Category: Bitcoin & CryptoCurrency

What is the real market value of cryptocurrencies like Bitcoin?

The numbers used to explain the performance of Bitcoin and other cryptocurrencies are less meaningful than most assume.

Cryptocurrencies are not exactly like stocks, and cryptocurrency exchanges do not work like traditional securities markets. As a result, many crypto-asset investment strategies based on conventional definitions of market share, capitalization, volatility, and trading volume are deeply flawed. Misleading numbers mean that cryptocurrency valuation and adoption is poorly understood, which creates a false perception by the media and investors about cryptocurrencies such as Bitcoin.  One implication of this analysis is that Bitcoin has captured the vast majority of the long-term upside in the cryptocurrency market despite having about half the nominal market share.

Most cryptocurrencies and crypto exchanges manipulate numbers in ways that publicly traded companies and traditional exchanges like NASDAQ and NYSE wouldn’t dream of.  As a result, “market capitalization” and “trading volume” are at best rough and relative measures of cryptocurrency adoption. Even when intentional manipulation is not involved, crypto-asset markets fundamentally just do not function like securities markets. It’s important to understand these differences to asses the state of cryptocurrency and crypto asset adoption.

Let’s look at three important differences between how cryptocurrencies and traditional securities markets work:

Happy birthday to Bitcoin! 10 years ago, Satoshi Nakamoto published a white paper for “a Peer-to-Peer Electronic Cash System” which would “allow online payments to be sent directly from one party to another without going through a financial institution.” Just a few short months later, the Bitcoin network launched on 3 January 2009.

Bitcoin is the culmination of thousands of years in the evolution in money. It is durable, portable, divisible, uniform, and limited by design. Over the span of human history, money has taken the form of shells, salt, coins, banknotes, and fiat bills. While money serves a crucial role in facilitating trade and wealth creation in society, it has often suffered from hidden inflation, outright confiscation, or the exclusion of unpopular groups from the economy. In the 100 years, the inherent flaws in fiat paper money have been used by governments to fund wars, corruption, and cronyism through the hidden tax of inflation.

Bitcoin is the first credible alternative to fiat currency and offers real, sound money made for the information age. The decentralized nature of Bitcoin has revolutionary potential for both the global economic order and billions of people who suffer from lack of access to financial institutions and corrupt governments and corporations. The concept of a distributed ledger stored on the blockchain has applications well beyond money, with the promise of creating a durable and credible record of property ownership, which has the potential to transform how we record property deeds, corporate shares, insurance claims, business contracts, and many more applications.

After the basic concepts of Bitcoin and the blockchain were discovered in 2009-2013, Bitcoin and the blockchain space entered the infrastructure stage. We are now building the ecosystem of tools, vendors, and relationships to make Bitcoin as easy or easier to use than products of legacy financial institutions. Once a mature infrastructure is in place for cryptocurrencies, the stage will be set mass adoption. Billions of people will have the devices, services, and vendor networks to use Bitcoin for everyday transactions, meeting the final requirement for money: widespread acceptability.

The mass adoption of cryptocurrencies will not create a utopia – it is more likely to be hugely disruptive to the economic-political order. However, genuine sound money is what humanity desperately needs to build a harmonious, robust, and integrated global digital economy on the backbone of the Internet.

Reposted from my Quora answer:

The way this question is phrased is problematic.

Are pencils useful to criminals? They can be used to write down schemes for robbing banks, kidnapping letters, etc.

What about guns? Weapons give criminals an edge in committing crimes.

Of course, pencils and guns can be used against criminals as well. Most people would agree that it’s a good idea that weapons exist (even if you think that only the policy and military should have them) — otherwise, the strongest bullies could force their will on everyone else, and society would collapse.

So what you should really ask is – will Bitcoin lead to more crime or less?

Arguments for more crime:

• The quasi-anonymous nature of Bitcoin makes it very convenient for extortion payments, bribes, etc.
• Stealing Bitcoin can be easier than stealing cash given that it is portable, easy to transfer, the transactions are irreversible, etc.

Arguments for less crime:

• Governments steal far more than common criminals by inflating the money supply and collecting taxes. Bitcoin makes it impossible to steal by inflating the money supply (of Bitcoin) and makes it harder to collect exorbitant taxes. For example, read: Why are Venezuelans mining so much bitcoin? and Inflation at 8900% Turns Venezuelans to Bitcoin In Record Volumes
• If Bitcoin is properly secured (on hardware wallets, in a vault, in your head), it can be harder to steal. Again, most theft is committed by governments, especially in the developing world, and cash is a lot easier to find that properly protected cryptocurrency.

Reposted from Quora:

The best way to estimate how many cryptocurrencies will survive the infancy period is to look at other markets.

For example, how many social networks survived the infancy period?

Facebook has 63% market share:

If you use a stricter definition of “social network” to mean “feed-based platforms based around personal profiles” Facebook has over 99.8% market share. Google+ and Diaspora are well under 1%.

