Warren Buffett: “ in a business ”. Never invest you cannot understand The Yet investors are throwing millions at cryptocurrencies offering terrible value propositions, and despite the recent market drop on the back of the , . Blockchain technology is revolutionary. China ban of cryptocurrency exchanges cryptocurrencies are still in bubble mode Prices may have risen too far too fast: the has gone from USD 18 billion to USD 135 billion between the start of 2017 and now, a 650% increase. Many valuations are outrageous; cryptocurrencies with no intrinsic value are currently worth hundreds of millions. Investors’ exuberance notwithstanding, the fundamentals are often excellent, and the hundreds of millions poured into strikingly poor investments should become a . aggregated cryptocurrency market capitalization technology is groundbreaking, drop in the bucket once cryptocurrencies undergo mass adoption Therein lies a seeming contradiction. Investing in businesses with solid fundamentals would typically represent a good investment rather than a poor one. If businesses fundamentals are great, how can there be a problem? The explanation is simple. Investments in blockchain projects are not going through traditional channels (i.e. stocks, bonds, etc) but rather through a new channel: cryptocurrencies themselves; and . cryptocurrencies often represent seriously flawed investment vehicles This article is meant as an . It covers the following: in-depth overview of cryptocurrencies for the savvy investor why bitcoin and ethereum have intrinsic value, a technical overview of cryptocurrencies and digital tokens, Initial Coin Offerings (ICOs), why is there a bubble, and why bubble notwithstanding prospects are bright. Bitcoin is the . Its current market cap is . The Bitcoin blockchain provides a decentralized peer-to-peer electronic cash system. Critics could say bitcoin has no intrinsic value, arguing it is a whose monetary value is entirely derived from people’s perception and, unlike fiat currencies, it has no central bank reserves backing. Bitcoin cryptocurrency king USD 65 billion financial asset Critics misunderstand bitcoin. Bitcoin behaves like a financial asset. Bitcoin is used like a financial asset. But bitcoin actually represents , not a financial asset. In other words, . Why do I say bitcoin represents property? Consider the following : “A financial asset is a non-physical asset whose value is derived from a contractual claim” (i.e. a financial asset represents a liability for someone else). Bitcoin is a non-physical asset, yet it does not represent any contractual claim. It is an asset that is not a liability of any entity or person. property bitcoin is property that trades like a financial asset definition From this vantage point, bitcoin is similar to gold. Gold also represents property that trades like a financial asset. Gold derives value from people’s perception of gold as an alternative to fiat currencies and a long-term store of value. And gold undoubtedly has intrinsic value. It is a metal that conducts electricity, does not tarnish, and has . About (gold is used inside electronics). Similarly, bitcoin’s value comes from people’s perception of bitcoin as an alternative to fiat currencies and a store of purchasing power. But bitcoin can also be considered to have intrinsic value. Think of bitcoin as an , that can only be transferred by holding cryptographic keys. Creating a bitcoin requires advanced coding and massive computing power. Bitcoin is mathematical art that cannot be copied. numerous real life uses half of gold’s demand comes from jewelry and technology Unhackable Piece of Electronic Art Even if one day bitcoin is deemed a dismal technology, given its , bitcoin would likely retain value because it was the first of its kind. So . Unless of course some day someone figures out , in which case bitcoin would go down to zero very quickly. fixed maximum supply best case scenario, bitcoin remains at the forefront of cryptocurrencies; worst case scenario, it becomes a prized relic how to hack the Bitcoin blockchain Ethereum is the second most popular cryptocurrency and the It is a with a scripting language. Like Bitcoin, it provides a decentralized peer to peer electronic cash system. Unlike Bitcoin, Ethereum allows for the creation of (i.e. programming code that auto-executes once certain conditions are fulfilled). And unlike Bitcoin, with Ethereum developers can build and deploy (e.g. an Ethereum-based decentralized Facebook). Ethereum king of Blockchain-As-A-Service. programmable blockchain Turing-complete smart contracts decentralized applications Smart contracts and decentralized applications enable Ethereum to uproot everything from basic user applications to how business is conducted. Consider a built on Ethereum where users control their own data. Consider decentralized self-executing or . Consider decentralized incorruptible . Consider decentralized . The list