Crypto

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.

Ethereum Performance BottleNecks

Ethereum imgagw with computer

Tether, a stable-coin has been consuming  Ethereum blockchain bandwidth and filling up possible transaction-space making it extremely expensive to execute actual business based transactions. The tragedy of commons on the Ethereum block chain possibly has no solution – nevertheless – several solutions based on bandwidth thresholds such as sharding, creating silo-ed data-sources that are separate from the common blockchain, etc…

Each public blockchain facilitates multiple markets – each of which has different actors engaged in a game that has a dynamic equilibrium – dynamic because the supply, demand and prices in each market varies according time based on exogenous factors. Below I highlight a few of these markets:

1. The first market is a token market – these tokens keep markets alive and provide direct fungibility to business processes, models, etc, in addition to providing liquidity to teams executing these projects.  They embody the value to the business model, often provide incentives for governance (DAICOS), and facilitate fungibility directly.

2. The second market is  a transaction market – where transaction fees are determined by prevalent market prices that miners are willing to accept to include a transaction into their next block, which has to be mined. This is a perennial market and determines when and how markets function – for example, if transaction fees peak, then authors of smart contracts will be forced to look elsewhere or reduce their dependence on the blockchain. 

There is perennial demand and supply in this transaction market  The transaction bandwidth – defined as  the maximum number of transactions per second  can cause a spike in price and reduce supply (i.e., number of transactions) and is limited by the technical architecture, design and support in this market.

3. The third market – the miner’s market which consists of actors with specialized equipment and whose roles are critical to the operation of the entire blockchain. They are incentivized per block mined. These miners bring tremendous value are significantly specialized in their operations – they search for geographic locations that have the lowest costs for electricity , maintain huge powered networks of specialized computing equipment (e.g., ASIC based computers). The more the number of miners, the lesser will be the transaction fees in this market, provided the underlying technology supports it.

Bitcoin Price Predictions

Bitcoin image

Firstly, the overall sentiment this year has predominantly been that the market is up about 68% till date and down 55% from its peak in January 2018.

This move has wiped out more than 300 billion dollars from the global crypto-markets. Most of this wealth lost  though, has not been created in the Bitcoin market- per se. The ICO’s and altcoins have lost more than they have actually gained.

What do scholars say about bitcoin prices – and predictions?

In a recent paper in Economics letters, Andrew Urquhart (2017) shows the price-clustering property of bitcoin wherein Bitcoin prices always cluster around whole numbers. He reviews several papers, most notably Briere(2015) which shows that Bitcoin offers diversification for investors and his own paper where he shows that the random walk property prevalent in stock markets don’t hold. Again, Balcilar(2015) shows that Bitcoin volume can be a good predictor of prices except when there is a bull or a bear market and volume cannot predict volatility.

There is also a paper by Dwyer(2015) which shows that Bitcoin is more volatile than gold, foreign exchange currencies. More recently there is a seemingly growing set of studies investigating the effect of social media sentiments on bitcoin value  (i.e. Feng Mai, etc… ), crowd sentiment on bitcoin prices, etc.. Exemplar work by Feng Mail et. al show that social media sentiments affect the prices of bitcoin and using two well accepted econometric methods demonstrate the effect of bullish and bearish tweets on future prices of bitcoin.

Market Sentiment

That being said the price of bitcoin and other digital assets (cryptocurrency) are highly volatile. Their prices are generally reflected by the demand and supply of the cryptocurrency in question and by user sentiment in markets.

Off late this sentiment has turned bearish on account of  a) Persistent regulatory hurdles – for e.g. over the past year SEC has rejected more than 12 applications for Bitcoin Exchange Traded Funds. b) Lack of international support -many of the largest economies of the world e.g. China, India, etc. prevent fiat to crypto-trade. This leaves out more than 1/3rd of the global citizens from participating in the crypto economy. c) technical challenges in surfacing bad actors – over the past year more than 1000 Initial Coin Offerings or crypto-offerings have  bombed – and the world is still counting the number of fake cryptocurrencies out there- from offering online grocery marketplaces to everything else.

The Promise of the Blockchain

Despite these negatives in the basic trade of crypto-currencies, blockchain has a technology is seeing tremendous innovation and is affecting almost all industries from supply-chain (e.g. IBM-Maersk partnership), to gaming(several new gaming platforms such as Tron, etc. are coming to the fore). Even incumbents such as Facebook, google are building blockchain based teams and recently Facebook has attempted to build a bridge the cryptomarkets with their own Libra cryptocurrency.

Social Media 2.0

Major Social Media icon like facebook steemit publish0x

Cryptocurrency and the Blockchain have enabled a new form of remuneration. Content creators are it on messaging platforms, or, be it on blogging platforms can earn cryptocurrencies based on the content they generate. These cryptocurrencies are tradeable on third party markets, and can possibly appreciate over a period of time.