What about Search Engines? Google has 87% market share.

What about Desktop Operating Systems? Windows has 82%.

What emerges from looking at these and other markets is that network effects lead to a dominant player, a secondary minor player, and about three competitors with marginal market share.

However, if you expand the definition of the market, the picture can change dramatically. For example, if you include mobile device in the “operating systems” market, Android is #1 at 41. Likewise, Facebook’s dominance varies from 60% to 99.8% based on how strictly you define “social network.”

Let’s apply these insights to cryptocurrencies:

A single dominant cryptocurrency is likely to emerge with 90%+ market share. Given the strong network effect of money and the probable lack of nation-state restrictions on adoption (unlike the USD), the dominance may be over 99%.

However, if we expand the market definition to “cryptographic assets” or “digital assets” then we need to include tokens and securities such as Ethereum and ERC20 tokens. This expanded definition may see the leader’s share drop to 60–70%.

Yesterday, the Guardian wrote that “researchers have discovered unknown persons are using bitcoin’s blockchain to store and link to child abuse imagery, potentially putting the cryptocurrency in jeopardy.”

Is that true? This is a serious allegation. Unfortunately, both the Guardian story and a Bitcoin.com article which rejects these claims make grossly inaccurate statements. Furthermore, the cited study makes false statements about Bitcoin in its abstract. Aside from the sensational claims in the abstract, and the even more sensational claims in mainstream media articles about it, the paper is fairly thorough and accurate – but contains no new insights or discoveries, and duplicates prior work without credit. This is a common pattern: researchers make modest claims about something, an editor exaggerates them in the abstract to get attention, and then allows ignorant journalists to make an even more dramatic exaggeration in the press.

So does the Bitcoin blockchain contain illegal content? Not really.

While the media and the public like simple and definitive answers, getting to the truth of this claim requires understanding something about how Bitcoin works.

Bitcoin is a payment network. For the most part, the network itself only records the destination addresses of payments and the amount sent. There is no need for the network to store any arbitrary information which is not specific to a transaction. For example, unlike bank wires, there is not “memo” field in Bitcoin for adding “for pizza, love mom.” Aside from an 80 character field available for miners who sign blocks, the primary way to store non-payment information in the blockchain to use fake destination addresses for transactions. It’s kind of like one of the crank calls in The Simpsons:

Moe: Hello, Moe’s Tavern. Birthplace of the Rob Roy.
Bart: Is Seymour there? Last name Butz.
Moe: Just a sec. Hey, is there a Butz here? Seymour Butz? Hey, everybody! I want a Seymour Butz! [the entire bar laughs; realizes] Wait a minute… Listen, you little scum-sucking pus-bucket! When I get my hands on you, I’m gonna pull out your eyeballs with a corkscrew!

As you might imagine, this is a very inefficient way to store information. Bitcoin transactions have size limitations, so one can either send very small files or split files among many transactions. Since the Bitcoin network charges senders based on transaction size, sending large files is expensive, and much more so with the increase in the price of Bitcoin. The more popular Bitcoin becomes, the more expensive it becomes to insert non-trivial amounts of information.

This is why most images stored in the Blockchain so far were placed there when Bitcoin was cheaper and are tiny, low-resolution images (sample embedded “image” follows):

---BEGIN TRIBUTE---
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=-=-=-=-=-=-=-=-=-=
LEN "rabbi" SASSAMA
     1980-2011
Len was our friend.
A brilliant mind,
a kind soul, and
a devious schemer;
husband to Meredith
brother to Calvin,
son to Jim and
Dana Hartshorn,
coauthor and
cofounder and
Shmoo and so much
more.  We dedicate
this silly hack to
Len, who would have
found it absolutely
hilarious.
--Dan Kaminsky,
Travis Goodspeed
P.S.  My apologies,
BitCoin people.  He
also would have
LOL'd at BitCoin's
new dependency upon
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Here’s the address for the above tribute. It cost 1 BTC to send or $8500 at the current price of Bitcoin. Not a very cost-effective way to share illicit files, is it?

Still, based on the above, it seems like it would be possible to store illegal information on the Blockchain if one were able to make it very compact and spend enough money on it. Even if there is nothing illegal in the Blockchain yet (and the study presents no evidence of such information, despite articles which state otherwise), it could always be added in the future.

However, here is an important point: arbitrary information in Bitcoin can only be included by steganography, and cannot be read without tools which have nothing to do with the primary function of Bitcoin. Steganography is “hiding data in plain sight” – in other words, using information flows in ways other than they were intended to and that are not visible to normal users without special tools. Steganography has been known since 440 BC when Herodotus mentioned two examples in his Histories.

There is no way to prevent information from being hidden in any communications channel. For example, two criminals could conduct a series of bank transfers where the monetary amount itself encodes a message with illegal content. There is no way to detect or prevent such a message. However —  the payment network itself has no capability to decode such a message and is not designed for such a use. It’s actively hostile to such a use since all transactions (whether we’re talking about Bitcoin or bank transfers) incur a cost and can store very limited data.

