Crypto

Why Emerging Economies need to invest in, legalize and regulate Blockchain and Major Cryptocurrencies?

Brics flag image

In this article I shall focus about the BRICS nations as they are the largest emerging economic bloc.

There have been talks of banning, opening up and re-banning the crypto-sector in India. Similarly there have been ambiguous laws about cryptocurrencies in china – which for the most part controls the entire mining network of Bitcoin, and possibly many other networks with the largest mining companies and hardware producers, exchanges operating from China or by Chinese nationals. In fact the largest crypto-exchanges both by daily trade volume and by market capitalization are operated by Chinese nationals (or former Chinese nationals). Some of the largest cryptocurrencies are operated by Chinese nationals as well. Another case is that of Russia, that has invested a lot of time in legalizing and to some extent regulating cryptocurrencies. Similarly Brazil hosts some of the most innovative blockchain experiments including legalizing land records on blockchains. With all such innovations happening,

Why should BRICS economies care about this technology?

  • Firstly, Cryptocurrencies are slowly becoming an alternative financial asset, similar to gold, diamonds, platinum – only that its properties make it more difficult to detect, control and ban. Even if countries were to legally void out cryptocurrencies, the ease of owning these assets for any individual or citizen would make it difficult to detect or control. In India during the 1980’s and 1990’s the government had imposed tremendous amount of taxes on importing gold, which led to an increase in gold prices, while giving birth to a whole range of gold-ornament firms – some behemoths worth more than several billion dollars just because they were able to “bring in” or “arbitrage” gold prices from international markets. Such legal requirements often – at the cost of preventing – normal retail customers from acquiring an asset will create an elite set of individuals who will possibly monopolize this market. Banning any economic asset for ever – has never been a possibility historically….
  • Secondly, stifling innovation in sectors that are heavily corruption ridden or asymmetric information driven, with virtually no legal oversight creates a bane to society. For example, the real estate sector and property registration issues in the emerging economies have long been an eyesore to the efficient functioning of markets due to heavy policy dependence. Decentralizing and plugging in blockchains has demonstrated significant efficiency into this sector.
  • Thirdly, being home to the largest technically capable information technology specialists in the form of programmers, designers and creators of software, these economies can rapidly scale to true products as has been demonstrated by many large exchanges and DeFI innovations that are shaping today’s world. If governments were to ban this technology or its associated crypto-currencies, they would be denying this huge population of technology professionals a true first chance at the leap. For long, hugely regulated telephone networks, service delivery systems such as utility had bought India and Brazil to a bottleneck. By the time liberalization happened – overnight after realizing the benefits of these technologies, it led to rampant “renting” by few vested parties denying ordinary citizens of the true right to access.
  • Fourthly, proper regulation and appropriate enforcement of financial instruments in this sector will lead to a huge tax collection for the government. An outright ban would leave huge amounts of money on the table. Not only that, properly regulating exchanges and using intelligent platforms such as chainanalytics and other financial tracking systems, money flows can easily be tracked back to owners much more easily than physical assets that are often hidden behind layers of owners. Thus proper financial regulation will bring in the necessary control and enhance government tax collections.

Insights from Ethereum Analytics

What is truly amazing about Ethereum Analytics on ethinfo.com is that it provides data backed evidence of all aspects of the blockchain ecosystem. As we’re ending 2019 – here are some insights:

  1. The network transaction fees has remained mostly constant for all of 2019 except for occasional spikes indicating that there is no surge in the number of transactions happening on the network.
Network fees

2. The total ethereum network utilization chart shows that the ether network utilization has been between 80 and 100 for almost all of this year, with some instances where the network utilization has been upto 98%.

The above image shows how much of the ethereum network is spread around the world. What is interesting to note is that despite the severe ban on “Cryptocurrencies” and other allied technologies in mainland china, there seems to be more than 1073 ethereum nodes active at this point. However, it is likely that these nodes are being run out of Hong Kong’s datacenters and not on mainland china. Similarly, India has about 160 ethereum nodes active at this point – despite the legal ambiguity.

