Document Text Content
Investment Management Division
An Overview of the Current State of Cryptocurrencies and Blockchain
Technology
November 15, 2017
Investment Strategy Group
Today’s Discussion
Investment
Management
Division
I. The Cryptocurrency Marketplace
II.
III.
IV.
Blockchain Technology and Potential Uses
How Cryptocurrencies Work
Is Bitcoin a Viable Currency?
V. Is Bitcoin a Viable Asset?
VI.
Cryptocurrency Risks
VII. Key Takeaways
Source: Investment Strategy Group
1
Cryptocurrencies Have Received Enormous Attention
Investment
Management
Division
1. Bitcoin Currency Value – Through November 14, 2017
2. Cryptocurrencies with Market Capitalization over US$1 Billion
$120
7000
6000
6,590
592%
YTD
$100
107.5
$80
USD per Bitcoin (XBT)
5000
4000
3000
$60
$40
30.2
2000
$20
22.6
1000
0
2011 2012 2013 2014 2015 2016 2017
$0
Bitcoin Ethereum Bitcoin
Cash
7.8
3.4 3.3
1.8 1.8 1.7 1.7 1.6
Ripple Dash Litecoin Monero NEO NEM IOTA Ethereum
Classic
• Bitcoin was conceived in 2008 by an anonymous inventor who is known by the pseudonym, Satoshi Nakamoto.
• Since then, an estimated 2,000+ cryptocurrencies have come into existence, with a combined market cap of over $200bn. 1
• There are an estimated 129 focused hedge funds 2 and 121 cryptocurrency exchanges globally. 3
(1) Coinranking.com, (2) https://next.autonomous.com/thoughts//how-many-crypto-hedge-funds-can-you-count, (3) https://cryptocoincharts.info/markets/info
Source: Investment Strategy Group, Cryptocompare.com.
2
Cryptocurrencies have Garnered Diverging Views
Timeline of Statements and Measures over Recent Months
Investment
Management
Division
Japanese
government
recognizes
Bitcoin as
legal tender
Apr. 1, 2017
China
bans
ICOs
Sept. 4, 2017
“It’s a
fraud…worse than
tulip bulbs” 1
–J. Dimon
Sept. 12, 2017
South
Korea
bans
ICOs
Sept. 28, 2017
Japan’s FSA
approves 11
operators of
cryptocurrency
exchanges
Sept. 29, 2017
“Still thinking about
#Bitcoin. No
conclusion - not
endorsing/rejecting” 3
- Lloyd Blankfein
Oct. 3, 2017
“Bitcoin is 'a ponzi
scheme’”
- DBS Group
(David Gledhill)
Nov. 14, 2017
Sept. 11, 2017
Sept. 17, 2017
July 24, 2017
US CFTC
approves
Bitcoin futures
trading
China bans
cryptocurrency
exchanges
BIS publishes
report weighing
risks and
benefits of
cryptocurrencies
Sept. 27, 2017
“[Bitcoin is]
certainly more than
just a fad” 2
– MS CEO, Gorman
Sept. 29, 2017
SEC
charges two
ICOs with
fraud
Oct. 13, 2017
“Index of money
laundering.”
- Blackrock CEO
Larry Fink
(1) Barclays Investor Conference, September 12, 2017. (2) Wall Street Journal Event, September 27, 2017. (3) Twitter, October 3, 2017. (4) CNBC, November 14, 2017.
Source: Investment Strategy Group, public news sources.
3
What is Blockchain Technology?
Investment
Management
Division
Illustrative Schematic: Centralized Network versus Distributed Network
Centralized Network
Distributed Network
• Blockchain is the critical and differentiating infrastructure that underlies cryptocurrencies.
• Unlike most networks today, which rely on a centralized hub, a blockchain is a public distributed network whose
complete database can be accessed and maintained by each member of the network.
• The blockchain is a shared and continually reconciled database. As new transactions occur, data is quickly
disseminated to, verified, and incorporated across all nodes on the network.
• Because it has no single maintainer, the blockchain’s history is resistant to editing by a malicious actor.
