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We are providing an overview of the Distributed
Ledger Technology (DLT) space, brought about by
the emergence of a ~$500B cryptoasset class most
of us hadn’t seen coming.
HIGHLIGHTS
After nearly a decade of booms, busts, forks, hacks and “frauds,” the cryptoasset �Block�
party has arrived on Wall St. Unlike the �dot com� carousel party of the ’90s, this block party
has a ride for everyone: coders, VCs, hedge funds, regulators, and chip makers...and please
don't mind the stray crypto-kitties (will explain later). Uncovering this emerging asset class,
we find a radical change in the economic model – decentrationalization by way of distributed
ledger technology (DLT), a transformative model for maintaining and transacting data/value
in a peer-to-peer framework.
• Distributed�Ledger�Technology�(DLT)�enables�this�dramatic�move�to�decentralize
economic�models.�The era of decentralization is upon us, and it has wide ranging
implications. We see use-cases emerging across public and private realms that can benefit
from a globally distributed, secure, encrypted ledger technology.
• Bitcoin�(BTC)�has�emerged�as�a�global,�decentralized�store�of�value�-�or�"digital�gold."
BTC’s scarcity, immutability, and distributed nature (secure) elevates it as a formidable store
of value (SoV). Most commonly referred to as “digital gold,” we argue BTC’s divisibility,
security, and transferability may make it even more attractive than the shiny relic as a SoV.
• If�BTC�is�"digital�gold,"�the�Ether�(ETH)�token�is�the�“digital�oil”�fueling�decentralized
economies. The Ethereum network is an open-source blockchain that enables �smart
contracts,� and is the �go to� platform for decentralized applications (dApps). Ethereum
is undertaking an ambitious (yet necessary) technological transition (�Proof-of-Stake,�
�Sharding,� �Plasma�), which if executed successfully, can dramatically improve transaction
speed, cost and power consumption footprint.
• Potential�regulatory�action�is�an�overhang�on�the�Cryptoasset�market,�but�may�also�serve
as�a�key�catalyst. While many view the potential for adverse regulatory action (namely from
the SEC) to be the greatest risk to the publicly traded cryptocurrency market, we believe
thoughtful regulation may actually provide a meaningful L-T lift, as it likely accelerates the
entrance of institutional money into the crypto asset class.
Continued on the next page
HIGHLIGHTS
Continued from previous page
• Potential�BTC�valuation�outcomes. In Figure 11, we highlight our BTC valuation sensitivity analysis based on:
1) Digital SoV penetration of total SoV Addressable market (Gold, Collectibles, Offshore deposits), and 2) BTC
Dominance as a percent of total digital SoV market. In addition, we offer an alternative approach based on an
measuring net inflows and the �multiplier effect� on overall market cap (we estimate a ~28x multiplier on every
USD of inflow). As such, if we were to see an incremental $10B flow into cryptoassets, and BTC dominance of
overall crypto assets remains steady at ~40%, that would imply a $17K valuation.
• Potential�ETH�valuation�outcomes. Ethereum's planned transition to Proof-of-Stake (PoS) alters the entire mining
process, and introduces a �yield� for validators. Our Discounted Cash Flow (DCF) analysis, demonstrated in Figure
20, offers a wide range of outcomes in Figure 21, based on: 1) projected 10-year CAGR in transaction growth on
the Ethereum network, and 2) Discount rate. The range of valuation outcomes varies greatly, but we note that ETH
valuation (in a PoS model) is largely dependent on transaction growth.
• Ethereum�is�in�the�midst�of�an�ambitious�technical�transition,�but�successful�execution�can�be�a�meaningful
catalyst. We note the Ethereum development team is actively working toward a transition away from Proof-of-Work
(PoW) to PoS, which would greatly reduce costs associated with computation (hardware, electricity). Additionally,
Ethereum's scaling solutions (sharding, plasma) are key and necessary steps to position Ethereum as a global
decentralized world computer that facilitates the majority of the world's decentralized applications (dApps).
• ETH�has�its�share�of�risks. Risks to ETH include: 1) delays/issues with Casper (code name for PoS transition), 2)
security issue (another DAO) arising from a bug in an app that runs on top of Ethereum, and 3) competition from
emerging smart contract platforms (EOS, ADA, NEO, Dfinity). That said, we note that Ethereum has more dApps
running on its network by a wide margin (1,448 vs. EOS of 114, NEO of 43, and ADA of 2).
• Potential�regulatory�action�can�serve�as�an�overhang,�but�it�may�turn�into�a�key�upside�catalyst�in�the�L-T. Global
regulation of cryptoassets has varied from region to region, but all eyes are on the US, and in particular the SEC. It
remains unclear to us if the SEC will declare all cryptoassets as �securities� (which would need to be registered), or
not. That said, we note that BTC has already been acknowledged by the CFTC as a commodity, though it remains
unclear if ETH will be considered a security or a commodity.
Decentralized Governance Is Perhaps One of the More Intriguing and Disruptive Aspects of this DLT Movement
We liken the shift in consciousness from centralized to decentralized platforms as a “transfer of power” where
a democratic form of governance overtakes that of a centralized one. To put it simply, as Buck Perley
illustrated in his Medium.com post, the blockchain public ledger system does not possess any central authority
(i.e., totalitarian regime), but rather has miners who process transactions and ensure security/immutability
(judicial branch), which is then transmitted via blocks to nodes which facilitate transactions (executive branch).
The developer community acts as the “legislative branch” by recommending technological improvements to
the network. The users determine the viability and value of the law by their transaction behavior.
FIGURE 1: BITCOIN’S GOVERNANCE MODEL RESEMBLES THAT OF US EXECUTIVE, JUDICIAL, LEGISLATIVE BRANCHES
We anticipate this consciousness shift in governance, namely in public ledgers, to fuel a surge in new “peer-
to-peer applications” that remove the intermediary. In many cases, the intermediary not only constricts the
economics of the system (i.e., profit), but also requires trust on behalf of the network’s participants.
Facebook’s recent data privacy concerns are a clear example of how a centralized social media platform
requires trust, but what if there were to be a decentralized, trustless and permissionless system that’s
governed by an ecosystem of developers, users, and miners? We anticipate this movement to eventually not
only disrupt social media, but traditional banking solutions (i.e., mortgage/title services), supply chain,
gaming, storage/compute resources, and others. In fact, we believe a decentralized trustless and immutable
system would make sense for voting, given that voters can be identified via personalized encryption, their
votes cannot be tampered with (immutability), and there is no central authority.
Blockchain technology is the most well-known of DLT frameworks, but we note the existence of other less
known DLTs, namely the directed acyclic graph (DAG) (utilized by Iota and Hedera).
Source: Fintechnews.sg
Blockchain
A “Blockchain” is a decentralized distributed ledger that groups data into blocks and seals the data using
cryptography, making past block additions unalterable. Blocks of data are validated using multiple protocols
to reach consensus, most notably Proof of Stake (PoS) or Proof of Work (PoW). In PoW, miners compete with
each other using their computing power to solve an algorithm that validates transactions on the network. The
miner that solves the algorithm then adds the block that contains the transactions during the time period to
the blockchain. As a reward, miners are paid in that cryptocurrency for contributing compute
power/stabilizing the network (payment is made in the form of transaction fees as well as a “block reward”). In
PoS, validators “stake” a specified amount of cryptocurrency in order to get a chance to validate a block. The
higher the amount validators stake, the more chance that they have to validate it. If stakers attempt to attack
the network, part of their stake is lost. Miners who submit valid blocks are rewarded with transaction fees and
blocks rewards of cryptocurrency.
ADVANTAGES
• Essentially Unhackable – Requires a hacker to hack countless numbers of nodes in order to be changed.
• Improved Transparency – Ledgers are publicly available as is the algorithm for completing the blockchain.
• Immutability – Blocks cannot be altered once they are confirmed, only separate forks are allowed.
DISADVANTAGES
• Slow Transaction Speed – Design of blockchain means that only one block can be verified at a time,
slowing the transaction/confirmation process (particularly in a PoW framework).
• Requires Scale – Can be attacked if someone gains control of 51% of the compute power on the network.
• Cost – The most common consensus algorithm, PoW, uses a lot of electricity to run/secure. Though we
note private “permissioned” blockchain platforms that run within a company do not use PoW, but rather
internally designed consensus frameworks, and as such, do not utilize a lot of power.