The above graph shows that the overall network difficulty as measured in TeraHashes has continuously increased over the past year.

In conclusion – we have a network that supports cryptocurrencies that is sufficiently decentralized and is bursting at its seams in terms of network throughput with the utilization of about 90% with near-constant/predictable transaction fees. If this network moves toward Proof of Stake and some of the changes such as sharding were to play out on schedule, we will see a significant number of apps being deployed on the global platform.

Earning interest while you HODL

currency and coin image

Cryptocurrencies and primarily Ethereum backed ones create new modes of earning interest. What was once an ICO backed increased adoption of cryptocurrencies – after being hyper-regulated, and banned by countries, has now transformed into an economy of regulated less riskier Decentralized Finance.

The premise for earning interest in cryptocurrency markets is simple, and below I list a few means to do so* . As a disclaimer, users who choose one of these means do so at their own risk.

  • Crypto-Exchanges and Margin Trading
    • Writing a crypto-exchange allowing traders to trade coins in exchange of small commissions per trade. There are more than 100+ decentralized exchanges which use smart contracts to swap one cryptocurrency to another. This approach needs deep expertise in a variety of areas including cybersecurity. The list of known ones is here (State of Decentralized Exchanges)
    • Margin Trading – On exchanges such as Poloneix.com users can lend their HODL-coins to others who trade on their behalf.
  • DeFI interest earning applications
    • With applications such as compound.finance, nexo.io, celsius.network and a host of others, users can invest their HODL -coins and earn interest off those coins based on rates determined by the network. These applications provide extremely high liquidity and enable users to withdraw the very same day.
  • Staking networks
    • Cryptocurrencies such as Tezos enable users to delegate their Tezos to bakers, who pay them interests. In fact, staked.us provides support to stake more than 10 different cryptocurrencies.
  • Collateralized Debt Bonds using Maker Platform
    • The Maker Network and crypto-platform enable users to set collaterals in their own bonds such that their existing crypto-currencies (e.g., ethereum, augur, etc) can be baked from the maker platform. The smart contract which locks the users’ cryptocurrency then issues a stablecoin known as DAI based on the existing governance rates of exchange. This DAI can either be invested in other DeFI platforms or can be locked into a savings platform through a Dai Savings Rate contract thus enabling them to earn interest on existing Dai holdings.

0X and the mission to enable “almost” free value flows

0X Token Symbol

The 0X token and protocol is one of the several generalized decentralized token exchange enablers. Their mission has been to decentralize the exchange of value.

While this mission per-se is genuinely a hard problem, whenever exchange of value happens – many intermediaries extract “fees”. Consider a simple case where you go to a store and buy a $5 item. Often there are several costs associated with the good’s sale, which we don’t pay attention to. For example, the state taxes, the value taxes, the surplus earned by the seller and many others. Often – despite the buyer willing to pay for the good immediately, the good itself is not available for sale. These challenges though multi-fold increase the difficulty in trade for the seller and for the buyer too….

Very often however, certain types of financial products are not even made possible by financial restrictions and often by meagre lack of imagination in the financial industry. For example, if one wanted to sell a portion of his mortgage to a lender who offers a lower rate than the current mortgage rate, that is difficult, since there are transfer fees in between. The transfer fees are significantly high that it discourages such transfers…. All of this though 99% of the regular checking accounts and savings accounts give their billions of holders less than 2% interest rates in the US, and in some cases like in Japan a negative interest rate. This 2% in absolute terms, if inflation adjusted would also be negative.

Similarly, if one were to create a peice of art or an e-book and sell it, the intermediary seller recieves a huge commission for the same. Often if the intermediary is a platform, the platform shares a meagre amount to the end seller. With smart contracts and tokenization of assets through smart contracts, it is possible to convert any asset (physical or virtual or even nonphysical) to tokens. Later those tokens can be put out on sale on a marketplace where takers (i.e., buyers) can buy it. Buying again can be apportioned using traditional bidding or at a fixed price. Similarly, apportioning of value based assets, token based assets, etc… all can facilitate the same.

