Crypto equity via ICO and the other innovation chasm

 

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Are you a bull or a bear on this question?

– Crypto equity via ICO is the secret to unlocking innovation capital and is the bridge across the chasm between crowdfunding and public market liquidity. This is the bull case.

Or:

– Crypto equity via ICO is a haven for scamsters and needs to be heavily regulated. This is the bear case.

Today we shine a light on that question. First we outline the bull and the bear case. Then we ask some experts to give their views. Bias disclosure: I am a bull, but having seen a few waves of disruptive change I know that change takes a LOT longer than people think and that the early unregulated wave of any disruptive change has a lot of what are politely referred to as “sketchy characters” and less politely as scamsters.

The other innovation chasm

The old saw is “if it ain’t broke, don’t fix it”.

The corollary, for entrepreneurs, is “if it is broke, find a way to fix it”.

The innovation capital business is broken.

Most entrepreneurs understand the chasm between MVP (Minimum Viable Product) and PMF (Product Market Fit). The low cost to build MVP increases supply, but real demand does not change that fast, so lots of MVP ventures fall into the chasm (i.e. they fail).

The next chasm is less well understood. This is the chasm between PMF and Liquidity (via an IPO on the Public Markets and failing that via trade sale).

Today, we don’t see this chasm so clearly because there is a very expensive bridge across it – in a few locations. The very expensive bridge is provided by the big PE/VC Funds. Uber has raised over $8 billion and is still supposedly not ready for an IPO. That is an expensive bridge a) for the Limited Partners (aka the LPs aka the real investors who pay the PE/VC Fund Manager their 2 and 20 cut) and b) for the entrepreneurs (faced with all those preferential equity terms that toss founder and management equity to the bottom of the stack).

Not only is the bridge very expensive, but it is only available in a few choice locations. If you are in Silicon Valley, no problem, there are lots of expensive bridges. If you are in New York, London, Singapore, you have a few bridges. Outside those centres you are scrambling and doing so in the knowledge that some entrepreneur in Silicon Valley just raised 10x what you raised and is planning on using that to crush you.

It gets worse. Unless you do your IPO on NASDAQ or NYSE, you will face a discount. Look at the valuation discount of great companies trading on reputable stock exchanges all around the world. So now you have a second very expensive bridge operated by the “bulge bracket” investment bankers (such as Goldman Sachs and Morgan Stanley) who you use to “take you out to IPO”.

So, yes it is broken. The innovation capital business does need fixing. Whether some variant of the ICO is the fix is what we now turn our attention to.

Crypto equity via ICO 101

ICO = Initial Currency Offering.

It makes you think of IPO. That means it also makes regulators think of IPO.

Yet it is C for Currency, not company shares. You buy a Crypto Currency Token that you can use on the network.

Some examples of ventures that have been funded in this way include:

  • Storj
  • Lykke
  • Ethereum
  • ZCash

In all cases, traditional VC were not in control. Sure they could invest alongside everybody else. But they had no information advantage.

The Howey test (from an SEC legal case from 1946) is basically – if it looks and acts like an equity it probably is. Many ICOs fail this test, putting them in the regulatory cross hairs.

Crypto Equity Bear Case

It is very simple to raise money via an ICO. This will bring out honest entrepreneurs who are fed up with the current way of raising capital. It will also bring out crooks. It already has. So far the losers have been people playing with found money. For example if you invested in Bitcoin in 2009, putting some of those profits into Ether in 2014 seems pretty easy, even if you follow it up by losing on the DAO in 2016. It is quite different when Joe Q Public is invested from earnings that took 40 years to accumulate and which he is banking on for a comfortable retirement. If ICO scales, more crooks and more Joe Q Public actors get involved.

Crypto Equity Bull Case

Crypto Equity – done right helps ventures get across both chasms:

  • Chasm 1 between MVP and PMF. The investors are often also the users. They use the tokens on the network. So they help get the venture to PMF.
  • Chasm 2 between PMF and Liquidity. The Crypto Currency Token is traded. Speculators provide liquidity.

The fat protocol thin app thesis

This thesis was articulated by Fred Wilson of Union Square Ventures in August 2016. I urge you to read the whole post and the very informed comments from the community. If you don’t have time, these two pictures paint a thousand words:

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The original thinking, from 18 months earlier and, amazingly prescient being  a few months even before the Ethereum ICO, was from Naval Ravikant (founder of Angel List who we have written about here, here and here).

What do the experts say?

The experts we reached out to are in what I call the “Other BBC” space (Bitcoin Blockchain Crypto), so they will be inclined to a bullish case. If you have an alternative view, please let us know in comments.

My questions to them are:

  • Use Case Suitability. Is ICO only suitable to businesses at what USV call the fat protocol layer? This will be very few companies. Or could the ICO, with some modifications and regulations, be used for any company? If yes to the latter, what do you see as the essential modifications and regulations?
  • ICO Lessons. What key lessons should entrepreneurs, bankers and regulators draw from the ICOs that have happened so far?

