TOOL SUMMARY: Cryptoassets — The Innovative Investor’s Guide to Bitcoin and Beyond
These notes were intended to be my personal summary of the book’s main ideas. I wanted to create a list of the many analytical tools that I knew would be available in it. I also included links to all the resources they use to research. I decided to make a post out of it as it would force me to keep it short and coherent.
Chris and Jack’s book is incredibly insightful. No summary could possibly do it justice. Their arguments are thoroughly researched and backed with empirical data and citations. They cover the entire cryptoasset ecosystem in a systematic and comprehensive way.
The book presents a wealth of tools (frameworks and formulas) useful for new and advanced investors. They share their personal valuation methods and the due diligence research process they use. I personally got tremendous value from this book — it is one I that I hope to see on shelves of my business partners.
Note: This summary is largely based on the ideas that resonated with me. Others may find different parts of the book more valuable. Purchase a copy of the book here.
CRYPTOASSETS: The Innovative Investor’s Guide to Bitcoin and Beyond
Introduction:
The term Cryptoassets is presented early on. The writers explain that not all investable digital assets are currencies — there are also commodities and polished digital goods on the blockchain. Therefore, they argue, cryptoassets is a better fitting term.
Part I — WHAT
Chapter 1: Bitcoin and the Financial Crisis of 2008
The Origins of Bitcoin
The book lays out the context in which Bitcoin was originated. The financial crisis of 2008 set the stage for Satoshi Nakamoto’s brainchild to flourish. The Bitcoin whitepaper was released on October 31st, 2008 — six and a half weeks after Lehman Brothers filed for bankruptcy. Lehman’s bankruptcy took the global capital markets down with it. Bitcoin was
“The first known attempt at a decentralized ‘trustless’ transaction system with no central server or authority had come at a serendipitous time.”
Satoshi Nakamoto, an anonymous developer(s), rallied the support of world-class cryptographers for the project via emails and forums. On January 12th, 2009, the first Bitcoin transaction ever was recorded between Satoshi Nakamoto and Hal Finney. Nine months later, the first exchange rate was set for Bitcoin at USD $0.00125/BTC.
Chapter 2: The Basics of Bitcoin and Blockchain Technology
Bitcoin with “B” refers to the network (the software, miners and nodes — the chain itself)
bitcoin with “b” refers to the native coin that is used to transact
“Blockchain technology facilitates transactions in real-time. The world is increasingly real time.”
“Bitcoin’s Blockchain is: Distributed, Cryptographic & Immutable. Proof-of-Work ties the three together and is the only feature that is inherently new about blockchain. It is how the network reaches consensus, incentivizes participants and distributes rewards.”
I wrote a post detailing Proof-of-Work here.
Chapter 3: “Blockchain, Not Bitcoin?”
Bitcoin’s Popularity Surge:
Google Search Trends are a good way of getting insight on what is grabbing mainstream attention. The authors argue that the popularity of the search term “Blockchain” was still increasing steadily at the time of writing — in part due to influential articles published by The Economist and Bloomberg discussing the potential of blockchain beyond Bitcoin and separating the 2 concepts.
Note: Below is an updated chart of the search terms compared. Bitcoin still dominates the mainstream’s attention. Search volumes for “Blockchain” have also gone down significantly since.
“SATOSHI NEVER SAID BLOCKCHAIN”
This one really stuck with me. It reinforced how important proof-of-work is, and how much of a challenge it will be for any developer(s) to improve on it. It made me shift my investment approach. I am very much skeptical of anything that is not proof-of-work at the time of writing.
Media has tried to disassociate Bitcoin from Blockchain — however, Chris and Jack rightfully assert that only public blockchains like Bitcoin with “native assets that incentivize the build-out of a robust network of miners” Are synonymous with blockchain. Other variations may exist, but Bitcoin & Blockchain cannot be divorced conceptually.