Tangle
Tangle is Iota’s directed acyclic graph (DAG) technology that raised $434,000 during its ICO with a current
market cap of around $3 billion USD. Tangle technology can be thought of more as a tree than as a straight
line because transactions are validated by the nodes that add subsequent transactions. When a transaction is
added to the Tangle, it references past transactions as a basis point. Past transactions with more references
are classified as having more transaction “weight” and thus determined to be true transactions. A
transaction’s weight is determined by its own weight in addition to the weights of all transactions that directly
or indirectly approve/reference it. Instead of spending time approving only the previous transaction, multiple
transactions can be approved at once and verified further by having subsequent transactions verify the
preceding transaction. Transactions that are false will not get referenced and thus orphaned.
ADVANTAGES
• Transaction Speed – Transactions can theoretically be confirmed almost instantly as they are verified
independently of one another and not packaged into blocks. However, under current network volume it
typically takes a few minutes because of the relatively low volume on the network.
• No Mining Costs – There is no need to mine Iota, transactions are validated by proceeding transactions
rather than a hashing algorithm.
• No Transaction Fees – Normally transaction fees would occur to incentivize miners to validate the block; in
this case people are incentivized by their desire to use the network.
DISADVANTAGES
• Nascent Technology – Iota’s Tangle technology is new (November 2015), and adoption rate is unclear.
• Size – In order to validate transactions, the system requires increased participation from parties also
executing transactions. It is much more difficult to get high weights on correct transactions if there are few
participants transacting on the network. The Iota Foundation currently runs “the coordinator,” which sends
transactions in order to help validate more transactions on the network.
• Risk of Double Spend – An attack can happen if someone issues many small transactions that approve a
larger double spending transaction, causing that transaction to have more weight and the correct
transaction to be orphaned.
Hashgraph
“Hashgraph” is Hedera’s DAG technology that is similar to Iota’s Tangle. Hashgraph uses “Gossip” to create
consensus. In the Hashgraph, each transaction is used, allowing for many simultaneous transactions at once.
New transactions are added to the ledger through an introduction by a node on the network. The node
introduces the transaction and then gives the transaction information to other nodes, who then proceed to
spread it themselves. By comparing the information each node has not only with past iterations of itself but
also past iterations of other nodes, it is able to reach a consensus as each iteration must be consistent with
one another.
ADVANTAGES
• Fastest Transaction Speeds – Transaction speeds are claimed to be up to 250,000 transactions per second.
• Efficiency – All blocks added to the ledger are used, unlike the pruning/orphaning that occurs with
blockchain and Iota’s Tangle.
DISADVANTAGES
• Private/Patented Technology – Not as much information available publicly, which can result in slower
general adoption. This also reflects a more centralized technology (i.e., patented, not open source).
• Adaptability – In order to function properly, all peer nodes must be known, making it difficult to scale and
to test as a public ledger.
Use as a Digital Currency (i.e., Bitcoin) Is the Most Well-Known Use of DLT
Perhaps the most popular application of distributed ledger technology is the bitcoin blockchain and other
cryptocurrencies. These crypto-currencies run on DLT and are digitally stored assets that are validated and
recorded on a global ledger. Currently there are over 1,700 different cryptoassets representing more than
$400 billion in total market capitalization. Bitcoin (BTC) in particular is important because it is the largest of
these digital assets with a $150 billion market cap representing just around 40% of the total cryptoassets. BTC
was created in 2009 and is the first cryptoasset in existence. Much of its utility comes from its usage as a
digital store of value similar to that of gold.
In this peer–to–peer network, the transactions are added to a chain, which is a digital ledger of transaction
history. The network uses encryption to create a secure method of transaction accounting.
Source: Insurancefunda.in
The bitcoin transaction process occurs in multiple steps. First, a user inputs a transaction, which is then
communicated to a node attached to the bitcoin blockchain. That node then communicates the transaction
to the rest of the network. A miner running mining hardware connected to the bitcoin network then produces
a block that includes the transaction. This block is sent to nodes for verification. Once it is validated by the
nodes, it gets added to the blockchain and the transaction is completed and viewable for everybody.
The bitcoin blockchain utilizes a consensus algorithm based on a “Proof of Work” (PoW) method, which
combines elements of game theory, economics, and technology to maintain an immutable ledger. PoW
concept was first devised in a 1993 journal article by Cynthia Dwork and Moni Naor. Since then, it has
undergone multiple iterations into the method used today by bitcoin and other cryptocurrencies.
PoW requires that the decentralized participants that validate blocks (miners) show that they have invested
significant computing power in doing so. Miners do this by processing enough random guesses on their
computer to come up with an answer within the parameters established by the bitcoin algorithm. Miners do
this by hashing. A hash is an algorithm that converts any sequence of characters (a word, a sentence, or a
novel) into a string of 64 letters or numbers. This string cannot be altered.
The existing ledger has the hash of past transactions (blocks). The hash of the prior block is added to the set
of transactions, and then a “nonce” is selected (a unique arbitrary number only used once) and added to the
block of text. The miner then performs a hash of the block (containing hashes of past transactions, existing
transactions waiting to be formed into a block, and a “nonce”) and the resulting hash must be a string that
has a resulting number of zeros in front of it. If the blocks are validated too quickly, then the bitcoin algorithm
automatically adjusts its “block difficulty” by adding more zeros in front of the hash so that difficulty is
increased.
It is important to note that if the number of miners on the network were to double or triple, the amount of
new bitcoins mined would still be the same, as the “difficulty” would go up for miners to process new blocks.
If costs are too high and miners drop out, the difficult would adjust lower, making it easier for miners to
process blocks. This ensures that the network would incentivize miners to secure it.
• Block Time
Time – Block time is the average time that it takes for a block containing transactions to be added to
the bitcoin blockchain. The average time it takes for a new block to be added is 10 minutes.
• Block Reward
Reward – Block rewards provide incentives for miners to secure the bitcoin network by awarding
miners whose block is validated on the blockchain with a certain amount of bitcoin. The current award is
12.5 BTC per block. Currently the rewards get halved about every 4 years, with the next halving occurring
in 2020.
• Nonce – A unique arbitrary number that is only used once. In bitcoin, the nonce is a 32-bit field that is used
to generate the correct cryptographic output that begins with a specified number of 0s at the beginning
depending on the difficulty level.
• Nodes
Node s – Participants in the network. This can come as validators who confirm block additions or miners
who propose new blocks to be added.
• Mining hardware – Hardware used to provide calculations that add blocks to the blockchain. For bitcoin
mining, specialty designed application-specific integrated circuits (ASIC) are most commonly used, which
are specifically programmed to solve bitcoin’s hash function.
• Difficulty – A measure of how difficult it is to find the nonce associated with the block to be added to the
blockchain. As new processing power gets added to the network and the amount of time that new blocks
gets added is lowered, the difficulty gets adjusted. Currently, this difficulty level is adjusted every 2 weeks
to a rate of 10 minutes between blocks.
• Mining Pool – Due to the difficulty of mining each block, miners join pools in order to smooth out their
rewards. Every time a miner discovers a new block, rewards are distributed across those who are part of the
pool.
• Hash Function – Algorithm that miners have to solve in order to come up with a specific nonce that will be
validated by the nodes and added to the blockchain. Bitcoin currently uses the SHA-256 hash function.
• Decentralized – The bitcoin network is not controlled by any single entity, but instead the code is
maintained by a community of volunteer developers, while the miners dedicate nodes around the world to
process transactions.
• Trustless – Satoshi Nakamoto’s whitepaper notes that the “root problem with conventional currency is all
the trust that’s required to make it work.” Banks, central banks, and counterparties must all be trusted, and
bitcoin removes this as a concern.
• Permission–
Permission– less – Since there is no central authority, anyone can participate in this network and anyone
can send/receive bitcoin, and conversely anyone can serve as a miner on the network.
• Immutable – Bitcoin transactions cannot be reversed or changed. If the transaction has been recorded on
the network, it is impossible to modify.
• Divisible – Bitcoin is divisible into 1/100,000,000s of a bitcoin – which is called a Satoshi. This enables the
ability to conduct micro–transactions.
