Introduction to CryptoEconomics New frontier or tulip mania?

Sep-2017

Disclaimer → This report is not an investment recommendation → There is no direct connection between past performance and future results → Do not invest more than you can afford to lose → Always control and keep private keys safe → Invest on your own only if you understand technology → Give funds to third party only if you trust incentives of the team which will be managing assets on your behalf → Do not stress and have fun

1

Table of Content I.

Gentle introduction to CryptoEconomics

II. Deep dive to public blockchain – technical, but essential to understand and follow the topic! III. DApps - Would we see social media, messaging and other apps in a decentralized form? IV. Infrastructure – gate from fiat to crypto world V. Contacts

2

I. Gentle introduction to CryptoEconomics

3

CryptoEconomics has emerged and it is difficult to ignore. Bitcoin is its core, but CryptoEconomics expands far beyond it CryptoEconomics market capitalization US$bn

Source: Coindance

Relative performance: crypto vs. traditional assets LTM

Source: Coindance, Bloomberg

Last twelve months Bitcoin outperformed all traditional assets and was itself outperformed by emerging CryptoEconomics asset class

4

Bitcoin was introduced by Satoshi Nakamoto in 2009. It innovated blockchain technology and gave a birth to the new ecosystem - CryptoEconomics

Enterprise Solutions

Private

Crypto Currencies

Public

Decentralized application platforms

Public

Decentralized applications

Public 5

Attention to CryptoEconomics from investment community and social media is increasing y-o-y In 2017 for the first time ICOs funding exceeded venture capital... US$mln

…while retail and social media attention is still primarily with Bitcoin Google trends index 120

Bitcoin

Ethereum

Blockchain

Cryptocurrency

100

80

60

40

20

0 Aug-15 Source: Coindesk

Nov-15

Feb-16

May-16

Aug-16

Nov-16

Feb-17

May-17

Aug-17

Source: https://trends.google.ru/

Some understand the underlying technology and other don’t, but everyone – from JP Morgan CEO Jamie Dimon to regular Joe - has an opinion about Bitcoin and CryptoEconomics these days

6

Majority of global regulators are taking a closer look at blockchain technology and CryptoEconomics 58 countries Permissive

8 countries Contentious

3 countries Hostile

Source: http://map.bitlegal.io

Regulation of CryptoEconomics is a matter of time. Recent actions in China confirm that regulator’s agenda is to regulate participants and instruments rather than banning CryptoEconomics as an asset class

7

Impact of CryptoEconomics on the real economy may be significant, but it’s a matter of time, tech development and regulation 58% of surveyed executives from tech sector believe 10% of global GDP will be stored on blockchain by mid-2020s…

… and blockchain technology would have the greatest impact on finance industry

US$trln 84.6

Finance

75.2

77%

Identity

54%

Property title

63x

9.4 0.15 World GDP 2025

RegularE

CryptoE 2025

Source: WEF, Bitcoin and Blockchain Thought Leader Annual Survey, RCP Research

38%

Communication

23%

Decentralized coordination

23%

Other

15%

Privacy

15%

CryptoE Sep-16 Source: WEF, RCP Research

Evangelists say it would change everything and skeptics say it would die and change nothing. The answer most likely will be somewhere in between, but to which of these two extremes the outcome skews towards and when it will do so is the subject of much speculation

8

II. Deep dive to public blockchain – technical, but essential to understand and follow the topic!

9

Using Bitcoin example to understand key terms and definitions 1

Bitcoin uses a distributed database to store transactions

Distributed ledger

2

in blocks, which refer to previous blocks,

Blockhain

3

and anyone can join the network

Public / permissionless

4

submit transactions

Users

5

create and add blocks

Miner

6

subject to commitment of computational resources

Hash power

7

and validate transactions and blocks by

Miner / Node

8

using consensus algorithm

Proof of work 10

Top-10 public blockchain account by ca. 70% of CryptoEconomics capitalization and represented by cryptocurrencies and decentralized applications platform Consensus algorithm

