Thanks for tuning in! This article wraps up my series on blockchain privacy by breaking down one of the most exciting new projects in the space: Dusk. In this post, I’m focusing specifically on the four areas that I consider to be the most important when evaluating an early-stage blockchain project: (i) market opportunity, (ii) technology, (iii) team/community, and (iv) economics. This article goes pretty deep into each of these topics so I’d encourage you to jump around and read whatever sections seem most interesting to you!
Also, if you enjoy this article and would like to have future posts sent directly to your email, please subscribe to my distribution list! Lastly, before we get started, I want to give a big thanks to both Philip Forte and Tyler Wellener at BlockVenture Coalition for introducing me to the project. Alright, let’s dive in.
The Dusk Network is attempting to design a scalable, private infrastructure layer that enables payments, digital asset transfer, and peer-to-peer communication. As you can imagine, that infrastructure would facilitate a wide range of potential functionality so Dusk’s founding team has honed in on several high-demand initial use cases; notably, (i) video / audio conferencing, (ii) confidential file transfers, (iii) on-demand media streaming, and (iv) compliant security token offerings (“STOs”). The latter is the most likely near-term use case so I’m going to focus on that particular market opportunity here.
Security Token Offerings (“STOs”)
So what exactly is an STO? Similar to an initial coin offering (“ICO”), an STO is a way to issue tokens in exchange for capital. However, whereas ICOs are generally utilized to raise capital for utility tokens, STOs are a way to raise capital for security tokens (don’t worry, we’ll break down the differences in a minute). Before we do, I’d like to take a quick step back and discuss the evolution of the capital raising environment over the past few years as I think this provides helpful context on the market opportunity for a platform like Dusk.
Background on Crypto Fundraising
As you may know, Mastercoin became the first company to raise capital through an ICO when it completed its token offering back in 2013. Mastercoin’s token offering proved that it was technically possible to raise capital via the Bitcoin network. However, the fundraising method didn’t gain traction at the time due to the technical challenges associated with Bitcoin’s scripting language. It wasn’t until the launch of Ethereum Frontier in 2015 and, subsequently, Ethereum Homestead in March 2016 that the ICO boom really took off. These two products made it possible for application developers to create flexible smart contracts with arbitrary rules for ownership, transactions and state transitions, which simplified the ICO process. Following the introduction of these two technologies, the ICO market took off like a rocket, growing from approximately $6 million of capital raised in 2015 to over $7.8 billion by 2018.
Right when the ICO market was looking like an unstoppable force that was bound to disrupt the traditional capital markets, its popularity began to stall. As you can see in the graphic to the left, ICO activity dropped precipitously in H2 2018. That slowdown is attributable to two factors. First, there have been a significant number of fraudulent ICOs over the past few years. This has dampened investor appetite for projects with limited transparency and poor governance. Second, the SEC has established a regulatory framework for cryptocurrencies and has begun to crack down on tokens that it considers to be securities. Specifically, the SEC has applied the Howey Test to blockchain projects, meaning that if a token “represents an investment of money towards a common enterprise with the expectation of making a profit”, it is considered a security and should be regulated as such. As a result, the token world has effectively split into two categories: utility tokens and security tokens.
Utility Tokens vs Security Tokens
So what exactly is the difference between security tokens and utility tokens? How can we differentiate between the two? In my opinion, the best way to do so is to look at the rights that the token provides to the token-holder. Generally speaking, utility tokens allow the token-holder to use the services provided by the network and participate in the network’s voting mechanism. For example, customers that want to tap into Golem’s decentralized supercomputer can acquire the GNT token to rent computing power. Similarly, customers that want to access Filecoin’s decentralized file storage network can purchase the FIL token to store their documents.
Security tokens, on the other hand, are digitized versions of conventional securities (like stocks, bonds, property, etc.). As you can imagine, security tokens are subject to much stricter regulations and are required to provide investors with the same rights that you would expect from conventional securities. That includes things like ownership rights, voting rights, interest payments, dividends, etc. Additionally, issuers and exchanges are required to make sure that the ownership of each company’s security tokens adheres to “Know Your Customer” (“KYC”) regulations. That essentially means that these institutions need to confirm that each project’s security tokens are owned by accredited investors and are not acquired with illicit funds.
