Here is our talk from the CryptoFin Conference from October 2019 in Tallinn about how to disintermediate the banks:
Here is the short summary. We need:
- More tokenization
- Crypto credit-money
- Wealth management automation
Here is the talk:
Here is our talk from the CryptoFin Conference from October 2019 in Tallinn about how to disintermediate the banks: Here is the short summary. We need: More tokenization Crypto credit-money...
Oct 16, 2019 . 20 min read
Here is our talk from the CryptoFin Conference from October 2019 in Tallinn about how to disintermediate the banks:
Here is the short summary. We need:
Here is the talk:
We look in this article on the risk management of the custodial crypto lending platforms and of non-custodial crypto lending platforms. The aim is not to say what is right...
Sep 28, 2019 . 10 min read
We look in this article on the risk management of the custodial crypto lending platforms and of non-custodial crypto lending platforms. The aim is not to say what is right or wrong, but to create transparency about both business models from the risk point of view.
We look here on Nexo.io and on Celsius.network. Both systems represent custodial lending systems. Clients transfer their assets into platform wallets and platforms control their assets. Platforms then lend out the assets via marketplace or institutional channels. Platforms receive interest, they keep smaller parts of the interest and the clients receive the bigger part of the interest.
Nexo.io and Celsius.network have bought insurance policies to cover the client asset losses on their platforms. They pay a yearly fee but their coverage is capped at a fixed amount.
We have two key sub-types of lending:
From this moment we have to trust the contracting party and his lending/margin management processes. We have to trust as well, that the contracting party will not be hacked or the assets are not frozen because of regulatory issues (think Bitfinex and 850 mUSD) and many other risks. This lending sub-type has a higher risk than the first sub-type.
The key difference between these sub-channels is the following – in case of the first subtype, the platform can manage the end-to-end process. In the case of the second subtype, the assets are under the legal control of someone else…
Of course, there are contracts in place, but let’s keep in mind two cases from not so distant traditional finance history:
In traditional finance, we have a sector called “prime brokerage”, which is providing services, especially to the hedge funds. Investment banks pool their client assets, which are lent to hedge funds, which pay interest for them. Hedge funds borrow these assets for short selling (you borrow an asset, sell it and hope to buy it back at a lower price).
If the trade works, then you make a nice profit. If the trade is not working, then the margin calls are issued to the hedge funds. If the trade goes totally wrong, then the hedge fund is not losing only the collateral but has to put in additional money, to cover the losses. If they, don’t have this money, then they are bankrupt. The pooled and sliced client assets will be part of bankruptcy proceedings.
That’s why the “primer brokerage” the business has high-interest margins. It’s because of the high risk. That’s the same business that the crypto lending platforms are doing with their institutional clients.
Yes, we have. The vision of the regulations is to create a fair marketplace for service providers. The reality of the regulations is that they create the entry barriers for the non-members of the club. It’s just because of the revolving-door-phenomena – the regulators hire their people from the private companies in the sector, which will by nature protect their sector. And the private companies hire as well people from regulators, let’s call it – for preferred information and access.
The current regulations state (de-facto in all countries) is following – if you control client assets, what the custodial platforms do, then you will need a financial intermediary license. You not only need to apply for this, but you also have to maintain it year by year.
Custodial platforms provide the services in “cross-border mode” to other jurisdictions as well. But that’s where it gets interesting – providing “cross-border service” to other jurisdictions is OK, but doing marketing for a platform is not OK, except when the platform has registered in the respective jurisdiction. In the case of the U.S., it’s even more complicated – it’s enough to have cross-border service clients from the U.S. and the platform will need U.S. licensing (think here on the NY Attorney General versus Bitfinex case because of presumably 1 NY client on Bitfinex platform).
We look here on MakerDAO and Compound.finance as examples. We look only at their AS-IS business model.
Their model is simple:
But what can be the failure points?
Black swans are defined as 3-sigma (standard deviation) events and they should be very seldom events. Funnily there are more black swan events than the statistical theory allows. Are the statistics wrong?
No, it’s just the wrong statistics which are used – the financial markets are modeled based on the random-walk-hypothesis (which has never been scientifically proved, it’s just as the name says – “hypothesis”) and this hypothesis implies using of the standard distribution (as everything is random, then this would be logical conclusion).
But the financial markets act based on the power-law distribution, as most of the things in nature. And by this distribution we have a much higher frequency of the black swans, meaning there are many more risk events than anticipated.
