Crypto Market Cycles: A Look Back & A Look Ahead (Part 2/2)
In the previous article, we looked back at Bitcoin’s historical cycles and identified that adoption leads to a crypto market boom and regulation leads to a crypto market bust. Here, we look ahead and identify what narratives will shape the market in the future.
A Look Ahead
We’ve seen that adoption (or the anticipation of it) drove the market up whereas regulation or insufficient infrastructure drove the market down. So what can we expect to come next? We summarized our observations and distilled key themes that can emerge below.
#1 Security tokens give deep pocket investors a crypto introduction
The narrative
If Bitcoin is programmable money, a security token is a programmable ownership. A security token is a regulatory compliant instrument that allows ownership of assets to be tokenized and traded (nearly) freely on the blockchain. Two main types of security tokens are those that are linked to real-world assets and those that are linked to the value of blockchain protocols.
Why should you care?
Security tokens will enable almost anyone to invest in almost any assets from collectibles to power plants (Security Tokens Primer). Today, investment option for the general mass is seriously limited, mostly to publicly traded stocks or mutual funds of specific assets, such as money market instruments or bonds. Yet, deep pocket investors enjoy making investments in illiquid assets, such as VC/PE funds. These assets produce extraordinary high ROI of around 20–30% per annum, but at the expense of liquidity and usually cumbersome paperwork.
Security tokens allow the ownership of these otherwise illiquid assets to be issued quickly on the blockchain, traded efficiently, settled near instantly, and at a fraction of a cost. And, with the right type of registration, these tokens could be accessible to the general public.
Why might the narrative take hold?
Security tokens might make deep pocket investors lukewarm to crypto. Getting someone to understand blockchain is like explaining to your granny what Apple cloud is. Getting someone to value tokens is way harder. Institutional investors can use their current asset valuation methods to value asset-backed security tokens while getting lukewarm to crypto without having to build up domain knowledge or buying into the crypto ideology of decentralizing everything.
Utility tokens may create, but may not capture values. In 2017, utility tokens were introduced to capture values created by protocols. But, some might argue that the value of these tokens should drop as velocity rises if reality follows the theory of the equation of exchange. If the ICO craze has taught us anything, it’s that forcing a multiple-purpose token only creates unnecessary frictions to the product. Thus, utility tokens might actually limit value creation and fail to capture value altogether. A case in point is DDEX, the largest relayer on 0x, who has decided to fork 0x because the team thinks ZRX tokens can be removed.
Separating utility and security tokens, therefore, enables protocols to raise capital while being able to bootstrap users in a legally compliant way. Airdrops used to be every project’s darling for acquiring users. But, airdrops without working products may be deemed illegal. Then, what can projects do to incentivize early users? After all, airdrops are the most innovative thing that has happened in the crypto space and no one has thought of a better airdrop yet. A two-token model might help projects avoid this issue. TenX has recently launched a new self-proclaimed legally-compliant token that will be used to distribute income to holders. But, the announcement may spook their existing investors as the new token comes with a KYC check and, possibly, a lack of liquidity (as the token might not be listed).
Our take
We see many benefits of security tokens, especially for those linked to the value of blockchain-based protocols. We believe that we’ll see the two-token model being used more widely. However, security tokens will take time and still have to overcome critical issues on the front of liquidity, capability, and scalability.
- Liquidity: Regulations can severely limit security tokens’ trading. Security regulations that apply to one country may not apply to another. Token transfers require KYC/KYB (Know your Customer/Business) process. Thus, liquidity can be highly fragmented and segmented to each type of assets. Even a top blockchain VC fund still struggles to find liquidity for its token.
- Capability: Instead of hiring investment bankers, STO issuers will need to depend on one-year-old-or-less third-party startups to underwrite their deals, solicit investor interests, and assure security & regulatory compliance.
- Scalability: How does one link ownership of actual assets with ownership of tokens on a decentralized database? And, how will this be done efficiently on a global scale is still questionable.
#2 Crypto with “money” attributes offers value reservation
The narrative
The Fat Monies narrative argues that the value of the crypto industry is going to accrue to a few cryptos which becomes a long-term store of value (SoV).