“A private blockchain is typically used to expedite and make existing processes more efficient […] the value creation is in cost savings, and the entities that own the computers enjoy these savings. The entities don’t need to get paid in a native asset as reward for their work, as is the case with public blockchains.”
“for Bitcoin to incentivize a self-selecting group of global volunteers, known as miners, to deploy capital into the mining machines that validate and secure bitcoin transactions, there needs to be a native asset that can be paid out to the miners for their work. The native asset builds out support for the service from the bottom up in a truly decentralized manner. Public blockhains are not so much databases as they are system architectures spawned from the bottom up to orchestrate the creation of globally decentralized digital services.”
Bitcoin Hype
In an attempt to discern where we are in the hype cycle, the authors introduce the Gartner Hype Cycle framework.
As per the writers, Bitcoin is about to exit the through of disillusionment, ICOs are in the Peak of Inflated Expectations, and “Blockchain” is somewhere in between.
Gartners’s Hype Cycle for Emerging Technologies
Chapter 4: The Taxonomy of Cryptoassets:
On what constitutes money:
“A currency fulfills three well-defined objectives:
1. Means of Exchange
2. Store of Value
3. Unit of Account”
Bitcoin’s Digital Siblings:
Litecoin:
Founded: 2011
Founder: Charlie Lee, MIT (worked at Google)
Features: Blocktime is 4x faster than BTC, Supply 4x as much as BTC, reward halvings are further apart.
Algorythm: Scrypt (purportedly ASIC resistant)
Ripple:
Founded: 2004
Founder: Ryan Fugger
Features: N/A… goal is to help banks do what they already do.
Algorythm: Centrally mined by company
Dogecoin:
Founded: 2013
Founder: Jackson Palmer
Features: Initially it started as a joke, it evolved to a coin that is very cheap and used to tip in blog sites and online services. It has strong community support.
Algorythm: Scrypt
Privacy Coins:
Bitcoin transactions are pseudonymous — they go to a wallet visible to the public. It may not be directly associated with a particular identity, but users could track the wallet transactions and potentially find out who the wallet belongs to.
Privacy coins like Zcash, Monero and Dash are coins that allow for anonymous transactions using advanced cryptography.
Monero (formerly known as Bytecoin):
Founded: 2014
Founder: N/A
Features: Privacy (ring signatures) — algorithm favors CPUs for mining. Adam Back mentioned it was the only idea outside of Bitcoin that had a “defensible rationale for existence”
Algorythm: CryptoNote
Dash
Founded: 2014
Founder: Evan Duffield
Features: Based on Bitcoin, with a two-tier incentive network, known as Masternodes. Darksend includes the ability for fast, annonymus payments.
Algorythm: Q11 (Not in the book)
Zcash
Founded: 2016
Founder: Zooko Wilcox
Features: Based on Bitcoin, private transactions with “zero-knowledge-proof” cryptography. Top tier developer team behind Zcash. Highly experimental technology.
Algorythm: Equihash (Not in the book)
Chapter 5: Cryptocommodities and Cryptotokens
Ethereum:
Ethereum is a decentralized world computer upon which globally uncensored applications can be built. The Ethereum Virtual Machine is made up of volunteer nodes. These nodes run/support its native blockchain and receive Ether, its native asset, as a reward.
This decentralized virtual computer paved the way for decentralized applications that run on it — creating a brand new ecosystem. A full list of Ethereum dApps can be seen at http://dapps.ethercasts.com/.
The DAO:
The DAO was a complex dApp that programmed a decentralized venture capital fund to run o Ethereum.
“Holders of The DAO would be able to vote on what projects they wanted to support, if developers had received enough support from DAO holders, they would receive the funding.”
Despite experts sounding off about the risks of such a high-stakes undertaking, the project went ahead and the raise was a huge success. It surpassed the original amount raised by Ethereum by almost one order of mangiture (USD $168 Million DAO vs. USD $18.4 Million for Ether). Through the raise, the price of Ether skyrocketed. When it was all said and done, the DAO held 11.8 Million ethers, roughly 15% of all ether that had been created by then.
