is Turing-complete? What can Ethereum do that Bitcoin can’t? Nick Szabo: No, the Bitcoin main chain is not Turing complete. It does have a Turing-complete sidechain called RSK. Ethereum’s programming language can do open-ended loops for example (up to gas limits) and Bitcoin main chain (layer 1) can’t. Programming Ethereum or RSK gives you the full expressive power of programming whereas programming on the Bitcoin main chain does not. This makes Bitcoin safer and is more appropriate where the main functionalities are store of value and medium of wealth transfer but makes Ethereum and RSK better for smart contracts.
Nick Szabo speaking with Richard Olsen at Money Museum in Zurich, 2016. Source: Google Images.
Demelza Hays: Do you think Bitcoin is digital cash or digital gold? In ten years from now do you think that we will be paying for our coffees with Bitcoin or some derivative of Bitcoin? I think Bitcoin and gold are too inelastic to be used as a unit of account. As the coinbase reward tapers, do you think the Bitcoin main chain will have many transactions with a small fee or do you think there will be few transactions with large fees?
In my opinion, setting an artificial data size limit for each block is similar to the government setting a price ceiling or floor on a good or service. I would allow the block size to be determined each block by the miners. This would be more similar to the free market. If the miners make the size too small in an attempt to earn more from fees, then users will switch to other blockchains that are a substitute service. If the miners make the size too large and certain miners gain an advantage because they can propagate blocks faster then users will switch to a substitute service.
Nick Szabo: Layer 1 is digital gold and Layer 2 is digital cash (among other things it can be — RSK is an example of Layer 2 for smart contracts).
Demelza Hays: Over the past decade, the correlation between Bitcoin and gold has been between positive 0.2 and negative 0.2 and has a slightly positive uptrend at the moment. Since some of gold’s demand comes from non-monetary purposes such as jewelry and industry, we argue that gold will always be less volatile than Bitcoin in terms of purchasing power of real goods and services over time. We have an investment strategy which intends to arbitrage between Bitcoin and gold. As Bitcoin becomes relatively expensive to gold, we sell Bitcoin and buy gold, and vice versa. Do you think the correlation in returns between gold and Bitcoin will go up in the future?
Nick Szabo: Very probably yes.
Demelza Hays: Are there any blockchain projects that piqued your interest recently?
Nick Szabo: The various Mimblewimble-based coins, some of the other privacycoins (Monero, ZCash, Dash), RSK (an Ethereum-like sidechain for Bitcoin).
Demelza Hays: Where do you see the US in ten years from now? Do you see Libra and Bitcoin competing or do you see a David Crowley-style Gray State? Nick Szabo: I suspect Libra will get buried under a political blizzard and doesn’t stand much of a chance. It would compete far more with payment systems like PayPal, and is more akin to things like Tether, than it would compete with or is akin to Bitcoin.
“With a commitment in a structured product,
specifically a tracker certificate, one does not invest directly in the
cryptocurrency but follows the price movements like a shadow. Investment risk
depends on price losses and creditworthiness of the issuer (default risk).
However, the investor must remain vigilant. Just because he has purchased a tracker
certificate from a bank, it doesn’t mean that it’s iron-clad. Should the price
of his cryptocurrency crash or even disappear from the market, there is, of
course, a total default risk here as well.”
Jürgen Kob and Paweł
Sobotkowski
We want to sincerely thank Lucas Ereth and GenTwo Digital for contributing this chapter. Lucas is a managing member of GenTwo Digital (https://www.g2d.io). Our readers can sign up for a free newsletter at https://www.g2d.io/blog. Please note, that GenTwo is a premium partner of the Crypto Research Report.
Lucas Ereth
This chapter features a sneak peek into
the life of the Managing Partner of GENTWO Digital and Forbes DACH 30 Under 30,
Lucas A. Ereth.
What does your business do?
To put it simply, we’re securitization experts working to bridge
the gap between traditional finance and the emerging crypto market. While our
parent company GENTWO creates securities for all asset classes, GENTWO Digital
specializes in the securitization of digital assets. In other words, we convert
digital assets, like cryptocurrencies, into structured products. These products
are then outfitted with an International Securities Identification Number (or
ISIN, for short) ‒ the de facto standard for securities trading internationally ‒ which ensures that the product is “infrastructure
compatible” with every bank and large scale/institutional investor.
