What began 9 years ago with a white paper and the Bitcoin genesis block has evolved into a fully fledged asset class. Traders the world over are drawn to the crypto markets by the exponential growth prospects of the technology as well as the opportunity to swing trade in such a volatile market.
Dabbling in the crypto markets is not for the faint of heart as the narratives driving price up and down are constantly shifting and changing. Despite witnessing the spectacular collapse of the 2017 bubble, 2018 has been an exciting year for crypto traders as the market edges its way towards maturity. Making bold predictions in such a rapidly evolving market is a particularly complex task. Nevertheless, there are a few broad themes that will exert a measure of influence over the markets in the coming months.
Here are 5 macro trends that crypto investors and traders should watch out for in the next 12 months.
1. Trading volume increasingly shifts to decentralized exchanges
2. The age of dApps: Money moves up a layer
3. Bitcoin ETF draws in the institutional investor
4. Valuation models introduce some sanity into the markets
5. Increased adoption of security tokens
I. Trading volume increasingly shifts to decentralized exchanges
Crypto enthusiasts are passionate about creating a parallel financial system that is more inclusive, transparent and equitable than the legacy system existing today.
However, centralized exchanges that allow buyers and sellers to trade cryptocurrencies are hampering the growth of the decentralized financial industry. By providing a single point of failure, these exchanges are attractive targets for hackers and regulators alike. From the infamous Mt. Gox breach which caused the 2014 bear market to the recent slew of hacks including Bithumb, Bitgrail and Coincheck, centralized exchanges have proven to be the weakest link in the crypto chain.
Thankfully, exchanges granting traders control over their funds are coming online with increasing regularity. Decentralized exchanges, such as those built atop the 0x protocol, promise to introduce the trustless, permissionless qualities of blockchains to the trading process. While the most commonly used DEX architecture employs centrally-managed, off-chain order books, traders retain possession of their private keys until a counterparty is found, at which point the trade is executed on-chain.
Traders on IDEX, for instance, do approximately $3 million worth of daily volume. While this still considerably less than centralized behemoths such a Binance, which often exceeds the $1 billion mark, as decentralized exchanges become more intuitive and pleasant to use, volume will undoubtedly start to shift towards DEX where traders can enjoy the security of transacting on the blockchain.
II. dApps: Money moves up a layer
Ethereum was created with the very serious purpose of revolutionizing the financial system with smart contract technology. However, the first use-case to highlight the viral potential of decentralized application was the fun, quirky digital collectible game known as CryptoKitties. Cryptokitties is a blockchain game which lets players collect and breed digital cats. During the raging bull market of December 2017, Cryptokitties caught fire with a 4833 ETH (more than $2 million) daily volume of these novel tokens being traded at the height of the kitty mania. However, with Ethereum capable of a measly 15 transactions per second, investors have preferred funding competing foundational protocols as opposed to Ethereum dApps which are constrained by the network’s low throughput.
Ethereum developers are hard at work on proposals such as Casper, sharding and plasma that would increase the transaction capacity of the network, while projects such as EOS and Cardano have launched mainnets in 2018 with the aim of significantly increasing throughput. As the scalability of dApp platforms begins to improve, investor attention will begin moving up from the infrastructure layer towards the applications that can be built on top of these platforms.
III. Bitcoin ETF draws in the institutional investor
Cameron and Tyler Winklevoss had their ETF proposal rejected in 2017, with the SEC blaming bitcoin’s volatility and illiquidity for the decision. 2018 is here and the stage for an ETF is significantly more set. CBOE futures have been trading without a hitch for the last 7 months, while Coinbase custody can ensure the underlying assets of a Bitcoin ETF are safe in a secure, compliant custody solution. In a nod to the likelihood of a favorable ruling, much-needed volume flowed into the crypto market giving prices a healthy boost. While an ETF promises a fundamental price boost by taking the underlying bitcoins out of circulation and reducing the supply, the psychological boost of a positive ruling promises to be altogether more significant.