0X (ZeroX) is a platform and a protocol that provides APIs, programming toolkits and interfaces that are user friendly. It is a layer atop Ethereum’s complex Solidity based interface, that allows users to create decentralized exchanges for “custom” tokens. The decentralized exchanges can then be used to trade “standard” established tokens such as bitcoin, ethereum, etc.. in exchange for “custom” tokens created by the user.

In fact within a few minutes one can create a simple web based interface ( with a Javsascript frontend) to create a simple token exchange for a “custom” token to be exchanged with any “standard” token, which underlying it can embody any complex smart contract. Such flexibility in creating newer types of financial assets and allowing a meaningful trade which is instantaneous, at almost no transaction cost – that too decentralized without a large intermediary firm controlling all transfers, and monitoring it, etc.. gives rise to several possibilities….

A future post will walk through the decentralization process using 0X.

DeFi- Decentralized Finance through Smart contracts & Stablecoins

DeFi Text with cryptocurrency image

It is well known that stable coins and stable coin issuance has given rise to accelerated adoption of cryptocurrencies and blockchain finance overall. Nevertheless, the reason for this adoption increase is in the ability to transport cryptocurrencies i.e., stable coins across exchanges, accounts, boundaries and even physically store it on a ledger or software such as exodus.

Decentralized finance using smart contracts and stable coins has seen profitable innovation in financial management, some of which are incomprehensible with traditional forms of money or other assets. For example, an exchange/defi institution situated in the USA can attract capital in USDC and then can lend it out to banks/financial institutions/retailers in other geographies for a higher rate of interest. In the process, they can then return a part of the profits to their end customers. The crux of the rule is that while retailers cannot lend internationally, institutions can.

Smart contract applications such as compound.finance which operate on the Ethereum network using ERC220 standards, attract investments in stable-coins such as DAI, USDC as stable coins and BTC, ETH, BAT, 0X, WBTC as cryptocurrencies. They create a lending contract between borrower and lender and facilitate paying back the borrowed amount in cryptocurrencies.

There are also a host of exchanges, wallets and applications like Celsius, nexo.io, Coinbase and Blockfi which provide interests ranging from 7% to 1.25% on your stablecoin holdings. The nexo.io also insure your stablecoin holdings using a federal program like the FDIC assuring customers of the safety of one’s holdings…

You might actually be better off just converting your fiat holdings to cryptocurrencies and earning interest off the holdings. This way it is a win-win situation for you. We are still scratching the surface of decentralized finance and as time goes by newer and newer innovations in this space will make finance accessible, decentralized and viable to both lenders and borrowers.

What should be developed on Ethereum?

Ethereum

This was a question posed by Elon Musk to Vitalik Buterin, in what has now become a widely public debate about market creation on a public blockchains. The response of Vitalik spanning across 5 tweets (https://twitter.com/elonmusk/status/1123126001171517440?lang=en) . Each market creation idea is tremendously powerful and can have multiple players that facilitate the decentralization of market functions.