Advantages of Security Tokens
Clearly, STOs are a bit more complex than ICOs. Fortunately, by serving as a bridge between utility tokens and the regulated financial markets, they offer advantages from both worlds. Those advantages include:
- Liquidity: Security tokens increase liquidity for early-stage investors (assuming of course that a viable secondary market exists for token exchange).
- Decentralization: Security tokens offer the same decentralization benefits as utility tokens. Specifically, they eliminate the need for trusted third parties, reduce brokerage / exchange fees, and lower the barriers to entry for small- and medium-sized businesses that are looking to raise public capital.
- Borderless: Security tokens remove geographic boundaries, allowing companies to raise capital from global investors.
- Asset Fractionalization: Security tokens enable the fractionalization of illiquid assets, which improves investor access and benefits portfolio diversification.
- Hard-coded Compliance: Security tokens are built on smart contracts. Therefore, regulatory compliance can be coded directly into the token offering. Said another way, the smart contract can be programmed to ensure that the token is “purchased, traded, and sold in a compliant fashion”. What’s more, the contract can be programmed to provide automated cash flow management (aka dividend payments, interest payments, etc.).
- Regulatory Oversight: Security tokens will be subject to a higher degree of regulatory oversight. This will likely reduce the amount of fraud in the market and may eventually open up the possibility of institutional investment.
Disadvantages of Security Tokens
As with all innovative technologies, security tokens also come with several disadvantages that investors and end-users need to be aware of. There are three core disadvantages to the STO fundraising method.
- Legal Risk: There is limited legal precedent for security tokens. This means that regulators could easily change their minds and make broad, impactful policy changes.
- Technology Risk: The technology underlying security token offerings is quite new and is constantly evolving. As a result, companies that raise capital via an STO are making a bet that the technology will function as expected and gain broader acceptance.
- Execution Risk: Companies that issue capital via an STO shoulder the full technical burden of raising capital. They are responsible for finding investors, generating interest, and executing the smart contract. This directly contrasts the traditional securities market, where brokerage firms bear the risk and responsibility of issuing a company’s equity or debt securities. While this significantly reduces costs, it also increases the issuer’s execution risk (of course, firms can always hire a consultant or an adviser but this would reduce some of the disintermediation benefits).
Current Market Size / Potential Market Opportunity
Now that we understand the pros and cons of the fundraising method, the next question to ask is: what is Dusk’s total addressable market (“TAM”). If security tokens take off like everybody seems to think they will, how much capital could potentially flow through the network? To understand this, we need to take a look at each of the traditional security markets that are at risk for disruption.
Real Estate: Many people believe that real estate will be the first major asset class to feel the effects of “tokenization”. Currently, if investors want to invest in real estate, they have a limited number of options. One option is to invest in a Real Estate Investment Trust (“REIT”), which is a publicly traded, ultra-diversified portfolio of real estate assets. If investors do not want to participate in a heavily diversified portfolio, they can make private market investments in either a single property or a fund of real estate assets. Unfortunately, private real estate investment is not an option for all investors as it typically requires a significant amount of capital and comes with high legal costs.
The value proposition for tokenizing real estate is that it provides greater liquidity and enables the fractionalization of previously indivisible assets. Tokenizing real estate would allow investors to make small, liquid investments in individual properties. This would broaden access to the real estate market and enable investors to construct their own real estate portfolio. With the global real estate market worth approximately $217 trillion, the market opportunity for security tokens is massive.
Debt: In addition to the advantages discussed above, debt tokens provide investors with another key benefit: immediate, contractual cash flow. This is important because investors may be more willing to test out the technology knowing that they’ll receive an immediate return on investment. If that turns out to be true, debt tokens may help to drive early adoption of the technology.
As of October 2017, the global debt markets were estimated to be worth approximately $215 trillion and are even larger today.
Equity: There has been a lot of speculation about the effects of security tokens on the equity markets. There have been claims that STOs will replace venture funding. There have been claims that they’ll replace IPOs become the most popular fundraising method for small- and mid-sized businesses. There have even been claims that they’ll uproot the entire global equity market.
Given the benefits we discussed above, it does seem likely that blockchain technology will collide with the equity markets at some point. However, it still remains unclear when that collision will occur and what the ultimate outcome will be. Luckily, any of the scenarios mentioned above would represent a large opportunity for security tokens. I’ve included a few numbers below to put this in perspective.