Use Case Suitability

From Fabio Federici

“I think we need to distinguish between two types of tokens. On one hand, we have the tokenization of equity, where the token does not serve any specific purpose in the product/protocol but rather represents a digital form equity as we know it today. While this will improve liquidity and efficiency, I don’t believe this to be a paradigm shift.

On the other hand, we have decentralized blockchain-assets, ranging from currencies (BTC), over commodities (ETH) to application-specific tokens like Golem (a decentralized AWS) or Storj (a decentralized Dropbox) (see @ARKblockchain). These are just some examples blockchain-based assets, where the value of the network is captured by its users, rather than a centralized entity – and that is what will power the next phase of the Internet. I believe that the most exciting use-cases are yet to come. Just like it was hard to imagine Google, Snapchat or Uber in the early days of the Internet, it is impossible to predict the applications that decentralized blockchain protocols will enable.”

From Oscar Jofre  (see our review of his Korecox venture here).

“I am a bull/bear crossover on this subject because of the lack of oversight even by the industry to make sure proceeds are used in a manner that will not cause a domino affect of disgruntled coin holders in an empty network.

Not everything needs regulations but given that the retail market is just learning of the crypto currency, the industry needs to mature so this can be a very viable method for companies to utilize.  Unfortunately at the moment we are not seeing that and my bear comes out because I am seeing first hand, how companies are using ICO as a form of equity raise and not having a care if the person purchasing their coins makes any return on that investment.”

Richard Olsen of Lykke:

“In future, any company will be able to take advantage of the ICO route. No regulatory changes will be necessary, because Lykke will acquire the necessary legal licenses and future ICOs can happen under the Lykke umbrella, www.lykke.com

ICO Lessons

From Fabio Federici:

“I think it is important to distinguish between the tokens representing pure equity, and blockchain-based assets that serve a purpose in a protocol. While the first is just a digital version of what we know today, the latter represents a new type of asset class.

Also, one should always take a close look at each asset before making a decision, whether it’s building on it, investing in it or regulating it. Many factors play into the evaluation of these assets, from the aforementioned purpose to the fundamentals, the code, the team and many more. We are still in the early days – ontologies and (e)valuation methods have yet to be developed.

The main lesson for me is to keep an open mind and evaluate each token or asset individually. We are in the midst of the rise of a new asset class that will change the world.”

From Oscar Joffre

“ICO’s are here and need guidance. They are not used to harm but to really bridge the large funding gap we have globally for companies.  The industry can choose to be proactive and self-regulate, which in the end will be better than regulators injecting in.”

Richard Olsen of Lykke:

“The new future has started – entrepreneurs, bankers and regulators have understood that ICOs are a new reality and are essential funding tools. They combine cost efficient funding with building a motivated network of supporters.”

 Conclusion

Crypto Equity is a gamechanger – if done right.

Those three little words –  if done right – cover a lot of complex detail.

We can leave that to regulators in each jurisdiction to create their rule books. That can take a lot of time and will devalue the frictionless cross border nature of ICOs today. Or the community can create a self-regulatory code of conduct as Oscar Jofre suggests. We have opened a thread on Fintech Genome where this initiative can be crowdsourced.

http://genome.dailyfintech.com/t/crypto-equity-via-ico-self-regulation/965

 

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Bernard is a Fintech thought-leader & deal-maker.

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Blockchain needs to become technically boring

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Clay Shirky, in Here Comes Everybody, writes:

“Communications tools don’t get socially interesting until they get technologically boring.”

Two examples of boring technologies having a big impact on Fintech are QR Codes and Prepaid Cards.

Blockchain is definitely not boring. It will probably have a bigger impact than QR Codes and Prepaid Cards, but it may still fade into the sunset of overhyped technologies. It is exciting because that is a huge delta – change the world or dustbin of history.

I incline to the former – that Blockchain will change the world.

However, that promise won’t be fulfilled until Blockchain becomes technologically boring. This post looks at why that is true and at efforts to make it technologically boring.

War is exciting too, but not productive

The internecine wars among Blockchain technologists are really exciting for those on the front lines. For the rest of us, who cannot say anything technically profound about SegWit and Lightning Network and Proof Of Stake, it is alienating. Could we just get a product we can use?

The answer is no, not really, not yet. In this post we looked at the scaling challenges. TL:DR: there is still technical risk here. Or to put this another way, build a proof of concept, attend hacktahons and conferences, issue Press Releases, but don’t bet your company’s future on this – just yet.

The technical debates are pretty ugly. It is like watching Blue and Red states in America. There is no middle ground and a lot of dialogue of the deaf – if I shout louder maybe you will hear me and agree with me. The Bitcoin scaling debate has rightly been compared to a Civil War within the Bitcoin community.