of possibilities is endless. In short, one may think of Ethereum as a or supercomputer that could redefine the world as we know it. decentralized Facebook insurance contracts financial derivatives voting platforms prediction platforms decentralized virtual machine is the cryptocurrency of the Ethereum blockchain. It is both a cryptocurrency and the means of payment for accessing the Ethereum network. Ethereum users pay with ether for the computing power they are using. . This is the source of ether’s intrinsic value. Ether’s current market cap is . It should be noted that even though Ethereum is the blockchain and ether is the currency, most people refer to ether as ethereum. Ether Think then of ether as the fuel for powering the Ethereum network USD 27 billion A Technical Overview of Cryptocurrencies (Heavy lifting in this section — if already familiar with the technical aspects of cryptocurrencies and Ethereum tokens you may skip ahead to the next section) — Cryptocurrencies, virtual currencies, electronic coins, digital coins, digital tokens and blockchain tokens are different names for the same thing. — A cryptocurrency is a stored on a decentralized public ledger known as a blockchain (for an in-depth explanation, refer to the original by Satoshi Nakamoto). chain of digital signatures Bitcoin whitepaper — Having a cryptocurrency means having a (similar to a password) giving the holder the ability to transfer the cryptocurrency to someone else. Private keys are stored in . private key digital wallets — Cryptocurrencies are transferred from one owner to another by adding a transaction to the blockchain (in-depth explanation ). here — Blockchains are kept , who validate transactions (in-depth explanation ). secure from hacking through the work of validators here — Validators are given cryptocurrencies as reward/payment every time they validate a transaction (i.e. for people to become validators). Validators may also be awarded paid by the sender. cryptocurrencies provide the economic incentive transaction fees — There are multiple for validating transactions. The main ones are: consensus mechanisms Proof-of-Work (PoW): validators validate transactions by running an algorithm to . This is known as . Mining creates new coins. Validators are rewarded with new coins and transactions fees (if any). solve a cryptographic puzzle mining (PoS): validators validate transactions by staking (“depositing”) cryptocurrencies. No new coins are (usually) created. Validators are rewarded with transaction fees only. Proof-of-Stake — Cryptocurrencies can be created by (e.g. bitcoin) or by simply allocating coins to an address (e.g. ). The latter is known as . It is convention to refer to non-mined coins as pre-mined, even though doing so is technically incorrect if the coin is not mine-able, such as Ripple’s. The term pre-mined comes from the practice by blockchain developers of creating mine-able coins for themselves before releasing the blockchain’s source code to the public, allowing the public to mine. mining Ripple’s XRP pre-mining — Cryptocurrencies can be defined as , which are intrinsic to a blockchain and used for validations (e.g. bitcoin), and , which are created on top of a programmable blockchain such as Ethereum, and used for multiple purposes (more on that later). Native Tokens Non-Native Tokens Creating a token on Ethereum is as easy as writing . This has made . Non-native tokens can be either mined or pre-mined, although they generally are fully pre-mined. 25 lines of code Ethereum the most widely used protocol for non-native token creation The name is mostly used in reference to cryptocurrencies built on the Ethereum platform (i.e. Ethereum tokens), even though technically all cryptocurrencies are digital tokens. digital token — Cryptocurrencies can also be classified as . Protocol Tokens or App Tokens Protocols are sets of rules, while applications are computer programs built on top of protocols. There is one native protocol per blockchain. Non-native protocols can be built on top of programmable blockchains such as Ethereum. Protocol tokens are required by a protocol to function. Protocol tokens can be both native and non-native. Most native tokens are protocol tokens ( is a noteworthy exception). Ripple’s XRP App tokens are not required by an application or protocol. Instead, App tokens are generally used by the application users to access the application’s services. Initial Coin Offerings The public can acquire tokens either through mining, by purchasing in secondary markets (i.e. through peer-to-peer transactions or in exchanges), or by participating in an (i.e. purchasing directly from token creators). . There are some notable differences between the two: Initial Coin Offering Initial Coin Offerings (ICOs) are similar to Initial Public Offerings (IPOs) where investors are buying cryptocurrencies instead of shares Shares give shareholders equity in a company, while