We looked at the risks in two different crypto lending business models – custodial and non-custodial. The custodial business model is rather similar to traditional financial intermediaries. The non-custodial business models are new innovative business models.
Regarding the platform risks – we will not say which platform has fewer risks.
However, we refer to the common-sense hypothesis – if comparing two different models, then:
There are the custodian and non-custodian crypto lending platforms. The key difference between them is who controls the assets - the first ones control your crypto assets, by the second...
Sep 22, 2019 . 10 min read
There are the custodian and non-custodian crypto lending platforms. The key difference between them is who controls the assets – the first ones control your crypto assets, by the second ones it’s you who is controlling your assets.
Both of them propagate the interest rates on their platform, as the key benefit for the borrowers and lenders on their platforms. But is the interest rate really all and everything, what should be followed?
Our answer is – actually not. While interest rates and risk management are the key drivers for the lenders, there is one more parameter to be followed – the capability to borrow for the borrowers.
Here are current interest rates for DAI (they are pretty similar to the USDC)
The interest rates between custodial and non-custodial platforms are more or less the same. Non-custodial platforms are saying that custodial interest rates should be higher because of more risks (hacks, loss of assets, etc). Custodial platforms are saying the non-custodial interest rate should be higher because of potential mistakes in smart contracts.
Therefore, let’s use the https://loanscan.io data as a basis.
Here are for example current DeFi (Decentral Finance) collateral rates:
These collateral ratios are more or less the same on the custodian and non-custodian platforms.
Let’s imagine two scenarios for the borrower:
The interest rates in both scenarios are the same, but the Loan To Value (LTV) is different:
Capability to borrow shows, how much can borrower borrow on his given asset basis. If the borrower would have two similar offers with different LTV’s, then the borrower should choose the one with higher LTV.
What does it mean?
The capability to borrow does not matter to the lenders. Lenders are interested in:
But the capability to borrow matter’s very much to the borrowers:
Let’s imagine further two scenarios for the borrower:
Scenario C (the same as Scenario A)
The Loan to Collateral Value’s (LTV’s) are different. The interest rates are different too. The loan amounts are the same. But which option is better for the borrower?
Scenario C: LTV: 33%; Interest 10%
Scenario D: LTV: 66%; Interest 15%
The borrower will pay in Scenario C for this 50% more interest for 100% higher LTV – the borrower will have higher leverage on his assets. If the borrower needs leverage, then Scenario D is preferable for the borrower – he would pay a little bit more interest for a much bigger loan
Current DeFi and custodial platforms are using very high collateralization ratios. This is protecting the lenders.
However, the borrowers would be interested not only about the interest payable but about lower collateralization ratios, which would lead to the higher capability to borrow.
We analyzed the reasons for high collateralization ratio’s in another blog article. Here is the summary.
SmartCredit.io is funded from 2 CFA’s and ex-Bankers. The risk management is never a one-dimensional approach of over collateralizing the loans, but it’s a network of different measures, which on the end translates into usability:
This results in the least factor 2 – 2.5 smaller collateral requirements as the current standard in the industry. Which results in a higher capability to borrow.
The current collateralization ratios are ca 300% + for the DeFi borrowing/lending protocols. These ratios benefit the lenders on these platforms because over-collateralization protects their loans. However, these ratios reduce...
Sep 18, 2019 . 10 min read
The current collateralization ratios are ca 300% + for the DeFi borrowing/lending protocols. These ratios benefit the lenders on these platforms because over-collateralization protects their loans. However, these ratios reduce borrower’s capability to borrow and therefore the usability of the system.
This article analyses:
These ratios are rather high compared to margin borrowing requirements in traditional finance. Why is it so?
The collateralization approach is directly linked to the risk management framework. The key here is to combine multiple risk management elements, which then leads from one side to the smaller collateralization ratio and from the other side to better risk management.
Here is the list of measures for collateralization reduction:
On Maker and Compound platforms the borrowers do have unlimited maturities.
The platforms protect themselves with the collateral liquidation, if for example, the collateral value sinks to 135% of the loan, then the Maker will liquidate the collateral. The same with Compound (the ratios might be different).
If we would have fixed maturity loan, then we could calculate via standard deviations and loan maturity, how much collateral we should have, so that by given probability we will not hit the liquidation threshold.