Highlight

→ $62.0

→ PoW, SHA-256

→ Peer-to-peer cryptocurrency → Digital gold

→ $270

→ $25.6

→ PoW, Etash

→ Smart contracts and decentralized applications platform

→ Cryptocurrency

→ $420

→ $6.9

→ PoW, SHA-256

→ Fork from Bitcoin

→ XRP

→ Permissioned settlement system

→ $0.17

→ $6.7

→ Trusted ledger consensus

→ Settlement system for banks

→ 2011

→ LTC

→ Cryptocurrency

→ $48

→ $2.5

→ PoW, Scrypt

→ Peer-to-peer cryptocurrency → Digital silver

→ DASH

→ 2014

→ DASH

→ Cryptocurrency

→ $358

→ $2.7

→ PoW, X11

→ Privacy-centric digital currency with instant transactions

7

→ NEM

→ 2014

→ XEM

→ Decentralized applications platform

→ $0.21

→ $1.9

→ Proof-of-Importance

→ Smart contracts and decentralized applications platform → P2P messaging system

8

→ IOTA

→ 2015

→ MIOTA

→ Cryptocurrency

→ $0.53

→ $1.5

→ n/a

→ Cryptocurrency for internet-of-things

9

→ Monero

→ 2014

→ XMR

→ Cryptocurrency

→ $89

→ $1.3

→ PoW, CryptoNight

→ Private and untraceable cryptocurrency

10

→ Ethereum clasic

→ 2015

→ ETC

→ Decentralized applications platform

→ $10

→ $1.0

→ PoW, Etash

→ Fork from Ethereum

№

Name

Year

Ticket

Type

1

→ Bitcoin

→ 2008

→ BTC

→ Cryptocurrency

→ $3,743

2

→ Ethereum

→ 2015

→ ETH

→ Decentralized applications platform

3

→ BCash

→ 2017

→ BCC

4

→ Ripple

→ 2012

5

→ Litecoin

6

Source: https://coinmarketcap.com, Sep-23,2017

Px US$

MCap US$bn

11

Bitcoin price performance Bitcoin price performance since Jan-1, 2012

Key events:

US$ 1

Oct-14, 2013 Baidu begins accepting Bitcoin

2

Nov-20, 2013 Subway begins accepting Bitcoin

4,000

3

Dec-13, 2013 China's Central Bank bans Bitcoin transactions

3,500

4

Feb-24, 2014 Mt. Gox closed

5

Jan-4, 2015 Bitstamp hacked

2,500

6

Apr-1, 2017 Japan declared Bitcoin as legal tender

2,000

7

May-23, 2017 Number of Tx/day reach all time high

8

Jun-1, 2017 Bitcoin hard fork fear

9

Aug-1, 2017 Bitcoin Cash splits from Bitcoin

5,000 11

BTC Price

4,500

3,000

8

10

9

1,500 3

6 4

1,000 1st halving day

7

2

500

5

0 Jan-13 May-13 Sep-13

End of Aug, 2017 SegWit locked in

11

Sep-13, 2017 China gov orders to stop local bitcoin trading

2nd halving day

1 Jan-12 May-12 Sep-12

10

Jan-14 May-14 Sep-14

Jan-15 May-15 Sep-15

Jan-16 May-16 Sep-16

Jan-17 May-17 Sep-17

Source: RCP Research

Regulation, technological development of Bitcoin protocol, business use of Bitcoin and malicious attacks have had significant impact on Bitcoin price during last years

12

Bitcoin is a pure speculation now. Multi-billion question - can it fulfill vision of its creator? Key facts

Network scale and security increased by 3.5x in LTM… 10

250 Hash rate, mln TH/s

8

245

6

240

4

235

2

230

0

225 Sep-16

Nov-16

Jan-17

Mar-17

Founder

→ Satoshi Nakamoto

Vision

→ Peer-to-peer digital currency

First block

→ Jan-3, 2009

Token

→ Bitcoin = BTC → 1 BTC = 100,000,000 Satoshi

Mining

→ Proof of work, SHA-256 → Block size 1 megabyte → 1 block every 10 minutes, ca. 2K Tx per block

Supply

→ BTC supply is capped at 21mln BTC → 75% has already been mined

Security

→ Bullet proof and military grade → Hash rate: 7.8mln TH/s (3.5x Y-o-Y growth)

Network processing capacity

→ Max of 3 transactions per sec → Fully utilized, scaling is required

Transaction confirmation time

→ Minimum: 10 minutes, e.g. 1 block → Recommended: 60 minutes, e.g. 6 blocks

Users

→ 17mln BTC wallets (2.3x Y-o-Y growth)

Development community

→ Bitcoin Core → >1000 developers, etc.

