Section 5: Trend by cryptoasset class
In the previous Quarterly, we introduced the concept of “Consensually Accounted Assets” (CAAs), in an effort to classify all the various kinds of available cryptocurrencies and DLT tokens, and to give a general definition and terminology to all the units of an account bearing value managed on a distributed ledger.
The CAA concept came as a follow-up on previous observations we made on utility tokens, published in our Q3 2018 edition.
Regulatory bodies, as well as traders, struggle to categorize these objects appropriately. The terms “cryptocurrency” and “coin” are hardly applicable to tokenized assets; and “token” does not describe accurately other cryptos like Bitcoin and Ethereum, amongst others. Not to mention that some are native to a DLT and some others are built on top of a native DLT.
We’ve received some comments that a more robust term would be Consensually Recorded Assets. And thinking about it further, a similar misuse of language has also led to the “crypto-asset” term. For the time being, and in the following sections, we will be using CAA and crypto-assets interchangeably in their broadest definition.
Following Cardano, EOS, Tron and other Zilliqas, there is no shortage of creative projects that claim to be a better alternative to Ethereum. They claim to differentiate on scalability (throughput rate), the consensus mechanism, management of private data, builtin KYC, and other compliance issues, with some that include identity management.
Not all of them are deployed DLTs or listed on coinmarketcap.com. Among those we have come across lately, it is worth mentioning a few:
DFINITY: “The Internet Computer,” i.e. “a decentralized public cloud designed to host the next generation of software and services.” The whitepaper describes a 4-layered consensus mechanism, relying on a verifiable random function decentralized among the nodes to elect the block’s validation leader on the blockchain itself. The real innovation is the introduction of a 4th layer, to notarize information: by not requiring full network consensus at this level, they claim that this top layer is very responsive and can scale up.
Concordium: “Designed for business”; this Swiss-based foundation and the independent company relies on substantial cryptographic expertise, mainly from Aarhus University in Denmark. The infrastructure that Concordium built aims to address business requirements, in the sense that anonymity is eliminated, but the privacy of transactions are allowed. Regulatory compliance is built-in (KYC, AML, and revocable privacy). The consensus mechanism is based on a refined implementation of PoS and includes a finalization mechanism.
All these projects look very promising, taken individually. However, there are many competing projects, and unfortunately, the success of infrastructure does not depend solely on its technical performance. In the forest of all the projects currently making noise, to get traction a given infrastructure must rely on good marketing and communication to build a community, to convince some proof of concepts to develop, and wait for systems to be put into production on it.
More than ever, the race to become the ultimate decentralized-applications IT infrastructure is on.
Enthusiasm and traction around a given DLT “infrastructure” depend heavily on its capacity to build an enthusiastic and working community around it and using it. While Ethereum is the clear winner at this game, we wanted to explore the size of these developer communities, and maybe characterize them.
A community is typically composed of:
• Developers of distributed ledger client software that agree on the protocol and its evolution;
• “Investors,” i.e., speculators, arbitrageurs, market makers, and liquidity providers of the underlying cryptocurrency;
• Miners, where applicable;
• Developers of decentralized applications;
• Users of decentralized applications.
Ultimately, everyone needs to make a living. Developers of decentralized applications are likely to continue trying to get paid in the ecosystem that they create on top of the infrastructure. The application users will not care much about the underlying system that they will not even see.
The valuation of an infrastructure crypto-asset is therefore derived from either or a combination of the following: the cost of secure execution of applications and the monetary turnover and number of participants willing to rely on it for payment and value transfer.
By simple reasoning, we can infer that, if the cost of secure execution is higher than running a central database, then people will not use it; and specifically, scaling is about consistently reducing this cost. So, while an infrastructure may have potential, it may be quite limited. For example, consider Amazon Web Services. The company makes money, with an annual turnover estimated at around 50 billion dollars. However, if a crypto-asset is used for these transactions, and were turning over half the issued tokens each week, the monetary volume necessary in the ecosystem would be around 2 billion dollars; Ethereum is already valued at much more.
So, let’s be clear; the secure execution of applications is not the primary factor to consider when valuing the infrastructure of crypto-assets, even disregarding the question of clonability of the protocols. Such cryptoassets are likely to earn value only if the users of the platform (at the lowest level, not the DApp level) use it as a vehicle to transfer or store value. In turn, this will only be possible if volatility declines. And if it does, then, of course, the more users, the greater the community, and the greater the potential for growth in value; in which case the turnover of fiat currency will be threatened, which is in the range of tens of trillions of dollars.