• Limited Supply – Bitcoin supply is capped at 21M bitcoin, which is a hard cap expected to be reached in
2140. Currently, miners are rewarded 12.5 BTC for every block that is mined, and the mining reward halves
every 210,000 blocks (or ~4 years). The next block halving is expected to occur in Jun 2020, bringing the
rewards down to 6.25 BTC per mined block.
• Censorship Resistant – There is no central control of bitcoin and as a result if a user wishes to participate
in the network there are no authorities who can prevent that from happening.
In fact, transparency is often an overlooked/misunderstood benefit of the bitcoin network. While bitcoin
usage in the early days has often times been associated with black market activity, we note that bitcoin is
more transparent than the use of cash. The bitcoin network is pseudonymous – while wallet addresses are
anonymous, the bitcoin network possesses a ledger maintaining all transactions on its ledger since inception.
Historically, criminals have used BTC as a way to buy and sell drugs or launder money because they thought
that its anonymous characteristics made it impossible to get tracked down. However, anyone can freely view
details of every transaction to ever happen on the BTC blockchain. Developments in forensic software and an
increased understanding of BTC have led to a number of startups such as Chainalysis and Elliptic helping
governments to track down criminals. In December 2017, Elliptic helped to catch a drug dealer in England
selling through a dark web marketplace.
Bitcoin Supply
50
21,000,000
45
18,000,000
40
15,000,000 35
30
12,000,000
25
9,000,000 20
6,000,000 15
10
3,000,000
5
0 0
2008 2020 2032 2044 2056 2068 2080 2092 2104 2116 2128 2140
We define “lost” coins to be effectively lost and will never be retrieved or transacted with. We believe this
can be quite important in determining the L-T value of bitcoin, given that L-T effective supply may actually
gravitate toward ~18M (or lower, depending on how many lost coins there are), rather than 21M. Further, if a
large scale event were to occur (i.e., natural disaster) that were to result in mass loss of life in a region that
possesses a high concentration of BTC holders, that would further (and greatly) reduce the amount of
effective BTC in circulation.
• Misdirected Transactions – Bitcoins can be made unusable by sending them to public keys with no
private keys accompanying them. Sending bitcoin through public keys rather than addresses with validity
checks was more common in the early days when there existed little infrastructure compared to now. In
recent times with the hard fork of bitcoin and bitcoin cash, many people found themselves accidentally
sending their BTC to BCC wallets and vice versa. If the owner sends their cryptocurrency to an address
whose private keys they own, reversing the transaction is easy. Likewise, if they send the BTC to an
exchange with a policy of reversing the transaction, then it is easy to get back. However, it is up to the
exchange’s discretion whether to return it or not.
• Lost Private Keys –During the first 3 years of BTC’s existence and at a time when it was nearly worthless,
over 10.5 million coins were mined. This caused many miners to be careless with their coins and as a result
misplace their private keys. One of the most notable examples is that of James Howells, a man who threw
away a hard drive with 7,500 BTC on it in 2010.
• Legal/Inaccessible – Represents bitcoin that has been rendered inaccessible because of law enforcement
shutting down dark web marketplaces such as the Silk Road. When the Silk Road was raided by the FBI,
they were able to seize around 144,000 BTC by searching through the Silk Road owner’s computer. It is
estimated that the Silk Road may have received up to 633,000 BTC through transaction fees, though it is
unknown whether the extra 489,000 BTC was cashed out or is still in storage somewhere.
• Death – Accounts that are attached to people who die without passing down their account info are
considered unrecoverable and whatever cryptocurrency was in those accounts considered lost.
• Satoshi Nakamoto Coins – During the early days of bitcoin and blockchain much of the hash power was
supported by machines owned by the creator of bitcoin, Satoshi Nakamoto. It is estimated that upward of
1 million BTC are owned by him, however, to date none of it has been touched. It is still unclear to us if
Satoshi Nakomoto (or anyone behind the pseudonym), is alive or not.
FIGURE 5: WHILE TOTAL BTC IS CAPPED AT 21M, WE CONSERVATIVELY MODEL TOTAL “EFFECTIVE” COINS TO CAP OUT
AT ~18M THROUGH 2050 AND BEYOND
17,000,000
13,000,000
Bitcoin
9,000,000
5,000,000
1,000,000
YE 2009 YE 2017 YE 2025E YE 2033E YE 2041E YE 2049E
Lost Private Keys 8,475 8,859 9,188 9,352 9,516 9,680 9,844 9,926
Lost Private Keys % of Total 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05%
Cumulative 324,055 332,914 342,102 351,453 360,969 370,649 380,493 390,418
Lost Coins Created 54,240 20,377 21,131 20,573 20,934 21,295 21,656 21,837
Cumulative Lost Coins 1,953,422 1,973,799 1,994,930 2,015,503 2,036,438 2,057,733 2,079,389 2,101,226
Total "Effective" Coins In Circulation 14,996,578 15,744,951 16,380,070 16,687,622 16,994,812 17,301,642 17,608,111 17,750,337
Lost Percent 12% 11% 11% 11% 11% 11% 11% 11%
Effective Percent 88% 89% 89% 89% 89% 89% 89% 89%
The spike in gold’s price during the early 1980s was due to a mix of factors including geopolitical tensions in
Afghanistan and Iran and high inflation. During this time of price fluctuations, gold was still considered a store
of value and remains so today. These same types of geopolitical and economic anxieties can also be a
catalyst for BTC and shows that even the most dominant stores of value experience extremely volatile
periods. In Figure 8, we illustrate BTC and Gold price fluctuations, though we acknowledge that these are not
similar time periods, and scale of fluctuation is different.
FIGURE 8: GOLD PRICE FLUCTUATION IN 1977 – 1983 AND BITCOIN PRICE FLUCTUATION 2017 – 2018
• Decentralization – BTC’s decentralized nature allows it to act relatively independently from governmental
interference and policy. In countries where there is high inflation of the local currency, BTC has the
potential to act as a “safe haven” store of value for people worried about losing the value of their net
worth that could be held in a bank.
• Security – Because of the cryptographic attributes of BTC, it is extremely challenging to steal a user’s
private keys to take their BTC. This allows individuals in more dangerous countries to know exactly who has
access to their wallet.
• Accessibility – Unlike traditional fiat currency, BTC can be accessed anywhere there is an internet
connection. This is contrary to a bank account, where withdrawal caps, and even bank closures are
possible. Moreover, while withdrawal caps limit the amount of funds that users immediately have access
to, BTC owners are free to transfer those funds anywhere they would like.
• Scarcity – In countries with high levels of inflation as a result of government monetary policy, scarcity
becomes an important consideration. BTC supply is capped at 21 million (to be reached by 2140).
• Ease of Mobility/Transferability – Unlike physical gold, BTC can be moved/transferred to anyone with a
wallet, at a relatively low cost and within minutes/hours.
Cyprus Crisis Is A Case Study For The Need for A Decentralized, Immutable, Secure, Store Of Value
We consider BTC to have properties of a safe-haven asset as discussed earlier. In BTC’s short history, we
recall a particular instance that exemplified BTC’s safe haven appeal – the Cyprus banking crisis of 2013.
On June 25, 2012, Cyprus became the fourth EU country to request a bailout due to the aftershocks of the
global financial crisis. Cyprus was offered a 10B Euro bailout by the European Union, International Monetary
Fund and the European Commission. In return, Cyprus agreed to a bail-in pertaining to two of the nation’s
largest banks, the Bank of Cyprus and Laiki Bank. Under the terms of the bail-in agreement, uninsured
depositors in the two banks who had accounts valued at more than 100,000 euros took a haircut off their
accounts. The deal allowed for up to 60% of uninsured deposits above 100,000 euros to be taken from the
Bank of Cyprus and that amount to be subsequently converted to Class A shares. The haircut at Laiki bank
was even more severe, with almost all money in uninsured accounts above 100,000 euros taken. It is estimated
that the total amount confiscated from these two banks to be in the ballpark of around 7B Euros.
These measures have had both a lasting effect on the trust of depositors in the Cypriot government and
banks. Over the next year, Cypriot’s Central banks lost about 35% of their total deposits, and 5 years later
have yet to recover from pre bail-in numbers.
As illustrated in Figure 9, BTC price increased >300% between Feb ’13 – March ’13, amid the Cyprus crisis
(namely, the announcement of the bank “bail-in”).