Step 1: Calculate 30-day standard deviation of the underlying collateral
Step 2: For calibrating standard deviation to loan maturity we have to multiply standard deviation with the square root of “loan maturity / 30”.
By doing this we can set the amount of collateral so that the liquidation probability will be low.
But Maker and Compound do not have fixed maturities, therefore it’s not possible to calibrate loan collateral to the loan maturity. This results in very high collateral requirements, which then reduces borrower’s capability to borrow.
Could Maker use fixed maturities?
Maker DAO uses Collateral Debt Positions to create the DAI’s – borrower puts Ether into the Smart Contract (CDP) and receives the DAI’s. Having fixed maturities would imply fixed maturity CDP’s – borrowers would need to close these CDP’s before the maturity with paying in DAI’s into the CDP’s and receiving back the collateral. If the borrower forgets to pay in DAI at the right time, then the CDP would go into automated liquidation, independently from the collateral ratio.
Could Compound use fixed maturities?
Compound could introduce fixed maturities exactly in the same way as Maker. As maturities have to match on borrowing and lending side, then lenders should make fixed maturity loans as well (otherwise we get into the maturity mismatch and “bank run” risk on the platform).
Having fixed maturities would imply moving away from the “money market fund with variable interest” rate, which would be quite a change into the Compound’s business model and smart contracts.
Some assets have lower standard deviation and their collateral requirements will be smaller. Other assets have a higher standard deviation, which leads to higher collateral requirements.
Collateralization parameters cannot be something static, which is fixed in the smart contracts, but need to be continuously re-calculated. If this is not the case, then the mitigation is to increase the collateral for any eventuality.
Compounds and Maker’s approach is to over-collateralize for avoiding the worst market dynamics. But the other approach would be to use Loss Provision Funds to protect against adverse market dynamics.
If one can use only over-collateralization, then one has to prepare for the worst-case for every loan – i.e. for the non-paying borrower and for the collateral value flash crash for every loan.
If one would use over-collateralization plus loss provision funds, then the over-collateralization could cover till 2-sigma events and after that, the loss provision fund would take over. The result would be increasing the borrower’s capability to borrow.
Current DeFi systems are not using credit risk ratings for the borrowers. From one side there are no systems available, which would provide this information, from the other side the DeFi systems are avoiding collecting any user data.
However, having credit risk ratings would allow us to separate good risks from less good risks. Good risks would get better collateral requirements and vice versa. Credit risk ratings would be the approach for the users to monetize their data – having good credit risk (and opening up his data) rating would result in better borrowing conditions.
Credit risk ratings would allow as well-diversified approach with the collateral handling. In case of good credit risks, one doesn’t need to rush into the collateral liquidation in flash crashes. However, in case of not good credit risk ratings or not opening up his data, one would need to liquidate the collateral during flash crashes.
In traditional finance we have legal contracts. If the debtor is failing to meet his obligations, then the NPL (Non-Performing Loan process) will be started. Usually, the debt will be sold to the debt collection agencies, which are paying 5% – 20% from the amount owed. Debt collection agencies continue then with the NPL process against the borrowers.
Using the NPL process would require KYC. Many DeFi products see KYC as something that should not be followed. However, as KYC is the law in practically all countries, then we can just forecast that most of DeFi products start to use KYC as well.
Current high collateralization ratios are driven by the respective business models. If we adjust business models, then we will adjust as well the collateralization ratios and increase the usability for the borrowers via increased capability to borrow.
SmartCredit.io collateral requirements are by factor 2 – 2.5 lower than the MakerDAO or Compound requirements.
It’s achieved via:
This results in a higher capability to borrow with equal interest rates to other platforms.
The lenders have unique features as well – the tokenization and transferability of their credit, which enables immediate liquidity to the lenders. And they have as well capability to define private fixed-income funds:
Some readers may remember the NASDAQ Dot-com bubble of 2000, but most readers will remember the Crypto bubble of 2018. In this article, we ask if we can leverage our...
Feb 28, 2019 . 5 min read
Some readers may remember the NASDAQ Dot-com bubble of 2000, but most readers will remember the Crypto bubble of 2018. In this article, we ask if we can leverage our knowledge of NASDAQ’s 2000 bubble in forecasting future crypto trends? What are their commonalities? And what will happen next?
NASDAQ composite is a stock market index of securities listed on the NASDAQ stock market. It is heavily tilted toward information technology companies. NASDAQ composite was launched in 1971 with a starting value of 100 and it peaked at 5132 in March 2000. After that, it fell to 1108 in October 2002, a — 78% decline. This was the dot-com bubble.
