Blockchain, Where Do We Go Now?

With the recent downturn in the crypto markets, there is much speculation about what will lead to a resurgence of the market. The difference of opinion usually turns on whether people believe hype is more important than fundamental value for this market. For those who think hype will lead to a resurgence, milestones like the opening of the Bakkt exchange e (operated by the owner of the NYSE) or the approval of a bitcoin ETF could really move the needle. This thinking also assumes the value of the general market will remain coupled to the value of bitcoin for the foreseeable future. The other school of thought is that like the internet stock market in the early to late nineties, value will only happen when actual projects are fleshed out. Obviously any forecasting of the evolution of the market is not simple, however, I will attempt to lay out some factors I think will drive the growth of the market over the next few years.

Problems

1) The general public still thinks of bitcoin when they think about cryptocurrencies. The wild fluctuations in the price of bitcoin has decreased confidence by many in the near term value of cryptocurrencies. Because of this, many projects with great promise are being undervalued.

2) Most existing smart contract platforms face significant hurdles to scaling. Many think of scaling as a smart contract being able to do a certain number of transactions per second (which is arguably a premature optimization, but one that most systems are not designed to accomplish yet), however, there is still the question of bandwidth and storage. Most systems with main nets functioning not only do not have the capacity to scale with all 3 of these components in mind, they do not have credible solutions to do so. There’s also the interoperability issue. Smart contracts are not yet capable of seamlessly interacting with smart contacts on other blockchains.

3) In the EU and US, securities regulatory framework still internalize the logic of Depression-era securities laws. Moreover, in the US, although the onerous federal laws are ubiquitous, the state level laws vary greatly and regulatory arbitrage is not as feasible for small businesses in the US (In NYC, bit licenses are required for virtual currency businesses). The harmonization of these laws as the security token infrastructure grows should bring a lot of capital into the ecosystem thereby restoring trust in some of the more credible projects.

4) Legacy financial systems are mostly not designed to interface with the virtual currency world. Because of this, the current processes for buying virtual currency are generally onerous with significant restrictions on the amount of capital that can flow into the ecosystem in short periods of time.

The Way Forward


Bitcoin

If the growth of bitcoin is the catalyst for the accrual of value in the crypto ecosystem, such value will likely be short-lived. Currently, bitcoin’s only value is its ubiquity in entering and exiting the crypto markets, and its memetic value. Many think this is enough. The thinking is that the increased adoption of bitcoin should lead to increased demand for bitcoin, which will inevitably lead to an increase in the value of the currency. There are some potential problems with this view. Mere demand is typically not enough to drive the price of an asset if the velocity of the asset is high. There often has to be an incentive to decrease the velocity of the asset. In other words, people have to hold the asset because they think it is worth holding (this is typically true through dividends or an objective reason to think the asset will provide more value in the future (like the maturation of a technology that will generate a revenue stream)). In the case of bitcoin, there are no dividends, and the only value would be a change in the number of consumers that use the product. Moreover, unlike ethereum, there is no potential move to a proof of stake system (such a system would allow ether holders who lock up their assets to receive passive income). Finally, bitcoin has no unique properties that would be particularly useful for commerce. With the appropriate infrastructure in place, stable coins will more useful for commerce than bitcoin currently is.

The best argument for bitcoin is that the current network will lead to it becoming something akin to digital gold. While this is possible, it’s still an argument worth being weary of. Gold has been seen as a safe way of storing value for millennia. Bitcoin, on the other hand, is a decade old concept that has seen a shocking amount of volatility. So much so that the top technical analysts on wall street have advised against investing in it despite its meteoric rise. Jeff deGraaf, the head of technical research at Renaissance technologies (the most profitable hedge fund in the world) pointed out that no asset with the parabolic movement of bitcoin over the past 12-18 months has ever regained public trust. So while asset prices might increase with bitcoin if there is a regulatory breakthrough like an ETF, assuming crypto market appreciation because of perpetual speculative value on a 10-year-old technology is likely not wise.