In doing so, we turn a digital asset into something that is
bankable and manageable within traditional investment portfolios inside the
global banking system. Why would we do that? Well, large private and
institutional investors were having quite a bit of trouble accessing the market
for digital assets due to different aspects of the traditional functional
framework. So, we set out to provide a service that would make crypto assets
accessible for qualified investors from around the world via GENTWO and GENTWO
Digital.
How are tokens different from
structured products?
Structured products are flexible investment instruments that offer
an attractive alternative to direct financial investments (such as stocks,
bonds, currencies, etc.). Thanks to their flexibility, structured products
allow for the creation of investment solutions that are suitable for different
risk profiles and market expectations, even in demanding market environments.
New, next-generation structured products can now be utilized to give access to
a myriad of digital assets.
Tokens, on the other hand, are digital assets themselves, and are
not necessarily considered financial instruments. Both structured products and
tokens can be used for similar purposes, but the two are not the same thing.
Tokens also live on the blockchain, while structured products are financial
products that live in the banking system, and asset managers, banks, and
professional investors use them in their daily lives to get access to assets
and markets.
What are advantages of securitization vs.
tokenization?
I think that within today’s investment
landscape, one could make use of both, as they are each tailored to different
purposes and clientele.
A token offering, for instance, is limited to investors that can
handle the complexity of crypto wallets. At this stage, most crypto wallets are
best suited for retail investors that usually invest in small ticket sizes.
With the help of securitization services (this is where we come into the
picture), you can now take a crypto portfolio or a portion of any token and
convert it into a traditional financial structured product. This “real”
security is now suddenly made available to banks, family offices, pension
funds, high-net-worth individuals etc. So, big investors who generally do not
make use of digital wallets are, thus, granted the opportunity to actively
participate within the crypto market.
What makes securitization attractive to
traditional market participants?
Institutional investors can invest in new assets with their proven
and compatible form of investment. Structured products are investment
instruments that are very familiar to traditional market participants. So,
institutional investors can finance a crypto venture, and serve as a strong,
key member of the project supporters’ community, all while using the same daily
financial instruments that they are already used to. This is a wonderful
example of how structured products and tokens complement each other. At GENTWO,
we firmly believe that this setup will not only grant access to but actively
attract investors of the highest caliber. We’re essentially allowing the
investor to choose which format he or she prefers: a fully digital asset that
lives on the blockchain and in a digital wallet or a traditional investment
certificate (structured product) that lives in your bank account and represents
a digital asset. Securities are issued through a tailor-made and segregated
issuance vehicle that is unique and stays off of a client’s balance sheet. With
this design, the so-called issuer risk is (by default) eliminated.
As someone who works with many
structured products on a daily basis, what would you personally invest in?
I personally currently hold 27
different coins and tokens in my crypto portfolio. If I were to create my own
structured product, I would most probably turn my portfolio into a so-called
Actively Managed Certificate (a structured product with an actively managed
strategy behind it) and make it available for qualified investors. This is
actually one of our most common use cases at GENTWO Digital – traditional or
crypto asset managers who utilize us to turn their strategy into an investable
asset. Our platform provides the tools to facilitate the process from start to
finish, from converting the AMC into a Swiss-compliant security to getting a
Swiss ISIN. All within 5 to 15 business days.
Just to be clear, this is my personal view; cryptocurrencies are
highly volatile, and it’s important to remember that while there are attractive
return opportunities, you have to be willing to expose yourself to high risk
and the chance of losing your principal if you choose to embrace crypto
investments.
What is the biggest opportunity for
entrepreneurs who want to make a successful business in the crypto space?
Today’s digital world is quite
literally at our fingertips. I would encourage entrepreneurs to try to look
into the future and play around with connecting the dots between what is
present and what is possible. Making use of and/or sometimes just breaking up
and reshuffling certain dots can make all the difference.