It turns out that the intrinsic value of an “infrastructure” crypto-asset will have a base value and an actual exchange value that remains quite volatile, preventing it, in the short term, from leveraging its real valuation engine: the monetary volume necessary for settlement (automated or not). Of course, if we envision that the tokenized fiats (or tokenized gold, or tokenized bitcoin) are going to be the currencies used on these networks, then, in the end, the community does not matter a great deal; Ether, Cardano and the like will be of little interest and value after all.
This is the case for tokenized securities that are liquid enough to be used for daily settlements in businesses. However, collateralized cryptoassets to be used for bulk payments look quite far away, and a range of services will need to be proposed before this is achieved.
Utility tokens are still a contentious class of cryptoasset. Despite their heterogeneity, the vast majority will fail due to the platforms, DApp, etc., not being built, or not being successful; but some teams might end up launching a distributed service where the cryptoasset will be alive and continue to exist. Such cases are highly speculative, of course, and each one will be specific, but a case for being good investments can still be made for some of these.
Tokenization of assets is a whole subject by itself, and many of these can be readily used as alternative stablecoins. The following paragraphs offer a review of this space by asset class:
The use of blockchain in the real estate business has gathered momentum lately since DLTs propose to solve the problem of large capital requirements, illiquid investments, third-party fee-grabbing intermediaries, and slow transaction times. Importantly, in addition to offering “digital shares” to investors, it can provide smart contracts, thereby automating payment of income for property owners.
A Consensys venture Meridio is addressing this segment. Their track record includes the tokenization of a building in Brooklyn.
They list the advantages of their solution: (1) land title and deed recorded; (2) property sale and title assignment; (3) tokenized property ownership; (4) investor/tenant identity verification; (5) payment and leasing; (6) real-time accounting.
IHT Real Estate is an initiative that claims to tokenize real estate properties, offering individual investors an opportunity to purchase an interest. BitRent is another venture that collects and redistributes revenues from the features that are rented.
Commodities (including precious metals)
The demand for tokenized gold has increased, as people look for crypto-based safe havens. For instance, the capitalization of the Digix Gold Token market has increased linearly to 4 million dollars, which is still relatively small.
Many other actors are entering this sector, including Eidoo from Switzerland and GoldMint from Russia.
Royal Mint, from the UK, has been prevented by the government from selling blockchain tokens representing physical gold.
Of course, venture capital is the most immediate application, with a large appetite from startups as well as from investors and, especially in DLT-related fintech. We have already highlighted in a previous issue of this Quarterly, the extent to which this is changing the business model and jobs of PEs and VCs.
The adoption of STOs is gaining momentum, but it remains quite sporadic in the overall landscape: only a few dozen per month—although increasing exponentially. There is no doubt though; this business is headed for mainstream success in the short to medium term. But for the moment, burdensome regulatory requirements seem to be still discouraging small companies from going that way, while larger companies, due to their conservative CFOs, are so far, not diving into the pool either.
A whole ecosystem is in its infancy here. There are some asset tokenization platforms; some exchanges (“official” or private) that will specialize in security tokens; some funds and investment bankers will package STOs into funds, shares, and derivatives; and some analysts and rating agencies will integrate them as well. We see a lot of enthusiasm and bullishness on the part of tokenization platforms and exchanges to push the adoption rate of STOs.
ERC20 standard from Ethereum is adopted by two-thirds of securities tokens, with Polymath’s ST20 accounting for 25%, and the rest split between EOS, Waves, and others. ERC1400, a new Ethereum standard, has been specially developed to support securities tokenization.
Loyalty program points
In July 2018, Singapore Airlines started a tokenization program (KrysFlyer) for its membership miles, thanks to a digital wallet developed in partnership with KPMG and Microsoft. The airline is onboarding retail partner merchants to accept the token in Singapore.
Artists or athlete career
SportyCo, a platform that enables the public to bet on the career of athletes seeking funds, collapsed since its ICO one year ago.
Collectibles (art, luxury, and historical objects)
Everledger, which, some time ago began placing diamonds as nonfungible tokens on Hyperledger, is now expanding its concept to wines. Traceability is systematically highlighted in their use cases. LVMH is working with VeChain; again, mostly with traceability in mind.