The DAO was hacked due to a security flaw causing chaos in the Ethereum community. In a landmark move, the Ethereum community leader Vitalik Butterin, decided to fork the Ethereum network and restart the network at a point in time right before the hack and “undo” it. The move was not without some backlash but the fork went ahead and created 2 networks from that point on, Ethereum and Ethereum Classic (for those who did not agree with the fork). Both still exist today.
Interesting dApps, Cryptocommodities, Cryptotokens:
Augur: Seeks to provide a platform for users to wager on the outcome of events.
Gnosis: Similar to Augur
Rootstock (RSK): An Ethereum-type virtual computer on Bitcoin
Tezos: Self-governing ecosystem (not in book)
Lisk: Platform for developers to build blockchain applications on JavaScript (not in book)
Note: The book spends a significant portion explaining portfolio theory, Bitcoin historical returns, Sharpe Ratio, Diversification, and other topics that I will skip. For full details read section II: WHY of the book.
Part II — WHY
Chapter 6: The Importance of Portfolio Management and Alternative Assets [not summarized]
Chapter 7: The Most Compelling Alternative Asset of the Twenty-First Century [not summarized]
Chapter 8: Defining Cryptoassets as a New Asset Class
Note on what defines an asset class: A set of assets that bear some fundamental economic similarities to each other, and that have characteristics that make them distinct from other assets that are not part of that class. The authors argue that cryptoassets do not fall in any of the classically accepted asset classes. These are:
· Capital Assets
· Consumable/transformable assets
· Store of value assets
They successfully argue that cryptoassets do not fit in any of the above classifications.
Chapter 9: The Evolution of Cryptoasset Market Behavior
Authors go through the evolution of Bitcoin exchanges, trading volumes and looking for potential signs of maturity within the cryptoasset ecosystem.
They identify the existence of trading pairs for a particular crypto asset as a sign of maturity for it. I strongly agree with this. They also argue that the volatility decreases as the asset matures.
Correlation between asset classes: The authors argue that while the asset class is first emerging, it will show little correlation with the broader capital markets because there is little overlap between the early adopters and market participants. As more people join, there will be more overlap, hence, a stronger correlation.
Graphs show that cryptoassets are uncorrelated with the S&P 500, Gold, U.S. Real Estate, Oil, and U.S. Bonds, (as expected).
Chapter 10: The Speculation of Crowds and “This Time is Different” Thinking
Understanding crowd mentality in the context of investments: “Psychology expert Gustave Le Bon, in his book The Psychology of Revolution writes that:
‘Man, as part of a multitude, is a very different being from the same man as an isolated individual. His consius individuality vanishes in the unconscious personality of the crowd. […] Affirmation, contagion, repetition, and prestige constitute almost the only means of persuading them. Reality and experience have no effect on them.’”
Basically, we are not the independent thinkers we like to think we are when everyone around is screaming “BUY” or “SELL” — and that is very important to be cognizant of that fact, and compensate for that biological urge through discipline.
Lesson: Bitcoin (and cryptoasset) bubbles are inevitable. Bubbles are part of human nature. Remember that. This time is NOT different.
“Within the periods defined as Bitcoin bubbles, the average decline from peak to through price was 63%.”
Chapter 11: “It’s just a Ponzi Scheme, Isn’t It?” [not summarized]
Part III — HOW
Chapter 12: Fundamental Analysis and a Valuation Framework for Cryptoassets
As a foundation for cryptoassets fundamental analysis, Chris and Jack propose that an investor should evaluate:
1. Project’s Whitepaper: Should outline the problem the asset addresses, where the asset stands in the competitive landscape, and what the technical details are. Stay away from white papers with vague language.
2. Decentralization Edge: Is there an advantage for this to be on a decentralized blockchain? If not, it has no real edge over the existing solution and will have trouble succeeding.