The reason that there is so much heated debate is that this is no longer just a cool computer science open source project. Real money is at stake. That makes people cautious. Yet it is broken today – as it stands, Bitcoin cannot scale.  So there is technical debt and legacy code and innovators dilemma. Welcome to the real world.

Boring is good for employer, not employee

Java, the Cobol of the modern era is a good example. It is boring and for an employer that is a good thing. Java coders are abundant and inexpensive. As an employee, the words abundant and inexpensive signal bad news. It is much more profitable to be an expert in an obscure but hot language. Even better to be an expert in Blockchain. So few people really understand it technically and yet because the upside & downside for huge enterprises is massive and existential they have been spending multi-million $$$$ on Proof Of Concept projects.

The Multi-Million $ Proof Of Concept

Blockchain will make tea for you in the morning. Blockchain will also make you a better lover. Back in the real world, most of the systems that Blockchain is being proposed for could use standard database technology (aka boring technology).

The reality is that in 2016, just the word “Blockchain” unlocked enterprise budgets.

It is a good time to be a Blockchain guru. For companies looking to avoid the Blockbuster fate a pitch that “this could be how we become the next Netflix” is beguiling enough to unlock multi-million $$$$ budgets for Proof Of Concept projects. These projects cannot grow beyond POC, because there is still technical risk around scaling, but the prize is big enough so the budgets get unlocked. The POC is simply an option on the future.

You can take two views on this:

A. It is all nuts, all the money going into POCs is wasted because Bitcoin/Blockchain will never scale.

B. The scale of the opportunity/risk is so great that some wastage is normal and the cost of doing nothing is worse.

I incline to B but also think it could be done more efficiently.

Three Months and Six Figure POCs

Three months and budget in 6 figures is the normal rule for a POC if you cannot use the magic B word to unlock multi-million $$$$ budgets for projects lasting 12 months or more. Coding a prototype to show stakeholders is easy – it can be done in days or weeks. Before that some work to determine business strategy and the level of technical risk is needed. The key job is EAU (Education Awareness Understanding) for senior stakeholders. The ones making the big decisions need to understand Blockchain beyond the simplistic “it’s a distributed ledger” mantra. There is too much at stake to simply leave these decisions to technical people without any understanding of how it really works.

Two things to make Blockchain technologically boring

One should be able to:

A. Create smart contracts aka Blockchain apps as easily as building a mobile app with lots of free components and standard tools that millions know how to use.

B. Deploy to any Blockchain with any cyber currency with any validation scheme (Proof Of Work, Proof Of Stake etc) as easily as deploying to AWS or Azure or any other cloud service.

I can see enough progress both within Bitcoin (Segwit, Sidechains and Lightning Network) and Ethereum to feel confident that this will happen and while I cannot see exactly when this will happen, I do believe it will mostly happen in 2017. If not, then Bitcoin and Blockchain will disappear into the dustbin of history. Yes, there is a lot at stake in those technical debates!

It’s OK, we are Blockchain not Bitcoin

Then there is the enterprise wing of the Bitcoin party. Their line is:

“We don’t need Bitcoin.  That can be a failed experiment and it won’t matter to us because we just need to scale to enterprise level and that is easy”.

Yes, it is easy to scale a Blockchain system to enterprise level, but why bother? This handy decision chart helps you figure out whether you need a Blockchain.

Blockchain Decision

In the vast majority of cases, the answer is no. In those cases, enterprise tech companies like Oracle will happily sell you the technology that gives you what you need without any Blockchain. For a skeptical take on Blockchain by Oracle, read this. Moving from POC to enterprise deployment puts $ billions at risk. That won’t happen while there is technical risk.

That is why the “we don’t need Bitcoin because we are enterprise” line is baloney. If Bitcoin fails, it will drag Blockchain along with it. Technically we can insert a “better cyber currency” but if Bitcoin fails, the sentiment crash will kill Blockchain projects and Altcoins as well. The naysayers on the project approval committee will have a field day.

Google Deep Mind AI and Immutable trust without Blockchain

Boy is that a tough headline guaranteed to lose clicks! The headline where I saw this was in the Guardian and it did draw me in with “Bitcoin-like” in the headline. The use case is healthcare, but it applies also to banking as we will see later.

“Google’s DeepMind plans bitcoin-style health record tracking for hospitals”

Hat tip to famed Femtech leader Efi Pylarinou for sharing this in her Twitter feed.

However when you dig below the surface of the headline, as is our habit at Daily Fintech, you get a more nerdy conclusion that reflects back to our core thesis that enterprise Blockchain is a passing phase that will lead to maybe 1% of the current enterprise Blockchain POCs turning into large-scale deployments.

This was great tech reporting by the Guardian. They related some deep tech to a concern shared by millions – privacy of medical records.