NASDAQ has recovered from these lows and the current price is around 7400 (in Feb 2019).
Here, we use Bitcoin as a proxy for the crypto markets. It reached a top price of 19500 in Dec 2017, and the current low, 3250, in Dec 2018. This represents an 84% decline.
Many believed, like in the NASDAQ 2000, that “this time it is different” or that it’s “the new economy”. It wasn’t so.
The dot-com bubble was driven by the belief in new technology — the Internet. The NASDAQ Composite was full of stocks which lacked real business potential.
The initial focus was on broadband cable companies, which were seen as a new infrastructure which would eventually generate huge revenues. However, this resulted in the oversupply of broadband infrastructure, internet connectivity prices collapsed and with them the stocks of the respective broadband companies as well. The positive outcome was that Internet broadband became a commodity and became available for most of the population.
The real business models of the Internet were not present before the dot-com bubble. These new, so-called Web 2.0 business models — Amazon, eBay, Facebook, Google,… emerged after the dot-com bubble.
All of them started to generate revenues/benefits compared to brick-and-mortar models, which translated into huge Discounted Cash Flow based valuations thanks to the network effects (value of the network increases in quadrat to the growth of the nodes in the network):
The internet was and is a major disruption enabler. However, interestingly — the initial business models on the Internet tried to mirror the brick-and-mortar world into the Internet. It took 5+ years before the new disruptive revenue generating business models emerged.
The crypto-bubble was driven by the belief in new technology — in this case, the blockchain. CoinmarketCap.com was full of projects without real business potential (remember that it was believed that you didn’t need cash flow/benefit based valuations then).
The initial focus was on the “smart contract platform” systems, which were the key enabler of blockchain disruption. However, being the key enabler doesn’t mean revenue generation. It can mean becoming a commodity as it happened with broadband during the NASDAQ bubble.
Our forecast is that smart contract platforms will consolidate, there will be some global/central platforms and other rather region specific platforms. (Having a smart contract platform could be compared to the importance of having/controlling maritime sea routes two centuries ago).
However, it is not the most technically advanced platform that will win the race, it will be the platform with the most users by now. Winning the race doesn’t mean becoming a cash flow generator, it will rather mean becoming a commodity or standard in the industry.
So, who will be the new eBay’s, Amazon’s, Google’s for the blockchain economy? The answer to this is in the new disruptive business models — it’s about cash flow/benefit generating disruptive business models.
So, what are the real disruptive revenue generating business models on the blockchain? There are the following:
These business models — money, credit, data, supply chain, energy, rights, and assets are by their nature decentralized. Adding a transaction fee per value-added business transactions will allow easy monetization and enables discounted cash flow based valuations. Adding a network effect will multiply these valuations.
The NASDAQ 2000 bubble and the crypto 2018 bubble were similar events. The next similarity will be what will happen afterward.
In both bubbles, the platforms (broadband or smart contract platforms) had the highest valuations. In the case of NASDAQ, broadband became the commodity. We expect the same from the smart contract platforms.
In the case of NASDAQ, the real value adding disruptive business models emerged. Real value-adding transactions drove the discounted cash flow based valuation of these companies.
Our forecast is that the same thing will happen in the crypto sector — new disruptive cash flow generating business models will emerge. The companies behind these models will become the new Facebooks, Googles and Amazons.
How to find these companies — it’s actually pretty easy:
We have heard many people saying “this time will be different”. We don’t think so, we think “this time will be the same”. History will repeat itself. Major disruptions are driven by real value-adding business models. It’s all the same. It’s the economy.
Here is our pitch from the Swiss Fintech Investor Day in Zurich: If you have only 10 seconds — here is the 10 seconds version: Here is the transcript: Hello,...
Nov 15, 2018 . 10 min read
Here is our pitch from the Swiss Fintech Investor Day in Zurich:
If you have only 10 seconds — here is the 10 seconds version:
Here is the transcript:
Hello, I am Martin. I’m Co-Founder and CEO of SmartCredit.io. We are crypto credit marketplace and we are creating programmable elastic crypto credit money.
Let’s start with the use-case. It’s about credit-markets. On one side we have Luiza from Poland, she needs credit. On the another side, we have Walter from Germany, 48 years old, established, a little bit gray hair – lucky one who invested early into the Ethereum.