3. Valuation: Value is made up of speculative value and utility value.
o Bitcoin’s Utility Value can be determined by assessing how much bitcoin is necessary for it to serve the Internet economy it supports. (Note: Or any other economy it serves, like a part of Venezuela’s) To find this value, one must make assumptions on Bitcoin’s use. The authors provide sufficient data for the rest of the equation:
“Roughly 5.5 million bitcoin, or US $5.5 billion at the price of $1,000/coin, is held by the top 1,000 addresses on the Bitcoin blockchain. […] Future utility value can be thought of as speculative value, and for this speculative value investors are keeping 5.5 million bitcoin out of the supply.”
§ Money Velocity in the context of Bitcoin: It is important to understand velocity in order to get a better picture of Bitcoin’s demand. The velocity of money is the frequency at which one unit of currency is used to purchase domestically-produced goods and services within a given time period. The velocity of a currency is calculated by dividing the Gross Domestic Product for a certain period over the total monetary supply. Currently, the velocity of the USD is a little north of 5.
“About US$500 billion is transmitted annually thought the remittances market. Assuming bitcoin serviced that entire market, then to figure out the value of one bitcoin, one would need to assume its velocity. Say bitcoin’s velocity is 5, similar to that of the U.S. dollar. Then dividing that $500 billion by a velocity of 5 would yield a total value of bitcoin of $100 billion. If, at this point, we are at the maximum of 21 million bitcoin, and this is the only use for bitcoin, then that $100 billion divided by 21 million units would yield a value per bitcoin of $4,762.”
· NOT IN THE BOOK: I believe bitcoin’s “chain velocity” can be estimated by dividing the total amount of bitcoin transacted over a year over the 21 million bitcoin supply. If we do it for 2017, we get that a total of 95,968,973.73 BTC exchanged hands — if we divide this by 21,000,000 — we get an approximate velocity of 4.57. Source: Blockchain.info
§ I have deliberately skipped over the time-value discounting of money for the context of valuation as I believe it will confuse more people than it will help. The concept to understand is that a dollar today is worth more than a dollar tomorrow because people could “save” that dollar and earn an interest rate.
4. Community & Developers: Research the asset’s developer team and see how active the community is. Resources to check are www.Reddit.com , www.Twitter.com , www.Slack.com , www.MeetUp.com
5. Relation to digital siblings: Is this a fork? Is it entirely new? Is it an asset built on another platform? Will it positively or negatively affect the host platform? Can the host platform handle it?
6. Issuance Model: There is no perfect model — the issuance should allow a fair shot to investors, if there is any favoritism, whether to founders or other investors, the market will clue in. These actions put dark clouds over projects as investors loose confidence.
Chapter 13: Operating Health of Cryptoasset Networks and Technical Analysis
1. Miners: Miners are the computers that support proof-of-work blockchain networks. The more miners are working on a network, the more secure it will be. In order to attack a network, an attacker would have to set up an equal amount of computers to gain control. Hence, the more computers are participating, the more expensive to attack.
A way to calculate the cost to attack the network (or the capital securing it) is for an investor to investigate the cost of each computer, how much it produces (the returns). To calculate the cost of the network, divide the total network by the computer’s hash rate (to get the approximate number of computers) and multiply it by the cost of the computer. Examples below:
“Using $660 million for Bitcoin and $294 million for Ethereum [referring to estimated value of mining hardware supporting each network], while the network values for the two cryptocurrencies are respectively US$17.1 billion and $4.7 billion, we get a range of 3.9 cents to 6.3 cents of capital expenditure per dollar secured by the network. This range is a good baseline for the innovative investor to use for other cryptoassets to ensure they are secured with a similar level of capital spend as Bitcoin and Ethereum, which are the two best secured assets in the blockchain ecosystem.”