I also think that making crypto-based
services or applications so accessible that an individual user does not even
realize that he or she is interacting with a blockchain-powered product or
service still remains the biggest challenge for mass adoption, and therein lies
the biggest potential for entrepreneurs within the crypto space.
What should entrepreneurs be aware of?
As always, everything starts with a
good business case, a business plan, and a good execution strategy ‒ I’d say that applies regardless of
whether or not you throw blockchain into the mix. Once you’ve laid that
foundation, you now need to evaluate how to use and leverage blockchain
technology for your specific case. Also, and I can’t stress this enough, ask
yourself if it even makes sense, because in most cases blockchain alone
probably won’t be the sole, magic ingredient that will ensure your business’
success.
What is the biggest threat to the crypto space?
I would say a lack of
understanding and public disinterest. If people fail to recognize or
acknowledge the benefits, value and possibilities of cryptocurrencies, Bitcoin
and the like will eventually die out as the hype and fanfare of even the
starkest supporters begins to wane.
Where do you expect the sector to be at the end of 2020?
It looks as though 2020 is set to be
the year where blockchain technology may (for the first time) reach billions of
people at once, as big tech firms like Facebook become active participants
within the space. I think this will mark the real start of the Internet 2.0,
with the potential to usher in an era of trust and digitized value.
Decentralized services will definitely help shape the future development of
this planet.
“The only reason that cryptocurrencies exist is because of regulations that stop us from using gold as money.”
Peter Schiff
Key Takeaways
Similar to gold-ETFs, all of the gold-backed cryptocurrencies on the market are centralized. This means they have counterparty risk. Unlike storing your own physical gold, gold-backed cryptocurrencies require you to trust a company for storage.
There are three main types of centralized, collateralized stablecoins: fiat, commodity, and crypto. Gold-backed cryptocurrencies are considered to be centralized and “off-chain-backed coins.” The most famous gold-backed cryptocurrency is the Digix Gold Token (DGX). DGX has a market capitalization of approximately USD 4mn and a daily trading volume of approximately USD 240,000 over the past year. Even though Digix is backed by gold, it often trades at a discount to gold, and Digix’s return is extremely volatile compared to gold’s return.
Gold-backed cryptocurrencies have higher costs and risks than ETFs and managed gold funds. Investors can suffer loss of value due to faulty private key storage, double-spends from weak blockchain security, regulatory uncertainty, lack of liquidity, and non-transparent accounting of gold vaults.
The first version of this article originally was published in the sister report of this publication, the In Gold We Trust report 2019. Interested readers can download the publication here: https://ingoldwetrust.report/
Last
year in the sister report of the Crypto Research Report called In
Gold we Trust, we featured an article exploring the intersection between gold
and Bitcoin.[1]
The article focused on how gold impacts Bitcoin’s application as a global store
of value. Now an even newer competitor
to gold is emerging: stablecoins. Stablecoins promise to improve on gold by
being digital and to improve on Bitcoin by being stable. But can the companies
behind these stablecoins deliver or are they just modern alchemists? This
chapter gives a rundown of the stablecoin market with a focus on gold-backed
stablecoins, which are in many ways similar to gold ETFs. Bottom line: All of the gold-backed stablecoins on the market are
centralized, which means they have counterparty risk. Unlike storing your own
physical gold, trusting a company to store your gold is required.
Gold has fascinated mankind for thousands of years. So far, more than 190,000 tons of the precious metal have been mined.[2] How much is still underground remains unknown. One thing is clear, however: The extractable quantity is finite and subject to diminishing returns. Similarly, the number of bitcoins that can be mined is limited: The mysterious inventor of Bitcoin has set the maximum amount to 21 million coins.[3]Unlike fiat money, gold and Bitcoin cannot be created by central banks at will in response to demand shocks. While the average annual growth rate of the gold supply is around 1.7 % with a rather small standard deviation,[4] Bitcoin’s inflation rate is currently 3.69 % and on a downward trajectory.[5] As mentioned in last year’s In Gold We Trust report, the supply of newly mined bitcoins follows a preprogrammed, transparent, and predictable schedule, which remains unaffected by fluctuations in demand.[6]Their inelastic supply makes the prices of gold and Bitcoin dependent on their demand.
