Sunstone Capital, Avalanche 2014 - Bitcoin: Primer, State of Play, Discussion

Primer, State of Play, Discussion

Yacine Ghalim & Max Niederhofer

Courmayeur, 24 January 2014

1.2m   1m   1.5m   1.5m  

11.1m  

Data:  Google  Keyword  Planner  

Bitcoin is becoming ever more popular in the public eye

GOOGLE TRENDS & SEARCH VOLUME

Data:  Google  Trends  

Average Monthly Search Volume (Google, past 12m)

Bitcoin  is  a  technological  tour  de  force.  

It  will  be  everywhere,  and  the  world  will  have  to  readjust.  

Bitcoin  is  the  beginning  of  something  great:  a  currency  without  a  

government,  something  necessary  and  imperaBve.  

Bitcoin  is  Evil.  

A  virtual  currency  scheme.  

Bill  Gates    

John  McAfee   The  European  Central  Bank  

Paul  Krugman  

Nassim  Taleb  

?  

A dividing topic

PERSONALITIES QUOTES

Source:  bitcoinquotaBons.com,,  ecb.europa.eu  

Bitcoin’s origin as the experiment of an anonymous cryptographer, Satoshi Nakamoto, is a boon to libertarian hero worship HISTORY / MYTHOLOGY

2008 -  Bitcoin.org registered by “Satoshi Nakamoto” -  “Bitcoin: A Peer-to-Peer Electronic Cash System” paper posted October 2008 (link: PDF) -  Bitcoin projected registered at Sourceforge

2009 -  Satoshi mines “genesis block” of 50 BTC – January 2009 -  Bitcoin v0.1 released on [email protected] mailing list… and Usenet – January 2009 -  First bitcoin transaction, #bitcoin-dev on Freenode, v0.2 released 2010 -  First offline transaction: 10K BTC for two pizzas -  v0.3 announced, Slashdotted, Mt Gox founded – July 2010 -  First specialized GPU hash miners and pooled mining operations -  Bitcoin economy surpasses $1 million, $0.5/BTC -  Satoshi hands project lead to Gavin Andresen, fades into background with est. ~1 million BTC

-  Bitcoins are digital units of account issued, authenticated and transacted through a peer-to-

peer network

-  The network/ecosystem is Bitcoin, the units are bitcoins -  Attractive due to low transaction costs, no taxation, (some) anonymity -  Key features safeguard issuance, authentication, ownership and independence -  For the first time in human history, a medium of exchange with no intrinsic value without a trusted

central authority

What exactly is Bitcoin?

DEFINITION(S)

-  A bitcoin is simply a chain of digital signatures using public and private keys

-  This is based on previous work, like hashcash, bit-gold and many other e-cash attempts -  The main problem of a digital currency is verifying ownership - double-spending and its most

obvious solution, a trusted central authority -  Bitcoin solves this through a public ledger, which creates a time-stamped history of all transactions -  This is known as the blockchain

Bitcoin works like previous attempts at digital currencies, but uses a public ledger of transactions instead of a central “mint”

HOW BITCOIN WORKS (1)

-  Bitcoin transactions are public, traceable and publicly stored…

-  This is similar to the idea of stock exchanges, where a tape of transactions is public, but the identity of the transacting parties is not

-  Preserving privacy on Bitcoin requires effort: discarding Bitcoin addresses constantly

A public record of all transactions implies a very different model of privacy, one that is arguably more strict

HOW BITCOIN WORKS (2)

-  The blockchain is built by the nodes in the network attempting to generate new blocks by solving a difficult proof-of-work problem, and thus making fraud highly unlikely

-  In Bitcoin, this proof-of-work is incrementing a nonce, or arbitrary number, to the point of where its

SHA-256 hash yields a value beginning with a set number of zeros (getting more difficult over time) -  Once a new hash has been found, the node broadcasts the new block to the network -  The first transaction of the new block is a new issuance of bitcoins (currently 25), a reward for the

“miner” -  Other nodes accept the block only if all transactions in it are valid, ie no double-spending -  In case of a conflict (branch), nodes will work on extending the longest chain -  In the long run, as issuance slows, Bitcoin allows for transaction fees paid to nodes for extending the

blockchain

Nodes in the peer-to-peer network compete to validate transactions and thus being allowed to issue new bitcoins through “mining” HOW BITCOIN WORKS (3)

-  While transaction validation in the blockchain is costly, single transaction verification is simple and cheap

-  However: all of this assumes that a majority of honest nodes control the network -  The blockchain generation means transaction confirmations take up to an hour