- 2017 Public Equity Issuance: $780.2 billion (*the 2018 data is not available yet*).
- 2018 Private VC Funding: $207 billion.
- Global Equity Market Capitalization: $80 trillion (the global market cap ultimately approached $100 trillion before the most recent market correction).
Derivatives: As the name implies, derivative tokens derive their value from other tokens. Examples would include futures, options, swaps, etc. These assets provide investors with numerous advantages. Most notably, derivative tokens would allow investors to hedge various risk exposures. Surprisingly, the traditional derivatives market is the biggest opportunity of them all, accounting for approximately $544 trillion of value “on a notional contract basis”. While the market opportunity for derivative tokens largely depends on the successful tokenization of other asset classes, it’s likely that they will play a crucial role in institutionalization the asset class.
Clearly, each market discussed here represents an enormous opportunity for disruption. The takeaway is that, if blockchain solutions are able to win a slice of any of these markets, then a significant amount of capital would flow through the underlying network, which would drive a substantial amount of value to the infrastructure protocol.
Given the market opportunity, you may be wondering how big the security token market currently is. The answer is…tiny. In 2018, there were a grand total of 103 STOs completed. To put that in perspective, there were over 2,100 ICOs completed in the same time period.
As you can imagine, the competitive landscape for STO issuance is rapidly evolving. However, two competitors have begun to separate themselves from the pack: Ethereum and Polymath. In 2018, these two solutions combined for a market share of over 90%.
- Ethereum: As always, Ethereum is the 1,000 pound gorilla in the room. According to InWara, Ethereum’s ERC 20 token was used for approximately 68% of all STO issuance as of October 2018. Additionally, the Ethereum community has continued to propose innovative new standards like the ERC 1400 standard and the ERC 1404 standard. These have the same basic functionality as ERC 20, but layer on additional features that make them ideal for security token issuance. It’s likely that these new standards will further improve Ethereum’s top market share over the near-term.
- Polymath: Polymath is a full-service layer 2 solution that is built on top of Ethereum’s ERC 20 protocol. Polymath has developed the ST-20 protocol standard that allows issuers to have control over token transfer. Additionally, Polymath has developed an application layer that simplifies the STO issuance process for both investors and issuers.
Clearly, Ethereum and Polymath have gotten off to a strong head start. However, both of these solutions fail to address a critical piece of the puzzle: privacy. Because each of these solutions are built on a fully transparent blockchain, the ownership of the underlying security tokens can be traced to specific wallet addresses. This presents several potential issues:
- Financial Transparency: Individuals that invest in public blockchain-based security tokens may reveal a significant amount of information about their investment portfolio. It’s hard for me to imagine that a meaningful number of investors will be willing to trade their financial privacy for the benefits provided by blockchain solutions.
- Inefficiency: If investors want to use these solutions while retaining their privacy, they would need to turn to a layer-2 or layer-3 “middleman”, which would add complexity and additional fee load to the equation.
- Market Manipulation: Transparent markets may be susceptible to market manipulation by large, influential investors. It’s likely that regulators will eventually require issuance platforms to provide a minimum level of privacy in order to promote fair market practices.
Luckily, Dusk is getting ahead of these issues by embedding privacy into the underlying infrastructure and building a token standard (XST) that enables compliance with the applicable KYC and AML laws. Let’s jump into the next section and discuss exactly how Dusk’s technology solution works.
Now that we have a good handle on the market opportunity for security tokens, let’s discuss how Dusk’s underlying protocol works. The Dusk protocol is divided up into three separate layers: (i) the anonymous network layer, (ii) secure tunnel switching, and (iii) segregated byzantine agreement.
Anonymous Network Layer
The lowest layer of the Dusk protocol stack is the anonymous network layer (“ANL”). While all privacy coins utilize some form of cryptography to obscure transaction data from the blockchain, Dusk has gone one step further and implemented the ANL to obscure IP addresses as well. While IP addresses technically only give away the location of the user’s internet provider, smart adversaries can use them to piece together a significant amount of private information via the web. Fortunately, Dusk’s ANL obscures IP addresses by implementing a technique called garlic routing, which is an advanced form of onion routing. If you’ve never heard either of those terms, you’re not alone. Let’s break them down.