Overall,
the supply trajectories of Bitcoin and gold show that Bitcoin is expected to
have a lower inflation rate by 2021. Every
210,000 blocks, the reward the miners receive per block is halved. This
roughly corresponds to a four-year “half-life.” 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 that came 378 days
before the first halving and again in the second bear market, 539 days before
the second halving.[7]
This equals an average of 458 days, and we are currently approximately
350 days from the next halving, which will probably take place towards the end
of May 2020. If the pattern observed so
far is confirmed, the bottom should have occurred somewhere between December
2018 and May 2019.
Source: bitcoinblockhalf.com, World Gold Council, Incrementum AG.
When we compare the supply of gold to the supply of Bitcoin, we notice
that both are being mined, albeit in their own particular ways. Gold can be
found in soil, rivers, and rocks all over the world, regardless of borders.
Similarly, independently of their location, Bitcoin miners receive a reward for
providing the network with computing power to verify and settle transactions. The main difference when it comes to mining
is that mining is what secures the Bitcoin network and the price of Bitcoin on
the market. In contrast, gold mining does not secure the price of gold.Therefore, we would like to make the subtle
distinction that Bitcoin is not a bearer instrument in the same sense that gold
is. Paying with gold requires absolutely no dependence on a network for
settlement. However, Bitcoin transactions can take hours to settle; and
trusting the software, hardware, and internet that support Bitcoin is a type of
counterparty risk even though the “party” is not human.
To make Bitcoin and gold even more scarce, a certain amount of Bitcoin
and gold becomes unusable every year. Previously, gold was used in quantities
that made smelting and recovery cost-effective and common. For example, the
gold in your mother’s necklace may well have in it metal mined by the Romans,
then used by the Tudors, etc. Now we see gold used in tiny amounts in high-tech
goods, amounts that may not be cost-effective to salvage for a long time. The British Geological Survey estimates
that around 12% of current world gold production is being lost for this reason.[8]This means gold is being consumed in
an absolute sense for the first time in history. Again, this is similar to
Bitcoin’s annual loss of coins that are unspendable due to lost private keys
and fat-finger mistakes while typing cumbersome recipient addresses. Two
different cryptocurrency researchers, Chainanalysis and Unchained Capital, have created an upper bound of 3.8 million
for the total number of Bitcoins lost.[9]
Overall, the supply trajectories of Bitcoin and gold show that Bitcoin is
expected to have a lower inflation rate by 2021.[10]
Since many young investors consider Bitcoin to be
digital gold with a payment option, some may suspect that the demand for gold
is adversely affected by the success of cryptocurrencies. As of yet, the correlation between gold and Bitcoin returns is still
low and slightly positive, indicating that the demand for gold is not adversely
affected by cryptocurrencies.
Source: Coinmarketcap, Gold.org, Incrementum AG.
This
secure demand strength of gold is due to the unique advantages it has over
Bitcoin. First, gold is far less volatile than cryptocurrencies and will
remain so for the time being. In 2017, Bitcoin was about 15 times more volatile
than gold. In addition, gold is much more liquid. On average, USD 2.5bn in
Bitcoin is traded daily.[11]
This amounts to just 1% of the total gold market: The daily trading volume of
gold is around USD 250bn. Furthermore, gold trades in regulated and
well-established venues and has long been accepted by institutional investors
as an investment alternative. This is not the case for cryptocurrencies.[12]
The US dollar’s hegemony is under increasing
pressure from China and Russia, as US national debt reaches record highs. Instead of returning to a gold standard in
support of a fiat currency, the 21st century could witness the
emergence of a gold standard involving a cryptocurrency.
The notion of a monetary system based on a cryptocurrency may be
surprising, given the fact that cryptocurrencies are the most volatile asset
class. Many Bitcoin holders have experienced a ride from USD 1,000 right up to
USD 20,000, and then steadily back down, culminating in a long, choppy sideways
market followed by the recent rally to USD 8,000. Enter stablecoins. Stablecoins promise to offer all of Bitcoin’s
benefits while fixing the problem of volatility.