“Google’s AI-powered health tech subsidiary, DeepMind Health, is planning to use a new technology loosely based on bitcoin to let hospitals, the NHS and eventually even patients track what happens to personal data in real-time.

Dubbed “Verifiable Data Audit”, the plan is to create a special digital ledger that automatically records every interaction with patient data in a cryptographically verifiable manner. This means any changes to, or access of, the data would be visible.

DeepMind has been working in partnership with London’s Royal Free Hospital to develop kidney monitoring software called Streams and has faced criticism from patient groups for what they claim are overly broad data sharing agreements. Critics fear that the data sharing has the potential to give DeepMind, and thus Google, too much power over the NHS.”

To understand the tech, dive into the blog post by the Google Deep Mind team to understand how verifiable data audit sounds like Blockchain but does not use a decentralized trust-less consensus mechanism to verify transactions.

What you will see sounds like Blockchain:

– immutable, append only: check

– Verifiable aka transparent in real time: check

– Merkle like tree structure: check

But it does not use a decentralized trust-less consensus mechanism to verify transactions. This makes it more efficient. There are no proof of work miners. Nor are there any as yet unproven consensus mechanisms such as Proof Of Stake.

The cost is some level of trust in institutions.

That pitch will resonate with the CXO suite at these institutions.

This is why I was writing as far back as November 2015 that the permission enterprise blockchain was a mirage beguiling both banks and IT vendors. This is like the Intranet phase of the Content Internet.

Commercial break: get these kind of insights ahead of the pack by subscribing to Daily Fintech – its free.

The big debate about PSD2, which we cover a lot on Daily Fintech, is who owns your banking data – you or the bank. Translate that to healthcare – where consumers care more about personal data and you have what Google is offering. Google is smart to launch first in Europe where consumers (and regulators) are more concerned with data privacy.

It’s binary. Bitcoin (and Blockchain) will either change the world or fade into the dustbin of history. When it does change the world (I think it will), then being a Blockchain guru will be about as exciting as being an HTML or TCP/IP guru today.

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Japan is another rich developed country where Bitcoin is becoming respectable

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Respectable is a prelude to mainstream. Bitcoin needs to seem normal, legal and safe before it can go mainstream. In this post we look at the signs of that happening in Japan.

Switzerland is another example of a rich developed country where Bitcoin is becoming respectable. Switzerland and Japan also have strong currencies. This is the opposite of the theory that Bitcoin adoption would happen first in countries with failing currencies. Many people were drawn to Bitcoin by dreams of stateless trust based on math replacing more authoritarian governance. So the meme got established that Bitcoin would first go mainstream in countries like Argentina; we debunked that theory here.

Japan is the third largest economy in the world (after America and China), so Bitcoin adoption here is a big deal.

Japan is where we go for some of the early history of Bitcoin. Magic The Gathering Online Exchange became MTGox. From trading cards beloved by nerds, they went to trading a currency beloved by nerds. When MTGox went bust and lots of people lost lots of money, it became a byword for the lawless dangerous world of Bitcoin.

That could be the end of the story, but it turns out it is only the first chapter. In chapter two, Japan has made three moves to encourage Bitcoin adoption:

  • Regulated Exchanges
  • Legal currency status
  • Elimination of sales tax

This has led to some good business results:

  • No 2 in trading volume
  • 5,000 merchants accepting Bitcoin
  • Strong VC funding (in a generally weak environment)

Regulated Exchanges and Insurance

The MTGox failure was explained by a simple old fashioned problem – commingled accounts. When you buy IBM shares on NYSE, you don’t worry that the NYSE can get your IBM shares. That is an easy fix; but it still needs to be policed/regulated.

In 2016, Japan passed a bill that mandates that virtual currency exchange operators have to register with the Japanese Financial Services Agency and submit to on-site inspections and KYC practices.

This level of regulation encourages insurance companies to step up the plate and offer insurance to bitcoin exchanges (a subject we first covered in this post).

Mitsui Sumitomo Insurance cover ranges from ten million yen (US$88,500) up to one billion yen (US$8.85 million). It also covers loss from internal and external threats, including employee theft, mistakes, cyberattacks, and other unauthorized access.

The first customer is Japan’s largest bitcoin exchange, Bitflyer. By working with a highly professional exchange, Mitsui Sumitomo Insurance can also offer best practice advice. After a number of bitcoin exchange blow ups, the best practices are now well established. If a bitcoin exchange follows these, the risk of loss goes down (which is good for the Insurer) and being insured will help bitcoin exchanges to gain consumer confidence.

Fear of getting ripped off is no longer a deterrence to bitcoin trading. Now it comes down to standard risk/reward calculations that traders make every day. Today bitcoin offers two things that traders love – volatility and wide spreads. However, none of this could happen until the exchanges became safe.