Source: Investment Strategy Group, http://cryptocurrencyfacts.com/how-does-cryptocurrency-work-2/ .
4
Blockchain Technology Holds Potential for a Range of
Applications
Investment
Management
Division
1. Financial Market Transactions
2. Identity Validation and Security
Client XYZ
Current
State
T+ 2
DMV
Blockchain-
Enabled
Settlement
T+ 0
Credit Card Issuer
US Dept. of State
Online Retailer
Mortgage Lender
Secure Digital Identity
• Banks are focused on blockchain technology for post-trade
settlement and clearing, with aims to:
� Streamline equities settlement from T+2 to T+0.
• Potential to securely link identity and payment credentials to
a unique individual.
� Benefit peer-to-peer businesses reliant on counterparty
trust.
� Streamline compliance and anti-money laundering
surveillance.
• Goldman Sachs Global Investment Research expects limited blockchain adoption over the next 2-5 years, and broader
acceptance after 5-10 years.
─
Capital market adoption may take over 10 years, given regulatory oversight and the multitude of participants.
Source: Investment Strategy Group, GS Investment Research, Profiles in Innovation: Blockchain: https://360.gs.com/gs/portal/?st=1&action=action.binary&d=21760456&fn=/document.pdf.
Goldman Sachs & Co LLC, Blockchain, The New Technology of Trust, http://www.goldmansachs.com/our-thinking/pages/blockchain/index.html 5
What is a Cryptocurrency and
Why is Blockchain Technology Important?
Investment
Management
Division
Common Features of Cryptocurrencies
Common Features of
Cryptocurrencies
� Digital
Attributes
• Coin ownership is represented by entries on a digital
ledger, not by a physical token.
� Decentralization • No single entity controls the currency.
� Open Source • All source code is available freely online.
� Distributed
Consensus
� Pseudonymity
� Cryptography
(computerized encoding)
• Each cryptocurrency uses a method for obtaining
consensus on ownership without a central arbiter.
• Coin ownership is not linked to real-world identities
within the blockchain.
• Several cryptographic techniques are used to verify
transactions, protect identities, and limit supply.
• A cryptocurrency is a decentralized digital coin. It allows users to make transactions and store money in a secure and
pseudonymous manner.
• All cryptocurrency transactions are recorded chronologically on a blockchain, which acts as the critical infrastructure
underlying a cryptocurrency.
• The process of verifying transactions and ensuring the validity of the blockchain is called “mining.”
• Mining solves the “double-spending” problem that had plagued previous attempts to implement a digital currency.
Source: Investment Strategy Group, http://cryptocurrencyfacts.com/how-does-cryptocurrency-work-2/ .
6
How Do Miners Process Individual Transactions?
Investment
Management
Division
Step 1: Bob wants to pay Alice 0.5 BTC
Illustrative Schematic of a Bitcoin Transaction
Step 2: Miners Verify the Transfer Request and add
it to the next block
Step 3: Block Containing Bob and Alice’s
Transaction is Added to the Blockchain
Bob
Alice
Miner
B
Bob owns 1BTC
Previous transaction
in which Bob was
paid 1 BTC
New transaction
Miner
A
Bob wants to pay
Alice 0.5BTC
Does Bob have
0.5BTC??
Yes!
Miner
C
1) Before sending any bitcoins, Bob must hold bitcoins
in his wallet from a previous transaction (or by
solving a block to earn the mining reward).
2) Bob creates a new transaction in which he pays 0.5
BTC (of his 1 BTC) to Alice.
3) Bob broadcasts this transaction to the network for
validation and inclusion in the blockchain.
Bob has 1BTC
Bob wants to pay
Alice 0.5BTC
Does Bob have
0.5BTC??
Yes!
Record Bob’s
0.5BTC Transfer
to Alice
Record Bob’s
0.5BTC Transfer
to Alice
Bob owns 1BTC
Bob wants to pay
Alice 0.5BTC
Does Bob have
0.5BTC??
Yes!
