CRYPTOCURRENCIES:FLASHINTHEPANORTHEFUTUREOFCURRENCY?

Hype,hopeanddisappointment

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TheRiseofCryptoCurrencies

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Andthebloomisnotofftherose,yet..

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ANewcomerrisestoo…

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TheArchitecturebehindtheCryptoCurrencies..

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TheBlockChain:Characteristics

¨ Decentralizedverification:Thevalidationofatransactionissourcedtomembers,calledminersinthecryptocurrencyworld.Validationusuallyinvolvestryingdifferentalgorithms(hashes)tofindtheuniqueonethatmatchesthetransactionblock,andthesuccessfulminerisrewarded,currentlywiththecryptocurrency.

¨ Completeandopenrecords:Everytransaction,oncevalidated,isconvertedintoablockofdatathatisrecordedintheblockchainledger,whichisaccessibletoeveryoneinthenetwork.Ifyouareworriedaboutprivacy,thetransactionrecordsdonotincludepersonaldatabuttaketheformofencrypteddata(hashes).

¨ Incorruptible:Ablockchain,oncerecordedandshared,cannotbechangedsincethosechangesarevisibletoeveryoneinthenetworkandarequicklytaggedasfraudulent.Thus,theledger,oncecreated,becomesalmostincorruptible.

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TheFutureofBlockchain

¨ Ineffect,ablockchainisadigitalintermediationprocesswheretransactionsarecheckedbymembersofthenetwork,andrecorded,andoncethatisdone,cannotbealteredfraudulently.

¨ Theblockchaintechnologyisaboutfarmorethancryptocurrencies.Itcanbeusedtorecordtransactionsinanyasset,fromsecuritiesinfinancialmarketstophysicalassetslikehouses,anddosoinawaythatreplacestheexistingintermediarieswithdecentralizedmodels.

¨ Banksandstockexchanges,whichmakethebulkoftheirmoneyfromintermediation,notonlyseeblockchainsasathreattotheirexistencebuthavebeenearlyinvestorsinthetechnology,hopingtoco-optittotheirownneeds.

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Currency101:ThePurposesofMoney

¨ Unitofaccount:Akeyroleforacurrencyistooperateasaunitofaccount,allowingyoutovaluenotjustassetsandliabilities,butalsogoodsandservices.Tobeeffectiveasaunitofaccount,acurrencyhastobefungible(oneunitofthecurrencyisidenticaltoanyotherunit),divisibleandcountable.

¨ Mediumofexchange:Currenciesexisttomaketransactionspossible,andthisisbestaccomplishedifthecurrencyinquestioniseasilyaccessibleandtransportable,andisacceptedbybuyersandsellersaslegaltender.Thelatterwilloccuronlyifpeopletrustthatthecurrencywillmaintainitsvalueandiftransactionscostsarelow.

¨ Storeofvalue:Totheextentthatyouholdsomeorallofyourwealthinacurrency,youwanttofeelsecureaboutleavingitinthatcurrency,knowingthatitwillnotloseitsbuyingpowerwhilestored.

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GoodversusBadCurrencies

¨ Forms:Currenciescantakeoneofthreeforms,aphysicalasset(gold,silver,diamonds,shells),afiatcurrency(usuallytakingtheformofpaperandcoins,backedbyagovernment)andcryptoordigitalcurrencies.

¨ TheSurvivor:Gold'slongtenureasacurrencycanbeattributedtoitsstrengthasastoreofvalue,arisingfromitsnaturalscarcityanddurability,thoughitfallsshortoffiatcurrencies,intermsofconvenienceandacceptance,bothasaunitofaccountandasmediumofexchanges.

¨ TheFiatCurrencies:Fiatcurrenciesarebackedbysovereigngovernmentsandconsequentlycanvaryinqualityascurrencies,dependinguponthetrustthatwehaveintheissuinggovernments.

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Howdocryptocurrenciesmeasureup?

¨ Asunitsofaccount,thereisnoreasontodoubtthattheycanfunction,sincetheyarefungible,divisibleandcountable.

¨ Theweakestlinkincryptocurrencieshasbeentheirfailuretomakedeeperinroadsasmediumsofexchangeorasstoresofvalue.

¨ UsingBitcoin,toillustrate,itisdisappointingthat sofewretailersstillacceptitaspaymentforgoodsandservices.Eventhemuchhypedsuccesses,suchas Overstock andMicrosoftacceptingBitcoinisillusory,sincetheydosoonlimiteditems,and onlywithanintermediarywhoconvertsthebitcoinintoUSdollarsforthem.

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Whytheslowacceptance?

¨ Inertia:Fiatcurrencieshaveahadalongrun,anditisnotsurprisingthatformanypeople,currencyisphysicalandtakestheformofgovernmentissuedpaperandcoins.

¨ Pricevolatility:Cryptocurrencieshaveseenandcontinuetoseewildswingsinprices,notabadcharacteristicinatradedassetbutdefinitelynotagoodoneinacurrency.

