Section 3: Blockchain industry players
News of mining plants closing or at least suspending business, continue to hit the headlines. For instance, Bitmain, the Chinese mining giant, has closed several offices (Israel, Netherlands, and Texas). Giga Watt in the US has also been forced to cease operations. This trend has resulted in the available bitcoin hash rate decreasing by 25 percent to 30 percent since October, despite the overall annual increase. In turn, this has an impact on the safety of the bitcoin network.
Only low-cost mining plants are today operating with a limited profit (the rest being unprofitable, see figure 6), mostly thanks to advantageous contracts with electricity providers. Even for these miners, unless mining difficulty level adjusts as a result of more miners unplugging, the threshold is 2,400 USD/bitcoin.
The consequences of this bear market are already being felt. China’s dominance in hash power concentration continues to increase, thanks to its competitors being driven out of business.
Additionally, nobody is buying brandnew mining equipment, so business is also slow for mining rig vendors.
More positively, the decrease in hash power has reduced electricity consumption and consequently the environmental footprint of PoW for the time being.
Centralized “off-chain” exchange platforms
Demand from ventures that issued an ICO for listing on the main exchanges (Binance, Huobi, OKEx, Kraken, etc.) is high. On the one hand, the benefits for projects that are listed on one of the main exchanges are significant, in terms of recognition, exposure, and access to liquidity. On the other hand, one of the business objectives of exchanges is to offer a maximum number of interesting tokens that they are confident will create a market that is active enough. Hence,
some exchanges have implemented admission processes, including token information disclosure requirements. ICO details and success criteria are often analyzed by the exchanges as a proxy for evaluating the attractiveness of tokens. Their focus is on avoiding listing scams and weak projects that have a high probability of failure—they, of course, want to protect investors who are using their platform, from being trapped and having a bad experience. Very often, a voting mechanism is deployed for investors and users of the exchange platform to nominate (in priority order) which tokens they would like to see listed on the exchange.
Some exchanges, such as Coinbase, have begun proposing a custodian service; holding and securing cryptoassets for its clients.
A few agitators are trying to raise public concern about exchanges taking control of their crypto-assets,not the least due to repeated hacks of exchanges accounts. The attitude that “it’s on the blockchain or it did not happen” or “if you don’t have your private key, you have no bitcoin” is quite important. Movements have been launched to plan a bank run by coordinating the withdrawal of a maximum amount of cryptoassets from exchanges at the same time—to check whether exchanges indeed own the relevant amount of cryptocurrencies.
Another distinct aspect that is worth highlighting is the PoS business that exchanges might be engaging in. As they own a lot of native cryptocurrencies that work with PoS or DPoS, staking these assets would be very tempting for them, and they earn a reward while doing so. While the European Union has started to express the view that a custodian should not be allowed to stake assets in their custody without explicit agreement from their customers, the business of holding crypto-assets and managing earnings,thanks to staking in the name of clients, could be seen as a new form of banking. There is no reason why this will not occur at some point in the future.
Despite the noise decentralized exchange projects still make (they represent one fifth of total number of platforms), their relevance in the overall traded volumes is still negligible (see figure 7). The evolution of these figures will tell a lot in the coming months.
Some sources have highlighted that the rising cost of compliance for off-chain exchange platforms has resulted in decentralized exchanges having a competitive advantage.
Exploring this trend is, in fact, very interesting. Decentralized exchanges cannot be stopped; governments cannot close them, they are available 24/7 to any citizen on earth to use, with no identity check, no financial cap, and without questions regarding the origin of the funds. Hence, their use is likely to be prohibited by financial regulators, if not completely, then at least as far as their jurisdiction applies.
It is not clear whether individuals will take personal responsibility for acting on these exchanges, aware of the concern that ultimately when attempting to return funds to the controlled “real world,” they may face difficulties in proving their legitimacy when questioned by traditional players and authorities. In turn, this may lead to a deepening of the separation between the legacy fiat environment and the new cryptocurrency environment.
Centralized exchanges are investing in the field of decentralized exchanges—with Binance being the flagship of this move. What this means is that people will be able to exchange assets directly from their hardware wallets, thanks to a sort of over-the-counter facility.
BLOCKCHAIN CREATORS, ENTREPRENEURS AND APPLICATION DEVELOPERS
At the price level that cryptocurrencies have now reached, holders of BTC and ETH, and even teams holding their own coins, are down to a tiny fraction of what they raised. From this moment on, it makes little sense for them to exit or sell what they still have.