FIGURE 9: BTC MARKET CAP ROSE SHARPLY AMIDST THE CYPRUS BANKING CRISIS
As we highlight in Figure 10, Cyprus deposits declined dramatically in 2013 (total -33% Y/Y), partially a result
of the government haircut on deposits, as well as capital flight.
Collapse
Domestic Residents -23.9%
Other Euro Area -57.7%
Total Euro Area -27.6%
Rest of World -45.3%
Total -33.0%
Source: Central Bank of Cyprus
In Venezuela, the rapid devaluation of the national currency (Bolivar/ VEF) has resulted in local residents
turning to BTC as a store of value. Bitcoin in Venezuela trades for around 7.3 billion Venezuelan Bolivars each
which, using the official exchange rate provided by Bloomberg, implies an 11.7x price premium. However,
there also exists a black market exchange rate for VEF provided by dolartoday.com which implies only about
a 26% premium in the Venezuelan markets.
Valuation Methodology #1: BTC As A % of Total SoV (Gold, Collectibles, Offshore Deposits) Market
We believe that BTC has the potential to replace certain portions of the global store of value market such as
gold, collectibles, and offshore deposits. We estimate the collective value of these three markets amounts to
~$40T. Moreover, we aggregate all “SoV” cryptoassets, and arrive at a total market cap of $204B. As such,
the total digital SoV market represents 0.5% of the total addressable market.
Within the total digital SoV market (incl. Bitcoin Cash, Litecoin, Monero, Zcash), we estimate BTC makes up
80% market share.
FIGURE 11: BTC AS A % OF TOTAL SOV (GOLD, COLLECTIBLES, OFFSHORE DEPOSITS) MARKET*
Total Market
(billions)
Gold $7,700
Collectibles $200
Offshore Deposits $32,000
Total Addressable SoV $39,900
Digital SoV** - Current $204
Digital % Penetration of SoV 0.51%
BTC Market Cap $164
BTC Dominance % of Crypto SoV 80%
*These are not price targets, but sensitivities based on various assumptions.
Source: SFG Research, taxjustice.net, hobbydb.com, onlygold.com as of 5/10/2018
In Figure 12 we offer a range of outcomes for BTC. The table below allows one to make assumptions on
BTC’s dominance as a % of total digital SoV and digital penetration of the total SOV addressable market to
arrive at different price levels for BTC under various assumptions.
FIGURE 12: ANALYSIS BASED ON DIGITAL % PENETRATION OF TOTAL SOV ADDRESSABLE MARKET, AND BTC SOV
DOMINANCE*
*These are not price targets, but sensitivities based on various assumptions.
Source: SFG Research
Valuation Methodology #2: Impact to BTC Price Assuming Inflows Into total Cryptoasset Market
Based on data pulled from Bitcoinity.org, our analysis suggests that every dollar of net inflow to BTC can have
a ~28x multiplier effect on the market cap. Conversely, for every dollar of outflow, the market cap can decline
by an order of ~30x. For context, if $100M of new capital flows into BTC, that can increase the total BTC
market cap by $2.8B. So, $2.8B in BTC market cap (when divided by total coins outstanding of ~17M) could
add ~$160 to the price of BTC. This inflow/market cap multiplier was obtained by aggregating the amount of
Bids/Offers across all exchanges amounting to 1% of price according to Bitcoinity.org.
Assuming the ~28x multiplier holds true to the entire cryptocurrency market (which is conservative, as we
believe more thinly traded tokens have a higher multiplier, given lower liquidity), if $100 billion of new money
were to flow into the overall cryptocurrency market, and BTC market dominance (“market share”) remains at
~40%, that could result in a rise in BTC price to ~$76,000.
We acknowledge that one caveat to the ~28x multiplier is that it does not include OTC trading of BTC, which
is not reflected in popular exchanges such as GDAX, Bitfinex, Bitflyer and Bithumb.
In Figure 13 below, we provide a sensitivity analysis on the price of BTC assuming a wide range of inflows into
the cryptocurrency market, combined with a range of scenarios of BTC dominance.
*These are not price targets, but sensitivities based on various assumptions.
Source: SFG Research, Bitcoinity.org
BTC fees are off of all-time highs of $60/transaction and multi-day transaction times, and have now settled at
around 10-15 minute transaction times at a cost of $1 per transaction (as illustrated in Figures 14 and 15).
While this shift is a step in the right direction, the cost and wait time is still far too high for everyday purchases
such as groceries that require near instant confirmation and near zero fees.
Source: Blockchain.info
Source: Blockchain.info
LIGHTNING NETWORK
Lightning Network is a network built on top of the BTC network that allows the execution of smart contracts in
order to speed up throughput and lower fees on the bitcoin network. The Lightning Network allows users to
set up individual channels between parties so they can transfer bitcoin between each other. Smart contracts
update the general bitcoin blockchain with the transactions that occur in the channels once they are closed.
On March 15, 2018, Lightning Labs released the main net ready Lightning Network implementation.
RSK (ROOTSTOCK)
RSK is a platform that aims to provide additional functionality to the bitcoin blockchain. RSK is a sidechain
that adds the ability to use smart contracts with bitcoin. Miners in the Rootstock sidechain are paid with
transaction fees in the form of Rootcoins (RTC), which are pegged to the value of bitcoin at 1:1. RSK most
recently released its V0.4.1 platform for testing on the main net and hopes to get a production version by
May 2018.
BULLETPROOFS
Act similarly to the zk-SNARKS on the Ethereum network. Bulletproofs help to increase the privacy in the
transactions of two parties on the bitcoin network by not revealing the quantities of transactions. Bulletproofs
are relatively far off, as some speculate that adoption of bulletproofs to bitcoin could take between 3 and 10
years.
SCHNORR SIGNATURES
Allows the aggregation of multiple digital transaction signatures on the bitcoin blockchain into one signature.
This speeds up the network throughput by requiring less storage for each transaction so that more
transactions can be validated per block. According to Bitcoin Core developer Pieter Wuille, there are several
BIPs in the process of being developed that have to do with the implementation of Schnorr signatures.
However, these will have to go through a lengthy vetting process and full scale implementation of Schnorr
Signatures could be years down the road.
• Bitcoin Cash (BCH) – BCH is a fork of BTC that occurred as a result of the SegWit hard fork. It is currently
the 4th largest cryptocurrency by market cap at ~$24 billion and aims to morph itself to what BTC was
originally intended to be, a peer-to-peer electronic cash system. BCH boasts larger block size (up to 8MB)
and is expected to increase block size even further (up to 32MB) to increase the amount of transactions per
block (and thus, increase transaction speed, and lower cost).
• Litecoin (LTC) - Founded 2 years after BTC in 2011, LTC functions in a very similar way as a store of value.
However, one of the major differences is its transaction speed, as it adds blocks every 2.5 minutes
compared to bitcoin’s 10 minutes. Additionally, LTC has a supply cap of 84M LTC (vs. BTC’s 21M)
• Monero (XMR) – XMR is a privacy coin that hides the sender, recipient and amount transacted from every
transaction. It was launched in 2014 and since then has gained considerable traction, cementing itself as
the ~12th largest coin by market capitalization at $4 billion.
• Zcash (ZEC) – ZEC is a cryptoasset aimed at providing secure and private transactions through an extensive
use of cryptography. While transactions of ZEC are published to a public blockchain, users can set whether
they wish to hide the sender, recipient, or the amount being transacted. ZEC’s price is currently ~$290 and
has a market cap of $1.15 billion, making it the 26th largest cryptocurrency by market cap.
• Ethereum (ETH) – while Ethereum’s primary use-case is to act as a smart contract platform for decentralized
applications (dAPPs), we believe ETH can increasingly become an SoV if it were to cap its supply (which is
under consideration), and were to successfully transition to a Proof-of-Stake (PoS) consensus mechanism,
which would include a yield for ETH holders that “stake” their ETH to become validators (as we highlight
later on in our report in Figure 21)
Supporters of Bitcoin Cash (BCH) Claim That BCH Is The “True Bitcoin”
BCH is a fork of the bitcoin network created in August 2017 as an attempt to alleviate some of the congestion
faced on the original bitcoin blockchain. The BTC community wanted to implement scaling of the network
gradually through the implementation of developments such as SegWit while an opposing faction wanted
more immediate relief and did not like the sacrifices that had to be made with SegWit, and instead decided
to expand the block size from 2 MB to 8 MB, theoretically increasing the transaction speed 4x. This resulted in
a hard fork of the BTC network to create Bitcoin Cash (BCH).