For something to be a SoV, it requires a few attributes:
- Social consensus that it has value (e.g. people believe that money has value, not beads)
- Not everyone has to believe in the same money (e.g. people in different countries accept different currencies)
- The usage of money reinforces a social perception that it has value (e.g. the dollar strengthens as more people use it)
Token value, thus, comes from consensus and usage, and the value placed on each crypto differs from community to community. For example, Ethereans believe Ether has values from its use case as gas, and the hard cap to Ether value is its community members.
Why should you care?
Token velocity might prevent utility tokens from accumulating value, especially Dapp native ones. There is a large barrier to access and use Dapp for end-users. Dapps won’t thrive if it can’t “cross the chasm” to reach the mass majority. Ethereum and EOS have only 60k Dapp daily active users as of December 2018.
Crypto is still very nascent, but the longer something exists, the longer people feel like it will inevitably exist (the Lindy Effect). Even people, who are building or using Dapps, will generally also invest in Bitcoin. So even if other narratives, that aren’t Fat Monies, come to dominate the market, there will still be buyers of Bitcoin.
Why might the narrative take hold?
The narrative is slowly shaping up.
- Bitcoin continues to see more activities, propelled by the launch of Lightning Network. Over $2 million is now held in its channels, an impressive 100x increase in channel capacity within just ten months.
- Bitcoin sees high demand as an alternative to today’s reserve currencies, especially for countries with hyperinflation. Venezuela’s Bitcoin transaction volume rose from zero to $5.5 million over the past three years.
- Traditional finance companies or banks start offering Bitcoin as a product to institutional investors. Goldman now offers Bitcoin Futures. NYSE owner, Intercontinental Exchange (ICE), has launched Bakkt, an institutional grade digital asset platform, whose first product will be a physically-delivered Bitcoin Futures.
Our take
The time is soon to ripe for this thesis. Bitcoin may not be the fastest blockchain, but it’s talked about the most, used most widely, and has the highest awareness among households.
The main hurdle is the lack of market breadth and depth for institutional and retail investors. By developing institutional grade infrastructure (the depth), regulators will be more likely to allow traditional investment instruments to be linked to crypto, such as a Bitcoin ETF. A move that, in our opinion, will enable the critical mass to invest and use crypto as “money” (the breadth). The next milestone will be the launch of Bakkt’s physically settled Bitcoin Futures, in which the buyer will receive delivery of a bitcoin from the Bakkt Digital Asset Warehouse at the end of the contract period, and the SEC decision on Bitcoin ETF.
#3 Utility tokens with protocol-market-fit find real adoption
The narrative
Adoption drives long-term value for utility tokens.
Why should you care?
Most of the tokens you bought last year might go to zero, but some might actually survive. Many projects have closed down, but some will eventually find a “protocol-market-fit”.
Dune Analytics did comforting research on Dapp performance in 2018. CryptoKitties saw its weekly active users tumbling from 30k in January to 1k in December 2018, yet 40% of these cat lovers keep coming back to breed their pets. VR also holds a soft spot in tokenholders’ hearts. Decentraland reported $215k of the virtual estate sold on its platform. Stablecoin space is also moving fast: 25%of the 10k accounts that hold DAI are monthly active users.
Why might the narrative take hold?
The upcoming Ethereum upgrades might allow some projects to scale as Lightning Network makes Bitcoin a better tool for P2P payments while preserving Bitcoin’s security property.
Our take
If there’s one thing you take away from this article, it’s that “adoption” drives crypto value. We think this narrative will take at least a few years to pan out. The number of crypto users is still limited, but it continues to grow.
For the industry to see higher growth, it’s not all about scaling, really. Bitcoin continues to see higher transactions vs Bitcoin Cash, though the latter was built to be cheaper and faster. User friendliness will determine adoption prospects. Devcon 2018’s theme was loud and clear. It’s not “ship or die” anymore, but “adopt or die”. 2018 marks the first time that Devcon features a “design track” specifically designed to promote user adoption, from using design research to find customer pain points to using Ethereum Name Service (ENS) to improve UX. While the thesis might take a while, we shall sleep with one eye open.
Time has shown again and again that adoption leads to crypto market boom and regulation leads to a crypto market bust. The last cycle’s downtrend lasted for only 14 months. We’re now 12 months into this cycle’s downtrend. 2019 will bring many new developments to the industry and we shall see how these narratives play out.
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