These are the want’s – by putting all these wants together we will get the crypto-currency credit-market. And it’s a global credit market for lending and borrowing.
What are the problems? We see the two key problems:
The first one: the current market, as it’s implemented is very over-collateralized. It’s a margin calls market with a very high probability of margin calls. We call it cripple credit market. Although it’s a cripple credit market – the lending volume has been 1 Billion USD.
The second problem – if we speak of lending, if we speak of commercial banking, there is always the question – it’s lending and it’s creating money. In Switzerland, 97% of the money has been created by commercial banks.
Let’s look at the Federal Reserve. It provides the base-money supply and on top is the credit-money. Let’s look on ECB – it provides the base-money and on top of it the credit-money. The same in Switzerland.
The big question is – how is it working in the crypto sphere, who will create the credit-money for the crypto sphere. Are the commercial banks creating credit-money for the crypto-sphere or is the crypto-economy creating the crypto-sphere crypto-money? That’s where we are.
Let’s speak of the past. The credit-money has been there for 5’000 years. Created first in Mesopotamia, used in Phonecia, used in Hanseatic network, in many times in history. It has been decentrally created credit-money. That’s what we want to achieve.
So, our solution – SmartCredit.io – is a two-step system – from one side decentral credit marketplace for ether and stable coin lending; from another side, we are creating programmable elastic crypto credit-money in the lending process – we call it Smart Money tokens.
What does this programmable elastic credit money mean? With respect to all our competitors – there are two boxes here – and all our competitors are here in the left box – they are lending, borrowing, they are just intermediating between them (between the lender and borrower).
On the right side, there is a bigger box – that’s where we are. That means we are in all these together – we are a marketplace and we are creating liquidity for the lenders, which they can pass on to the next persons, and so on and so on. We are creating decentral credit money.
So, how does it then work in the crypto? We take the loan agreements, we tokenize them, and these tokens can be passed on to the next persons, One Smart Money token is worth at least one Ether or one stablecoin, underlying currency, which we are using. We have a protection mechanism, it’s a decentral community-based protection mechanism. And this means the Smart Money tokens can be passed on to the next parties, next parties, next parties – we are creating credit supply for the lenders.
The market – there are now 130 million crypto users, by the end of this year it’s 150 million, by the end of next year it’s 500 million. It’s an exponentially growing market. We are focussing on millennials – these are 55% of this. And from them, it’s 10%, who have the financing needs. So, our market size is like 6 million people and exponentially growing.
Our Competition – with all respect to our competition – we did a lot of number crunching – the existing business models are over-collateralized, there are long processes, there are no insurance or protection mechanisms, no-one is providing the crypto credit-money. We are doing all of this. That’s a small difference.
The Go-To-Market – it’s three pillars. The first one is the community. If we are building decentral systems, then everything is about the community. We are building it through he ICO marketing, we are building it via airdrops, community market. Second, it’s viral marketing – because Smart Money tokens are free marketing for us. It’s are the lenders who are doing marketing for us, to create liquidity for themselves. The third one – the credit marketplace – it fits with any wallet, with any marketplace, it’s an integration.
Our Roadmap – we started one year ago. We have our Whitepaper, we have our Pilot running, actually now the Pilot Phase II, we are completing our MVP in December. We started with whitelisting to start to build up the community. And we are focusing now to get 10’000 whitelisting, to start with the ICO.
The Team – these are some of our pictures. It’s me – I have been working 10 years in banking, my twin brother – as well 10 years in the banking. There are many other people in the team – we have 100+ years of finance experience, 50 years crypto experience, 10 years of artificial intelligence experience. That’s our team – we are the experts.
The Summary – the Bitcoin defined the base money for the Internet, the monetary systems don’t need only the base money, but they need the credit-money. So, what we will do is – we will create credit money for the Internet. We will create decentral programmable elastic credit money. Meaning our impact will be the same to the commercial banks as the impact of Skype to the telcos.
Thank you. I was a little bit faster. So, let’s move to the questions.
On 29th of March I was giving a lecture about Blockchain Use Cases in Finance at University of Applied Sciences in Basel. [caption id="attachment_381" align="aligncenter" width="556"] Basel[/caption] Blockchain started with...
Mar 29, 2017 . 10 min read
On 29th of March I was giving a lecture about Blockchain Use Cases in Finance at University of Applied Sciences in Basel.