This change is particularly interesting because BCH recently announced yet another fork, this time increasing
the block size from 8 MB to 32 MB. This update is slated to commence on May 15, 2018, and would allow
BCH to perform 16x the transactions of bitcoin in addition to allowing the BCH blockchain to implement
simple smart contracts.
Notable supporters of BCH include: Jihan Wu (CEO of Bitmain) Roger Ver (owner of Bitcoin.com, and early
investor in Bitcoin), and Gavin Andresen, former lead developer of Bitcoin Core.
While we consider BCH as a competitor to BTC in the SoV space (with perhaps more favorable medium-of-
exchange characteristics), we note BTC’s network value, development and mining community, and
transaction volume are clear indications of broad acceptance of it being the “true” bitcoin. That said, we
cannot rule out increased competition from BCH for market share in the digital SoV opportunity.
There are three ways that this type of 51% attack could happen:
As shown in Figure 18, gaining control of enough hardware to double the hashrate or buying up half the
existing network would prove costly, upward of one billion dollars. Furthermore, this figure does not include
the difficulty in acquiring hundreds of thousands of mining units, which would likely drive the cost much
higher.
Should an attacker execute a 51% attack on the bitcoin network using hardware, they would in effect be
burning money, as BTC mining is done with specialty ASICs, purpose-built machines that can only do narrow
functions. As such, a 51% attack by a mining pool or even a hardware supplier would be self-defeating, as the
network would lose its appeal, chips would become idle and mining pool participants would look elsewhere.
Executing a 51% attack by gaining control of mining pools that are in charge of 51% of the hashrate might
prove to be easier than buying hardware, however, it would still be extremely difficult. In the event of an
attack, miners with nodes on the mining pools involved could switch over to another non-participating pool,
diluting the attacking pools’ hashrate while strengthening the opposition.
Source: Blockchain.info
What is Ethereum?
The Ethereum network is a smart contract platform that runs on blockchain technology. While the bitcoin
blockchain was designed to transact value from peer to peer, the Ethereum network is a programmable
blockchain, whereby smart contracts can be built into the code underpinning transactions that occur under
programmed conditions.
The ether token (ETH) represents the medium of exchange within the Ethereum network, and ETH must be
spent in order to pay transaction fees to the nodes completing the calculations necessary to mine new blocks
and secure the network.
Source: Blockgeeks.com
• Augur (REP) – DApp that aims to create a prediction market platform. Within Augur, users can create
betting markets that aim to predict events in real time and are rewarded for placing correct bets.
• Storj (STORJ) – Decentralized file solution storage solution where users can store their data in a secure
way and make sure that they are the only people who can view it. Storj has over 8 petabytes of storage
available and users pay for this storage space using the native STORJ token.
• VeChain (VEN) – Decentralized supply chain management solution that allows users to track a product
across its lifecycle by attaching to it a VeChain compatible RFID tag. VeChain uses the VEN, an ERC-20
token, to power its network.
• Golem (GNT) – DApp that aims to create a market for selling idle computing power to those who need it
so that instead of building out physical computing infrastructure, companies/individuals can just rent it out
when they need it.
• FunFair (FUN) – Funfair is a platform in which users can participate in a decentralized gambling network.
Casino operators have the ability to license the platform and customize the games to their specifications
and users can play those games online in a trustless manner. Its native token, the FUN token, acts as the
casino chip, which are used to operate the games.
• 0x (ZRX) – 0x is a decentralized exchange in which users have the ability to trade Ethereum based tokens
directly. This exchange would represent a shift from centralized exchanges such as Coinbase and Kraken.
The token, ZRX, is used to pay for listing trades on the exchange.
As such, we believe that by applying a Discounted Cash Flow (DCF) methodology to ETH may have utility,
where we illustrate a transition from PoW to a “hybrid PoS/PoW” system beginning in 2019, and consequently
a full PoS implementation in 2020, where stakers begin earning transaction fees and block rewards.
For illustrative purposes in Figure 21, we apply a 10-Year DCF model based on transaction fees earned by
staking ETH assuming a 10-year CAGR of 100%. For reference, Facebook’s user growth during its first 10 years
(2004 – 2014) reached a CAGR of around 100%, while overall internet traffic from (1990 – 2005) reached a CAGR
of around 150%. Figure 21 includes several assumptions that can differ greatly from actuals (i.e., # of ETH staked,
transactions on network, transaction costs, LT growth rate, and discount rate).
FIGURE 21: ILLUSTRATIVE ETHEREUM PROOF OF STAKE DISCOUNTED CASH FLOW (DCF) METHODOLOGY*
YE 2018E YE 2019E YE 2020E YE 2021E YE 2022E YE 2023E YE 2024E YE 2025E YE 2026E YE 2027E YE 2028E
Supply (Mil) 103.3 106.4 106.9 107.4 107.8 108.3 108.8 109.2 109.7 110.2 110.6
Staked N/A N/A 15% 15% 15% 16% 18% 18% 18% 18% 18%
Total Stake (Mil) N/A N/A 16.0 16.1 16.2 17.3 19.6 19.7 19.7 19.8 19.9
Transactions (Mil) 296 1,036 3,109 8,551 19,239 38,479 76,958 134,676 202,014 252,518 303,021
Growth 194% 250% 200% 175% 125% 100% 100% 75% 50% 25% 20%
Network Capacity (Mil) 378 31,536 47,304 31,536,000 31,536,000 31,536,000 31,536,000 31,536,000 31,536,000 31,536,000 31,536,000
TPS 12 1,000 1,500 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000
Block Utilization 78.3% 3.3% 6.6% 0.0% 0.1% 0.1% 0.2% 0.4% 0.6% 0.8% 1.0%
Cost Per Transaction 0.93 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01
Fees Received N/A N/A $ 2.01 $ 2.89 $ 6.49 $ 12.11 $ 21.43 $ 37.35 $ 55.79 $ 69.45 $ 82.99
Present Value N/A N/A $ 1.66 $ 2.18 $ 4.43 $ 7.52 $ 12.10 $ 19.17 $ 26.03 $ 29.45 $ 32.00
*These are not price targets, but sensitivities based on various assumptions.
Source: SFG Research
Our Assumptions
• Supply – We mapped out what we project to be the supply of ether based on current and future block
reward sizes and times. Implementations such as Casper FFG and Metropolis Byzantium have/will
reduce(d) block reward sizes and decrease(d) the rate of supply inflation. It should also be noted that there
is currently a proposal being discussed to cap the supply of ether at ~120 million.
• Stake Percentage – The proposed number is based on Vitalik Buterin’s estimate of the amount of ether
staked at an initial minimum staking lockup of 1,500 ETH as discussed in the Casper FFG proposal. Future
increases in the amount of ether staked are based on assumptions that as the minimum lockup amount
decreases with the ability to add more nodes to the network, more people will participate in staking.
• Network Capacity –Network throughput and consequently network capacity values are taken from our
estimates for the effect of scaling implementations such as sharding and plasma well as estimates for when
these implementations will take place.
• Cost per Transaction – Our cost per transaction estimate are based on projected block utilization rates. It
should be noted that stakers are paid in terms of ether and not a dollar value. The dollar values are
assuming that stakers immediately cash out their earnings.
• Long Term Growth Rate – While the L-T growth rate of global GDP over the past 20 years has been ~3%,
we assume a 5% L-T rate, given that we expect economic activity associated with decentralized
applications would outgrow the remainder of the global economy.
Given the Variability in the Assumptions, We Apply a Sensitivity Methodology (see Figure 22)
The price of ETH has a wide range of valuation outcomes that are largely dependent on how one views the
growth rate of transactions as well as measures their perceived risk of holding the cryptocurrency. The future
value of ETH is quite volatile and highly dependent on the amount of usage the network receives. This is
because while the growth rate is a measure in relative terms, the payout is redistributed in absolute terms.