Record Bob’s
0.5BTC Transfer
to Alice
1) Miner B happens to be the first to solve this block
and adds it to the blockchain. Miner B collects 12.5-
bitcoin reward.
2) If Bob’s transaction is included the block, Alice
becomes the owner of 0.5 BTC, which will register
in her wallet.
• Consensus transaction validation creates a book of record for all transactions that have ever occurred.
– Transactions may only occur if they are supported by evidence from previous transactions.
– To send bitcoins, an owner’s wallet uses its private key to prove ownership of the referenced bitcoins.
• Transaction processing typically take 10-20 minutes, but can take up to 18 hours if the network is congested.
Source: Investment Strategy Group. 7
What is Mining?
Investment
Management
Division
ASIC Mining Computer and a Mining Rig
6.2”
13.8”
5.3”
• Miners use highly specialized computers designed to run an algorithm that attempts to solve a cryptographic puzzle in order
to add a new block on the blockchain. By design, a bitcoin block is created once every ten minutes.
• The computing power required to solve the cryptographic puzzle is high and expensive; bitcoin mining consumes an
estimated $1.3bn worth of electricity annually 1 —equivalent to Ireland’s annual electricity consumption.
• In order to incentivize mining, the first miner to complete a block is rewarded 12.5 bitcoins. The global supply of bitcoins is
capped at 21mil (currently ~16.5m) and follows a predetermined growth rate—the miners’ rewards halve every four years.
• Given ~1-1.5m mining units globally, the likelihood of any one miner solving a block is low. Many miners join “mining
pools,” which are cooperatives which share block rewards proportionate to contributed mining power.
– Mining pools are highly concentrated; the top four pools represent over 50% of total mining power.
(1) Bitcoin Energy Consumption Index: https://digiconomist.net/bitcoin-energy-consumption
Source: Investment Strategy Group, http://cryptocurrencyfacts.com/how-does-cryptocurrency-work-2/.
8
ICOs Fund the Development of New Currencies
Investment
Management
Division
1. Approximate Funds Raised by ICOs by Calendar Year (US$ Milllions)
2. Total Funds Raised by Month (US$ Millions): Angel and Seed Stage
Internet VC versus ICO
$4,000
900
Angel & Seed VC Funding (Internet)
ICO Fundraising
839
Approximate Annual Funds Raised Through ICOs ($mil)
$3,500
$3,000
$2,500
$2,000
$1,500
$1,000
$500
$0
$3,461
$222
$26 $14
2014 2015 2016 2017 YTD
Total Funds Raised ($Mn)
800
700
600
500
400
300
200
100
0
369
346
298
262 271
256
259 268 278
235
235
207
190
80
638
572
397
319
230 237
2 12 12 12 21
5 15 25 19
7/16 8/16 9/16 10/16 11/16 12/16 1/17 2/17 3/17 4/17 5/17 6/17 7/17 8/17 9/17
• New blockchain-related projects are funded via an Initial Coin Offering (ICO). This process raises capital through token sales.
• In an ICO, the object offered is either a new digital coin or a yet-undeveloped concept in search of funding. ICO investors
purchase an ownership percentage of a future money supply or functionality.
• While many ICOs support legitimate use cases, Autonomous Research asserts, “unfortunately, many ICOs are fraudulent.” 1
• Rather than raising fiat currency, ICOs primarily raise capital in the form of Bitcoin and Ether, driving additional demand for
the cryptocurrencies.
(1) #Token Mania, Autonomous Research, July 2017.
Source: Investment Strategy Group, Bloomberg, Goldman Sachs Global Investment Research, Cryptocompare.com.
9
Why Have Cryptocurrencies Rallied So Much?