Difficulty, #

May-17

Jul-17

Sep-17

Source: https://blockchain.info

…and reached its transaction processing capacity limit 4.5

Tx/second

4.0 3.5 3.0

Maximum transaction capacity

2.5 2.0 1.5 1.0 0.5 Jan-11

May-12

Sep-13

Jan-15

May-16

Sep-17

Source: https://blockchain.info

13

Miners economic incentive mechanism embedded into Bitcoin PoW protocol creates additional pressure to scale the network ca. 90% of the miners revenue comes from the block reward that halves every 210,000 blocks…

…currently users are paying only a fraction of the miners fees, but this is not sustainable long term Miners revenue as % of daily transaction volume

Block reward, BTC

25

BTC supply, mln

0.80%

50.0 50.0

20

40.0 15 30.0

0.09%

Tx cost

25.0 10

Block reward

Miners revenue

Source: RCP estimates

Decreasing miner compensation could be balanced by increase in…

20.0 12.5 5

10.0

1,956 BTC daily

60.0

6.3 3.1

1.6

0.8

0.4

0.2

2028

2032

2036

2040

0.0

Bitcoin price

Tx Fees

Tx volume

x

x

x

0 2009

2013

Source: RCP estimates

2016

2020

2024

Source: RCP estimates

Mining is essential to cryptocurrency as it provides security of the network, lack of economic incentive would eventually result in decrease of security and make Bitcoin more vulnerable for the malicious attacks

14

Ethereum price performance Ethereum price performance since ICO Key events:

US$ 7

400

8

Daily ETH exceeded BTC transactions

350

300

1

Mar-14,2016 HomeStead protocol upgrade to ETH network

2

Apr-30, 2016 DAO established and raised US$150m

3

June-12, 2016 DAO is compromised by the hacker, US$60mln lost

4

July-02, 2016 Ethereum Classic hard fork

5

Nov-11, 2016 Further improvement of ETH protocol, thwarted further spam attacks

6

Apr-1, 2017 Japan declared Bitcoin as legal

7

Julu-2017 1st all time high for BTC in 2017– US$2,800

8

Sep-2017 2nd all time high for BTC in 2017 – US$4,800

9

Sep-2017 Announcement of technological roadmap for 2017-2018

250 9

200

150

100 ICO Mania begins

50

0 Nov-15

Jan-16

1

2

Mar-16

May-16

3

4

Jul-16

6

5

Sep-16

Nov-16

Jan-17

Mar-17

May-17

Jul-17

Sep-17

Source: RCP Research

Bitcoin developments as well as ICO mania have had significant impact on Ethereum price during last year

15

Ethereum is an evolution of blockchain technology from being a pure cryptocurrency to a foundation layer for DApps Key facts

Network scale and security increased by 19x in LTM… 100.0 Hash rate, K GH/s

90.0

250

Founder

→ Vitalik Buterin and the team

200

Vision

→ Censorship-resistant self-sustaining decentralized world computer that can perform calculations, store data, and allow communications

First block

→ July-30, 2015

Token

→ Ethereum = ETH → 1 ETH = 1,000,000,000,000,000,000,000 Wei

Mining

→ Proof of work, Etash → Maximum block size in Ethereum is around 5.0mln Gas. Average transaction = 50,000 Gas

Supply

→ Uncapped → Constant supply- ca. 18mln. ETH/year → May change when PoW -> PoS

Security

→ High → Hash rate: 97.6 K GH/s (19x Y-o-Y growth)

