Published on February 5, 2014
Primer, State of Play, Discussion Yacine Ghalim & Max Niederhofer Courmayeur, 24 January 2014
Bitcoin is becoming ever more popular in the public eye GOOGLE TRENDS & SEARCH VOLUME 11.1m Average Monthly Search Volume (Google, past 12m) 1.2m Data: Google Trends 1m 1.5m Data: Google Keyword Planner 1.5m
A dividing topic PERSONALITIES QUOTES Bitcoin is a technological tour de force. Bitcoin is Evil. Paul Krugman Bill Gates It will be everywhere, and the world will have to readjust. John McAfee Bitcoin is the beginning of something great: a currency without a government, something necessary and imperaBve. Nassim Taleb Source: bitcoinquotaBons.com,, ecb.europa.eu A virtual currency scheme. ? The European Central Bank
Bitcoin’s origin as the experiment of an anonymous cryptographer, Satoshi Nakamoto, is a boon to libertarian hero worship HISTORY / MYTHOLOGY 2008 - Bitcoin.org registered by “Satoshi Nakamoto” - “Bitcoin: A Peer-to-Peer Electronic Cash System” paper posted October 2008 (link: PDF) - Bitcoin projected registered at Sourceforge 2009 - Satoshi mines “genesis block” of 50 BTC – January 2009 - Bitcoin v0.1 released on firstname.lastname@example.org mailing list… and Usenet – January 2009 - First bitcoin transaction, #bitcoin-dev on Freenode, v0.2 released 2010 - First offline transaction: 10K BTC for two pizzas - v0.3 announced, Slashdotted, Mt Gox founded – July 2010 - First specialized GPU hash miners and pooled mining operations - Bitcoin economy surpasses $1 million, $0.5/BTC - Satoshi hands project lead to Gavin Andresen, fades into background with est. ~1 million BTC
What exactly is Bitcoin? DEFINITION(S) - Bitcoins are digital units of account issued, authenticated and transacted through a peer-topeer network - The network/ecosystem is Bitcoin, the units are bitcoins - Attractive due to low transaction costs, no taxation, (some) anonymity - Key features safeguard issuance, authentication, ownership and independence - For the first time in human history, a medium of exchange with no intrinsic value without a trusted central authority
Bitcoin works like previous attempts at digital currencies, but uses a public ledger of transactions instead of a central “mint” HOW BITCOIN WORKS (1) - A bitcoin is simply a chain of digital signatures using public and private keys - This is based on previous work, like hashcash, bit-gold and many other e-cash attempts - The main problem of a digital currency is verifying ownership - double-spending and its most obvious solution, a trusted central authority - Bitcoin solves this through a public ledger, which creates a time-stamped history of all transactions - This is known as the blockchain
A public record of all transactions implies a very different model of privacy, one that is arguably more strict HOW BITCOIN WORKS (2) - Bitcoin transactions are public, traceable and publicly stored… - This is similar to the idea of stock exchanges, where a tape of transactions is public, but the identity of the transacting parties is not - Preserving privacy on Bitcoin requires effort: discarding Bitcoin addresses constantly
Nodes in the peer-to-peer network compete to validate transactions and thus being allowed to issue new bitcoins through “mining” HOW BITCOIN WORKS (3) - The blockchain is built by the nodes in the network attempting to generate new blocks by solving a difficult proof-of-work problem, and thus making fraud highly unlikely - In Bitcoin, this proof-of-work is incrementing a nonce, or arbitrary number, to the point of where its SHA-256 hash yields a value beginning with a set number of zeros (getting more difficult over time) - Once a new hash has been found, the node broadcasts the new block to the network - The first transaction of the new block is a new issuance of bitcoins (currently 25), a reward for the “miner” - Other nodes accept the block only if all transactions in it are valid, ie no double-spending - In case of a conflict (branch), nodes will work on extending the longest chain - In the long run, as issuance slows, Bitcoin allows for transaction fees paid to nodes for extending the blockchain