Onion Routing: You may have heard of a network called Tor (most likely in a dramatic news article about the dark web). Tor stands for “The Onion Router”. Essentially, Tor directs internet traffic through a network of volunteer computers in a way that makes it difficult to track. It does so by wrapping each user’s request up in a bunch of layers (like an onion). Each layer contains the address of a different computer. When a computer receives a TOR packet, it removes the outer layer and sends it along to the next IP address. The computer that peels back the final layer sends the packet to the intended recipient.
To give a simplified example, imagine that the Tor network consists of four nodes (A, B, C, and D). If Bob wants to send an HTTP request to a server, Tor would take that HTTP request and add three layers to it. The first layer would tell his computer to send the package to node D. The second layer would tell node D to send the package to node A. Then, the third layer would tell node A to send the package to the appropriate server. In this instance, the request would look like it came from node A, obscuring Bob’s true IP address. Obviously, the Tor network is much more complex but this should give you an idea of how it works.
Garlic Routing: As I mentioned before, Dusk uses an extension of onion routing called garlic routing. This solution was inspired by, and fully compatible with, the Invisible Internet Project (“I2P”). Garlic routing differs from onion routing because it bundles messages together (similar to a clove of garlic). By bundling messages, garlic routing makes it more challenging for third parties to analyze network traffic and increases the speed of data transfer. Historically, garlic routing has been limited to unidirectional links, meaning that you can only send data one way as in streaming or file transfers. However, Dusk has implemented bi-directional links into its protocol, enabling two-way communication such as audio and video calls. The ANL is the entry point into Dusk’s network and establishes the connection between peers.
Secure Tunnel Switching
The second layer of the Dusk protocol is the secure tunnel switching (“STS”) layer. The STS layer enables secure, private two-way communication on the network. It was inspired by, and actually works similarly to, a payphone. So how exactly does it work? Essentially, when you want to communicate via Dusk, you lock a pre-specified number of Dusk tokens up in a state channel. Locking these tokens up ensures that the price of the call will not change due to token volatility. Once you lock up a certain amount of Dusk, the network creates a secure connection between you and the person you are trying to contact (using the anonymous network layer described above to rout the call through a number of random nodes).
If your call exceeds a pre-specified time limit and you would like to continue speaking, you can add more money to the state channel. Once you do, it opens up a new communication channel (routed through a different set of nodes) and syncs the new channel with the old channel via a process known as bitmatching. Once the two communication channels are in sync, the network closes the initial communication channel. Creating multiple communication channels per call improves the call’s privacy as each node only holds a piece of the encrypted communication.
Segregated Byzantine Agreement*
The third layer of the Dusk protocol is the consensus mechanism. As you probably know, the two most common consensus mechanisms in existence today are proof-of-work (“PoW”) and proof-of-stake (“PoS”). Unfortunately, neither of these solutions are perfect. PoW has proven to be incredibly energy inefficient, which is damaging to the environment, limits scalability, and leads to high transaction fees. PoS, on the other hand, has been knocked for “making the rich richer” (a pretty harsh criticism for a decentralized system). This claim stems from the fact that PoS mechanisms select the winning node based on the amount of money that each miner has put “at risk”. As you can imagine, nodes that have more money are able to put more money at risk and, therefore, have a higher chance of being selected to mine the block. This often becomes a reinforcing cycle as the fee that the miner earns from winning the block makes them even richer, which gives them a better chance of winning the next block. Luckily, Dusk has created a brand new consensus mechanism, which it calls Segregated Byzantine Agreement* (“SBA*”), to solve the issues that are inherent in PoW and PoS systems.
To illustrate exactly how SBA* works, I think it would be helpful to walk through the process of selecting and validating a block on the Dusk network. First, it’s important to know that there are two types of actors on the Dusk network: Nodes and Provisioners. Each actor is responsible for a different part of the consensus mechanism. Nodes have limited skin in the game and are solely responsible for proposing new blocks. Provisioners are nodes that have committed a pre-specified minimum stake and are responsible for the computationally intensive tasks such as block verification, voting and notarization. The process for verification is as follows:
- Each Node sends a certain amount of Dusk to a stealth address, entering themselves into a random lottery process. These tokens act as the Node’s “stake”. Similar to a PoS system, the more tokens the Node stakes, the higher its chance of winning the lottery. The Node that wins the lottery, wins the right to propose a new block. If the Node performs any kind of malicious action or proposes a bad block, it will immediately lose its stake. This disincentivizes bad behavior on the network.