Legal Currency status

The new law defines bitcoin as a legal currency that can be used to make payments and an asset that can be transferred digitally. That is simple but game-changing. You may pay for illegal things using bitcoin, but the currency itself is just as legal as a suitcase full of cash in a parking lot.

No sales tax

Later in 2016, Japan defined plans to drop sales tax on Bitcoin.

This is not yet a done deal, but could take effect as early as July 2017, according to CoinDesk. This means customers don’t have to pay tax for each transaction. This is similar to the early days of e-commerce when no sales tax was levied. This will make paying with bitcoin more attractive, by making it cheaper for the buyer and lower admin for the seller.

So much for what has been done to encourage adoption, here are the signs are that adoption is happening:

  • No 2 in trading volume
  • 5,000 merchants accepting Bitcoin
  • Strong VC funding (in a generally weak environment)

No 2 in trading volume

While China is easily the leader in Bitcoin trading volume, Japan is the silver medalist. As in China, a lot of the volume can be attributed to the fact that Bitcoin trading on exchanges is zero cost in China and Japan, encouraging frenetic trading that does not mean that much. Many say that real volume is less than 30% of headline volume.

While the trading volumes may be misleading, there is a wall of money ready to move into bitcoin trading if Mrs Watanabe steps seriously into the game. Mrs Watanabe is the archetypical retail investor in Japan. Culturally, Japanese retail investors have sought safe investment options. However, perpetually low interest rates since the 1990s led many to become active in the carry trade (in which investors borrow a low-cost currency like the yen and buy high-growth currency, netting a profit). It is a short step from that to trading in bitcoin, which is attractive to traders because of volatility and wide spreads.

The real proof of the bitcoin pudding is whether it is being used to buy and sell goods and services.

5,000 merchants accepting Bitcoin

Today more than 5,000 merchants and websites in Japan accept Bitcoin as payment.

We still cannot see merchant transaction volume, a subject we covered in our latest bitcoin ecosystem health check.

Some speculate that the Olympics, due in Tokyo in 2020, will give bitcoin a boost as visitors can pay in bitcoin rather than converting to Yen. This is where the sales tax could be critical.

Strong VC funding

In a generally weak environment for bitcoin VC deals in 2016, Japan saw two significant deals – bitFlyer and Techbureau.

bitFlyer

The third largest VC investment in 2016 happened at the end of April for US$27 million to Tokyo-based Japanese bitcoin exchange bitFlyer. It was a Series C round, bringing their total funds raised to $33.94 million. Investors include Venture Labo Investment and SBI Investment.

TechBureau

TechBureau, which operates a bitcoin exchange called Zaif and a permissioned blockchain platform named Mijin, raised $6.5m in a Series A. Participants in the round included Arara, a financial services firm; online information portal OKWAVE; VC firms Nippon Technology Venture Partners and Hiroshima Venture Capital; and FISCO, a corporate analysis firm. TechBureau bill themselves as a ‘Crypto-FinTech Laboratory.’ Many Japanese startups and projects were born in the lab including the popular Zaif bitcoin exchange.

Regulation does matter – ask Coinbase

Compare Coincheck which has the lion’s share of bitcoin merchant processing in Japan to Coinbase which has that position in America.  While Coincheck operates in a relatively benign regulatory environment, Coinbase is in legal battles with the IRS.

The key part of merchant processing is off ramp ie converting to Fiat. This a function of an exchange. Lots of traders also make for liquidity and price discovery which will be good for merchant adoption and mainstream use. So the Japanese focus on exchanges makes total sense.

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Another bitcoin ecosystem health check as we slide into 2017

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Gute rutsch is the Swiss greeting for New Year. Translation = good slide. I hope y’all had a good slide into 2017.

 Now for all those resolutions – like going for regular health checks.

As we try to determine the health of the bitcoin ecosystem, some regular health checks are called for.

We have done two bitcoin ecosystem health checks in the past –  in June 2015 and April 2016. We publish those today for reference. All the data we use is in the public domain and we publish our methodology, so anybody can run these tests at home – no expensive medical equipment or training needed. All we ask is that you tell us if you see a way to improve the testing methodology.

Yes, the image is of only one health check, which is price, but the reality is that the price is what gets people’s attention and the price is rising. The biggest barrier to traction is being ignored and we can see the Google Trends and price of bitcoin correlate well. A rising price gets attention and that may impact the other metrics.

Methodology

We look at 4 indicators

  • Indicator 1 = Price. What do investors/traders think? This shows the wisdom of the crowd with skin in the game. Yes, we can also see the madness of crowds in the chart, which is why our health check looks at 4 indicators not one.
  • Indicator 2 = Merchant Transaction Volume. Is bitcoin being used as a currency in the real world? What do merchants and their customers think? This is a good forward indicator – like a blood pressure check. The problem is that this data is tough to get.
  • Indicator 3 = Cost Per Transaction. It ain’t free, but we hope it is cheaper than credit cards. Entrepreneurs will markup cost to provide valuable services, but what is the cost?
  • Indicator 4 = Transaction time. Is this approaching the “human real time” (a few seconds) that consumers expect from digital services? Or will we have to trust centralized intermediaries to make it look like human real time (rather ruining the core proposition of bitcoin)?