While Bitcoin solves key digital currency problems elegantly, some vulnerabilities remain

HOW BITCOIN WORKS (4)

•  2,500+  brick  &  mortar  places  (mostly  mom  &  pop  shops)  

•  50,000+  online  places  •  Large  online  players  accep<ng  it:  

•  Officially  banned  it:    

•  OAen  compared  to:        

•  Shares  the  most  aCributes  with  precious  metals:  

•  Limited  supply  increasingly  difficult  to  extract  

•  “Decentralized”  crea<on  

•  Non  yielding  asset  

Store  Value   Transact   Move  Money  

•  More  easily  fungible  than  precious  metals  

•  No  storage  costs  •  (Temporarily)  unclear  tax  

treatment  of  capital  gains  

vs  Cash:  •  Dematerialized  

•  Circumvent  EM  countries’  capital  controls  (China,  Argen<na,  North  Africa)  

•  Faster  and  cheaper  than  some  tradi<onal  transfer  services  

•  Pseudonymous  

Bitcoin’s current use cases are threefold : store value, transact and move money

THE CURRENT BITCOIN USE-CASES

•  Transfers    

•  Interna<onal  remiCances  

Data:  Coinmap.org  

vs  Cards:  •  Lower  

transac<on  fees  •  No  charge-­‐back  •  Pseudonymous  

 -­‐        

 5,000,000    

 10,000,000    

 15,000,000    

 20,000,000    

 25,000,000    

2009  

2013  

2014  

2017  

2021  

2025  

2029  

2033  

2037  

2041  

2045  

2049  

2053  

2057  

2061  

2065  

2069  

2073  

2077  

2081  

2085  

2089  

2093  

2097  

2101  

2105  

2109  

2113  

2117  

2121  

2125  

2129  

2133  

2137  

2141  

12.2m  (58%)    

21m  (100%)  99%  

Most of the bitcoin creation is designed to occur between 2009 and 2025

MODELED BITCOIN CREATION OVER TIME

Data:  BitcoinWiki  

$1,203  

$584  

$210  

$0-­‐1  $35   $2-­‐15  

75x  

1

2

3

Data:  blockchain.info,  Bloomberg  

•  Trading  in  step  func<on  (low  liquidity,  binary  events,  buzz  factor)  

A wild ride up…

HISTORICAL PRICES ($)

•  Trending  up…best  performing  asset  in  2013  (75x)  

•  Tremendous  vola<lity  (2013  realized  vol.  =  100)  

$14  

$1,045  

6.3%  

1.3%  

Average  Daily  %  Move  

0.4%  

€/$  

Biggest  up  day:  +42%  

Biggest  down  day:  -­‐49%  

$1,300bn  

Data:  blockchain.info,  BoFA  Macro  Research  

$1,500bn  

Value of the outstanding stock – low, but not negligible

VALUE OF OUTSANDING STOCK ($)

ETFs  

(private  hands)  

(foreigners  deposits)  

(large  denominated  bills)  

#  Outstanding  Bitcoins  *  mkt.  price  =  $11.5bn  $50bn  

$11.5bn  

$17,559m  

$9,863m  

$7,562m  

$2,434m  

$397m  

$216m  

$100m  (normalized)  

$15m  

$487m  

Data:  blockchain.info,  coinometrics,    companies’  reports  

Transaction volume – once again: low, but not negligible

DAILY TRANSACTION VOLUME ($)

Circa  $100m  

Infrequent  transac<ons:      41/min  (2,000/min  Visa)              

Large  transac<ons:      $1,700  avg.  ($60  avg.  Visa)              

Miners  

-­‐Validate  transac<ons  and  confirm  ownership  

Exchanges  

-­‐Buy/Sell  Bitcoins  against  fiat  currencies  (p2p)  

Wallets  

-­‐Store  bitcoins  -­‐Send/Receive  bitcoins  w/o  fric<ons    

Payment  Processing  

-­‐Enable  merchants  to  accept  bitcoins  payment  w/o  fric<ons  

ETFs  &  Funds  

-­‐Tradable  vehicles  with  bitcoin  underlying  -­‐Buy  bitcoins  in  the  open  market,  repackaged  into  financial  securi<es  

-­‐Winklevoss  twins  filed  plans  to  list  a  Bitcoin  ETF  -­‐SecondMarket  launching  Bitcoin  Investment  Trust  (BIT),  non  listed  -­‐Fortess  Investment  forming  a  Bitcoin  Fund,  non  listed  

32%  mkt.  share  

26%  mkt.  share  

20%  mkt.  share  

ghash.io    BTC  Guild  

Equipment  Makers:  -­‐Avalon  Clones  -­‐Cointerra  

 38%                              26%  Exis<ng  Hash  Power  

Increasingly consolidated value chain & ecosystem – centralize to decentralize?