Blockchain started with the Bitcoin and we can consider Bitcoin as a new base-money. But Bitcoin is just one of many use-cases in the blockchain economy.
In this lecture we analyze what are blockchain potential use cases in finance. Here are the slides:
My friends, myself and my brother published book Blockchain Technology: Einführung für Business- und IT Manager Blockchain Technology - Einführung für Business- und IT Manager OK, it’s in German. However, it’s...
Nov 22, 2016 . 5 min read
My friends, myself and my brother published book Blockchain Technology: Einführung für Business- und IT Manager
OK, it’s in German. However, it’s very praxis oriented and follows always the thought about what is business value and what business models we will have.
Video of the first book presentation is available here. I’m starting to talk at 18:28, my brother follows immediately to me.
If you have more time to watch, then we had here as well very nice presentation about Hyperledger and discussion about Ethereum Classics versus Ethereum.
Bitcoin is a digital currency that enables instant payments to anyone and anywhere in the world. There are many differences to other currencies: · Other currencies are issued by Central...
Jan 10, 2014 . 12 min read
Bitcoin is a digital currency that enables instant payments to anyone and anywhere in the world.
There are many differences to other currencies:
· Other currencies are issued by Central Banks and have the role of legal tender. Bitcoins are issued de-centrally; there is no Central Bank, and they are not legal tender.
· Other currencies have some physical representations (bills). Bitcoin exists only digitally.
· Other currencies have central authorities. Bitcoin has no central authority; validation of transactions is done from Bitcoin Network.
· Monetary Base of other Currencies is continuously increased, which translates into inflation in the long term. But in Bitcoin Network will contain only 21 Million Bitcoins (the smallest transferable unit being 0.00000001 Bitcoins), which translates into deflation in the long term.
Bitcoin is based on a combination of several existing technologies:
· Peer to Peer Systems (like BitTorrent)
· Private / Public key Cryptography
· Application of this combination for creating a currency
First Private / Public key cryptography algorithms were published in 1977. The first famous Peer-to-Peer system was Napster, published in 1999. However, it took till 2008 when Satoshi Nakamoto (pseudonym) connected peer to peer systems with state of the art cryptography to create the first cryptocurrency — Bitcoin.
Bitcoin has properties of currency — it’s unit of account; it’s portable, durable, divisible and fungible. However, Bitcoins are much more just as a simple currency. Satoshi’s ideas went much further — Bitcoin Network is a mean to describe economic contracts and transactions between the participants of the Network. Additionally, the distributed storage of transactions (Blockchain in Bitcoin terminology) can be considered as a public general ledger, but not only simple payment transactions but many more complex economic contracts can be stored and easily distributed/published to any node of the network.
Bitcoin price development from Aug 2010 till Jan 2014 is described on the following graph. It follows a linear trend on the logarithmic graph.
There have been several price corrections, which have received quite some media attention:
· In 2011 from 31 to 2 USD per BTC
· In 2013 from 266 to 50 USD per BTC
· In 2013 from 1242 to 455 USD per BTC
However, we hardly recognize these price corrections on the logarithmic scale.
Will this logarithmic growth continue? Where will be the price of one Bitcoin in one year? How to calculate the fair value of Bitcoin? This article evaluates approaches for Bitcoin valuation.
Bitcoin Network has currently 2’400’000 addresses. One person can have more than one address.
The value of the network is not growing linearly but in the square with the growth of network members (Metcalfe’s law). I.e. if we have 2 times more participants, then the value of the network grows 4 times; if we have 10 times more participants, then the value of the network grows 100 times and so on.
Currently, the network grows by 7000–8000 addresses per day. If we assume the same constant growth for the year, then the number of addresses will double this year, implying the value of Bitcoin Network will grow 4 times this year.
As we are speaking of ca 2 million people using the network then we are still in early phases on the Bitcoin Network development. It can be compared to the “pre-Mosaic browser” phase of the Internet — there were many enthusiasts on the Internet, but most of them were “techies”. The breakthrough happened when Netscape introduced the Mosaic Browser. The rest is history.
There are several discussions about the intrinsic value of the Bitcoin Network. One side has the opinion that Bitcoin Network does not have any intrinsic value; the other side has the opinion that there is high intrinsic value.
Bitcoin Network is like an Internet network. It’s not the Internet that has the value, but its diverse products and services on top of the Internet network, which creates the value of the Internet. It’s the same with Bitcoin Network — it’s the products and services on top of Bitcoin Network, which create value for Bitcoins.