Miners should be decentralized — although the authors argue that decentralization can be measured by way of mining pools, I believe geographic distribution through different jurisdictions makes the system more robust. (This point is made in the book)
Nodes and miners used to mean the same thing. A [Bitcoin] node is merely a point of connection to the network. As mining hardware became more specialized, the two concepts became divorced. A node needs to have a miner behind it, whereas a miner need not be a node.
Difference between miners and nodes:
“Not all nodes are made equal. A single node can have a large number of mining computers behind it, hence capturing a large percentage of the overall network’s hash rate, while another node could have a single mining computer supporting it, amounting to a tiny fraction of Bitcoin’s hash rate.”
2. Software Developers: Initial “pedigree” of developers is important. Long-term commitment is equally important. Open source software platforms like www.GitHub.com & www.OpenHub.com allow investors to track developer involvement. www.CryptoCompare.com has also created a developer involvement index.
3. Company Support:
Investors should check:
a. How many places/companies accept the cryptoasset? One way to do this is to research websites that show the number of places that accept them, such as www.spendbitcoins.com. This is not as important for cryptocommodities as it is for cryptocurrencies.
b. Has the project raised venture capital? If so, how much?. www.CoinDesk.com provides some information about this.
c. How many exchanges accept the cryptoasset? How many currency trading pairs does it have? Check regulated exchanges first such as Bitstamp, GDAX, and Gemini — listings on regulated exchanges are positive signs as they are rigorous to accept new assets.
4. User Adoption:
Investors should check:
a. Number of wallets — some networks list the total number of active wallets and users on their networks. This is more difficult for Bitcoin as there are many wallet providers.
b. Google Search Trends on the asset: Research by Willy Woo proposes that Bitcoin user growth is doubling every year. It should grow by an order of magnitude every 3.375 yearas.
c. Number of Transactions: Most network scanners display this information. www.blockchain.info and www.etherescan.io
i. Dollar value of those transactions.
A POTENTIAL VALUATION METHOD FOR CRYOTOASSETS
“One valuation method we are considering is to calibrate how much the market is willing to pay for the transactional utility of a blockchain. [To calculate] we divide the network value of a cryptoasset by its daily transactio volume. If the network value has outpaced the transactional volume of that asset, then this ratio will grow larger, which could imply the price of the asset has outpaced its utility. We call this the crypto ‘PE ratio’”’.
“Upside swings in pricing without similar swings in transaction volume could indicate an overheating of the market and thus, overvaluation of an asset.”
“It appears that bitcoin has a comfortable base when its network value is 50 times its daily transactional volume. Maintaining a price that keeps the ratio near 50 could indicate that the asset is being fairly priced, and wide swings beyond that range can signal bearish or bullish trends.”
Personal note: Bitcoin spent most of 2017 hovering at around 100. Today, this ratio for Bitcoin is hovering at around 200, suggesting that it is overvalued. Interesting insight.
Technical Analysis — I will deliberately skip this part of the book. It covers basic technical analysis terms/indicators on trading charts — arguing that they can provide good entry/exit points to investors. Pay attention to trading volume.
Chapter 14: Investing Directly in Cryptoassets: Mining, Exchanges, and Wallets
Mining: Mining investment returns are a function of hardware costs, operating costs (hosting), and the earnings of the machine. Profitability of miners can be checked in websites like www.cryptocompare.com
Not in book: ASIC hardware prices can be checked on manufacturers websites such as www.bitmain.com
Cloud mining: Some websites allow investors to rent mining hardware and earn the returns that they generate. Some of these websites are www.genesismining.com and www.nicehash.com
Staking: Staking is a way of “mining” on proof-of-stake networks. Investors “stake” funds for a fixed period and earn a yield.
Cryptoasset Exchanges:
Over The Counter (OTC) Exchanges: Private exchanges where large amounts are transacted (commonly used by large miners and large investors). These private exchanges do not display the orders to the public-facing exchanges.
