Sunstone Capital, Avalanche 2014 - Bitcoin: Primer, State of Play, Discussion

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Information about Sunstone Capital, Avalanche 2014 - Bitcoin: Primer, State of Play,...

Published on February 5, 2014

Author: yghalim



Every winter, Sunstone hosts an offsite event with the participation of executives from our portfolio companies, fellow VCs, and various thought leaders.

The event is designed to mix informal networking, stimulating discussions around key topics shaping our industry, and intense skiing. We find that the best inspiration and ideas are generated when you least expect it, and in company with people that challenge your thinking.

This year's edition took us to Courmayeur in the Italian Alps, and Bitcoin was on the list of topics we discussed. Here are the supporting slides from our Jan 24th presentation "Bitcoin: Primer, State of Play, Discussion".

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:,,   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 - 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 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:   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:,  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:,  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:,  coinometrics,    companies’  reports  

Increasingly consolidated value chain & ecosystem – centralize to decentralize? THE BITCOIN ECOSYSTEM Miners   -­‐Validate   transac<ons  and   confirm  ownership    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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