That is, at its most bullish valuation of 150% CAGR there are ~9,000x more transactions (2028 vs. 2018) to go
around for ~20 million ETH staked, whereas in the bear-case of 50% CAGR there are only ~50x (2028 vs. 2018)
more transactions to go around for the same ~20 million ether staked.
It should be noted that although the implied price at a 50% CAGR and 30% discount rate is dramatically lower
than current prices, we acknowledge that even in the event that application and transaction growth is
underwhelming, there are also a faction of investors who hold ETH not only for anticipated stake
contributions, but also as a store of value. Additionally, we note that new projects typically raise new capital
with ETH, and many hold ETH on their balance sheet.
While we believe bitcoin is currently a superior store of value, we do believe even if ETH were to fail as a
platform for dApps, yet would hard cap its supply (which is under consideration) the token could still possess
some store of value properties and maintain a value (in that store of value context) above our worst-case
valuation below.
FIGURE 22: ETHEREUM DCF SENSITITIVY BASED ON TRANSACTION GROWTH CAGR VS. DISCOUNT RATE*
*These are not price targets, but sensitivities based on various assumptions.
Source: SFG Research
Staking ETH would also provide a source of yield in another way; block rewards. The block rewards from
staking would vary depending on when and how changes are implemented in the ecosystem. According to
our estimates for block reward size and staking percentage, block reward yields vary from between 2-5% and
would (likely) add a premium to the sensitivity scenarios outlined above, as per Figure 23.
It is speculated that the strife caused by such high transaction prices was due to the unexpected success of a
game built on Ethereum called CryptoKitties, where users can collect, breed, and raise digital kittens. The
resulting uptick in the amount of transactions caused by this game pushed block utilization near gas limits.
Gas limits (and consequently the amount of transactions that the Ethereum network can handle) have been a
major issue within the developer community, and improvements such as sharding and plasma aim to increase
transactions per second from current levels of around 15 to well over 1,000.
80%
$1.000
60%
$0.100
40%
$0.010
20%
0% $0.001
As per Figure 25, we arrive at a Block Utilization % schedule, which underpins our assumptions around L-T
transaction costs given growth in network throughput and transaction volume.
FIGURE 25: BLOCK UTILIZATION % DETERMINES THE TRANSACTION COST, WHICH IS A KEY INPUT INTO A DCF
METHODOLOGY ONCE ETHEREUM MOVES TO A PROOF-OF-STAKE MODEL
Market Value/Transactions
We acknowledge that the value of a network can also be measured by aggregate usage (i.e., a measure of its
utility). One of the primary ways to gauge the utility of various networks is to use the number of transactions
as a proxy for interest/activity. Using a trailing 30-day average of a coin’s market cap divided by its on-chain
transaction volume denominated in USD (as per coinmetrics.io), we can examine how much the cryptoasset
markets value each network’s usage. ETH, one of the most promising cryptoassets, trades around the middle
of the pack at ~61x, when compared to other large cryptoassets. However, its Market cap to transaction ratio
is noticeably higher compared to other competing platform coins such as EOS, NEO, and Cardano (ADA),
which trade at 28.5, 20.0, and 5.6 respectively. We note, however, that our analysis in Figure 26 includes data
on “on-chain” transactions, which may include transactions associated with exchange trading.
FIGURE 26: AVERAGE MARKET CAP AND ON-CHAIN TRANSACTION VOLUME FOR VARIOUS CRYPTOCURRENCY DURING
APRIL 2018
Source: coinmetrics.io
Another proxy for activity when looking at development platforms such as Ethereum, NEO, EOS and
Cardano, is the number of decentralized applications (“dApps”) running on the network. According to Figure
27, the amount of dApps running on the Ethereum network increased by ~75% from Oct ’17 to April ’18 (from
805 to 1399).
There are two development phases ahead: Metropolis Constantinople and Serenity, which are aimed at
improving the functionality of the Ethereum blockchain. Alongside the implementation of these phases also
comes the rolling out of a switch from a Proof of Work (PoW) consensus algorithm framework to a Proof of
Stake (PoS) consensus algorithm. The particular PoS endeavor is labeled “Casper” and divided into two steps:
the first being a hybrid PoW/PoS system named Casper the “Friendly Finality Gadget,” and the final step
being a full PoS system named Casper “The Friendly Ghost.”
Metropolis Byzantium
Part one of a two-part update to upgrade the Ethereum network to “version 3.0,” Metropolis Byzantium
includes the following upgrades:
• zk–SNARKS: Stands for “Zero–Knowledge Succinct Non–interactive Argument of Knowledge.”
Implementing zk-SNARKS into Ethereum transactions allows users to execute transactions more privately
than before.
• Reversion: Users normally pay “gas” to execute smart contracts and transactions. Before Byzantium, if a
user wanted to go back to an earlier state during the execution, they would have to use up all the gas they
set aside to pay for the contract. With this new function, contracts will be able to be reverted back without
using gas.
• Ethereum Ice Age: Ethereum developers added in an Ethereum “Ice Age” in order to force miners to stop
mining. The Ice Age greatly increases the mining difficulty to the point that it is unprofitable to continue.
Developers included an update with Byzantium that reduces the block reward from 5 ETH to 3 ETH and
also delays the Ice Age for another 18 months.
Metropolis Constantinople
Metropolis Constantinople reflects part two of a two-part upgrade to the Ethereum network to version “3.0”:
• Account Abstraction: There are currently two accounts that exist on Ethereum, an external account that is
linked to a user’s “wallet” and a contract account that is used with smart contracts. The account abstraction
helps to blur the line between the two to eventually make smart contracts and dApps more accessible to
the average user.
• PoS/PoW Hybrid: Otherwise known as Casper the Friendly Finality Gadget (Casper FFG), it is the first
bridge to a full PoS system. In this hybrid system, 1 out of every 50 blocks will be validated using a PoS
consensus mechanism, while the others would continue to be validated using the traditional Proof of Work
mechanism. In addition, the draft of Casper FFG requires stakers to stake a minimum of 1500 ETH for a
lockup period of around 4 months and also reduces the block reward size from 3 ETH to only .6 ETH.
Serenity
The planned final phase for Ethereum whose main component is a full switch from Proof of Work to Proof of
Stake.
• Proof of Stake: Also known as the Ethereum Casper Protocol. PoS is a system in which blocks are validated
through the method of wagering or “staking” one’s cryptocurrency. Validators will be selected based on
the amount of cryptocurrency that they stake, with those who stake more having a higher probability of
being selected.
• Sharding: Sharding is intended to dramatically increase transactions per second on the network. Sharding
refers to the breaking down of each block into smaller and more manageable parts for nodes to handle
parallel to each other, instead of handling them linearly. This implementation is expected to improve
throughput drastically, allowing the network to handle multitudes more transactions and lower transaction
costs.
• Plasma: Plasma is a 2nd layer scaling solution for the Ethereum blockchain that works similarly to the
lightning network. It proposes to increase the throughput of Ethereum network through the
implementations of child chains on the main Ethereum chain. These child chains act as channels between
users where only the final hash is put on the main chain. Child chains off the main Ethereum chain can also
open up their own chains, scaling the amount of transactions that can be processed tremendously.
• Proof of Stake Concerns – While the benefits of moving from a Proof of Work to a Proof of Stake
consensus algorithm can include faster/cheaper transactions as well as less global power consumption,
there are also concerns with PoS. These concerns include the “nothing at stake” issue where validators are
able to stake more than one block at a time, as well as the wealth concentration issue, where new block
rewards are earned by those that have large amounts of ETH. However, Ethereum’s PoS mechanism is
differentiated from other PoS deployments in that any malicious validator will lose the funds that he/she
has to lock up in order to validate transactions. This would make any malicious activity very costly.
• Security – A lack of regulation of ICOs has led to numerous problems regarding the security of tokens
based on the Ethereum platform. The most notable example of this is the 2016 hack of the DAO, a type of
decentralized autonomous organization that hosted an ICO in order to raise initial funds by exchanging
ETH for the native DAO token. In June 2016, a vulnerability was exploited by hackers and they siphoned off
~3.6M ETH. As such, Ethereum’s open platform for dApps comes with risks, as the Ethereum network
becomes more vulnerable to bugs associated with dApps. As a result of the DAO incident, the SEC
launched an investigation into the practices of the DAO and concluded that the DAO violated securities
laws.