If it no longer makes sense sell out at those price levels, this means that the downward pressure on prices is likely to be almost exhausted.
In parallel, of course, ICOs currently going public are raising only a fraction of what similar projects were able to raise just one year ago.
Decentralized autonomous organizations (DAOs), or decentralized applications are sets of smart contracts that offer functionalities on publicly distributed ledgers, accessible to everyone. These are the most disruptive application of DLTs.
Even if progress has been slow and below expectations for decentralized applications that launched in recent years, there have been some successes, which should not be ignored or marginalized, including:
• Augur, the prediction market application is live and was used with success in the US midterm elections.
• Status, a decentralized messaging platform, has moved to a beta version.
All these services are not yet easy to use or scale, but they are still embryos of what we can expect. Nevertheless, some argue that decentralized applications have no chance of becoming mainstream any time soon because the required supporting infrastructure is still being developed. In this sense, a parallel drawn with the internet phenomenon would have to be based on the decade of the 1990s, rather than the 2000s.
The model for decentralized applications offers nothing less than a complete reshaping of how activities are constituted, how money is raised, how stakeholders are economically rewarded, how financiers are attracted and compensated, how governance is expressed and enforced. So, considering that this ultimately has the potential to challenge even the status quo of capitalist profit-seeking companies, it is normal that the model is currently still in the very early stages.
Utility token ICOs
The failure of utility tokens has been well-advertised. Even if one wants to advocate for the system, it is difficult to regard it as successful at the moment. You could argue that the extreme crypto volatility was a paroxysm for utility ICO tokens, or that these price curves merely show that start-ups pass through very difficult downturns in their first year, which was not observable before when continuous trading in venture capital funds was not the practice.
However, it should be acknowledged that the utilitytoken-style ICOs currently being conducted are mostly based on highly dubious projects. Very few serious projects go that way, partly because not many new promising ventures are being launched during this crypto winter, and partly because the utility-token model has been roundly criticized, and credible new projects are currently opting for other, more traditional, alternatives.
Regarding estimating the worth of utility tokens, sound valuation approaches are scarce. One equation attempts to model the case: M×V=P×Q, where the total number of tokens in circulation, or Mass M (which equals the number of tokens × price per token) multiplied by their turnover, or Velocity V, in a given period will equal the Quantity Q of the digital service being performed in a given period on the platform, multiplied by the Price P of the service. This is straightforward, and from there, the token price can be deduced. This approach does not account for speculators holding the crypto-asset, and therefore the result can be regarded as a floor price. Be aware that applying this equation is difficult when a platform is still under development, or an early minimum viable product (MVP); it’s all about estimating projections.
Security token offerings (STOs)
The regulations for offering and issuing securities are clearly framed in almost all jurisdictions. Regulations applicable to IPOs and public companies’ capital management are usually quite constraining in terms of information disclosure, prevention of insider trading, accounting procedures, etc. All of this naturally applies to enterprises that wish to issue securities as tokens on blockchains.
A substantial number of articles have presented STOs as evidently the new way to raise funds, thanks to blockchain technology, which is bringing clarity to the “Wild West” that the crypto space has been. We would be cautious on that: while there is no doubt that STOs have a bright future due to the continuum in functions that tokens offer, as we have seen repeatedly, other categories of tokens also have a future. It is worth mentioning that small ventures—and ventures unlikely to attract venture capital—do not have the money to go through the costly process of an STO, and this is precisely the issue that ICOs were trying to solve.
We can conclude that, although the forest of projects still needs to be sorted out, security tokens are by no means going to be the only option to remain on the landscape.
Airdropping is a practice by which the team behind an ICO or an STO, sends its token to the wallets of individuals—and mostly exchanges— for free. Wallet owners will then be motivated to sell the newly received token for any price a buyer would be willing to pay on the exchanges. If there is a market, then the tokens gain a market value, and the creating team can then sell some of the tokens they retained to fund their activity.
The biggest news in the world of airdrops is the TRON move to revive Bittorent and distribute BTT tokens to Tron holders every eleventh day of each month till 2025. The effect of this airdrop initiative is to strengthen the value of the supporting blockchain. People are likely to hold their TRON tokens in hopes of receiving airborne money on a regular basis, thereby locking out of the market a significant supply of the cryptocurrency— decreasing supply, and, in turn, supporting an increase in the price.