The most exposed intrinsic value is the Bitcoin Network as a Payment Processor:
The additional intrinsic value of Bitcoin Network is the “base money” functionality and “value-added services”.
Bitcoin enables payments just in time between any countries in the world it practically no fees. Bitcoin is the current 9th biggest payment processor worldwide. Additional adoption of the Bitcoin Network will result in reduced demand for the services of companies like Visa, Mastercard or Western Union.
Visa’s market capitalization is 140 B USD, Mastercard’s capitalization is 100 B USD, and Western Union is 9 B USD.
Let’s assume the total market cap of these payment processors is 250 B USD, If Bitcoin Network would replace 1/3 of their businesses, then this result in the price of 3929 USD per BTC.
Payment Processors total Market Capitalization (in B USD) 250
Substitution ratio with Bitcoins 33%
Total Bitcoin Network Valuation (in B USD) 82.5
Final Number of Bitcoins (in B USD) 21'000'000
Value per 1 BTC (in USD) 3'929
Bitcoin can be considered as “base money”, it can be considered as gold — “crypto gold” in this case. One way to value Bitcoins is to compare the money supply of Bitcoins to the U.S. money supply.
The current market capitalization of Bitcoins is 12 B USD. The current monetary base of the U.S. is 4’000 B USD.
If Bitcoins would substitute U.S. monetary base, then their value should increase 4’000 / 12 times. However, let’s assume 10% of the US monetary base will be substituted with Bitcoins. The money velocity of Bitcoins is much higher (let’s say 10 times higher than the velocity of fiat money); this would reduce the demand for the Bitcoin base money. This would result in the following valuation:
U.S. Base Money (in B USD) 4'000
Substitution ratio with Bitcoins 10%
Increase in money velocity (in times) 10
Total Bitcoin Network Valuation (in B USD) 40
Final number of Bitcoins 21'000'000
Value per 1 BTC (in USD) 1'905
However, Bitcoin is not a national currency; it’s a supra-national currency. If we repeat the same exercise for the world monetary base and if we use the substitution ratio of 5% then we get the following valuation:
World Base Money (in B USD) 26'903
Substitution ratio with Bitcoins 5%
Increase in money velocity (in times) 10
Total Bitcoin Network Valuation (in B USD) 135
Final number of Bitcoins 21'000'000
Value per 1 BTC (in USD) 6'405
Levers for valuation:
Bitcoin is not only a payment mechanism; it allows building a stack of additional services and products on top of the Bitcoin protocol.
It’s the same as the Internet — what started initially as simple web browsing with Netscape Browser, developed into Google search and Web 2.0 — Facebook, LinkedIn, and Twitter. All these products are based on Internet stack. However, it took 10+ years, till these Web 2.0 products emerged.
Bitcoin protocol allows moving asset ownerships into the Bitcoin network — for example share registries and custody solutions can be implemented as part of the Bitcoin network. Ownerships of any assets (real estate, shares, and cars) can be stored in the Bitcoin network. Most public registries will become obsolete as all this information can be mapped into the Bitcoin network.
We are still in the very early phase of Bitcoin adoption; we are in the “pre-Mosaic Browser” phase. We can expect many new applications on top of the Bitcoin network — in the same way as it happened with the Internet network. However, we are not able to quantify the value of these additional services. We just say — there will be many additional services.
We looked at three valuation approaches. All of them are complementary.
Ergo Bitcoin valuation is:
Bitcoin as Payment Processor 3'929
Bitcoin as Base Money 6'405
Bitcoin as Additional Services NA
Value per 1 BTC (in USD) > 10'334
We foresee continuing network growth (based on Metcalfe’s law) and we foresee the significant potential for Bitcoin price appreciation.
We recommend allocating part of alternate assets in investment portfolios into Bitcoins.
(This article was first published in Swiss CFA Society Magazine 2014 January Edition)
· Bitcoin live market data: https://www.tradingview.com/x/0JIHqWR4/
· Bitcoin Wiki: https://en.bitcoin.it/wiki/Main_Page
· Daily transaction volume of payment networks: http://www.coinometrics.com/bitcoin/btix
· Monetary base of national economies: http://www.coinometrics.com/bitcoin/bmix
· Exchange volume comparison by Currency: http://bitcoincharts.com/charts/volumepie/