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.

The Impact of Central Bank Digital Currencies on the Banking Sector

David Andolfatto


Here is an interesting podcast by David Andolfatto. About the Impact of Central Bank Digital Currencies on the Banking Sector. He also gave a short summary of his recent paper about Central Bank digital currency, It doesn’t think a lot of Central Banks will be willing to experiment with the notion of issuing, the equivalent of digital cash, just for a lot of regulatory concerns, like knowing your customer requirements or anti-money laundering rules.

The Two payment structure in the US today-

  1. On one hand, you have these big powerful depository institutions, these private banks that have access to and can hold accounts directly with the Federal Reserve Bank. These accounts are interest-bearing accounts. They presently earn a 2% interest. The banks can send money between themselves using Fedwire, which is a real-time gross settlement system. So you can send money instantaneously and there’s like trillions of dollars that flow through this system every day and moreover for the banks, it costs almost nothing to operate this Database Management System. It’s basically free as far as the big banks are concerned.
  2. On the other hand, you have the retail experience. The one that he has to go through or some small business for example. They either have to use cash which is very costly which takes a lot of resources to secure, to transport and to deposit.
    So in contrast to these big banks that pay basically nothing for instantaneous payments, you have the small business person who’s working on very small margins. They have to pay these big interchange fees and the payments don’t clear for two or three days.

His proposal in this paper is to say, what if we combine/permit these regular retail people to have access to interest-bearing Central Bank digital money, where the payments clear instantaneously on a real-time gross settlement system.

He also discussed a few words about Blockchain and shared database system and the idea of a central bank holding reserves in some security like crypto or Bitcoins and Gold.

A more detailed podcast from David Andolfatto on the Epicenter channel is given below:


Consensus algorithms on the blockchain

blockchain image

Distributed consensus based algorithms on crypto-networks have been created to ensure byzantine fault-tolerance. Many such algorithms have their sources in the Proof-of-work. Proof of work itself has evolved to different mechanisms e.g. ethhash, SHA-256, scrypt, equihash, cryptonode, and others.

A few other important ones are listed below:

1. Proof of stake (PoS) – going to be adopted by most leading blockchains
2. Delegated Proof of Stake (DPoS)- Adopted by STEEM wherein witness nodes randomly selected validate transactions and create blocks. The witnesses are voted by other members of the community.
3. Proof of activity (PoA)- a mixture of Proof of Work and Proof of stake
4. Federated Byzantine Agreement – Proof by consensus amongst nodes – Ripple and Stellar cryptocurrencies use this mode.
5. Proof of Space – Here, nodes concur about the amount of space or storage that has been used.
6. Proof of Authority – wherein a particular set of nodes randomly become validators, with the rule that no two subsequent blocks are not mined by the same node
7. Directed Acyclic Graphs ( DAGs ) – Examples include Pay-it-forward consensus where each node on the network is responsible for validating networks before forwarding it. Typically a centralized node also validates each transaction. e.g. IOTA uses this.
8. SPECTRE – Serailized Proof of work through Recursive elections: This proposal uses a combination of PoW and DAGs to accomplish scalability on the Bitcoin blockchain.


Each of these consensus algorithms have suffered from one or more drawbacks e.g. PoW is computationally expensive, PoS leads to No Stakes problem, FBA proponents disagree about the decentralized nature of the protocol, PoS claims resource usage in terms of space, etc… Overall, what we see is practical manifestations of years of research in computer science in fields as diverse as graph theory and theory of computation taking shape and supporting a large economic and financial shift in the way business problems are solved.

Proof of Work Alternatives (and irrelevance to the future of cryptocurrencies)


Proof of work

Most cryptocurrencies today employ proof-of-work mechanisms; that evolved from Bitcoin’s original mechanism, solving complex hashing problems and consuming a lot of energy.¬† The current Bitcoin implementation uses SHA-256 .¬†This approach to confirming transactions, after validation (on the nodes) is extremely wasteful for many reasons. Crypto-currency designers and blockchain designers¬†such as Dash have created¬†incentive mechanisms, wherein¬†“node” maintainers¬†who validate transactions also¬†get rewarded, in addition to the miners.¬† Some¬†economists and a few bitcoin champions have argued that¬†this¬†conversion of energy to “bits and bytes” through hashing is what provides the fungible value to Bitcoin as an asset.