Interestingly, exchanges quickly claimed that they would support the airdrop, which confirms the view mentioned above that exchanges will play an ever-increasing role in managing the rights of token holders, which they in effect pool (see comment on “Exchange platforms”).
News of former central bankers and other high-level executives joining boards of advisers and management of crypto-related businesses continue to hit the headlines regularly.
In most countries, the median annual salary for blockchain developers is on the rise, with developers in Switzerland routinely paid 15kCHF a month (15 thousand USD), due to the increase in wages caused by the scarcity of resources and the continuing demand for the competencies.
But probably the most interesting news item is the layoff of more than 300 people by Consensys: over 30 percent of the workforce—later declared to have been limited to 10 percent, mostly in support functions. Bitmain and Steemit have been reported to be reducing their headcount in comparable proportions. These are significant events in the industry.
In particular, Consensys had the reputation that Joseph Lubin, a co-founder of Ethereum, was willing to pay for his vision of the expansion of the sector, no matter what. It seems that Mr. Lubin’s confidence has reached its limit; the fintech consultancy firm is shrinking by 80 percent, and incubating companies are encouraged to seek investors elsewhere. This could be a sign the bottom in crypto prices may arrive sooner than later.
One interesting thing about crypto, compared to conventional analysis of stock prices, is that it is possible to scrutinize not only the volumes on the exchanges but also to have a perfect view of the movements on the blockchain. This is particularly true in the case of bitcoin; analysts can process the data available in the ledger to assess which types of owners are exhibiting which types of behavior.
For instance, some analysts claim that by looking at wallets that have been inactive for the past three to five years, it is possible to assess the willingness of these people to sell out. They think that selling is largely exhausted as of the beginning of 2019, pointing to what occurred in a similar case in 2014-2015. Interesting views, of course, even if this field of study is still young.
On a similar note, a study by Chainalysis earlier in 2018 estimated that 3.5 million BTC have definitively been lost. This amount represents more than 20% percent of the available bitcoin supply.
Below, we will explore recent activities of independent investors, or individuals acting for themselves: casual holders and “crypto whales”.
In this quarter, it is particularly difficult to clearly express the general sentiment among average investors. Firstly, there is not much discussion these days. Secondly, among individuals active on social media, who claim to be crypto experts, the tone and feeling are primarily objective; dispassionate, but still quite positive. In summary, there is no real evidence of deep despair, which is typically present when markets bottom out.
Retail investors appear to be inactive, although probably, not many are unsettled at this stage. Most people who entered the market after November 2017 were individuals who invested a small amount of their wealth and can afford to lose the investment without being financially affected. These people are now, at most, at 10 percent of their initial investment value. They do not care anymore; they played, and they lost. However, before they consider getting involved again, the price needs to rise above their entry level to confirm their initial view, regardless of whether they held or not.
Since the advent of bitcoin, dominant cryptocurrencies have emerged in a fairly small environment, and those who have been involved since the early days— especially in mining—now own a disproportionately large amount of the underlying cryptocurrency. There are accounts, publicly monitorable on the blockchain, that contain fabulous wealth, and any movement involving these accounts (or the absolute movement of large amounts of crypto wealth) is carefully watched by the communities.
When the so-called “whales” move their assets, many think that it is a sign that “something is happening.” Whether or not this is true, it is a fact that these people have such a large share of the cake that they could influence the market if they chose to. Interpretation of such on-chain movements, of which nobody knows the origin or the destination or the price at which the movement is valued, is open to question. A simple way to interpret this information is that these people are active and are dealing with their assets: they are either waiting, consider when to sell, or when it is appropriate to buy.
Whales have been active in recent months, e.g., on XRP and BTC. A huge transaction occurred on January 10, 2019: 130,004 bitcoins moved from one address to another. There is no way to know what this means, but a lot of addresses that have been inactive for years also transferred bitcoins back in October 2018.
Private equity (PE) and venture capital (VC)
Many initiatives seek to address the financing issues of start-ups and are now working to deliver their solutions. Traditional players are continuing their business as usual and are probably more concerned about the tech stock market crashing than by a new entrant disrupting their business.
Private bankers and classical investment and hedge funds
Traditional investors continue to say that they trust stocks more than cryptos. That is what they have been specializing in, and it’s no surprise they are reluctant to change. Bankers, in general, continue to be very averse to crypto-assets and are totally against the pure cryptocurrencies, which they see as a threat.