There are many such blockchain-based properties namely: 1) Steemit – the earliest one launched in 2016, 2) publish0x.com, 3) Lunyr. There are also sites where one can earn a bounty for writing reviews e.g., bounty0x.

A few questions remain though:

  1. How will markets value such content?
  2. Will such content be valued satisfactorily to the writer of the content?
  3. Can such markets – over – a period of time, overtake platforms such as facebook, twitter, etc. in creating quality content.
  4. How will the fairness of the reward mechanism on these platforms be judged?
  5. Will Artificial Intelligence and Machine Learning algorithms be able to judge the value of content appropriately.

Overall, the cryptocoin reward mechanism over a period of time will evolve to become a powerful factor in media and will attract top-notch writers, who today have to depend on media/publishing houses to earn satisfiable rewards.

Bitcoin vs. S###coin

blockchain image

Recent senate hearing on Libra cryptocurrency

Here is an interesting question raised during a recent Libra cryptocurrency hearing:

https://www.youtube.com/watch?v=vf1dym16poc

Then we have the following follow up:

https://www.youtube.com/watch?v=2WOVukI3f-g

Consortium controlled cryptocurrency

When a consortium-based non-sovereign entity that has access to a captive network of several billion users proposes to launch a financial instrument which is a digital asset, the proposal leads to several challenges:

  1. A regulatory challenge
  2. The disenfranchisement of existing financial entities like banks, mutual fund investors, etc.
  3. The rather unnerving possibility of seeing use cases of the technology and digital asset completely unseen earlier.
  4. The scary proposition of allowing a large consortium to control money supply in international markets when a sufficiently large population agrees to use it as a mode of payment.

Another followup, discussion about the same: https://www.youtube.com/watch?v=t1-9Hm_rF6A

 

The rise and rise of Stablecoins

Stablecoin

The rise of Stablecoins

AVC blogged about stablecoins today. There is this detailed wiki on this topic that has upto date information about different stable-coins and the reasons why cryptocurrencies that have less volatility – often with 0 volatility, are useful in different markets.

On the overall crypto-markets are characterized by volatility, so much so that it has made equity market veterans call it names.  Bitcoin has risen by 100x in the past 4 years, and so has Ethereum. However, in between Bitcoin dropped a massive 70% in its USD value within 6 months, and Ethereum dropped about 80%. This volatility makes crypto-currencies attractive to speculators, arbitragers and such but reduces its attractiveness as a medium of value exchange. Behaviorally, while majority of bitcoin owners  would either hoard this as a long term asset similar to gold or diamond, a minority of them would trade it in the short term in expectation of profits.

This has given rise to the mushrooming of Stablecoins across global cryptomarkets. While Tether was the first stablecoin, supposedly backed by liquid assets, and audited, there are newer approaches to creating stable-coins. USDC is another such stablecoin, predominantly used by traders on Coinbase, by far the world’s largest cryptoexchange in terms of total assets stored. USDC though is backed by the US-Dollar held in a bank account. TrueUSD is another stablecoin that promises to back up each crypto with a dollar in the bank account. Dai is another stablecoin, backed by other types of assets stored and recorded on the Ethereum Blockchain. The Dai value proposition is similar to that of tether or USDC, except that it is backed by assets and not by another currency. While all of these i.e., tether, USDC and Dai are pegged at a 1:1 ratio of crypto to USD, Libra is another cryptocurrency which is supposed to be a low volatility stable-coin backed by different forms of assets from currencies, bonds, etc..

This space of stable-coins is seeing reduced volatility assets such as gold, silver and other metals being transferred onto the blockchain, most predominantly onto the ethereum blockchain. Over a period of time we will start seeing innovations in this sector that will bring assets such as mortgage rates, lending rates, etc. onto the blockchain at very low volatility, and amenable to trade. This is extremely beneficial to the entire sector.

Libra – and the monetization of network effects

Facebook Libra coin

Over the past few days, there has been a lot of buzz about Libra – Facebook’s version of a (stable)cryptocurrency and potentially a smart programming platform. While Libra is a brand new innovation and yet another blockchain with an extremely well-defined governance model, adoption and governance are not as straightforward as it seems. Below I highlight some of the features, use cases, and challenges that will be faced by an ecosystem like that of libra’s – including regulatory ones.

What is Libra?

Libra is a cryptocurrency proposed by Facebook going to launch in 2020. It is a stable coin with governance from corporate partners like Visa,eBay, Uber, Paypal, and Mastercard. The libra association is a governing body that open sources the libra blockchain and developer platform along with developing its own programming language called MOVE.