• Competitive Smart Contract Technologies – A number of smart contract development platforms
compete along with Ethereum for developer and investor attention. The most notable of these platforms
are EOS and Cardano.
o EOS – EOS is currently trading at a ~$16B market cap and offers functionality similar to Ethereum,
however, has a “DPoS” protocol where there are only 21 delegates assigned with validating each
block. As a result, the throughput is much higher than that of Ethereum with the caveat that the
DPoS protocol brings a greatly increased level of centralization. It also boasts no transaction fees
because bandwidth is assigned as a proportion of total coins staked rather than gas payments.
According to EOSindex, there are around 100 dApps in development on the EOS platform.
o Cardano (ADA) – Currently trading at a ~$10B market cap and is a decentralized app platform
whose selling point compared to Ethereum is that it uses academically peer reviewed code that
goes through a rigorous vetting process to identify faults that other crowdsourced blockchain
projects do not go through. It is known as a third-generation blockchain and its implementation has
the benefit of hindsight into what works and doesn’t work compared to the blockchains that came
before it. As of now there are only two dApps running on the platform.
o NEO – This is widely considered to be the Chinese version of Ethereum. It was launched in February
2014 and has since grown to a market cap of over $5B. NEO’s biggest selling point is its PoS
consensus mechanism, and the accompanying 10,000 transactions per second throughput, much
higher than Ethereum’s 15. Despite these technological advantages, development on top of the
NEO platform has lagged significantly, with only mid double digit dApps run on the network.
• No Malicious Validators – All the validators on the network are known, so they can be trusted not to act
maliciously.
• Alterable – Easier to change rules of the blockchain in order to better adapt to different conditions.
• Cheaper Transactions – Requires fewer nodes on the network to verify transactions so they are cheaper to
run.
• Faster Transactions – Latency on the network is much less as transactions do not have to go through tens
of thousands of nodes.
• More Privacy – Organizations such as financial institutions operate under strict regulations that prevent
them from revealing public too much information. Using a private blockchain allows organizations to
control who can see what.
Disadvantages of Private Ledgers include:
• Development – While development of the private ledgers has recently taken an upswing with the open
source nature of many of the platforms, public blockchain development remains the focus of much of the
blockchain community’s efforts (and anecdotally, we believe this is where most of the talent is headed).
• Onboarding – Because of the nature of a private, trusted network, adding new nodes becomes much
more of an expensive affair compared to a trustless one. Each new party has to be screened and validated
in order for them to be added to the network because malicious actors have a much higher potential of
successfully attacking a private ledger than a public one.
• Network Effect
Effect – Many public blockchains have other applications built on top of them, allowing different
dApps to communicate with each other should they desire cross-functionality. In the case of private
blockchains however, each of those dApps must be developed from scratch which may turn out to be
expensive. Additionally, cross-functionality between private ledgers (particularly between two companies)
is likely to be much more challenging than that of public ledgers.
Public Private
Permissionless Permissioned
Participants Anonymous Identified
Possibilty of Maliciousness Trusted
Long Short
Bitcoin: 10 Minute Block Time 100 Milliseconds
Transaction Approval Time
Source: Blockchainhub.net
HyperLedger Fabric
Hyperledger is a blockchain consortium founded by the Linux foundation in 2015 and launched in 2016 in an
effort to create enterprise blockchain solutions for businesses. It was initially started with two framework code
databases: Fabric (in partnership with IBM) and Sawtooth, which was developed by Intel’s incubation group.
Currently, it operates as an open source initiative to advance cross-industry blockchain tech with five
frameworks on its platform. Fabric is Hyperledger’s most popular project and its effectiveness is evident from
its deployment by companies such as IBM and Microsoft across a host of industries.
MONAX Burrow
The Monax application platform provides software development kits for developers to use in app
development that solves problems specific to their businesses. They currently have four different development
kits out specified for more specific uses; a base SDK, Finance SDK, Insurance SDK and Logistics SDK.
R3 Corda
Corda is the blockchain development platform owned by R3 that uses smart contracts to execute
transactions. While Corda’s goal is to record, manage and execute financial agreements made by institutions
to create friction/costless transactions of commerce, its uses can be adapted to other industries.
Ethereum
While Ethereum is widely known as the most popular public blockchain for dApps, its flexibility allows it to be
adapted to the private blockchain space as well. Case in point, JP Morgan has its own enterprise private
blockchain called Quorum, which is based off of Ethereum. Quorum’s primary uses are in finance and help to
enable payment settlement and tracking.
Byzantine Fault Tolerance Byzantine Fault Tolerance Deposit Based Proofof stake
Consensus
Several Tech Companies Are Taking The Lead In Offering Blockchain Solutions
As blockchain technology continues to mature, large companies such as IBM, Microsoft, Amazon and Oracle are
expanding their services and leveraging their partnerships to help their clients implement blockchain solutions.
• IBM – IBM is widely considered one of the premier leaders in helping enterprises deploy blockchain solutions.
In total, there are over 1,500 blockchain professionals working for IBM and it is one of the key growth areas for
the company. IBM’s core offering is the Hyperledger Fabric, a private blockchain platform based off of IBM’s
own blockchain development. Wal-Mart, Maersk, and the Depository Trust and Clearing Corporation are just
some of the companies working with IBM to implement blockchain solutions in their business.
• Microsoft – Microsoft offers an array of enterprise blockchain platforms for businesses on its Azure
marketplace. Among them are Ethereum, Quorum, and Hyperledger Fabric. Companies such as Webjet
and the Monetary Authority of Singapore are using blockchain technology on Azure to change the way
they do business and streamline processes.
• Oracle – Enterprises can engage with blockchain through Oracle by utilizing the Oracle Blockchain Cloud
Service. Oracle offers a Hyperledger Fabric-based blockchain platform that comes equipped with
infrastructure services and resources, designed to help businesses launch their platform quickly and
efficiently. While the services are not up and running yet, the target time for launch is 1Q18 (3QFY18).
• Amazon – Amazon Web Services offers blockchain-as-a-service solutions to participants in its partner
ecosystem. It has partnered with companies such as T-Mobile, Guidewire, and VSP Global to provide solutions
with Hyperledger Sawtooth. Other partner solutions that Amazon Web Services offers are R3 and PokitDok.
That said, while many fear a harsh stance by the SEC on existing cryptoassets, we believe the finality of the
SEC’s decision may solidify cryptoassets as an “asset class,” and may usher inflows from institutional
investment managers that have been on the sidelines pending the SEC’s final stance.
Additionally, on January 18, 2018, the Director of the Division of Investment Management of the SEC, Dalia
Bass, wrote a no action letter to two sponsors of potential cryptocurrency ETFs. In it, she highlighted several
issues regarding valuation, liquidity, custody, arbitrage, and manipulation of cryptocurrencies as reason for
not allowing registration of cryptocurrency funds.
Department of Treasury
The Department of Treasury’s efforts have mostly been focused on investigating cryptoassset involvement in
illegal activities such as money laundering and terrorism financing. Treasury Secretary Steve Mnuchin
announced in January that there were working groups within the Financial Stability Oversight Council focused
on cryptoassets.
China
China has taken a relatively unfavorable stance on the trading of cryptoassets compared to many other
countries. On September 4, 2017, China banned ICOs and cryptoasset exchanges. In February, it looked to
take it a step further and also ban people from trading cryptoassets on foreign exchanges as well, trying to
limit cryptoasset trading even further.
Japan
The Japanese government is one of the most progressive when it comes to regulating cryptoassets. In April
2017, Japan authorized use of cryptoassets as a legal method of payment. Even with this level of
progressiveness, Japan has been taking steps to increasingly regulate the cryptoasset markets following the
$530 million hack of one of the largest exchanges at the time, Coincheck in January 2018. Following this, it
has been reported that some exchanges in Japan have organized in an attempt to self-regulate and provide
legitimacy to the industry.
South Korea
Historically South Korea has had large presence in the cryptoasset community, and over the past six months
authorities have begun to tighten regulations. In December 2017, South Korea issued bans on securities firms
trading BTC futures and additional regulation on the speculation of cryptocurrencies in general. In January,
South Korea also started requiring Investors to use real name accounts to trade cryptocurrencies rather than
virtual name accounts.