- As the Node is proposing the new block, the Provisioners simultaneously generate a blank block. Running this as a dual-track process is helpful because Provisioners can simply sign the empty block if they are not able to reach consensus on the Node’s proposed block.
- Once both of these two blocks are proposed, a validation process is run. To validate the node, a subset of Provisioners, known as “Verifiers”, check that the transactions are legitimate and that the block was proposed by the correct Node. If all of the Verifiers agree, they will sign the block that was proposed by the Node. If they cannot come to consensus, then they will sign the empty block instead.
- After a block is validated, it goes to the voting stage, which consists of several voting rounds. Each round of voting is completed by a separate subset of Provisioners that Dusk creatively calls “Voters”. If each group agrees on the transactions, they will sign the block. If they do not, they will sign the empty block. Once there have been an appropriate number of voting rounds, the Voters will “notarize” the block, meaning that they’ll add the appropriate block reward information. In doing so, the Voters create a coinbase transaction that compensates both the Node and the Provisioners for their work. The Voters then become Verifiers for the next block.
You may be thinking, well that’s a great step-by-step description but how exactly is SBA* differentiated from existing consensus mechanisms? In my opinion, there are really two features that distinguish SBA*. First, it mitigates the “rich getting richer” problem by implementing an innovative reward system. Similar to proof-of-stake systems, the lottery for selecting the winning Node is weighted by how much Dusk each Node initially stakes; however, with SBA*, the Node’s reward is actually inversely correlated with the amount that was staked. As a result, the more Dusk that a Node initially stakes, the higher its chance of winning the lottery, but the lower its reward for proposing the block. This is an interesting model because it limits the advantage of well-endowed market participants by making it economically disadvantageous to stake a significant amount of money; however, it still disincentivizes bad behavior by probabilistically selecting the nodes that have the most to lose. Additionally, by creating an inverse relationship between rewards and stake, Dusk discourages miners from organizing into centralized pools. The second feature that distinguishes SBA* is its ability to prevent forking. By including the option to sign an empty block when consensus is not reached, Dusk ensures that all nodes are always in agreement.
The final, and arguably most important, component of Dusk’s protocol is its ability to provide users with transaction privacy. To provide privacy, Dusk has implemented the core features of Cryptonote into its underlying infrastructure; notably, it utilizes (i) stealth addresses and (ii) ring confidential transactions (“Ring CT”) to obscure identities and transaction amounts from the blockchain. If that sounds familiar, it’s likely because Monero (the top privacy coin by market cap) is also based on the Cryptonote protocol. I’m going to cover each of these features at a very high level here; however, if you want more detail, I’d recommend reading my recent article on Monero as it provides a comprehensive overview of Cryptonote’s history and cryptographic techniques.
Stealth Addresses: Stealth addresses are one-time public addresses created by the transaction sender to obscure the identity of the transaction recipient. Essentially, by multiplying the recipient’s public address by a random number, the sender can create a new one-time public address that can only be identified by the two participants in the transaction.
To better understand how this works, let’s consider a quick example. Imagine that we have two fictional characters: Bob and Alice. In our example, Bob wants to send money to Alice. To do so, he must create a one-time public address. To create the one-time public address, Bob selects a random number and multiplies it by Sue’s public key. Because the protocol is based on elliptic curve cryptography, Bob and Sue can both derive the result of that calculation; however, it would be infeasible for anybody else to do so. Bob then hashes that number to create a one-time private key, and uses that one-time private key to generate the corresponding one-time public key. By creating the public key in this manner, Alice is able to quickly scan the blockchain to identify transactions that were directed to her while remaining completely anonymous.
Ring CT: Ring CT is an advanced form of ring signature that obscures both the sender’s identity and the transaction amount. Ring CT can be broken out into three parts: (i) the ring signature, (ii) the key image and (iii) the Pederson commitment.