Investment
Management
Division
1. Bitcoin Supply Over Time (Million Tokens)
2. Currency Composition of Bitcoin Purchase Volume
25
100%
US Dollar Japanese Yen South Korean Won Chinese Renminbi Euro Polish Zloty British Pound
90%
20
80%
Bitcoin Supply (Million)
15
10
5
Current Supply
70%
60%
50%
40%
30%
20%
10%
0
2009
2014
2019
2024
2029
2034
2039
2044
2049
2054
2059
2064
2069
2074
2079
2084
2089
2094
2099
2104
2109
2114
2119
2124
2129
2134
2139
0%
2011 2012 2013 2014 2015 2016 2017
• In addition to speculation, which has been the biggest driver of cryptocurrency appreciation, other drivers include:
• Perceived Scarcity: Bitcoin’s 21 million token cap is expected to be reached in 2140 (16.5 million today). Many of the
over 2,000 other cryptocurrencies, however, do not have a capped supply. Further, while unlikely, bitcoin’s token cap
could be raised if a consensus of programmers decided so.
• Desired Safe-haven: Increased global participation reflects desire for an asset independent from governments or central
banks (“digital gold”). Many governments from which investors have sought diversification, however, have recently
banned domestic crypto-exchanges.
Source: Investment Strategy Group, Bloomberg, Cryptocompare.com.
10
As Bitcoin Ownership is Not Anonymous, Illicit Use has Fallen
Investment
Management
Division
Larry Fink on Bitcoin’s Illicit Use
"Bitcoin just shows you how much demand for money
laundering there is in the world. That’s all it is. It’s an
index of money laundering.”
– BlackRock CEO Larry Fink, October 13, 2017
• Because bitcoin is pseudonymous, not anonymous, users’ real-world identities are ascertainable once the individual
converts bitcoin to fiat currency.
• Digital intelligence companies continually scan the blockchain to identify suspicious transaction activity.
• The Blockchain Intelligence Group estimates that illegal transactions in bitcoin fell from ~50% of total volume in 2015
to ~20% in 2016, and represent “significantly less than that” today.
• As law enforcement has become better able to track bitcoin ransom, cybercriminals have begun to favor currencies that
allow anonymity, such as Monero and Zcash, and even Ether.
Source: Investment Strategy Group, Blockchain Intelligence Group, https://www.cnbc.com/2017/08/29/dark-web-finds-bitcoin-increasingly-more-of-a-problem-than-a-help-tries-otherdigital-currencies.html.
11
Sovereign Currencies Meet Three Criteria
Investment
Management
Division
1) They are used as a medium of exchange.
– To represent a medium of exchange, an instrument must facilitate the transaction
of goods or services between parities (US$ are used to buy a barrel of oil).
2) They serve as unit of account.
– A unit of account is a measurement which allows value to be accounted and
compared (a barrel of WTI is worth ~$55).
3) They are a store of value.
– A store of value is an asset that can be saved, stored, and exchanged in the future
for a predictable stable value (with 2% annual inflation, a nominal dollar today
will be worth 82¢ in 10 years).
Source: Investment Strategy Group, Do Digital Currencies Pose a Threat to Sovereign Currencies and Central Banks?, Daniel Heller, PIIE.
12
Do Cryptocurrencies Meet the Criteria for Currencies?
1) Bitcoin is an Inefficient Medium of Exchange
Investment
Management
Division
Average Transaction Fees (US$ Monthly Average)
6
5
4
$ Per Transaction
3
2
$3.4
$2.1
1
0
Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17
• Processing is expensive. The average transaction cost is ~$3.40, rendering transfer of small fund balances uneconomical.
• Processing is slow. Transaction processing typically takes a minimum of 10-20 minutes, but can take up to 18 hours if
the network is congested (Visa and Mastercard authorize transactions in ~20 milliseconds).
• Bitcoin is not broadly accepted. A mere 9k merchants accept bitcoin, compared to the 37mil that accept Visa and
MasterCard, and the billions of merchants and people globally that accept US dollars. 1
• Further, the IRS considers all cryptocurrency gains a taxable event (including for de minimis purchases).
(1) Do Digital Currencies Pose a Threat to Sovereign Currencies and Central Banks?, Daniel Heller, PIIE.
Source: Investment Strategy Group, Bloomberg, Cryptocompare.com. 13
Do Cryptocurrencies Meet the Criteria for Currencies?
2) Bitcoin is an Unreliable Unit of Account
Investment
Management
Division