THE BITCOIN ECOSYSTEM

Data:  bitcoinity  

Data:  The  Bitcoin  Database  (  compiled  by  Joel  Eriksson  Enquist  at  Creandum),  Crunchbase  

Flourishing startup ecosystem, relatively muted VC Involvement despite large outliers

VENTURE HISTORY

319  startups   80  startups  

VC/Angel  Funded   33  startups  (10.3%)  

Total  Funding  $   $87.5m  

Median  $  Funding   $540k  

Outliers  $31.7m  (USV,  A16Z)     $9m  (Accel,  GCP)    

$59m  

$13m  

$4m  

 -­‐        

 10,000,000    

 20,000,000    

 30,000,000    

 40,000,000    

 50,000,000    

 60,000,000    

 70,000,000    

Exchanges/Wallets   Payment  Processing   Miners/Mining  Equipment   Other  

Coinbase   $10m  

Data:  The  Bitcoin  Database  (  compiled  by  Joel  Eriksson  Enquist  at  Creandum)  

The most central parts of the “value chain” have attracted most of the funding

$ VC/ANGEL FUNDING BY CATEGORY

-  Bitcoin Foundation and others call Bitcoin a “crypto-currency” -  Bitcoin is “currency” in the most general sense, since it can be accepted as a means of exchange -  Fulfills most criteria of a medium of exchange, but limited utility due to limited adoption -  Widespread acceptance as a means of payment is key to meet definition of a currency -  Problematic as a unit of account given volatility – hence Bitcoin becomes an intermediate asset

traded into or out of following a transaction in a more commonly accepted currency -  Speculative interest fuels growth in value versus actual transactions, which suggests it is a store of

value rather than a means of exchange

-  Related key question whether Bitcoin will be treated like cash or asset: income vs capital gains tax

Bitcoin has currency features, but viewing it solely as a currency ignores its more widespread application

THE CURRENCY QUESTION

-  Bitcoins have no intrinsic value: there is no interest (cash deposits), no promises of future cash flows (stocks/bonds), nor is there a use value (gold/silver/commodities)

-  However, Bitcoin has significant and interesting features that make it a possible alternate store of value

-  outside of the current financial system -  semi-anonymous -  easily concealable from tax authorities -  low/no correlation

-  Volatility, high barriers to transaction, lack of eg FDIC insurance currently preclude larger asset base moving into Bitcoin

-  As volatility decreases, the utility of features above will likely cause significant capital in-flows

Bitcoins’ acceptance as a store of value currently relies on speculation… “fiat” of a different kind

THE ASSET QUESTION

As Bitcoin volatility decreases, capital will flow into the market based on utility rather than speculation

VOLATILITY VS UTILITY

Capital Inflows  (BTC)

Time  

Speculation  

Utility  

Value Store  

-  If Bitcoin becomes an accepted alternative medium of exchange -  Powering ~10% of global ecommerce transactions: approx. $5B annual transaction volume -  Rising to become a player to rival Western Union/Moneygram: approx. $4.5B market cap

-  If Bitcoin becomes an accepted store of value -  Similar to gold: no cash flows/interest, limited supply, limited traceability -  Total gold outstanding in coins/bars/ETFs is ~ $1.3T -  Based on silver (1/60 value versus gold): ~ $5B potential value

-  Medium of exchange + store of value = ~ $15B market, or $1,300/BTC

-  However, what if BTC becomes truly widely accepted? -  Total currency in circulation: ~ $4T -  If we assume BTC makes it to 1% of all currency = $400B, or $34,000/BTC -  …and the upside is high from there

Bitcoin’s “fair value” will be determined by how widespread its use becomes as a means of exchange

THE $1B QUESTION

-  Hype or reality: what do you think?

-  Friendster/Napster or Facebook/Spotify?

-  Vast economic, social, political, financial implications -  What happens to an international financial system if you can opt out? -  Kiss AML/KYC goodbye: say hello to drugs, terror and tax avoidance

-  And yet, this is thinking too short: -  For the first time ever, Bitcoin decentralizes trust -  You can deal with a perfect stranger at low/no transaction costs -  And a Bitcoin is just a hash – you can attach anything to it contractually…

The implications of Bitcoin are as far-reaching as the advent of the transistor, the PC, the internet…

DISCUSSION