cryptocurrencies do not give coin holders any equity. Shares give shareholders rights, while cryptocurrencies do not give holders any rights (with a few rare exceptions). Shares are regulated as , while coins are not (although this is changing, see for example recent US developments ). securities here Cryptocurrencies are usually paid for with other cryptocurrencies, which facilitates participation of international users. One can think of ICOs as , or meets . ICOs give blockchain enthusiasts direct and easy access to investing in blockchain start-ups. ICOs enable blockchain start-ups to raise early stage capital bypassing venture capital firms, without even diluting equity ownership. And ICOs can also be great for venture capital firms willing to give up the equity ownership associated with traditional financing in exchange for a highly liquid investment (typical venture capital investments are illiquid and may take many years for investors to cash out). democratized venture capital venture capital crowdfunding The major downside of ICOs is the , which allows those raising funds to offer minimal disclosures for investors, “ ”. Fund raisers may even be anonymous, such as is the case with the extremely popular ( , market cap USD 910 million — note market cap is not the number listed by coinmarketcap.com, , but rather the often considerably larger number resulting from multiplying Price by Total Supply). lack of regulatory oversight exaggerate benefits, fail to identify risks, and create unsubstantiated hype Bitconnect BCC by definition computed using Circulating Supply For further reading about ICOs I recommend this . article covering the lack of ICO disclosure regulations ICOs & Non-Native Tokens While Ethereum has made it easy for developers to create digital tokens, ICOs have made it easy for investors to those digital tokens. The lax regulatory framework coupled with the ease of matching entrepreneurs with eager investors has resulted in a massive ICO boom. It is in the ICOs of non-native tokens that investors’ becomes apparent. access irrational exuberance Uninformed or informed, unsophisticated or sophisticated …. investors of all kinds are participating in ICOs and throwing hundreds of millions at often worthless tokens that offer the investor little beyond possible gains from selling tokens later at a higher price. Picture Pether Block (pun intended), a sharp entrepreneur seeking to raise funds. Imagine Pether raises funds not by issuing equity (stocks) or legal promises to pay funds back (loans, bonds), but instead by giving out pretty bits of paper with no legal backing saying he plans to pay back. Now imagine Pether actually gets funding by giving out pretty bits of paper that do not even promise to pay back. Furthermore, imagine a case where Pether is actually anonymous, he did not even have to disclose his identity to raise funds. This is happening in some ICOs. abound. is the most famous uncovered Ponzi scheme. Bitconnect, a cryptocurrency that offers (assuming daily reinvestment) plus variable returns generated by a “volatility trading bot”, is in my humble opinion the most striking Ponzi scheme of present times. Ponzi schemes OneCoin guaranteed 149% annualized returns Think about it… Buy a share, and get legal ownership of a company. Buy a bond, and obtain the right to receive interest payments. Buy bitcoin, and receive a liquid asset that derives its value from the computing power dedicated to creating such piece of mathematical art. Buy ether, and receive a liquid asset that derives its value from both the computing power dedicated to creating it, as well as its value as means of payment for using the Ethereum supercomputer. Buy any native token, and receive a cryptocurrency providing economic incentives for a blockchain to function. Buy a non-native token … and what do you receive? There are : categories of Non-Native Tokens eight Protocol tokens. (e.g. : , market cap USD 200 million). Augur REP Tokens issued for accessing the platform/services of the issuing company; future services, to be precise, as in most cases tokens are issued when the platform is no more than an idea. Think of them as utility tokens or . (e.g. : , market cap USD 160 million). Gift Cards Factom FCT , where the blockchain asset represents a claim on an underlying asset, and to claim the underlying one sends the blockchain asset (i.e. the token) to the issuer. (e.g. USD: ). Asset-backed tokens Tether’s USDT Token issued under the in future revenues, even though there typically is no legal obligation for companies to honor such promises. Participation percentages and timing are almost always left undefined. (e.g. : , market cap USD 150 million). promise of participation DigixDAO DGD Tokens in the issuing company, giving token holders votes as shareholders, participation in future dividends, and supposedly ownership of the company as well. (e.g. : , market cap USD 410 million). said to represent