While the decentralized and independent nature of their supply makes
gold and Bitcoin good stores of value, there are major differences with respect
to other monetary features. Following Dobeck and Elliott[13]
and Berentsen and Schär[14],
the next table gives a quick overview.[15]
Source: Incrementum AG.
However, the promise is most likely to be optimistic, as promises often are in the cryptocurrency space. For several decades, countries around the world have tried to peg their exchange rates to other more stable currencies. Not a single fixed peg has lasted in the long run.
Take for example the European Exchange Rate Mechanism (ERM), which
attempted to keep the plethora of European currencies within a narrow band of
each other during the ‘80s and ‘90s. Since the UK could not keep their print
presses turned off, George Soros and other speculators were able to mount a
speculative attack and profit from breaking the peg. This is because whenever a currency holds fractional reserves,
arbitrage opportunities arise between it and other currencies. Therefore,
stablecoins that are not fully backed are trading off between stability in the
short run and blow-up risk in the long run, because keeping a fixed peg without
investing in the underlying asset makes the peg fragile to black swan events.
Source: Incrementum AG
However, Bitcoin is volatile, and many cryptocurrency users are now
demanding stability. To meet this
demand, the new stablecoins are combining the advantages of gold and Bitcoin.
Gold-backed stablecoins are similar to gold ETFs. For example, the most famous
gold ETF, SPDR Gold Shares (GLD), is a fund that buys physical gold and divides
the ownership of it into shares.
In theory, gold-backed cryptocurrencies are supposed to work the same
way. However, there are currently no
cryptocurrency exchanges that are licensed to trade tokenized ETFs. Even if
regulators eventually approve an application for such an exchange, they will
require KYC/AML on each transaction.[19]
This begs the question: How is a
centralized gold-backed stablecoin any better than a gold ETF?We have still not found a suitable answer
to this question. In fact, the solution seems inferior at first glance,
because investors still have to safely protect the private keys that control
the gold-backed stablecoins, and if the tokens are traded on a public
blockchain like Ethereum, then the coins will be subject to volatile and
increasing transaction fees when they send and receive the gold tokens. Then
there are all of the problems associated with public blockchains, such as
latency, lack of scalability, and security.
As shown on the next figure, there are three main types of
collateralized stablecoins: fiat, commodity, and crypto. Gold-backed cryptocurrencies are considered to be centralized “off-chain-backed
coins” because they generate value by a counterparty’s depositing gold, gold
certificates, or other gold-related securities into a vault. Similar to
fiat-collateralized coins like the infamous Tether, gold-backed
cryptocurrencies are supposed to be listed on cryptocurrency exchanges so that
gold positions can be opened and closed within seconds by retail and
professional investors alike.
Over 50 cryptocurrencies are
somehow backed to gold. The next section summarizes just a handful of the
gold-backed projects. The projects selected were drawn from responses to an official
@CryptoManagers tweet
on Twitter. We asked our followers what coins they wanted to learn more about.
We also selected a few coins from the German-speaking countries, including
Vaultoro, Novem, and AgAu. Finally, we have included an update on the
gold-backed tokens that we covered last year.[20]
Source: Incrementum AG.
*Please be advised that the table includes fees
such as transfer fees, custody fees, subscription fees, and redemption fees. We
included all information which was provided to us by the companies. However, a
substantial cost that investors will have to bear may be the spread between the
price of gold on the market and the price of gold that each company charges
investors. This markup on the price of
gold is often not stated clearly in the whitepaper. The table is not
complete because the information was unavailable. Readers are responsible for
their own due diligence on each firm, and this is not investment advice.
Digix
Gold Tokens (DGX)
There are two tokens
associated with this company: DGD and DGX. The DGD crowdsale in March 2016 was
the first crowdsale and major DAO hosted on the Ethereum network. A
decentralized autonomous organization (DAO) is a type of decentralized application
(dApp) that allows owners to make business decisions by voting electronically,
and execution of the business decisions is performed using smart contracts.[21]
The second is the DGX token, which equals one gram of standard gold.[22]
The company reportedly procures its gold from LBMA-approved refiners. The
tokens are issued by Pte. Ltd. in Singapore, and the gold is stored at The Safe
House in Singapore. As you can see in the next chart, the daily trading volume
is approximately USD 243,000 over the past year, and USD over the past month.