- The ring signature obscures the sender’s identity by randomly selecting transaction outputs from the network, taking the public keys from those transactions, and mixing them in with the sender’s one-time public key. In doing so, the ring signature effectively makes it impossible to determine which of the public keys was the true initiator of the transaction. To a third party, each public key has an equiprobable chance of being the true sender.
- The key image is a way for the protocol to eliminate the potential of a double spend. Essentially, the key image is calculated by multiplying the one-time private key by the hash of the public key. In doing so, the key image becomes a unique transaction identifier as there can only be one key image for each private / public key pair. This mitigates the double spend problem while shielding the true value of both the public and private key.
- Pederson commitments obscure the transaction amounts by applying a linear shift to both the inputs and the outputs. For instance, imagine that Bob had recently received 2, 3, and 5 Dusk from Jen, John and Jerry, respectively. He wants to use these three amounts as inputs to pay 10 Dusk to Alice. Pederson commitments allow verifiers to check that this transaction is legitimate without knowing the actual amounts by multiplying both the inputs and the outputs by some scalar value. For instance, verifiers can check that 2+3+5 = 10 by checking that 7(2+3+5) = 7(10). In doing so, the verifier does not know the value of the inputs or the output but is still able to validate that the inputs and outputs balance out. You might be wondering, what if somebody sneaks a negative input in there in order to game the system and create tokens out of thin air? Ring CT prevents that possibility through the implementation of range proofs.
Bulletproofs: The last privacy technique that needs to be mentioned here is Bulletproofs. Bulletproof technology was designed to replace range proofs, which have proven to be somewhat slow and cumbersome. In doing so, bulletproofs are supposed to drastically reduce transaction fees and improve transaction speeds. Bulletproofs were recently implemented in the Monero protocol through a hard fork. Thus far, they’ve proven to be extremely effective, reducing transaction fees by as much as 96%. Dusk is currently in the process of implementing Bulletproofs into its protocol. If it is able to do so successfully, it will likely improve the network’s speed and fee load.
Hopefully this section has given you an understanding of how Dusk’s protocol will ultimately work. Of course, for early-stage projects like Dusk, investors need to consider more than just the technology vision. They also need to determine whether the team has the experience and resources to successfully execute on that vision. That’s what we’ll discuss next.
Team / Community
As I mentioned above, successful blockchain projects need to build out an experienced team and an active community. By that, I mean they need to attract / hire talented developers, properly incentivize miners to process transactions, convince exchanges to list their token, bring on experienced investors / advisors to provide strategic direction, and ultimately drive end-user adoption. So how has Dusk performed on each of these fronts to date? Let’s take a look.
Dusk has split its development efforts up into three groups: Dusk R&D, Dusk Core, and Dawn Public Development.
Dusk R&D focuses on iterating the initial white paper and researching fundamental improvements for the Dusk protocol. The idea is that the research completed by Dusk R&D will ultimately be implemented by the Dusk Core team and the Dawn Public Development team.
Thus far, Dusk has done a good job of attracting research talent. Most notably, Dmitry Khovratovich, the co-developer of the Equihash consensus algorithm (used in the Zcash protocol) recently joined the team as the Lead Cryptographer.
Dusk Core is the team that is responsible for implementing the core aspects of the Dusk Network protocol. Currently, the team is focused on implementing SBA* and Secure Tunnel Switching into the protocol. The Dusk Core team is led by Fulvio Venturelli and Emanuele Francioni, each of whom has a significant amount of startup and development experience. Prior to Dusk, Fulvio was an ICT Architect at 2SQRS, a Co-Founder of Beestar and a software engineer at numerous startups (including Amazon). Emanuele previously worked as an Engineering Manager at TomTom, founded GoSparc and co-founded Beestar alongside Fulvio.
Dusk has continued to add high-quality development talent to its core team. Notably, Dusk recently hired Toghrul Maharramov as a Consensus Architect and Kevaundray Wedderburn as a Blockchain Engineer. Both of these professionals have substantial development experience and have contributed heavily to the NEO blockchain.
Dawn Public Development is Dusk’s attempt to open development up to the broader blockchain community. Dawn will be focused on “improving the user experience, different language libraries, improvement proposals, wallet implementations, block explorers, and many more things”.