equity Lykke LKK Tokens issued under the backed by promises from the company to repurchase and destroy tokens once sustainable revenue materializes. (e.g. : , market cap USD 150 million). promise of appreciation Populous PPT Tokens issued with no value proposition whatsoever. Think of them as . (e.g. : , market cap USD 290 million). toy casino tokens Steemit STEEM Potential (e.g. : , market cap USD 8.9 billion — note only 2% of coins are in circulation). scams Veritaseum VERI If the associated blockchain or service becomes popular, their value will rise accordingly. They represent a bet in the success of the underlying technology. Protocol tokens (#1) and gift card tokens (#2) could certainly be valuable. (e.g. it is easier to transfer ownership of 1000 ounces of gold in digital format than in physical format). Their downside is the credit risk of the issuing company (what if they go bust or they run away with the money?). Asset-backed tokens (#3) are useful . Ideally participation conditions (percentages, timing) would be defined prior to the ICO, and the distribution of profits would happen autonomously following instructions in a smart contract — although this is not happening. Some issuers get creative and define these tokens as “Economic Shares” or “Non-Ownership Shares”, in an effort to convey that tokens are shares, which is not the case. Tokens that offer revenue participation (#4) could be valuable hard-coded with the explicit mention of “dividends” and/or voting rights**.** Equity tokens have been mostly avoided by issuers to reduce the probability of regulators classifying tokens as regulated securities. Marketing of equity tokens is generally misleading, because simply calling a token a share does not make the token a share. A . Equity placements require documentation filings with a regulator and the publication of a prospectus for investors. Furthermore, even if equity documentation were there, at this point it is not clear equity tokens could legally represent shares (laws are country dependent and subject to change). Equity tokens (#5) are similar to participation tokens token that isn’t backed by equity documentation cannot be equity . Yet investors gobble them up, often failing to differentiate between a great project and great value. A project may represent a fantastic idea, while the associated investment vehicle may nonetheless offer terrible value for investors. And we are not only talking about great ideas here; one may get any idea (even a terrible one such as the ), bundle it with a no-strings-attached token, and investors’ money will likely follow. Somebody even launched an ICO for the and raised $40,000. The latter three types of non-native tokens (#6–8) have little if any intrinsic value Fuck Coin Useless Ethereum Token The Cryptocurrency Bubble Despite the recent market correction following China’s ban of cryptocurrency exchanges, this year. this year. Does this represent a bubble? Not necessarily. this year: the all-time cumulative ICO funding is $2.3 billion, it was $295 million by January 1st. If you start the count on May 1st, then bitcoin is up 190%, ether is up 240%, and ICO funding is up by 420%. Bitcoin is still up 305% Ether is up 3400% ICO volume is up 675% Why do ICOs matter that much? After all, bitcoin and ether represent two-thirds of the combined . So why do ICOs matter? Because ICOs are mostly paid for in bitcoin and ether, and also a great number of tokens are Ethereum tokens. cryptocurrency market cap ICOs are driving prices! Given that it is real projects driving prices, one could then argue there is no bubble. Right? Now remember how investors are throwing hundreds of millions into ICOs in which the tokens are gift cards at best and goodwill promises at worst. Many of these projects would not receive a penny from investors without shiny coins involved. Companies’ are getting funding with tokens that represent no liability, yet investors those tokens give investors the to participate in the growth of the business. Investors are behaving irrationally. convince themselves right Investing in an asset whose value depends on the goodwill of the company’s management represents bubbly behavior, allowing one to conclude that there indeed is a bubble. Publicly traded bitcoin investment vehicles are visible proof of the bubble. In the absence of bitcoin (ETFs) in which to invest ( ), US asset managers and investors seeking exposure to bitcoin without having to buy bitcoins have flocked to the Bitcoin Investment Trust ( ), a publicly quoted security supposed to track the performance of bitcoin as its fully backed by bitcoins. Demand for GBTC is so high that GBTC currently trades at (i.e. GBTC does not track bitcoin well at all). exchange traded funds the SEC is yet to approve any GBTC 90% premium over its net asset value Another great example of the bubble is , a publicly traded Canadian company ( ) that claims to be a vertically integrated