¨ Competingcryptocurrencies:Thecryptocurrencygameisstillyoungandthecompetingplayerseachclaimtohavefoundthe"magicbullet"foreventualacceptance.Astechnologiesandtastesevolve,youwillseeathinningoftheherd,wherebuyersandsellerswillpick winners,perhapsfromthecurrentlistormaybesomethingnew.

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TheDisconnect

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ExplainingtheDisconnect

¨ Marketsareforwardlooking:MarketareforwardlookingandthattheriseinthepricesofBitcoinandEtherreflectsmarketexpectationsthattheywillsucceedascurrencies,ifnotrightaway,inthenearfuture.

¨ Speculativeasset:Inthevaluegame,youtrytoattachavaluetoanassetbaseduponfundamentals,andinthepricinggame,itismoodandmomentumthatdrivetheprocess.Cryptocurrencymarketsarepurepricinggames,wherefundamentalshavebeenlongsinceforgotten

¨ Lossoftrustincentralizedauthorities(governments&centralbanks):Goldhasheldaspecialplaceinthecurrencycontinuum,oftenbeingtheassetoflastresortforpeoplewhohavelostfaithinfiatcurrencies.Forsomepeople(especiallyyoungerandmoretechnologicallyinclined),bitcoinandetherareplayingthesamerole.

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GoldversusCryptoCurrencies

¨ Timetested?Goldhashelditsvaluethroughthecenturiesandisaphysicalasset.Forbetterorworse,itisunlikelythatwewilldecideafewyearsfromnowthatgoldisworthless.

¨ TheCurrencyTest:Acryptocurrencythatfewpeopleuseascurrencyultimatelywillnotbeabletosustainitself,asshinerandnewerversionsofitpopup.Ironically,iftradersinbitcoinandetherwanttheirinvestmentsinthecryptocurrenciestoholdtheirvalue,thecurrencieshavetobecomelessexcitingandlucrativeasinvestments,andbecomemoreacceptedascurrencies.

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Keytestsforsuccessincryptocurrencies..

¨ Transaction,nottrading,talk:Fromcreatorsandproponentsofthecurrency,youwillhearlesstalkabouthowmuchmoneyyouwouldmakebybuyingandsellingthecurrencyandmoreonitsefficacyintransactions.

¨ Transaction,nottrading,features: Thedesignofthecryptocurrencywillfocusoncreatingfeaturesthatmakeitattractiveasacurrency(fortransactions),notasinvestments.

¨ Trustinsomething:Tobeeffectiveasacurrency,youdoneedtobeabletotrustinsomethingandperhapsacceptcompromisesonprivacyandcentralizedauthority(atleastonsomedimensionsofthecurrency).

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TheCapEffect:AnAcidTest

¨ Bitcoinandetherminershavebeenwillingtoputintheefforttovalidatetransactionsbecausetheyarerewardedwithissuesofthecurrency,feasiblenowbecausethereisslackinthecurrency(thecurrentnumberisbelowthecap).

¨ Asthecapbecomesabindingconstraint,therewardsfromminershavetocomefromtransactionscostsandseriousthoughthastogointocurrencydesigntokeepthesecostslow.

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A“Fair”priceforCryptoCurrencies

¨ Afairexchangeratebetweentwofiatcurrencieswillbeonthat equalizestheirpurchasingpower,anold,imperfectandpowerfultheorem.

¨ Ifyouarepaying$2,775forabitcoinonAugust1,2017,iswhetheryoucan(orevenwillbeableto)but$2,775worthofgoodsandserviceswiththatbitcoin.¤ Ifyoubelievethatbitcoinwilleventuallygetwideacceptanceasadigitalcurrency,youmaybeabletojustifythatprice,especiallybecausethereisahardcaponbitcoin

¤ Ifyoudon'tbelievethatbitcoinwilleveracquirewideacceptanceintransactions,itistimethatyouwerehonestwithyourselfandrecognizedthatisjustalucrative,butdangerous,pricinggamewithnogoodending.

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DigitalCurrencies

¨ Notthereyet:Cryptocurrencies,withbitcoinandetherleadingthepack,havesucceededinfinancialmarketsbyattractinginvestors,andinthepublicdiscoursebygarneringattention,buttheyhavenotsucceeded(yet)ascurrencies.

¨ Buttheyarecoming:Therewillbeoneormoredigitalcurrenciescompetingwithfiatcurrenciesfortransactions,soonerratherthanlater.Iamhardpressedtofindawinneronthecurrentlist,rightnow,butthatcouldchangeifthefocusshiftsfromtradingtotransactions.

¨ Winnercouldbeanewentrant:Ifthatdoesnothappen,wewillhavetowaitforafreshentrantandthemostenduringpartofthisphaseinmarketsmaybetheblockchainandnotthecurrenciesthemselves.