The Bitcoin core-dev team led by luke-jr (one of the highest contributors) to the Bitcoin core code, have proposed algorithms to update the current Proof of work system. This system hasn’t as yet gained approval of the core – team, miners, etc. however, at some time in the critical future, this might take shape.

Issues with Hashing

a) Firstly, solving the hashing problem consumes significant energy, and this consumption increases as the difficulty of the solution¬†increase at regular intervals. By some estimates, the¬†largest miners combinedly surpass¬†power consumption in some of the world’s nation states.

b) Despite spending the energy there is a possibility that all transactions included in the newly mined block can be abandoned for many reasons, one of which includes the race to include only the longest block with the most number of transactions for reward. In Bitcoin this leads to orphaned blocks. In Ethereum, this leads to blocks called uncle-blocks that are not entirely abandoned but are connected with the main blockchain.

c) Thirdly, the rewards for mining reduces over a period of time, and halves every few months. The next day for halving rewards for the bitcoin blockchain. The assumption of most miners is that this reduction in rewards will be offset by the positive growth in USD valuation of the cryptocurrency.

d) Lastly, as the difficulty levels increase, and the rewards from mining reduce,  equipment used for mining would become obsolete.  This creates a marketplace for mining wherein a few specialists with the ability to keep up with the technology changes needed to mine would dominate.

e) To top it all, there are incentive alignment challenges in these markets, wherein the few miners who dominate the mining market would wield enough controlling power (as in network hash rate) to block any new development initiatives by the core development team. These handfuls of miners can pretty much block or allow any change to the protocol layer.

Lastly, this process of earning disproportionate rewards has led to significant investment in the ASIC technology, and the over-demand for GPUs that are used for mining. Almost the entire of GPU inventory sometimes get bought out by miners, leaving very few of them for the gamers.

To solve this problem of extreme wastefulness, and making crypto-currencies more efficient, there is this massive initiative of the ethereum network towards proof of stake. More on this approach later.


Marketplace for computations


Distributed computing affordable.

In my senior year as a Computer Science undergrad, ¬†I asked the guest speaker about “why it was not yet possible to access sizeable computing power and resources on the internet at very low costs. This given that there were more idle computers on the internet that used computers.” Professor V Rajaraman considered the founding father of computer science education in India was the chief guest, and he gave me an amazing answer – about how if one were to lift a large object say 100 times one’s weight, it would need lock-step coordination. He gave the example of ants and the swarm of ants being able to – in lockstep, carry an object many times their weight because they were able to coordinate¬†perfectly.


Computation Power for hire

Later, as generations of computers were built, there was the whole mainframe revolution, then a distributed cluster revolution, and, more recently in the past decade a cloud revolution that started offering such clustered-coordinated-computations as a marketplace. Pay-as-you use models, became possible, though the price of computation seemed exorbitant for students, and firms with very low budgets.  obviously, as with any large infrastructure based marketplace a few top players dominate.


Golem, a distributed app, running on the ethereum network is one such solution. It allows a pay-per-use model for renting as many nodes as needed to run applications. Both the service providers i.e. individuals who are willing to let other people use idle computing time on their systems, and, customers of the service are bound by an ethereum smart contract. Though Golem is in its very early stages with a Beta being released on the Ethereum Main-net, this distributed app is extremely promising if it succeeds in accomplishing what it has set out for. The kinds of distributed apps, that need high-end computing ranges from developing 3-dimensional graphical applications for games, to, enabling deep learning through massively parallel analytical tools. Today, such infrastructure is accessible only at research universities, large firms or governments. Renting such infrastructure say 10 nodes on the cloud would set one back by a few 100 dollars per day of usage, based on the usage. Golem’s fee-based revenue model will hopefully cost much less for computational usage, and, will possibly democratize and make computation pervasive.

The baby steps were made this past week, but, over the next few years, the possibilities of this are immense. If price parity and network scaling for smart contracts do not bottle neck the growth of this app, a few years down the line, this could truly challenge the dominance of large cloud based infrastructure players, who will either have to switch to a similar model or alter the focus of their businesses. This application is decentralization at work.

Decentralized Exchanges and Atomic Swaps

Decentralized Exchanges

With the blockchain in itself being a decentralization enabler, how can exchanges remain so centralized? Decentralization that is core to the entire crypto-ecosystem is enabled on exchanges through a technology known as atomic-swaps. Decentralized exchanges such as waves, barterdex, etc. enable one cryptocurrency to be exchanged for another at the current exchange rate. This enables almost frictionless, movement of currencies and tokens globally.