  1. Store of value markets : for payments, value exchanges, and for innovative financial products like insurance (hurricaneguard from etherisc). I have widely discussed the economic properties of etherisc in a Managerial Finance journal paper co-authored with their former CTO Alpen Sheth.
  2. Markets that manage private identity (e.g., single -signons without giving single firm access to all of an individual’s private information that the firm can now use to sell downstream to marketeers) – an approach that has long caught the imagination of individuals and companies but still experiencing difficulties that are related to usability and user acceptance. Imagine remembering 12 or 22 words each time you need to login….or having to download software to login.
  3. Markets of registries of public information.
  4. New forms of decentralized organizations – this form of organization completes Hart and Holmstrom’s – incomplete contracts – hypothesis wherein they argue that firms are incomplete structures of organization for human interactions.
  5. Markets for facilitating micropayments across organizations and individuals – this also extends into microfinance and microlending which is a global phenomenon with a hugely unsuccessful business model. Altering financial behaviors of entire societies is a difficult proposition with lots of entrenched incumbents opposing such a move. Nevertheless, such a mechanism can possibly be developed with the right partnerships, incentives, and structures.
  6. Markets for data/business analytics – that use homo-morphic encryption to enable private data to be analyzed and modeled without providing access to the actual underlying data.
  7. Markets for spam prevention in blockchain-enabled social media- several problems of incentive incompatibilities exist, and greedy user maximization inefficiencies face public social media blockchains e.g., collusion amongst providers as in the case of steemit, bad actors reaping excessive benefits, etc… incentive models that include a combination of recommendation systems, moderation facility, social mobilization, and crowdsourcing can facilitate this extremely complex functionality.
  8. Markets for rewards – creating unique reward mechanisms that are based on economics and can just be deployed by either traditional web-based businesses or blockchain-based businesses. These rewards should be based on incentive maximization economics.
  9. Stickers and Badges – These are an extension of either art created on the blockchain and of rewards on the blockchain and are valuable propositions.
  10. p2p markets for anything that is incentivized – Peer to peer marketplaces for internet connections are already taking shape in the form of helium.io wherein devices that operate with radio frequency transmit the internet over a large area and are owned by individuals and not by firms. the device owners are incentivized by usage in cryptocurrencies.
  11. Identity systems, reputation systems, and credit systems for those that are resourceless – these systems could help refugees and several stateless people who have no means of livelihood.
  12. Decentralized alternatives to DNS which is today centrally controlled by ICANN and a few government organizations, which can at the word go shut it down entirely.

National Cryptocurrencies: Boon and Bane

cryptocurrency bitcoin ethereum ripple images together

Nation states such as China India US and Senegal have embarked on an agenda to either propose or start creating cryptocurrency infrastructure to replace existing “note” based infrastructure. Singapore, a trailblazing technical powerhouse is at the leading edge of implementing such technology through their well publicized Project Udin experiment. Such an initiative has several advantages:

  1. The robustness of a permissioned or permission less blockchain ecosystem is extremely well known and well understood. It is secure and extremely robust to all kinds of attacks on its cryptographic protocol.
  2. Dynamic monetary policies will enable governments and national financial institutions to accurately create, tweak and develop new forms of monetary policies that did not exist earlier.
  3. The cost of printing, regulating and preventing fake -or duplicate physical fiat currencies is reduced to 0 – since digital cryptocurrencies can never be duplicated and/or faked. The ledger validates with 100% surety.
  4. Problems such as double spending, money laundering, etc. are easily stoppable and recognizable.
  5. Governments, now need not necessarily introduce different fiat nominations and digital nominations and over a period of time, can wield significant control over the country’s money supply, flow and accounts which today – due to the percolation of physical fiat currency notes  is very difficult to ascertain.
  6. Nevertheless, e-commerce and regular commerce will significantly become easy.

There are some disadvantages too for the national cryptocurrency system.

  1. the volume of cryptocurrencies needed will significantly be large – and as a result will need decades of developing a robust infrastructure to support both high cost and high speed of transactions.
  2. If national monetary systems become completely digitized over time then existing business models including those of currency notes, banking infrastructure i.e., money transfer systems, ATM networks, connection infrastructure among banks,  that has existed over the past 100-150 years will have to be replaced in its entirety. Imagine if one just needs an internet connection and a digital wallet to access one’s account – what would be the need for a bank?
  3. Such national cryptocurrency systems will need to interoperate among different nation states since each nation state will want to build its own infrastructure.
  4. Lastly, monetary freedom of a nations citizens and people can completely disappear when central control of digital currencies happen.

Flippening of demand

Number of Transactions

Over the past year, an important happening titled “The Flippening” has been observed in the cryptocurrency and cryptotoken sector. One of the key determinants of demand has traditionally been a total volume of a crypto-tokens that have been traded. Nevertheless, consistently Bitcoin’s transaction volume has far surpassed every other crypto token in the market.

Transaction Volume

This transaction volume has often been measured in US dollars and not in terms of the number of Bitcoins.