European Union
The European Union has been slow and measured in its approach to regulating cryptocurrencies. The
European Central Bank’s president Draghi struck down Estonia’s bid to launch a state run cryptocurrency on
September 7, 2017. However, other than this act, there has not been much specific regulation coming out of
the EU, and as of February 26, 2018, the EU has noted it would enact regulation if risks are not addressed.
However, Lagarde subsequently in April 2018 noted that cryptoassets “could have a significant impact on
how we save, invest and pay our bills. That is why policy makers should have an open mind and work toward
an even-handed regulatory framework that minimizes risks while allowing the creative process to bear fruit.”
We find this statement as a stark difference from earlier comments, and perhaps an indication that the IMF
was taking a more open-minded and pragmatic approach to cryptoassets.
Many funds that have already entered the market have developed their own methods of storing cryptoassets
such as using hardware wallets, cold storage solutions and third party providers. Recently however, more
formal approaches to custody of these assets have emerged. Exchanges such as itBit and Gemini and wallet
providers such as Ledger provide custodial services for the largest digital assets such as BTC and ETH, and
are working to provide these services for a larger selection of cryptoassets.
We believe custodial solutions are especially relevant for larger financial institutions such as long-only funds,
pension funds, and endowments. The following companies have announced custodial solutions, and we
anticipate further solutions to be introduced over the next few years:
• Kingdom Trust – Partnered with Bitgo to offer end-to-end capabilities to secure cryptocurrencies such as
BTC, ETH, XRP, and LTC.
• Gemini – Offers custodial services to institutional investors through a segregated custody account where
the digital assets are stored through Gemini’s cold storage system.
• Coinbase – Offers services that have strict financial controls, account representatives/support, multi-user
accounts, and external security audits for custody of all major cryptocurrencies such as BTC, ETH, LTC,
ERC20 tokens, etc.
• Xapo – Offers services where users can create unlimited amounts of accounts to divide funds by teams and
set different permission levels for each user.
• Itbit – ItBit is a regulated custodian and subject to oversight by the New York State Department of
Financial Services. They provide cold storage of crypto assets and verification/reporting services at
monthly, quarterly, and annual intervals.
Proof of Work
Miners dedicate compute power in order to solve an algorithm that validates the new blocks on the
Blockchain. The more work a miner does the more likely that they will be the one selected to have their block
validated.
ADVANTAGES
• Widespread Adoption – Many of the largest cryptocurrencies use this consensus algorithm and as a result
people know that it works and trust it.
• Mining Power – Those with more computational power more likely to earn rewards. This encourages
cryptoasset liquidity as miners cash out in order to buy more compute power.
• Security – In order to attack the system, hackers would have to gain access to 51% of all the hash power, far
too difficult for any one person (or entity) to consider doing.
DISADVANTAGES
• Transaction Speed – Miners must take the time to solve the hashing algorithm and validate it. Blocks
cannot be validated in parallel.
• Energy – The compute power necessary to mine blocks comes at a high power draw as miners compete to
add more hardware to the network. This results in extremely high electricity needs.
Proof of Stake
Validators dedicate or “stake” their cryptoassets in order to add the blocks. Those with more at stake have a
higher chance of validating the next block. As a reward, the stakers earn the transaction fees (as well as block
rewards) to incentivize staking.
Source: Blockgeeks.com
ADVANTAGES
• Security – An attacker would need a majority of the value of the cryptocurrency staked in order to stage an
attack; this would amount to millions if not billions of dollars’ worth of cryptocurrency.
• Energy – Does not require excessive compute power in order for blocks to be validated.
DISADVANTAGES
• Barrier to entry – Stakers have to commit a lot of capital in order to stake enough cryptoassets to compete.
For Ethereum, we believe a minimum of 1,500 ETH will be required to stake (~$1M).
• Nothing at Stake Problem – Forks become more common because miners don’t have to dedicate their
compute power to support either side. A validator can stake in both forks without risking their cryptoassets.
ADVANTAGES
• Transaction Speed – The group of witnesses are incentivized to work together instead of against each
other.
• Energy – A small group of people validating the transactions requires much less compute power.
DISADVANTAGES
• Centralization – Transaction validation is in the hands of a small group of people, and as such, this
consensus mechanism appears more centralized.
Proof of Authority
This is similar to Delegated Proof of Stake, where a select group of validators are in charge of approving
transactions and in turn receive rewards from approving said transactions. The difference lies in that the
selection system is automatic and the validators have their identity information public so that members have
the ability to cross reference.
ADVANTAGES
• Energy – A small group of people validating the transactions requires much less compute power
• Better for Private Networks – As validator, identity is public and chosen automatically, which better suits
private networks.
DISADVANTAGES
• Centralization – Transaction validation in the hands of a few group of people and as a result is more
centralized than other mechanisms.
Proof of Weight
This is similar to Proof of Stake in that validators “stake” tokens and their chances of finding the next block
are determined by the amount that they stake compared to the rest of the network. This variable can be
changed. For example, blocks in Filecoin are awarded to users who can store the most data.
ADVANTAGES
• Variability – The variable in which the probability of discovering blocks is based on can be changed.
DISADVANTAGES
• Nothing at Stake Problem – Forks in Blockchain become more common because miners don’t have to
dedicate their compute power to support either side. They can stake in both forks without risking their
cryptocurrency.
Proof of Activity
This represents a hybrid system between Proof of Work and Proof of Stake, and is similar to Proof of Work in
that miners compete to solve a hashing algorithm. Once a miner wins, a group of validators are then chosen,
with those who stake more cryptoassets being more likely to win. Once those validators sign off on the block,
the fees are split between both the miner and the validators.
ADVANTAGES
• Stability – Incentivizes miners to continue mining even after they can no longer earn reward blocks.
DISADVANTAGES
• Resources – Requires participants to have both compute power and cryptoassets dedicated to mining the
blocks.
• Nothing at Stake Problem – Forks become more common because miners don’t have to dedicate their
compute power to support either side. They can stake in both forks without risking their cryptoassets.
Proof of Burn
Miners “burn” (sacrifice) coins in order to have a better chance at being selected to mine the next block.
Miners who have burned the most coins relative to the total amount burned on the network have a higher
chance of being selected to discover the next block.
ADVANTAGES
• Power – Blocks are rewarded to those who have burned more cryptoassets rather than those who dedicate
more compute power.
DISADVANTAGES
• Capital Intensive – Block rewards go to those who burn more money, incentivizing miners to burn large
amounts of cryptoassets.
Proof of Importance
The likelihood of a miner being allowed to discover (harvest) the next block is determined by their importance
rating. This importance rating is determined by several factors including: the amount of coins owned, the
amount of transactions made, and with whom the transactions are made.
ADVANTAGES
• Interest – Importance score ensures that those who are most invested into the system can benefit most
from harvesting the blocks.
DISADVANTAGES
• Involvement – Requires a high amount of involvement from miners in order to successfully harvest blocks.
Block–Lattice
Each participant on the network has their own Blockchain that they keep account of. The Blockchains on the
network operate by shooting “send and receive” blocks, whereby “send blocks” subtract from a user’s
account and “receive blocks” add to a user’s account. New account balances are recorded on the main chain
rather than transactions. The Designated Proof of Stake protocol is then used to verify the main chain.
ADVANTAGES
• Transaction Speed – Each transaction only involves two parties and does not need the verification of the
network to confirm transactions.
• Scalability – Network account balances are recorded on the main chain instead of blocks of transactions,
making it easier to handle higher volumes of transactions.
DISADVANTAGES
• Availability – The current coin is available only on a few exchanges and the development team is quite
small.
ADVANTAGES
• Transaction Speed – Validating transactions involves fewer nodes in order to reach consensus.
• Transaction Cost – Few nodes on the network means that the cost of validating transactions is significantly
lower than algorithms such as Proof of Work.
DISADVANTAGES
• Centralized – Fewer nodes mean that control of the blockchain is very concentrated, which means that
changes to the blockchain can happen much more easily.
• Untested – In the case of PBFT, running it on a large amount of nodes makes validating transactions very
messy and it remains untested with many nodes.
Block-Lattice XRB
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I, David Ryzhik, hereby certify that the views each of us has expressed in this research report accurately reflect each of our respective personal views about the subject
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Covered companies in each Category Investment banking client in each category
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