Makes me wonder why forex trade is rife with between 2% and 10% commissions per trade.

Atomic swaps

Atomic swaps enable trade amongst currencies using smart contracts, that prevent seller and buyer defaults. The decentralized exchange is responsible for creating and holding the value being exchanged as part of the contract. Usually, decentralized exchanges have their own tokens that in some ways are used to guarantee this asset transfer. In exchange, some decentralized exchanges charge a very small fee (0.01%) for each such atomic swap, in the exchange’s token.

Dilineating the Blockchain from Cryptocurrencies


Congressional Hearing

Anyone working in the blockchain sector has to listen to the congressional hearing about cryptocurrencies, that conclude a couple of weeks back.  In addition to the debate about the legalities of Cryptocurrencies, and, ICOs, there were presented; many interesting industry applications were presented too.  The interesting piece about the benefits of the blockchain starts at 1 hr: 25 minutes about here.. and ends 2 minutes later.

Walmart-IBM-Blockchain application

Recently, Walmart and IBM demonstrated how the blockchain reduces shipment tracking time to about 2.2 seconds from 2 weeks. In providing traceability of transactions through a chain of records, and, almost instantaneous validations, the blockchain reduces the query times across data stores.  Industries that traditionally have relied on record keeping and verification benefit the most from the Blockchain.

Improvements in tracking transactions

An article here cites that the blockchain can tremendously improve efficiencies in the food chain; right from the farmer till the end consumer. In addition, due to the persistence of identity and records on the Blockchain, the data can be queried, validated and fetched almost instantaneously. This creates immense possibilities, for firms, moving large commodities across geographic boundaries and locations.  Such tracking capabilities that are dependent on multiple players integrating and updating their logistic management systems are now vastly simplified through the implementation of smart contracts.


One of the important takeaways from any regulatory hearing (including this one) was the proposal to legally dileneate Cryptocurrency and the Blockchain. What this means is that regulation (when it arrives) will treat blockchain applications differently than cryptocurrency. Many blockchain applications do not need tradeable tokens. Though creating a token of value is beneficial for many things such as
a)  setting up contracts between different economic actors,
b) making network effects fungible for all users by tangibly rewarding stakeholders,
c) providing a viable funding mechanism for the business,
d) Locking-in customers by increasing switching costs.
Overall, the blockchain applications can influence the entire supply chain industry. This delineation when regulation hits this nascent sector will hopefully allow innovation to continue un-hindered.

CryptoKitties, Price irrationality and scaling

Cryptokitties mother and board (owned by an early crypto-kitty enthusiast and collector)


CryptoKitties is the first game created on the Blockchain.  The game works when individuals purchase a digital cat by spending ethereum. Individual cat owners can combine one or more cats to produce a third cat that shares physical features of  it’s parent cats. Additionally, there is a marketplace where one cat owner could trade in digital cats. During the initial stages of the game, each digital cat, that released onto the network sold for 1$ worth of ethereum.

Irrationality in Prices of Cats.
Over a short period of time (past 2 weeks) the marketplace exploded with millions of dollars worth kitties trading hands. More recently, cats that were sold during the early stages of the game were being sold at prices more than 100000 USD. The processes of breeding, selling, and buying were all configured as smart contracts wherein trade was autimated when suitable buyers and sellers were matched. An exponential increase in trade of kitties was responsible for almost 15% of the most recent transactions (1500 blocks) on the ethereum network as per the ETH Gas station.

This backlog of transactions resulted in excessive delays on the Ethereum network, even holding up some ICO offers.

Price Irrationality

Off late,¬† crypto coins¬†(bitcoin,¬†litecoin, ethereum, etc..) and crypto assets¬†(e.g. crypto kitties, ICOs, etc.) have seen extreme price irrationality combined with volatility.¬†This has caused significant press and attention to these assets. In this case of crypto kitties, linking the ownership of a digital asset (crypto kittie) through a smart contract and allowing this contract to reside permanently on a globally distributed Blockchain is the main feature.¬† The same functionality can be accomplished for other types of assets, e.g. titles of cars, titles of houses, or titles of land, birth certificates of individuals, etc… and is much more potent at changing real-world product markets. With crypto kitties, price irrationalities are potentially related to the scarcity of supply, since, the rate of production of new kitties is significantly lower than the demand from blockchain enthusiasts.