For data we mostly use Blockchain.info

Note: in order for this doctor to have a holiday, the health check took place in December 2016.

To discuss and improve the methodology, please go to this thread on the Fintech Genome. We are open sourcing our methodology in order to get contributions from the community to improve it.

Why 4 indicators are needed

If your doctor only ran one test, they would be negligent. The bitcoin ecosystem is complex and therefore also requires a number of tests. I am using this analogy to debunk three memes that took hold in 2016:

  • Meme # 1: Don’t worry about the bitcoin currency use case. The thesis is that bitcoin is just a store of value like Gold (so price is the only thing that matters). This is mostly said by people who own a lot of bitcoin “talking their book”. It is also said by bankers who find the idea of a currency outside their control to be deeply disturbing. It is far from certain that bitcoin will gain mainstream traction as a currency, but I am absolutely certain that bitcoin cannot be a reliable store of value if it fails to become a mainstream currency. It is hard to imagine a store of value (as opposed to a speculative instrument) that you cannot also use as a currency. Tulips is not a good case to cite. Gold is both a store of value and a currency; prudent people use it as a hedge against Fiat currency failure on the assumption that people will accept Gold in return for goods and services if everything goes pear shaped . Speculators will do what you see in that price chart spike in 2014 – if you bought at the bottom and sold at the top, well done; most people did not do that in which case the spike and crash was meaningless. Long term wealth protection clients look for something a bit less volatile with some fundamental value. So, they will also want to see thar the other 3 indicators are healthy. It is hard to imagine the price of gold going to zero. It is not hard to imagine the price of bitcoin going to zero if the other 3 indicators show sickness. Great cholesterol numbers are no consolation if you have cancer.
  • Meme # 2: bitcoin is just the first application use case for Blockchain technology and it is OK if bitcoin fails. If Indicators 3&4 are weak, then it means that all consumer Permissionless applications will fail. Without consumer Permissionless applications, the Permissioned enterprise Blockchain stuff will just get rolled up into the Oracle stack and be a footnote in enterprise technology history.
  • Meme # 3: Cyber currency is inevitable, it just might not be bitcoin.If bitcoin fails, after so much hype, it will take a really, really long time before another Cyber currency gets past the resultant skepticism. This brings to mind the famous quote by John Maynard Keynes in 1923:

“The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.”

Indicator 1 = Price

Look at this long term price chart:

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The 2014 spike is pure speculation. The 2016 price chart looks more suitable for investors – as long as the other health indicators come out OK.

One of our 2017 Predictions is:

“bitcoin price will go past its all time peak of $1,242 (from 2014) and then settle back just below $1,000 for most of 2017.”

If that prediction is true, then bitcoin will be seen as best performing currency of 2017. That will bring in mainstream investors.

The problem is that you can assess bitcoin as a store of value in three ways:

  1. currency
  2. commodity
  3. startup stock

The latter is where we get the wild forecasts of a single bitcoin being worth $100,000 or $1,000,000 (from about $966 as I put key to pixel). Before dismissing that as crazy, consider the fact that one share of Berkshire Hathaway is worth about $250,000

Like a stock, the supply of bitcoin is fixed. In the case of bitcoin, it is fixed at 21 million. If you own 210,000 bitcoins you own 1%. That is why bitcoin people talk about market capitalization (which is not how you talk about currency).

Bitcoin as an asset class is gaining some momentum. For example, Polychain capital, a hedge fund investing in digital assets has managed to raise $15m from top tier VC such as Andreesen Horowitz and Union Square Ventures.

The near zero correlation to other asset classes is attractive. Volatility and liquidity look fine.

This is where the other tests matter. Investors will happily take a punt on a big upside if the downside risk is protected. If you bought bitcoin in 2009 it was like buying founder stock – you have no downside. If you buy bitcoin in 2017, you spend real money. For downside risk to be protected, bitcoin must be more than tulips. It must be a real currency. Which brings us to Merchant Transaction Volume.

Indicator 2 = Merchant Transaction Volume

We want to track this because we need to see how much are people paying for goods and services using bitcoin. In short, is bitcoin being used as a currency?

To track this we need to subtract the transactions done for speculation or money laundering.

This data is surprisingly hard to find. One data point on Blockchain.info that is helpful is Number of Transactions Excluding Popular Addresses.

This does show some reasonable growth and excludes speculative bursts around events such as Brexit.