Maecenas tokenized, on Ethereum, and sold a 31.5% stake in Andy Warhol’s painting, “14 Small Electric Chairs”, to bidders who could pay with bitcoin, ether or its cryptocurrency, ART. In a survey, the European Fine Art Foundation found that 75% of auction houses, and 33% of intermediaries, intend to offer some blockchain technology within the next five years.
CAAs are pure tokenized financial instruments; bonds, stocks, and all kinds of derivatives. They all have a value that can be estimated with traditional approaches and are of little interest for us here other than highlighting the fact that the support for these securities is poised to change and with it the jobs of many financial market professionals.
A - ANONYMITY FUNCTIONALITY
KYC/AML/CFT can hardly apply on these, and as such, we can expect that regulators will clamp down on them, while they will be favored by cypherpunks and their descendants.
Again, MimbleWimble-based distributed ledgers are getting traction in this field.
In summary, all the functionality can be allocated single-, double-, our multiusage features.
With five major functionalities usable to classify CAAs, we end up with a 5-dimension matrix; which is not very convenient to represent nor to navigate into. But since we have only two positions in each dimension, we have just 2^5=32 possible categories; and some of them are going to be irrelevant or nonexistent (the blank one).
We will keep this matrix updated as we continue with our Quarterly reviews.
A FOCUS ON BITCOIN
Cryptocurrencies are now more than ever all linked to bitcoin, so it is worth focusing on BTC to check the overall health of the sector and the likelihood of a trend reversal.
Bitcoin is incrementally claiming back the ground it lost to the emergence of altcoins throughout 2017. Its predominance had fallen as low as 30% and is now back to 55%. There are no indications that it will not continue to regain lost ground, and it is worth examining why.
Peer-to-peer money is still as cool as it was ten years ago. The value proposition is still to store, and exchange value using a means the government or large corporations do not control that. This view is still as attractive as it was in the beginning, maybe, even more, considering the measures regulators have taken to put more compliance pressure on exchanges (e.g., KYC)—thereby effectively ensuring a clear distinction between the “free world” and the constraint-laden, establishment-favored, tax-intensive world. More than ever, bitcoin is about providing freedom to whoever wants to conduct business without intermediaries or third-party surveillance. Therefore, cryptocurrencies that focus on anonymity have an exciting future; but as the legacy cryptocurrency, bitcoin is more than ever here to stay.
Almost unanimously, bitcoin holders and crypto pundits believe that a price bottom will occur in the first quarter or first half of 2019. However, even if this happens, prices would need to hold for another 9 or 12 months for this view to be confirmed.
Hereafter are some metrics on bitcoin’s health:
The hashrate has progressed from 18 Ehash/s in January 2018, to 40 Ehash/s one year later: this shows continued interest by miners, despite the profitability issues they face .
Wallets containing anything from 100 to 1,000 bitcoins owned 23.3% back in September, whereas now they own 21.4% of all coins. Conversely, the five wallets containing anything from 100,000 to 1 million BTC—which belong to crypto-exchanges (and their customers)—own today 3.3% of all coins, an increase from the 0.7% share in September.
The average cryptocurrency payment in 2018 was 680 USD, while in 2017 it was half that, 340 USD.
Bitcoin volume, expressed in bitcoin, increased drastically during 2018, as we saw earlier.
Transaction fees over the network are back to their high levels.
The number of bitcoin ATMs is said to have passed 4000 units, and the pace of installation is accelerating. ATM operators are currently living on the earnings from their business, which is already good progress.
A couple of other considerations:
Some people have noticed that bitcoin’s price witnessed huge increases on two occasions following the coin’s block reward halving (in both cases, around a year after the halving occurred on November 28, 2012, and July 9, 2016). Whether it’s related or not, the 4-year interval also corresponds to the inter-peak period of the price between 2013 and 2017. This may be an interesting fact to keep in mind.
Bitcoin and its PoW consensus mechanism are still the best of what has been proposed in terms of security of the network to counter attackers. PoS scales a little more, but it is challenging to prevent new kinds of intermediaries overseeing the network. One should not forget that it all started to create a decentralized currency system.
Even in the event of a 51% attack, the loyal bitcoin community would still be able to maintain a chain of valid transactions—but just.
For scalability, one should note that it is always possible to tokenize bitcoin on another chain— paradoxical perhaps, but a potential solution, nevertheless.
Without a doubt, bitcoin remains “the king of cryptocurrencies,” and its future seems as bright as ever.