The next chart shows that the Digix Gold Token is not correlated with the price
of gold. The token is more volatile and often trades at a discount to gold.
AnthemGold
What makes
AnthemGold unique is that it is the first insured, fully gold-backed stablecoin
based in the US. The token is open to citizens of 174 countries, and the vault
where the gold is stored can be viewed on video, on the AnthemGold homepage.[23]
Currently, there are 20kg of gold there. The gold is insured through Lloyd’s;
there is zero FACTA reporting required for investors; and according to the
founder of AnthemGold, Anthem Blanchard, the gold has zero risk of bank deposit
freeze or closure. There is a 0.40 % storage cost per year, extracted from
metal (which is the same as the GLD gold ETF fee structure).[24]
AgAu
AgAu is a gold-backed token that is being developed by
Thierry Arys Ruiz and Nicolas Chikhani, the former CEO of Arab Bank in Geneva.
Their offices are located at the Zug-based blockchain incubator, Crypto Valley
Venture Capital (CV VC). Their coin will be audited by E&Y and built as an
ERC-1400 smart contract on the Ethereum blockchain. The gold is 1 kg LBMA bars
stored at Trisuna in Liechtenstein. AgAu will be engaging in a token generation
event (TGE) to raise the initial round of capital that will be used to buy the
gold required for backing the tokens. The storage fees are 0.2 % per annum, and
each transaction has a maximum total cost of 0.4 %.
HelloGold, a Malaysian-based company founded in 2015, offers a token
backed by 1 gram of 99.99 % investment-grade gold. The tokens can be converted
into physical PAMP Suisse gold, and the shipping is insured. The total GBT
supply is limited to 3,800,000 (representing 3.8 tons of gold). Users also have
the opportunity to convert their gold into a digital gold token (GBT) if they
have a “pro” account, which requires standard AML/KYC. This enables them to use
the stored gold as a value outside the HelloGold system.
In addition, people may use their gold as collateral for loans made available by Aeon Credit Services, giving them access to personal finance. Finally, HelloGold offers a Smartphone app with which users can trade their tokens and exchange them for their corresponding shares of investment-grade gold. When they redeem their GBTs for physical gold, they receive the corresponding amount in bullion, coins, or jewelry via recorded mail.
GBT accounts are charged an
annual fee of 2 %. Interestingly, the HelloGold blockchain operates on a
private network to reduce fees and transaction latency and avoid the risk of
independent developers adding their own contracts to the blockchain. This means
that HelloGold and its nodes control block times as well as the execution of
the gold transactions.
Due Diligence on Gold-Backed Stablecoins
Can the cryptocurrency be converted into physical gold on demand? How easy is the process?
Does the company disclose how it stores the gold?
Who is storing the gold that backs the cryptocurrency? Is that company trustworthy?
Is the gold insured?
Does the company have a well-known and reputable auditor? If the company is not audited, then it can easily issue more tokens than gold, thereby creating fractional reserves.
What happens if the company goes bankrupt? Is it a limited liability company that could leave investors empty-handed?
What blockchain are the gold tokens built on? Is that blockchain secure?
Do you know how to store the private key to the wallet that controls the gold tokens? What happens if you lose the key? What happens if the key is stolen?
Gold-backed cryptocurrencies are similar to ETFs, which may make them subject to securities laws in Europe and the US. Is the company selling the cryptocurrency regulated? Does it store the gold in a country that has approved their token?
Where can the gold-backed token be traded? Gold ETFs are traded on exchanges, but there are currently no cryptocurrency exchanges that are licensed to trade tokenized ETFs.
How much liquidity does the gold-backed cryptocurrency have? Can you really close a position in case of a liquidity trap? The largest gold-backed cryptocurrency, Digix Gold Token, has a small daily trading volume of USD 243,000 over the past year, and USD 27,000 over the past month.