What will be the Use of Libra?

Libra is supposedly going to be the form of value transfer on Facebook’s network which includes the Facebook platform, facebook messenger, Instagram, and WhatsApp’s crypto-wallet Calibra. Libra’s use cases vary – firstly, from providing a user friendly way to transfer money between people using WhatsApp, to trade with other affiliate companies (or use as a currency on eBay, uber, PayPal, etc).. In addition, Facebook expects that its 2.38 billion people will somehow get to use Libra, while its value is stable – This onboarding of 2.38 billion people onto the ecosystem will suddenly bring the whole connected world- in direct touch with cryptocurrency through one of Facebook’s many services. This reach is truly the largest a cryptocurrency can expect in the world and will significantly increase volumes significantly on exchange markets because once people realize how easy it is to adopt or use libra then they will trade/participate on exchanges that support other cryptocurrencies too, cross chain innovation (e.g., multiple blockchains being able to interact among themselves), applications in other constrained environments too.

Bitcoin, Ethereum VS Libra.

Libra is a centralized permissioned blockchain network backed by real currency value in the form of currency and/or debt bonds from the stakeholders or partners. Bitcoin and Ethreum have their own value but Libra will depend on the currency value. Bitcoin is highly volatile but Libra will be a Low volatility stable coin – according to Facebook.
. Every large firm in the world will now be motivated to launch its own crypto e.g., United Lever, AT&T, Verizon, Sprint, etc… or join the Facebook Libra or one other crypto platform. In foreign countries like India – ridesharing firms such as Ola and e-commerce platforms such as Flipkart have their own rewards mechanism.

Challenges

1) Government regulation on monetary equivalents or money will significantly challenge libra’s global adoption – since governments control all aspects of money within their boundaries. While Facebook has the monetary power to push through or lobby for regulation in all geographies, it will take time to really make it a globally adopted monetary equivalent. Secondly, Facebook’s push into cryptocurrency markets will overall be good for the entire crypto-ecosystem since regulation will now ease adoption of other cryptocurrencies as well. We have seen this with organized efforts from the

2) While Facebook has promised to back up libra with monetary equivalents – it has yet to be seen how this will be audited in each geography.

3) The low volatility coin hopefully does not lead to secondary markets where libra is traded and demand far outstrips supply.

4) The reach of libra is far greater than that of any other cryptocurrency – but, will libra now managed (and governed) by the libra organization, be able to replace all banking infrastructure globally.

Government regulation Vs Libra.

1. US, Maxine Waters, the chair of the House committee on financial services, said that Facebook should hold the Libra launch temporarily.
2. The current state of India cryptocurrency policy won’t allow Libra to launch in India.
3. China already banned crypto activities, Companies like Ali express and Tencent are not going to follow Facebook

Let’s wait and watch this private digital currency future.

Peer-to-peer cryptomarkets

Peer-to-peer cryptomarkets

Peer-to-peer markets

Governments around the world have attempted to control both currency circulation, and, its exchange rates through either central banking mechanisms or through other forms of private institutions. True peer-to-peer money exchange markets have been very difficult to sustain when physical currency notes or bonds was a requirement. With Bitcoin and other forms of cryptocurrencies, we are seeing multiple forms of peer-to-peer markets where-in crypto-to-fiat third party escrows often governed by smart contracts are playing a tangible role in facilitating transactions.  These escrow services often charge a small fraction of the transaction but do enable and guarantee transactions. As a result, with the growth and mushrooming of private escrow services that will continue to facilitate and foster fiat-to-crypto exchange markets, it will take both governments and agencies large amounts of resources to completely cease and stop these transactions – as in the case of India or China.

A prudent way is to facilitate regulation through large exchanges similar to what is seen in the developed economies. Regulation has multiple benefits. Firstly, it enables the newer technology to facilitate industries and trade that were otherwise not feasible. For example, Ethereum based markets have enabled the growth of a significant number of technologies and markets such as in the insurance sector, computer storage, processing and such.  Secondly, it facilitates alternate markets to the most centralized and privatized stock markets, by giving anyone with a computing device access to financial resources. Thirdly, it increases the government’s tax base since they can now earn taxes (About 15% – 20%) off profits made by traders and participants in these markets.

A careful regulation will empower citizens tremendously, but enforcement of these regulations at a mass scale in large countries needs to also follow regulation. It is mostly the enforcement costs – that will hamper free crypto-markets, but when there are a few large crypto-exchanges that services the entire country, enforcement will be a lot easier, than attempting to enforce control on peer-to-peer markets that operate through private escrows.  The latter will convert the crypto-sector into something like a global sports betting market, which if legalized and regulated has several advantages.