Ponzi scheme, tulip and ‘its going to zero’ narratives become less effective when pension funds and endowment have the blessing of the SEC to expose themselves to Bitcoin.
The SEC is hesitant to hamper innovation, as their decision to place any token or coin that is sufficiently decentralized, such as Ether, beyond their jurisdiction as securities regulators demonstrates. A favorable ruling on a Bitcoin ETF is exactly the governmental stamp of approval institutional players on the sidelines have been waiting for. Once the ETF arrives, according to Galaxy Capital CEO Mike Novogratz, ‘institutional fomo’ will start flooding the market. The effect will first be felt on Bitcoin’s price before spreading across the altcoin market.
IV. Valuation models introduce some sanity into the markets
Crypto enthusiast are accustomed to regular statements by the old guard of finance that Bitcoin has no inherent value. While the creation of digital scarcity that was pioneered by Bitcoin gives cryptocurrencies cryptographically-secure value, putting a number to that value has proven rather difficult. Unlike its more mature equity counterparts, the cryptocurrency markets have historically lacked a comprehensive valuation framework. The lack of substantive valuation models has created a disconnect between crypto prices and their underlying fundamentals with market movements driven largely by sentiment. Introducing robust models will allow the market to coalesce around consensus valuation models.
Since traditional cash flows are ill-suited for the task of valuing peer-to-peer networks, early efforts to create a valuation framework have focused on repurposing the equation of exchange for cryptocurrency markets.
The formula is given by:
- MV = PQ
- M = Size of the asset base
- V = Velocity of asset
- P = Price of digital resource
- Q = Quantity of digital resource
Leading thinkers in the valuation space include Chris Burniske, whose essays on the subject introduced the equation of exchange and whose book ‘Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond’ serves as an investment bible for the crypto industry.
Other attempts to value cryptocurrencies have centered around Metcalfe’s Law, which claims that the value of network is proportional to the square of the number of connected nodes. These models are expected to increase in sophistication as more bright financial minds devote their research capacity to unraveling the mysteries of the crypto markets, bringing cryptocurrency valuations more in line with underlying fundamentals.
V. Increased adoption of security tokens
When Vitalik Buterin launched Ethereum in 2015, he introduced the world to his vision of a ‘shared world computer’ on which decentralized computation could take place. Thus began the age of the ‘utility token’, tokens representing shared ownership of a digital resource. Computing power, processing power and file-storage capacity are all examples of digital commodities that can now be bought and sold on a decentralized marketplace thanks to the discovery of utility tokens.
Developers soon realized that smart contract technology could be used to raise funding for their open-source protocols, with investors receiving native network tokens in exchange for their contribution to the project. This led to the ICO mania which saw projects raise over $17 billion in the last 12 months. In total, utility tokens contribute $88 billion worth of market cap, or 31% of the crypto market as a whole.
Unlike utility tokens which aim to decentralize away the risk of regulation, security tokens are fully-compliant representations of ownership in traditional asset classes such as real-estate, equities and bonds. The blockchain present a 24/7, transparent and global platform for investors to trade securities of all kinds. Security tokens have a significantly large addressable market, with the equity and bond markets constituting $70 trillion worth of assets in the US alone. Investors who are worried about the discrepancy between the high market prices of utility tokens and the value of the utility they provide will be significantly more comfortable buying a token that is backed by real-world, tangible value. Many believe that capital formation is the next killer app of the blockchain and that Security Token Offerings will soon see similar levels of enthusiasm exhibited in ICO markets.
2. https://onchainfx.com/. As per the cryptoasset taxonomy suggest by Burniske et al, utility tokens are all tokens not classified as cryptocurrencies (Bitcoin, Litecoin, Bitcoin Cash etc)
3. https://coinlib.io/exchange/idex Average volume traded 29th June — 27th July
Written by: David Azaraf