Hard data is hard to come by, but we see anecodatal evidence such as (from Techcrunch) that Airbnb CEO Brian Chesky asked for product suggestions for 2017, and accepting Bitcoin payments was the number one most requested feature for the company.

Is there a better data point to track? I imagine that big payment processors such as Coinbase, Bitpay and Circle have this data, but do they put this in the public domain?

Indicator 3 =Transaction time

The Average Transaction Confirmation Time shows this. There is nothing dramatic about this chart, it looks stable as one would expect unless there had been a significant change to the protocol. The problem is simply the numerator, which is in minutes.

This is where we expect to see a lot of change in 2017 as Segregated Witness and Lightning Network roll out. For background on these scalability issues please read this post.

Indicator 4 = Cost Per Transaction

Blockchain.info shows this. The data problem is that this chart is in USD, so the exchange price gets in the way. What we need is cost per transaction in bitcoin (just like we use transaction volume in bitcoin). If anybody knows where to find this, please tell me. Maybe one could compute this from a mix of things like Hash Rate and Difficulty. However, that is a nuance. The big picture is that small transactions are not economic today. Which means some combination of offchain centralized processing and/or use of Sidechains. This is another area where Segregated Witness and Lightning Network rolling out in 2017 will have a big impact.

Past checkups

As you can see, the methodology is evolving.

April 2016

June 2015

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Capital Markets and IDs

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In theory, we have been able to design Digital Identity solutions for a while now. However, the costs were prohibitive and interoperability issues needed to be solved.

Today, we can implement technology (hardware) that is cheap and this allows us to experiment and target opportunities that couldn’t be exploited before.

It is cloud computing, cryptography, public key encryption and peer-to-peer networking protocols that are the critical “cooking ingredients” for recipes that can solve costly and basic problems in Capital markets, like provenance, authentication and reconciliation.

In this post, we zoom into the Digital identity issue (whether for an end-user or a corporate entity) in Capital Markets. In traditional financial lingo, this is coined as KYC and it shifted on the very top of the stack of issues that keep up managers at night, mainly after Sep 11.

Currently in Capital Markets we are looking for the following qualities in a Killer Digital Identity solution:

  • Cheap
  • Ability to be accurately updated
  • Accessible and Granular = Interoperability and Granularity
  • Immutable

The last two qualities are critical and encapsulate the practical difficulties of such a service. A Killer Digital Identity solution should offer both individuals and organizations the ability to authorize actions on their behalf. This can range from settling a trade, to registering for a financial product or service like an investment product or a loan.

At the same time, it has to be granular so that only the pertinent bits of the Digital Identity are used.

This is what Pascal Bouvier has been pointed out for a while. It is critical because it enables individuals and corporates to choose how to interact with a merchant or a supplier or a client. Being able to have a secure way to divulge only the granular bits of information is the key. It is also the enabler to be used in different contexts without having to go through the whole process again.

Imagine a world that any individual can open a bank account for their consumer banking needs, a telco account, an investment account, a brokerage account …. with different institutions securely, with all updated info, without having to repeat the whole process (e.g. they all need a copy of passport or a digital picture but the telco account needs much less information than a brokerage account that allows me to trade options and futures and buy stocks on margin). In addition, in order to register a corporate entity for a business, imagine a world where one can avoid repeating the process that overlaps with all the above, the registry is able to obtain accurate Social KYC information around the shareholders and directors of the company (updated real time), and have access to any particular cross-border information necessary.

There is one Fintech based on the Isle of Man that has been focused on developing such apps using blockchain technology. Credits, has been working with the government on the Isle of Man to develop “The Federated Know your Customer” app that was demoed at the recent Misys World Trade Symposium. This sits on the cloud and has the four elements mentioned above. Credits is also in conversations with the UK government for use cases in regulatory reporting and healthcare. Credits has not been at all focused on creating some cryptocurrency or some decentralized app. They have been thinking differently, in that they are focused on solving specific problems in the infrastructure of capital markets. Digital ID has been their first use case.

We are in the very early stages leading towards an invisible ID for individuals and corporates for the variety of functions in Capital Markets.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Efi Pylarinou is a Digital Wealth Management thought leader.

Watch Season II of the Swiss Bitcoin Reality, with EY leading.

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In the first season of the Swiss Bitcoin Reality show, we saw SBB announcing the introduction of Bitcoin ATMs by using its existing extensive network of ticket dispensing machines. We covered this in The radical change coming to Financial Services & Fintech in Switzerland and Matthias Muller, group innovation manager at SIX, used the witty analogy of The Monkey Business illusion in “Did you notice the Gorilla on stage?” as he (along with all of us) was surprised by this move.

EY 2017: from talk to walk

In the second season of the Swiss Bitcoin Reality show, which starts early 2017, we will be watching another bold move by EY in Switzerland! The plan cannot be seen as an under-the-radar screen move or lets get our feet wet, or lets be trendy.