Exchanges: Open to the general public — have fiat onboarding ramps/capabilities. Many exist now — some regulated and some are not.
When selecting an exchange, it is important to check:
1. Security: How do they store your cryptoassets? Protection from hacking.
2. Access: How many cryptoassets do you have access to?
3. Reputation: What is the reputation of the exchange?
4. Are there extra capabilities offered? Like Derivatives or Margin Trading?
5. What funding mechanisms are available to open an account?
6. Is the service geographically constrained?
7. What are the Anti Money Laundering and Know Your Client Requirements?
8. Does the Exchange provide insurance?
Popular exchanges: Gemini, GDAX, Bitstamp, Kraken
Wallets:
Wallets can be divided into Hot and Cold wallets — this refers to whether the wallet’s private keys are stored in a device that is connected to the internet or not.
In “hot” wallets, the private key is located in a device connected to the internet. It can be in a computer/device, or a third party online wallet provider.
Cold wallets are wallets that store the private keys in locations that are not connected to the internet — such as paper, offline computers or devices.
In both cases, the private keys can be held either by the end-user in the device, or by a secure third party (as is the case with cryptoassets under custody of large institutions). They use vaulting services like Xapo.
· Hot Wallet
· Investor Controls Private Key
· Hot Wallet
· Third Party Controls Private Key
· Cold Storage
· Investor Controls Private Key
· Cold Storage
· Third Party Controls Private Key
Hot wallet examples: Exchanges, most web wallets, Blockchain.info, Coinbase.com.
Cold wallet examples: Hardware wallets such as Trezor, Ledger Nano S, KeepKey and paper wallets.
Chapter 15: “Where’s the Bitcoin ETF?”
Cryptoasset Investing in Capital Markets:
GreyScale Bitcoin Investment Trust (GBTC in the OTCQX market)
https://grayscale.co/bitcoin-investment-trust/
ArkInvest ETF — ARKW (owns shares of the GreyScale Bitcoin Investment Trust — also known as BIT)
Cryptoasset custodial services:
Xapo it is a company that offers vaulting of crypto assets for large institutions. It provides maximum security cold storage for cryptoassets.
Tracking Bitcoin Price in the Capital Markets:
New York Stock Exchange bitcoin pricing index NYXBT (https://www.nyse.com/quote/index/NYXBT)
Chicago Mercantile Exchange Bitcoin Real Time Index:
(http://www.cmegroup.com/trading/cf-bitcoin-reference-rate.html)
Tradeblock Index (XBX):
(https://tradeblock.com/markets/index)
Chapter 16: The Wild World of ICOs
Note: I will largely skip this section aside from the tools that they share to research and track ICOs.
Authors prefer the term “Initial Cryptoasset Offering” as most recent offerings include much more than just “coins” or “tokens”.
Keeping Track of ICOs:
Smith + Crown is a well-respected firm that positions itself as an information source for the ICO world. https://www.smithandcrown.com/
Countdown http://www.icocountdown.com/
Cyber-Fund https://cyber.fund/radar
CoinFund ICO Slack channel: https://coinfund.slack.com/
The Howie Test for Discerning If an ICO is a Security:
“If an asset meets the following criteria, it will likely be considered a security:
1. It is an investment of money.
2. The investment of money is in a common enterprise.
3. There is an expectation of profits from the investments.”
Personal Note: Investors can take a margin of safety by assuming that all ICOs can be treated as securities.
Chapter 17: Preparing Current Portfolios for Blockchain Disruption [not summarized]
Chapter 18: The future of Investing is here [not summarized]
Chris and Jack’s Go-To Crypto Resources:
www.coursera.org/learn/cryptocurrency
Twitter Handles:
Chris Burniske @cburniske
Jack Tatar @JackTatar
My personal twitter handle is @Cryptonomista
Chris and Jack, if you read this — thanks again for a great book.
To everyone else, thank you for reading. Feel free to share if you found this useful.
Mauricio