The Business Development team is focused on “building relevant groups around Dusk’s three initial use cases”. Thus far, it has formed one such group, which it calls the Tokenized Securities Consortium. The consortium is focused on bringing small businesses and consumers to the Dusk platform. As part of the effort, Dusk is creating an STO incubator with its consortium partners. Over time, Dusk’s Business Development team will continue to create additional sub-groups / consortium to bring together partners and consumers in each of its targeted use cases.
On 12/1/18, Dusk successfully completed its capital raise, generating a significant amount of interest in a relatively tough crypto environment. Through this, Dusk sold approximately 140 million tokens, which came out to approximately $8.08 million of total capital. Its investors include Maven 11, GSR, BlockVenture Coalition, Blockwall, Olymp Capital, Blockground, CryptoLabs, CipherBlad, The Reserve, and iFinex. If you are unfamiliar with these names, they represent a global group of angel and institutional investors. The team has also reserved another 50 million tokens for an “interesting opportunity”, however, it’s a bit unclear what that means. Dusk expects to primarily use this influx of capital to fund blockchain development, exchange costs, partnerships / ecosystem development, marketing, etc.
Exchange listings are important for blockchain projects as they typically bring legitimacy and liquidity to a project. Dusk was expected to begin trading on iFinex’s two platforms (Ethfinex and Bitfinex) earlier this year; however, the listing was delayed for unknown reasons. On its blog, Dusk noted that the team “received a great opportunity that requires a delay in order to pursue”. I guess we’ll have to wait and see on this one!
Given Dusk’s early stage of development, the standard user metrics such as # of wallets, # of individual addresses, total transaction volume, etc. are not yet relevant. However, it’s worth highlighting here that, despite the lack of a proven infrastructure, Dusk has already managed to secure its first user. In December 2018, a Maltese real estate company called BWRE agreed to launch a $24 million STO on the platform. This is encouraging as it demonstrates that customers are already buying into the product vision.
The final topic I want to touch on is token valuation. The reality is that it’s almost impossible to come up with a realistic valuation for something that is as early stage as Dusk. Therefore, the goal for this section is to provide a conceptual framework for estimating Dusk’s token price as the network expands.
So how would we ultimately value something like Dusk? As Chris Burniske and Jack Tatar lay out in their book “Cryptoassets”, there are two primary methods for token valuation: fundamental valuation and relative valuation. Fundamental valuation is an estimation of a network’s intrinsic value using various financial and economic factors. Relative valuation, on the other hand, uses ratios to estimate a network’s value by comparing it to other similar networks and to its own historic average. Let’s dive a little bit deeper into each of these concepts.
Fundamental Valuation: Utility Value
A network’s fundamental value can be broken out further into two sub-types: utility value and speculative value. Utility value is generated from consumers utilizing the network for its intended purpose. For example, Bitcoin’s utility value is derived from people using the protocol to send remittance payments. Ethereum’s utility value is derived from people using the network to execute smart contracts. Naturally, Dusk’s utility value will be derived from people using the network to launch STOs, transfer assets, communicate, etc.
So how would we quantify Dusk’s utility value? As you’ve probably guessed, Dusk does not currently have any utility value because it has not yet deployed its mainnet. Instead, let’s think about what Dusk’s utility value might look like in a few years. Doing so will provide us with a valuation framework and allow us to estimate the token’s current speculative price (we’ll touch more on this soon).
In our hypothetical scenario, let’s imagine that it’s 2023 and Dusk has become the premier network for issuing security tokens. Not only that, let’s imagine that the world has finally embraced the benefits of blockchain technology and that security tokens have become the norm for small- and medium-sized businesses that want to generate early liquidity. The result is that approximately $500 billion of value is transacted on the Dusk network annually. With $500 billion of value being transacted on the network, how would we calculate the fundamental value of a single Dusk token? The best way to think about this is in terms of supply and demand.
- Demand: To quantify the demand, we need to determine the total annual transaction value. We estimated that to be approximately $500 billion above.