That being said, these technology demonstrator distributed apps and their problems have larger engineering and economic impacts.

  1. The large adoptions of the dapps surfaces infrastructure and engineering problems related to scalability that cannot be unearthed through any form of distributed software testing.  In the short term, the core engineering teams will have to increase their scalability efforts so as to support scale. Just a single successful app, can hold up transactions for hours from other applications on the network at the current rate. If the original goal of becoming a world computer that can theoretically execute any type of contract, has to be achieved, this scalability is imperative.
  2. This explosion of dapps, increases monetary gains for all segments of the crypto-ecosystem e.g. dapp writers, traders, and,  other owners of ether. Such a sudden increase in valuations for a tradeable digital asset has physical limitations, and is going to be corrected Рhopefully by market conditions and not by regulation.

The Battle for Scaling Transactions

transaction support
A total number of transactions supported by ethereum has surpassed the combined transaction volume of all other cryptocurrencies in the past 24 hours.

Over the past few weeks, support for large transaction volumes has been at the heart of all design and other discussions in the cryptocurrency ecosystem. Scaling has two key aspects to it. Firstly, the ability to support large number of transactions (count). This means the underlying network should authorize the exchange of value, by Byzantine fault-tolerance and double spending prevention. Secondly, the time to validate each transaction on a network of nodes that are globally distributed should be within reasonable limits to allow for real-time trade. Though a sub-second (millisecond) transaction time is ideal, for most real-world systems such as a POS a confirmation on the blockchain is not possible and may not be required. Payment systems, point of sale systems, etc. will need to use completely different mechanisms to validate transactions  in real time, be it for either the bitcoin or for ethereum.

Currently, bitcoin’s block confirmation time is around 8 minutes as per this chart.¬†If the Segwit2X performance enhancement was rolled out, this time would¬†have reduced to under a minute.

In fact, in the real world it is much more delayed because at least 6 confirmations are needed for confirming a new transaction.

Comparing this with Ethereum’s block confirmation time, Ethereum has been able to, despite the surge in volumes, keep the block confirmation times to under 0.5 minutes (or less than 30 seconds). This is because of their most recent network upgrade that was not contentious as the Segwit2x and had wholesome support from the ethereum¬†community.

Eventually, in my opinion, the cryptocurrency battle, will in the short term be based on scaling. The payoffs for the platform that scales the fastest in terms of two parameters i.e. transaction time, and, transaction count (volume) will be the highest.

Bitcoin speculation


Speculation is described by the modern dictionary in two related yet different¬†ways :(1) “the forming of a theory or conjecture without firm evidence.” and ¬†(2)“investment in stocks, property, or other ventures in the hope of gain but with the risk of loss”.¬†

In the context of cryptocurrencies Рdefinition (1) seems to have an impact on the definition (2). The past week has seen an immense number of theories Рfrom the banning of exchanges by China, to a known name in the financial world calling cryptocurrencies frauds. The market reacts to every one of these news articles that are sourced sometimes from unconfirmed sources Рirrespective of whether the player has any real investment in that asset class or not.


There are 160+ obituaries written for Bitcoin documented here¬†since¬†Genesis. Prices have dropped (sometimes significantly) each time any negative news makes it to the headlines causing significant profit booking by active traders. A classic event study will demonstrate the reliability of these markets on information from any source -reliable or not. Most of these news articles are the basis of Speculation but increase the “risk of loss” to long term investors.

Mature markets

Mature securities markets do not react with such swings in the face of unconfirmed news or rumours, since firms usually control their¬†public announcements.The biggest difference between an evolving technological market, and, a mature one is ¬†in the level of volatility (- mismatch in supply and demand -) ¬†a market exhibits in the face of external news (- e.g. a trader who has zero stake in the Bitcoin ecosystem commenting about its problems without providing any evidence). Overall, mature markets will need more evidence, so as to increase the “risk of loss”.

In other words, the higher the evidence an actor provides to either support or oppose a viewpoint, the lower the “Risk of loss” would be. This maturity in terms of resilience (of supply and demand) is probably coming soon (and) will probably be a facet of these markets. Such maturity and reliance can happen only when we see mass adoption of applications such as the ¬†“Brave Browser” , or, the instantaneous remittance application ABRA.