Here is a screenshot I took of a Bitcoin transaction which contains the entire whitepaper where Satoshi Nakamoto presented Bitcoin:

As you can see, the output (aka destination) field contains a hex-encoded alpha-numeric string, which no Bitcoin client can convert into a human-readable message – because that is not their purpose. Furthermore, using Bitcoin to share secrets is a terrible idea. Not only is the amount of information that can be stored very limited, but the information is public for the world to see. Worse, Bitcoin transactions require spending Bitcoin and have the potential to trace back the transaction to a real-world Bitcoin purchase.

A final note: a major inaccuracy is the paper’s claim that “clearly objectionable content such as links to child pornography, which is distributed to all Bitcoin participants.”  The paper provides no such evidence, and only mentions that it found unspecified “nudity of a young woman.”  More importantly,  99.9% of Bitcoin users use a “light” client, which does not contain the full blockchain. Light clients defer blockchain validation to online servers which store the full node.

Here is an earlier and more accurate paper which contains a more fair analysis of the possibilities for data insertion on the Bitcoin blockchain.

 

Is the value of Bitcoin based solely on speculation?

No. Bitcoin has a use value which would exist even if all the speculators vanished.

I know a Latin American company that pays their employees in Bitcoin – not because they think its value will go up, but because it’s cheaper than the transaction costs involved in fiat-denominated payments. I know a lady in Zimbabwe who is using Bitcoin because she does not have access to a sound currency.

These people are not speculators: they may prefer to trade their Bitcoin for a fiat currency at the first chance. However, their ongoing usage provides a demand for Bitcoin and thus establishes a price floor. The price of Bitcoin is the combination of current non-speculative usage and expectations for future non-speculative use cases for the Bitcoin network. This is different from a purely speculative asset like rare stamps or baseball cards, which have no practical use value.

With time, there will be more and more business cases where Bitcoin provides a superior business model. Bitcoin is like an iceberg which is slowly emerging from the water: we can already see the very limited applications where it already the best currency, but we can only imagine its potential after the crypto asset ecosystem matures and cryptocurrencies become a superior option for the majority of financial transactions.

Like any startup company, the valuation of Bitcoin today is driven mostly by the expectation of future market share. The difference is that the profit will be captured by the network’s users, and not by any central entity.

I’ve heard an assumption that because many alt-coins do “more” than Bitcoin and have a higher combined market cap, their technology must be more advanced, and therefore Bitcoin will be left behind in value and market share.

I disagree for two reasons:

First, the fact that an asset such as Ethereum does “more”, does not mean that the market will value its feature set higher.
The potential market value of any given cryptoasset depends on the value proposition it offers to individuals times its potential market share. It remains to be seen whether Ethereum will be able to create meaningful products for individuals and how big the “smart contract” market will be in the near to medium future. Likewise for Blockchain-based lending, eSports, prediction markets, or organic banana crypto assets. Currency is a more universal need than smart contracts, so even if Ethereum provides a lot of value to autonomous corporations, the Bitcoin market may be much larger.

Second, the market cap of crypto assets is not an indication of the pace of technical innovation. Bitcoin is worth less than 35% of the 400 billion + crypto market cap, but that does not mean that it has 35% of the resources. According to analysts at JP Morgan, the ratio of money invested to market value for crypto assets is about 50/1. In other words, there has only been a few billion dollars invested in crypto, not $400+. That’s why the price fluctuates so wildly. ICO’s and altcoins are even more overvalued than Bitcoin given how fast their price has shot up. Altcoins have far fewer resources at their disposal than the price would suggest because their price would rapidly drop if the founders sold their share to pay for innovation. The vast majority have only a few people (if any) actively doing development. Bitcoin and Ethereum have the largest development teams by far. I suspect Ethereum has more contributors, but it also has a far larger feature set, so core functionality gets a lot less attention than core Bitcoin functionality.

The fact is, the vast majority of ICO’s and cryptocurrencies are doing very little technical innovation compared to the resources invested in Bitcoin Core. This is not at all to dismiss the value of experimentation and innovation, just to put it in context. As an analogy, it’s great that Bugatti and McLaren are innovating in supercars, but Honda and Toyota invest far more in technology that is practical to the vast majority of drivers and therefore are worth far more. Honda’s work in automatic accident mitigation/prevention is far more important than shaving 1/10th second from your 0-60 time. Likewise, Bitcoin Core’s work in implementing fast and stable large-scale networks (with Segwit and Lightning Network) is more important than the latest exotic token.

I believe that the market will eventually correct the imbalance between the fundamental value of Bitcoin and the hype over altcoins. It is also possible that some other asset has or will come up with a genuine valuable technical innovation, overcome Bitcoin’s network effects, and gain dominance. Presumably, that hope is why Bitcoin is down to 35% market share. However, I have not seen the evidence for it yet, and I would not dilute my portfolio over 1000+ assets (as some friends have) in the hope that one of them will hit the crypto jackpot.