- Supply: To quantify the supply, we need to determine (i) the number of tokens outstanding and (ii) the token velocity. Unfortunately, we cannot perfectly predict the number of tokens outstanding in 2023 as Dusk does not have a pre-determined issuance schedule. Therefore, let’s just assume that there are 105 million tokens outstanding in 2023. That would be equivalent to the total number of Ether currently outstanding (for a frame of reference, Ethereum is approximately 4 years old). As I mentioned, we also need to determine the network’s velocity. If you’re unfamiliar with this term, velocity is essentially the number of times a token is exchanged in a given year. Velocity is an important figure because it has an inverse relationship with price. If tokens are rapidly moving through the system (which is common for DApp and payment tokens), there will be a greater effective supply and a lower price per coin. Conversely, if users are unwilling to trade their coins (which is common for tokens that are used as a store of value), velocity will be low. If velocity is low, the effective supply would be low, and price per coin would be higher. For right now, let’s assume that Dusk’s velocity is the same as that of USD (approximately 5.5).
Now that we have our assumptions for supply and demand, we can use them to calculate a price target. The first step is to take the total demand of $500 billion and divide by the velocity of 5.5. This would give us a total network value of approximately $90.9 billion. We could then divide that network value by the 105 million tokens outstanding. That would give us a price target of approximately $865 per coin in 2023.
Obviously, the inputs I used above are pretty arbitrary. Fortunately, for networks that are live, many of these metrics are made publicly available. For example, you can find most of Ethereum’s relevant metrics here.
While this model provides a way to quantify a network’s current utility value, it does not help us to determine the fundamental value of an early-stage protocol. That’s when we need to turn to speculative value.
Fundamental Valuation: Speculative Value
Speculative value is derived from investors that buy and hold a token with no expectation of using the network for its intended purpose. Speculators hold these tokens in hopes that the protocol is ultimately successful in attracting end-users. If the protocol is successful, the increase in demand will drive up the token’s price and net a nice profit for early investors.
As we discussed earlier, Dusk’s valuation is entirely speculative at this point. To be exact, following its token sale in December, the network’s total speculative value was approximately $20.2 million (500 million tokens multiplied by a price of approximately $.0404 per token).
A useful way to think about speculative value is to consider it “future utility value”. In other words, we can use our assumptions for future supply and demand to determine an appropriate speculative price for the token today. To do this, we would discount our expected future token price by our required return. For instance, if you require a 50% annual return on investment due to the significant risk and volatility of an early-stage crypto asset, you could discount your expected future price of $865 per coin back to today. The calculation for this would be as follows:
Price in 2019 = Price in 2023 / (1 + required return)⁴
Price in 2019 = $865 / (1.5)⁴ = $171
As you can see, this model allows you to determine the current fundamental value of a token based on your assumptions for future demand, velocity, required return, and tokens outstanding. One thing that’s extremely important to note here is that small changes in any of these assumptions will lead to large differences in the output value. For example, I used pretty aggressive assumptions above and came up with a very high speculative valuation. This should indicate that, while the model is a helpful way to derive a ballpark estimate and understand the network’s value drivers, the output should be taken with a grain of salt (particularly for early-stage projects).
The second type of valuation is relative valuation. Relative valuation uses ratios to compare an asset’s value to its peers and to its own historic value. One popular relative valuation technique is the market cap to transaction value multiple (“MCTV multiple”). Many people consider this to be similar to the price-to-equity (“P/E”) multiple in public equities investing. To use an example, if Bitcoin had a market cap of $100 billion and total annual transaction value of $20 billion, then its MCTV multiple would be 5. You could then compare that multiple to its historic average. If it’s above (below) the historic average, then you could consider it to be over (under) priced. Additionally, you could compare the network’s multiple to those of other similar networks. For instance, if Bitcoin’s multiple was 5 but Monero’s multiple was 15, you might consider Bitcoin to be underpriced. Again, this technique will not be relevant for Dusk until the network is up and running but it will be another tool in the toolbox to assess its value over time.
There are several other relative valuation multiples in use today, such as the Price to Metcalfe Ratio and the Google Search Ratio; however, these are somewhat less prevalent than MCTV. I’d definitely recommend researching them on your own if you’re interested!
That wraps up my analysis of the Dusk Network, I hope you found it interesting! Please stay tuned for my next post, which will dive into the topic of blockchain interoperability. Also, If you enjoyed this post and would like future posts sent directly to your email, please subscribe to my distribution list or reach out to me at firstname.lastname@example.org. Thanks for reading!