Bitcoin entity. This is a company that pays dividends with coins itself makes up (i.e. TeslaCoilCoin). Check for a fun read on the subject. It’s a lot of fun, for as long as you are not of those who bought BITCF in August just because it was one of the few publicly traded alternatives to invest in bitcoin. On August 24 the SEC suspended trading on BITCF for 10 days “because of concerns regarding the accuracy and adequacy of publicly available information about the company”. On September 8 BITCF resumed trading, opening 69% lower. First Bitcoin Capital BITCF this Bloomberg article Still need convincing? The latest by Howard Marks features a list of nine necessary conditions for a bubble to occur— it states “a few [of these conditions] will give us a bull market; all of them will deliver a boom or bubble”. It’s a noteworthy read. It’s also noteworthy that all conditions are undoubtedly present in the cryptocurrencies market. Oaktree Capital memo Market Outlook China ban notwithstanding, the ICO gold rush is nowhere near its end. Most institutional investors have yet to participate in the asset class. There are large sums of money from institutions and high net worth individuals about to enter the market through newly minted . Most retail investors don’t know how to get their hands on bitcoins and ether. Relatively few people understand how Bitcoin works, let alone Ethereum. And polls indicate extremely few women are participating in the bitcoin rush (coin.dance publishes a weekly poll called “ ”, with the percent of male participants consistently above 95%). Bitcoin was created eight years ago, yet the blockchain industry is still in its infancy and mass adoption is yet to happen. Prospects are bright. Will the bubble continue? I believe it will. hedge funds Bitcoin Community Engagement by Gender . China just banned all cryptocurrency exchanges, and nothing stops other countries from following that route. Governments are not precisely ecstatic with cryptocurrencies ability to avoid capital controls, nor with its use by tax evaders and money launderers. Furthermore, you can rest assured even the most pro free-markets Western governments would be quick to ban or heavily regulate cryptocurrencies if they were to grow large enough to have an impact in central banks’ ability to dictate monetary policy. The main market risk is the potential of government intervention That being said, one may then ask, Look into the following for answering that question: do current levels represent a good price to buy? On September 4 China banned ICOs, and on September 15 by September 30. This has caused a significant price drop. Bitcoin fell from $4400 on Sep/4 to $2970 on Sep/15, before bouncing up around 30% on on that same day. The ban is shutting out a fifth of current worldwide demand (for example BTC/CNY volume stands at 18% of worldwide volumes, per ). This will diminish capital flows into cryptocurrencies, but will not affect long-term fundamentals. Chinese regulators announced cryptocurrency exchanges must stop trading record volume bravenewcoin.com : on Jul/18/2017 ether dropped and bounced back a full (it happened on the now defunct ), and on Jun/21/2017 ether , to almost fully recover in less than two minutes (it happened on the GDAX exchange; note did not cancel trades, those who profited from buying the crash kept their profits, yet those who lost money during the crash). An investor could use limit orders to take advantage of flash crashes. Ether has a history of flash crashes 20% in just 3 seconds BTC-e exchange dropped from $319 to $0.10 in seconds GDAX GDAX compensated out of pocket . The information for most upcoming ICOs is , and future ICO volumes can be estimated. Furthermore, is on its way. The day the SEC approves a cryptocurrency ETF, funds will pour in. Consider that current total cryptocurrencies market cap represents just 0.17% of assets managed by the . The key determinant of prices is capital flows publicly available institutional money top 400 institutional asset managers Think of . Some estimates indicate there are , which represents 0.14% of the in the world between 14 and 65 who have internet access. Can you imagine market penetration increasing to 5% within five years? That would mean 105 million users. What would happen with price then? Jeremy Liew, Snapchat’s first investor, thinks bitcoin could hit , taking its price to $500,000. Would that be outrageous? market penetration three million cryptocurrency users 2.1 billion people 400 million users by 2030 , bringing significant uncertainty regarding governance of the Bitcoin protocol and even greater 2-way price volatility. By itself, this is good reason to be bearish in the short term. Bitcoin is expected to hard fork again by mid-November Patience, decisiveness and skepticism are crucial tools in the toolkit of the savvy investor. Is it time to buy? You decide. 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