Number of Transactions

The above plot from coinmetrics.io shows how the number of transactions on ethereum have far surpassed Bitcoin since Jan 2017.

Does this mean that there is more demand for Ethereum than Bitcoin?

There is no definite answer to this since both coins have different purposes. Bitcoin is considered as the fiat currency in the cryptocurrency world and is supposedly a holder of value. Ethereum is considered as a token that is used to stake business models by means of smart contracts. Ethereum is spent each time a smart contract executes  or some form of transfer happens on the blockchain. Nevertheless considering the fact that there are far more ethereum available (about 106 Million Ether in supply) in supply compared to  Bitcoin (500000 BTC) we  would expect more of ether to be spent.

Additionally the total transaction value of BTC in USD has consistently been atleast twice that of ethereum.

Total Transaction Fees in USD

Another important metric most analysts and industry experts consider to be important is that of total transaction fees. The total transaction fees for Ethereum has since 2019 started surpassing the total transaction fees on the Bitcoin network, indicating the large number of ethereum applications consuming huge amounts of gas for conducting smart contract enabled transactions.  The following graph (again from coinmetrics.io) shows how recent total network transaction fees in USD on ethereum has started surpassing that of Bitcoin.

network transaction fees ethereum

 

This is happening despite Ethereum’s USD value being 1/50th  of that of Bitcoin.

Does this indicate that Ethereum’s demand is significanly higher than that of Bitcoin? – Where is this demand coming from?

Again this question has no direct answer.  The Ethereum network consists of approximately 100000+ active smart contracts running at any given time. Some of these smart contracts are part of complex applications like the ones in this list:https://www.stateofthedapps.com/platforms/ethereum

These programs spend gas (small quantitites of ethereum) for each and every asset transfer of conditional execution of programs in the smart contract. This expenditure creates the demand for ethereum on the network.  The largest such smart contract executing on the network is that of the stable coin Tether which in 2018 migrated off the bitcoin blockchain to the ethereum blockchain. Tether’s value is pegged at 1USD and is the standard of value on most cryptocurrency exchanges around the world including Binance.  Analysts have pointed to the fact that 20% of Ethereum’s transaction demand arises from Tether thereby giving the ethereum network this tremendous demand. 

On the overall though – as the number of ethreum applications increase and as the demand for ether increases this trend of transaction fee flippening will sustain in markets. However, it is yet to be seen if the fee flippening will ever lead to the flippening of value on the ethereum network.

 

Instruments for Cryptocurrency investments

Bitcoin image

There are many ways to invest in cryptocurrency markets. For example, if one were to directly learn to use coinbase or any other cryptocurrency wallet, one could directly exchange fiat to cryptocurrencies. However, this mode of investment is slowly becoming more and more difficult as governments, banks and other financial entities are tightening their regulations that permit fiat-crypto exchange. Many countries such as India prevent such direct exchanges. If countries do not prevent such access, banking systems such as those in the United Kingdom can often change the rules and make it extremely difficult for banks to serve crypto-exchanges through increasing costs of compliance.

Therefore, it is only a matter of time, before derivative higher-order financial instruments provide the most popular way for retail and institutional investment in the crypto sector.

For example, Exchange Traded Funds that are regulated by all national financial regulators are an important development. For several years now (atleast 5) many different ETFs have been proposed in the US, with each one being rejected for one reason or the other. These Exchange Traded Funds are secondary instruments that would invest in a portfolio of cryptocurrencies and would be similar to any professionally managed equity fund. During the last four years, the SEC has turned down proposals from at least 20 different organizations for launching such funds.

The second option is the Bitcoin Futures. A futures contract is an agreement to buy or sell an asset at a future date at an agreed-upon price. Investors have an ability to invest (go long) or go short at a certain price. These futures though have definite expiry dates and mandate that only relatively larger investors. The Chicago Mercantile Exchange and Bakktt trade these futures.

A third option is the Bitcoin Options. These options are settled daily, and prices of options vary by future prices.

Nevertheless, for HNIs or accredited investors there are specialized hedge funds that institutions will allow investment in.