Regarding utility and company tokens, it is surprising that, to date, no private or investment banker has expressed the view that their perceived threat is irrelevant: stocks will be represented by tokens, but the core job of stock analysis and choice will remain the same, yet using a different supporting framework.
It is crucial here to discuss the subject of ETFs. Usually, when there are some noises in the US about the SEC examining a proposal for a bitcoin ETF, there is a huge expectation and then a huge disappointment, which has a great impact on crypto-asset prices. This topic seems to be sensitive, especially since the SEC is continually rejecting proposals made in this direction.
So, why is there an interest in ETFs when people can buy bitcoin directly without going through a fund? And what would a BTC ETF change in the investing landscape?
An ETF is an exchange-traded fund, i.e., a security that tracks an asset or a group of assets; in our case, bitcoin. Therefore, it is traded on the classic financial market infrastructure, “off-chain,” of course. And this is a big advantage; some people are unable to back up their photos, let alone their private keys.
Its aim, ultimately, is to provide investors with exposure to bitcoin in a manner that is more efficient, convenient and less volatile than purchasing stand-alone bitcoin. This means it is a financial instrument to deal with bitcoin in the conventional financial system.
So, the big hope for speculators is that offering bitcoin through an ETF would make it accessible to more people in a way that would be likely to trigger massive acceptance and therefore investment from financial institutions (traditional banks, investment banks, and asset managers). This move could contribute to triggering a potentially massive inflow of cash into the crypto sphere. If bitcoin is packaged in an instrument that investors are familiar with, pension funds may take a small position, and if it is a positive experience, they may progressively increase their holdings.
The supporters of a BTC ETF also claim that it could have the effect of reducing BTC’s price volatility.
Now, what is preventing the inception of a BTC ETF?
One major failure was the Gemini attempt. The Winklevoss brothers concluded that the SEC was calling for more market surveillance and protections in the marketplace to prevent price manipulation. The security offered by ETF applicants has been deemed to be insufficient. Volatility also has been reported as an SEC concern.
Some reviewers of BTC ETF proposals have expressed the view that it should have been allowed, which indicates there may be some political pressure to prevent it. SEC officials are bound by their mandate, which is a political one. The place of fintech on the US landscape is being debated, with no doubt a lot of lobbyists around; the anti-crypto crowd seems to be in control.
Similarly, Japan has also been constantly rejecting proposals for a BTC ETF.
Emerging dedicated crypto investment funds
Crypto investment funds have conceded that 2018 was a difficult year for the market and their funds. Pantera Capital is one of them, calling for patience, and expressing confidence that “digital tokens will achieve real-world usage.” Its ICO fund (with investments in 40 projects, see figure 8) lost 75 percent during the first ten months of 2018. As bad as this looks, it is still far better than the overall market. Galaxy, another fund, was down 50 percent over the same period, while the management explained that “the asset classes show signs of maturing.”
It appears that these actors are actively refining their approach by distinguishing the various types of cryptoassets, especially “utility” token assets relative to pure cryptocurrencies. This move is evident and sensible; they are taking advantage of the bear market to properly position their funds to attack when a positive trend re-emerges.
While some crypto funds have reported gains by trading short-term trends, it appears that crypto funds have taken very few "short" positions. This may be due to a lack of supply (owners unwilling to lend), or lack of shorting facilities on trading platforms, but it most likely reflects faith in the long-term success of the economic or business models of the various tokens, and that the market may be approaching the bottom.
And, of course, in the current market context, small and less robust funds have been driven out of business, earning no income and, also, suffering the loss of their subscribers.
CONCLUSION ON CRYPTO ECOSYSTEM CASHFLOWS
Where is the money that is entering the crypto sphere likely to come from and where is it likely to go?
• Miners that are still operating are not likely to sell their crypto-assets at the current prices if they can avoid it. They are likely to mine as an investment from now on. Exchanges are in a similar situation, even more so considering that they do not need the money in the short or medium-term.
• The prices are now almost low enough for whales to re-enter the market at a significant discount. This may prevent the market from falling much further.
• At the same time, it is too early for retail investors to return, or for institutional investors, who are likely to shortly face an economic downturn.
So overall, from this analysis, the conclusion is, there is no urgency to act, even on BTC, regardless of the soundness of recent and near-term technological progress.
Some studies claim that in recent months gold has been favored by investors at the expense of cryptocurrencies. If true, that would mean that when these return, gold may suffer.