What is the total expense ratio for the tokenized shares of the gold fund? The most famous gold ETF, SPDR Gold Shares, has a management expense ratio (total fund costs / total fund assets) of only 0.40 %.
What is the business model of the coin? How do the people who created the coin make money? If there is not a clear way that they are profiting, then be suspicious of indirect costs or high risk.
Conclusion
A gold-backed cryptocurrency promises to be digital gold: no
weight and stable. However, no one has figured out yet how to make a
decentralized gold-backed stablecoin. All gold-backed stablecoins are
centralized in the sense that you have to trust someone to store the gold for
you. Similar to an exchange-traded gold fund, gold-backed stablecoins have
counterparty risk. In the cryptocurrency world they say, “Not your keys, not your crypto.” Well, the parallel for gold would
be something like, “Not your vault, not
your gold.”
Backing a cryptocurrency in a way that an intermediary is required – a custodian or a bank for instance – actually conflicts with one of Bitcoin’s central tenets, namely, that users do not have to trust any intermediary. The security of Bitcoin and other cryptocurrencies is based on cryptographic technology. In contrast, the gold-token projects we have presented above are managed by real companies. They are responsible for the safekeeping of the gold. Therefore, the user has to trust that no state or private actor will be able to steal or confiscate the gold from the vaults.
Furthermore, the coins are often traded on a public blockchain structure such as Ethereum, which means the coins also suffer from all of Ethereum’s problems, such as scalability and security. Finally, there are over fifty gold-backed coins currently, and most likely, many of them will fail. It will take a few years for the market leaders to emerge, gain widespread exposure, and thus secure the standing of gold-backed tokens as a store of value. This year will be pivotal in identifying which projects are going to take the lead in this endeavor.
[3] In this context, we should note that the edge
length of the cube that could be cast from the total amount of gold already
mined is roughly 21 meters, which may have been Satoshi Nakamoto’s inspiration
for the arbitrary 21 million hard cap.
[12] This may change quickly, however, as more and
more countries open their financial markets to blockchain-related investment
vehicles. To give an example, the Liechtenstein Financial Market Authority
(FMA) has recently approved three alternative investment funds (AIFs) for
crypto-assets. See “Liechtenstein gives green light to crypto
funds“, Liechtenstein.li –
official website of Liechtenstein Marketing, March 6, 2018
[13] Dobeck, Mark F.; Elliott, Euel: Money.
Greenwood Press, 2008, pp. 2-3
[14] Berentsen,
Aleksander and Schär, Fabian: Bitcoin, Blockchain und Kryptoassets. 2017, pp. 16-17
[15] This table was inspired by a presentation
given by Frank Amato at the LBMA/LPPM Precious Metals Conference 2018 in
Boston, Massachusetts.
[17] Transfers within the Bitcoin network can be
tracked indirectly due to the transparent nature of account balances. Companies
such as Chainanalysis offer to analyze the entire Bitcoin blockchain in order
to forensically detect transfers between addresses and identify the owners of
the accounts. The US tax authorities are already using this service to track
cases of money laundering and tax evasion.
[18]
The counterparty of Bitcoin defined as functionality of the Network
[19] Know your customer (KYC) and anti-money
laundering (AML) are standard protocols that require a customer to verify their
identity in order to use specific services, such as bank accounts and
cryptocurrency exchanges.
“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.
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]
Source: Jason Bloomberg, Forbes.com
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.
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.
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.”
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.
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.
Source: Coinmarketcap.com
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
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.
Source: Arewedecentralizedyet.com
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.
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.
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]
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.
Source: Incrementum AG.
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.
Source: Incrementum AG.
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.
[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.
“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.”
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?
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.
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.
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.
[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.
[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.
Bitcoin’s price crossed USD 13,000 on July 10th, 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.
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 13th, 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 2nd, 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 2nd, 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 1st 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]
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.
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.
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.
Source: HTC.
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]
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]
Source: Twitter.
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 22nd, 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.
Source: g2fp.com
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.
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.
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!
[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.
“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
“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.
“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:
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)
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.