While Bitcoin solves key digital currency problems elegantly, some vulnerabilities remain HOW BITCOIN WORKS (4) - While transaction validation in the blockchain is costly, single transaction verification is simple and cheap - However: all of this assumes that a majority of honest nodes control the network - The blockchain generation means transaction confirmations take up to an hour
Bitcoin’s current use cases are threefold : store value, transact and move money THE CURRENT BITCOIN USE-CASES Store Value • OAen compared to: • Shares the most aCributes with precious metals: • Limited supply increasingly diﬃcult to extract • “Decentralized” crea<on • Non yielding asset • • • Transact • • More easily fungible than precious metals No storage costs (Temporarily) unclear tax treatment of capital gains 2,500+ brick & mortar places (mostly mom & pop shops) 50,000+ online places Large online players accep<ng it: • Move Money • vs Cash: • Dematerialized vs Cards: • Lower transac<on fees • No charge-‐back • Pseudonymous • • • • Data: Coinmap.org Transfers Interna<onal remiCances Oﬃcially banned it: • Circumvent EM countries’ capital controls (China, Argen<na, North Africa) Faster and cheaper than some tradi<onal transfer services Pseudonymous
Most of the bitcoin creation is designed to occur between 2009 and 2025 MODELED BITCOIN CREATION OVER TIME 25,000,000 21m (100%) 99% 20,000,000 15,000,000 12.2m (58%) 10,000,000 Data: BitcoinWiki 2141 2137 2133 2129 2125 2121 2117 2113 2109 2105 2101 2097 2093 2089 2085 2081 2077 2073 2069 2065 2061 2057 2053 2049 2045 2041 2037 2033 2029 2025 2021 2017 2014 2013 -‐ 2009 5,000,000
A wild ride up… HISTORICAL PRICES ($) • Trending up…best performing asset in 2013 (75x) 3 • Trading in step func<on (low liquidity, binary events, buzz factor) • Tremendous vola<lity (2013 realized vol. = 100) $1,203 $1,045 Average Daily % Move 6.3% Biggest up day: +42% 1.3% 0.4% €/$ $0-‐1 Data: blockchain.info, Bloomberg $584 Biggest down day: -‐49% 75x 2 $210 1 $35 $2-‐15 $14
Value of the outstanding stock – low, but not negligible VALUE OF OUTSANDING STOCK ($) $1,500bn (large denominated bills) ETFs $1,300bn (private hands) $50bn (foreigners deposits) $11.5bn Data: blockchain.info, BoFA Macro Research # Outstanding Bitcoins * mkt. price = $11.5bn
Transaction volume – once again: low, but not negligible DAILY TRANSACTION VOLUME ($) $17,559m $487m $9,863m $7,562m $2,434m $397m $216m Infrequent transac<ons: 41/min (2,000/min Visa) Large transac<ons: $1,700 avg. ($60 avg. Visa) $100m (normalized) $15m Circa $100m Data: blockchain.info, coinometrics, companies’ reports
Increasingly consolidated value chain & ecosystem – centralize to decentralize? THE BITCOIN ECOSYSTEM Miners -‐Validate transac<ons and conﬁrm ownership ghash.io BTC Guild 38% 26% Exis<ng Hash Power Equipment Makers: -‐Avalon Clones -‐Cointerra Data: bitcoinity Exchanges -‐Buy/Sell Bitcoins against ﬁat currencies (p2p) 32% mkt. share 26% mkt. share 20% mkt. share Wallets -‐Store bitcoins -‐Send/Receive bitcoins w/o fric<ons Payment Processing -‐Enable merchants to accept bitcoins payment w/o fric<ons ETFs & Funds -‐Tradable vehicles with bitcoin underlying -‐Buy bitcoins in the open market, repackaged into ﬁnancial securi<es -‐Winklevoss twins ﬁled plans to list a Bitcoin ETF -‐SecondMarket launching Bitcoin Investment Trust (BIT), non listed -‐Fortess Investment forming a Bitcoin Fund, non listed
Flourishing startup ecosystem, relatively muted VC Involvement despite large outliers VENTURE HISTORY 319 startups VC/Angel Funded Total Funding $ Median $ Funding 80 startups 33 startups (10.3%) $87.5m $540k Outliers $31.7m (USV, A16Z) Data: The Bitcoin Database ( compiled by Joel Eriksson Enquist at Creandum), Crunchbase $9m (Accel, GCP)