EY Switzerland is already bold in the first phase already, of the strategic move.

  • A new Bitcoin ATM machine installed in their public office building in Zurich
  • A digital wallet app for all Swiss branch employees
  • EY clients in Switzerland, can pay for consulting services with Bitcoin

The Bitcoin ATM machines can of course, be used by all EY employees but also from any individual passing by.

Any EY employee in Switzerland will receive an “EY secure digital wallet app” that can be used to pay with Bitcoins. This is much like, receiving a corporate email address once joining a company that is secure within the corporate environment. EY is providing all its employees in Switzerland with a specially developed EY digital wallet app (I suspect in collaboration with Bitfury who is their partner on the innovation lab, but have not been able to confirm this) to load on company smartphones.

EY is leading the movement of “Bitcoin goes mainstream” in the both the advisory sector and as a large publicly traded entity that accepts crypto currency payments for its services. It is surpassing Deloitte, who has also installed a Bitcoin ATM machine in the Toronto office of the building housing the Rubix team (Rubix is the team and platform focused on blockchain solutions). Not only because EY’s ATM is in the main office building, and the welcoming – standard employee kit includes EY’s digital wallet app and EY corporate email; but also because EY is accepting compensation for advisory services from its clients in Bitcoin.

EY advisory services in the most recently reported financial year (July 1, 2015-June 30, 2016) have grown 21.7% and reached 210.8 million CHF with total gross revenues were 661.2 million CHF. By inviting clients to pay for EY consulting services in Bitcoin, EY signals its commitment to the digitization underway, its strategic decision to make crypto-currencies integral part of the business offering.

This latter part makes the EY Garage-Lab, not just another safe playground for clients to experiment with blockchain but a safe platform to experiment within a company who is putting its money where its mouth is.

On cryptocurrencies, EY is putting its money where its mouth is!

On cryptocurrencies, EY is boldly moving from Talk to Walk!

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Efi Pylarinou is a Digital Wealth Management thought leader.

Insurance helps Bitcoin become safer for mainstream consumers

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Bank depositors get tax-payer funded insurance in many jurisdictions (such as FDIC in America) in case a bank goes bankrupt. Your Bitcoin in Mt.Gox or BitFinex….buyer beware.
People paying by Credit Card can fight back against a fraudulent charge. Once you send those Bitcoin it is like handing over cash…buyer beware.
Bitcoin early adopters and true believers are technically savvy enough to protect themselves in these kind of situations. For 99.99% of the world, a bit more reassurance is needed.
That sounds like a job for Insurance – pay some money for peace of mind. This post looks at how Insurance companies are stepping up to the plate.
Japan 
The most high profile Bitcoin exchange failure was Mt.Gox, based in Japan. So it is no surprise that the first major rollout of Insurance for Bitcoin exchanges comes from Japan
Mitsui Sumitomo Insurance offers insurance to bitcoin exchanges globally. This is not exactly new, but in the past each deal was very custom negotiated. Mitsui Sumitomo Insurance seems to want to make this a more routine line of business.
Brave New Coin has the details, which is useful as the Mitsui Sumitomo Insurance offering to bitcoin exchanges is still only in Japanese.
The plan’s total theft cover ranges from ten million yen (US$88,500) up to one billion yen (US$8.85 million). It also covers loss from internal and external threats, including employee theft, mistakes, cyberattacks, and other unauthorized access.
The first customer is Japan’s largest exchange, Bitflyer. By working with a highly professional exchange, Mitsui Sumitomo Insurance can offer best practice advice. After a number of bitcoin exchange blow ups, the best practices are now well established. If a bitcoin exchange follows these, the risk of loss goes down (which is good for the Insurer) and being insured will help bitcoin exchanges to gain consumer confidence.
This is a critical plank in Bitcoin growing up and becoming mainstream.
The Bank like Bitcoin platforms
For a while we had very distinct companies in each Bitcoin segment – wallet, exchange, payment processing. However, as Bitcoin grows up we are seeing more Bank like Bitcoin platforms in the sense that they offer a full suite of services. These full service Bitcoin platforms such as Coinbase, Xapo and Circle already have insurance. Mainstream insurance offerings will let new players get consumer confidence – just like a small bank being able to offer deposit insurance.
Xapo pioneered the use of insurance because secure storage is their core proposition, using A.M. Best rated insurance providers.

Taxpayers and regulators  should breathe a sigh of relief

There is no possibility of bailout in Bitcoin-land. Private sector Insurance becomes the alternative. This will raise the professional bar for all Bitcoin players. To get Insurance they will have to meet basic standards and without Insurance they won’t get consumer confidence. Regulators and their political masters may then relax a bit more because the risk is left to the private sector to manage. Taxpayers will never be on the hook again in a bailout.

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Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.