Limitations of the Smart Contract Ecosystem

Scaling and interoperability are huge issues for many projects in the space. While many projects are promising a way to solve this problem, it is simply not clear who will be able to do so in a meaningful way. Vitalik Buterin of Ethereum has made many promises however, none have materialized. Projects like Cardano have formal proofs that validate their approach to proof of stake, and other features should allow them to scale. However, Cardano’s test net won’t be up until 2019 (and it’s not clear when the main net will be up). Since many of these projects will only be capable of generating significant revenue in an economy where many transactions are carried out on the blockchain, solving this problem in a meaningful way will likely be a catalyst for the appreciation of worthwhile assets.

Regulations and Security Tokens

Another potential catalyst for crypto-asset appreciation is the growth of a significant security token ecosystem, and the regulatory harmonization likely to accompany it. Currently, the laws between the EU, US and other jurisdictions present some serious barriers for companies not capable of dealing with the regulatory infrastructure. The capacity to bring significant liquidity to illiquid assets like real estate will likely bring a lot of capital into the ecosystem. While it is not clear how much many adjacent assets will appreciate due to this influx of capital, smart contract platforms capable of scaling, or projects that become an important part of the security token infrastructure, should gain a lot of value when the technical and legal framework for these tokens become robust. Projects like Harbor (CEO is the former General Counsel of Blackwater), Securitize and Polymath will likely be winners in this space.

Infrastructure of Legacy Banking Systems

This is likely going to be the last bottleneck. Lobbying can change laws and developers can scale systems. However, banks are inherently conservative in updating technology. Moreover, the SWIFT system is integrated into the entire global financial ecosystem. Creating reliable infrastructure for this reality will include things like formalizing KYC/AML policies (the solution for this might depend on the success of projects like Sovrin), and most banks being able to accept a wide range of currencies and immediately changing them to some sort of fiat currency (at least initially). Building out this infrastructure should take time. Smart contract platforms like Cardano, understanding the importance of solving this problem are building out technological stacks that should more readily be able to interact with financial systems. Ripple is famously trying to replace the SWIFT system with their technology.

Because it is often easier to build new systems than update complicated existing ones, the first crypto banking services will likely be provided through banking startups. There are already many interesting smaller banking startups trying to solve this problem. Because this is an obvious problem many companies are working on, I will only mention one to illustrate the kinds of problems that need to be solved.

Fotonbank is a young company attempting to take advantage of the growing demand for crypto banking. The project is promising a few key features:


1) Being able to issue virtual cards with multicurrency wallets;


2) An exchange where cryptocurrency and fiat money can be changed instantly;


3) A variety of business services combining work systems for users Fintech partners and data centers to store payment history;


4) Its own blockchain for financial transactions, data storage, clearing and business;


5) Customizable stable coins (not necessarily tied to the dollar).

These features will be critical in the first stage of the growth of crypto banking. Many projects have solved one or two of these problems. Projects like Basis and Gemini are trying to solve the stable coin problem. Binance has created a platform where stablecoins like tether can instantly be exchanged for fiat however, there is a 2 BTC limit on how much can be withdrawn per day (a similar number is true of Gemini’s exchange). Projects like TenX have issued cryptocurrency cards in the EU. And while a project like 0x is very useful, the regulatory environment around companies promising to build decentralized exchanges is not clear. After all, the SEC recently fined the creator of decentralized exchange etherdelta.

Multilevel integration is the name of the game for banking. As mentioned above, many projects (some banking focused and some not) are attempting to solve problems that need to be solved for the ecosystem to grow. However, there are very few attempting integration in a meaningful way. Projects like ZeosX promise to bring similar projects to market however, they have not even released a white paper. Fotonbank is worth keeping an eye out because they are one of the few projects attempting to integrate many elements of traditional banking with the crypto ecosystem.

Takeaway

Buy low sell high


Do not live or die by bitcoin


Speculative value could increase in the near future however, many pieces need to be in place for these projects to generate fundamental value. These include:


a) maturation of the technology for scaling and interoperability


b) regulatory harmonization to decrease barriers for the securitization of assets that normally would not be, and


c) new banks will likely lay out the infrastructure that legacy banks will follow.

Keep these in mind, invest in projects you think will be valuable in 10 years and HODL.

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