The most central parts of the “value chain” have attracted most of the funding $ VC/ANGEL FUNDING BY CATEGORY 70,000,000 60,000,000 $59m 50,000,000 40,000,000 20,000,000 10,000,000 Coinbase 30,000,000 $13m $10m $4m -‐ Exchanges/Wallets Payment Processing Data: The Bitcoin Database ( compiled by Joel Eriksson Enquist at Creandum) Miners/Mining Equipment Other
Bitcoin has currency features, but viewing it solely as a currency ignores its more widespread application THE CURRENCY QUESTION - Bitcoin Foundation and others call Bitcoin a “crypto-currency” - Bitcoin is “currency” in the most general sense, since it can be accepted as a means of exchange - Fulfills most criteria of a medium of exchange, but limited utility due to limited adoption - Widespread acceptance as a means of payment is key to meet definition of a currency - Problematic as a unit of account given volatility – hence Bitcoin becomes an intermediate asset traded into or out of following a transaction in a more commonly accepted currency - Speculative interest fuels growth in value versus actual transactions, which suggests it is a store of value rather than a means of exchange - Related key question whether Bitcoin will be treated like cash or asset: income vs capital gains tax
Bitcoins’ acceptance as a store of value currently relies on speculation… “fiat” of a different kind THE ASSET QUESTION - Bitcoins have no intrinsic value: there is no interest (cash deposits), no promises of future cash flows (stocks/bonds), nor is there a use value (gold/silver/commodities) - However, Bitcoin has significant and interesting features that make it a possible alternate store of value - outside of the current financial system - semi-anonymous - easily concealable from tax authorities - low/no correlation - Volatility, high barriers to transaction, lack of eg FDIC insurance currently preclude larger asset base moving into Bitcoin - As volatility decreases, the utility of features above will likely cause significant capital in-flows
As Bitcoin volatility decreases, capital will flow into the market based on utility rather than speculation VOLATILITY VS UTILITY Capital Inﬂows (BTC) Speculation Value Store Utility Time
Bitcoin’s “fair value” will be determined by how widespread its use becomes as a means of exchange THE $1B QUESTION - If Bitcoin becomes an accepted alternative medium of exchange - - - Powering ~10% of global ecommerce transactions: approx. $5B annual transaction volume Rising to become a player to rival Western Union/Moneygram: approx. $4.5B market cap If Bitcoin becomes an accepted store of value - Similar to gold: no cash flows/interest, limited supply, limited traceability - Total gold outstanding in coins/bars/ETFs is ~ $1.3T - Based on silver (1/60 value versus gold): ~ $5B potential value - Medium of exchange + store of value = ~ $15B market, or $1,300/BTC - However, what if BTC becomes truly widely accepted? - Total currency in circulation: ~ $4T - If we assume BTC makes it to 1% of all currency = $400B, or $34,000/BTC - …and the upside is high from there
The implications of Bitcoin are as far-reaching as the advent of the transistor, the PC, the internet… DISCUSSION - Hype or reality: what do you think? - Friendster/Napster or Facebook/Spotify? - Vast economic, social, political, financial implications - - - What happens to an international financial system if you can opt out? Kiss AML/KYC goodbye: say hello to drugs, terror and tax avoidance And yet, this is thinking too short: - For the first time ever, Bitcoin decentralizes trust - You can deal with a perfect stranger at low/no transaction costs - And a Bitcoin is just a hash – you can attach anything to it contractually…
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