Network processing capacity

→ Max of 6 complex Tx per sec, e.g. smart contracts → Fully utilized, scaling is required

Transaction confirmation time

→ Minimum: 17 seconds, e.g. 1 block → Recommended: 2 minutes, e.g. 6 blocks

Users

→ 3.5mln ETH wallets (7x Y-o-Y growth)

Development community

→ Ethreum Foundation → Turing colmplete programming language

Difficulty, #

80.0 70.0 60.0

150

50.0 40.0

100

30.0 20.0

50

10.0 0.0

0

Sep-16 Nov-16 Source: https://blockchain.info

Jan-17

Mar-17

May-17

Jul-17

Sep-17

…and as well as Bitcoin has reached its capacity limit Tx/second 7.0 6.0

Maximum transaction capacity

5.0 4.0 3.0 2.0 1.0 Jul-15

Dec-15

May-16

Oct-16

Source: https://etherscan.io, http://www.ethgasstation.info

Mar-17

Aug-17

16

Ethereum developers proposed miners incentives mechanism whereby miners are not required to compensate its falling revenues by users users are paying only a fraction of the miners’ revenue and it looks sustainable until ETH supply model stands unchanged

For the time being Ethereum protocol assumes unlimited supply of its token with a stable block reward…

Miners revenue per one block 120

Sypply, ETH mln

7.0

Reward, ETH/block

100.00%

6.0

110

5.0 100 4.0 0.01%

90 3.0

Tx cost

Block reward

Miners revenue

Source: RCP estimates

80 2.0

70

One of the questions is how migration from PoW to PoS would impact existing equilibrium?

1.0

PoW 60 Jul-15

PoS

0.0 Oct-15

Source: RCP estimates

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Jul-17

17

Scaling is the main and universal challenge for the public blockchain that stands on a path to the mass adoption In order to scale public blockchain to a billion of users…

…community needs to develop a technical soliton(s) to find an equilibrium between security, speed and cost

Transaction cost

High

Medium

Medium

Low

Low

Security

High

High

Medium

Medium

Medium 175,000

Processing capacity (Tx/ second)

1,700

3 BTC

7 ETH

200 PayPal

VISA

Facebook

Source: @VladZamfir | Twitter Source: RCP Estimates

18

Various scaling alternatives are being considered and implemented by the blockchain community Security

Speed

Tx cost

№

Solution

BTC

ETH

WTF?

Status

1

→ Segregated witness

Yes

No

→ Decreases average size of Tx → Increases number of Tx that could be fit in one block → Expected Tx processing capacity increase – 60%

→ Implemented in Q317

2

→ 2MB block size

Yes

No

→ Increases block size from one to two megabyte → Increases number of Tx that could be fit in one block → Expected Tx processing capacity increase by 2x times

→ Ongoing debate → Hard fork is needed → May happen in Q417

3

→ Off-chain payment channels

Yes

Yes

→ Mechanism by which Tx that would normally occur on the blockchain instead get conducted off of the blockchain

→ Ongoing debate → BTC: Lightning → ETH: Raiden

4

→ Sharding

Yes

Yes

→ Blockchain is separated into different shards → Each shard is process by different nodes → Shards communicate to form the blockchain

→ Ongoing debate → ETH is more advanced

5

→ Plasma

No

Yes

→ A series of contracts that run top of a blockchain and treated as blockchain with its own history and computation – “Plasma child chains”

→ Ongoing debate → May happen in 2018

6

→ Off-chain computation

No

Yes

→ Mechanism by which computation, e.g. PoW that would normally occur on the blockchain instead get conducted off of the blockchain

→ Ongoing debate → May happen in Q118

7

→ Proof of stake

No

Yes

→ Stakeholders vote with their “dollars” instead of computational power

→ Ongoing debate → May happen in 2018

Source: RCP research

There is no single silver bullet to deal with the scaling challenge - most likely combination of various approaches will eventually solve the issue and allow public blockchain to leap forward

19

If scaling issues are resolved and Bitcoin is not banned by the regulator, the price could rise by multiples Metcalfe’s law - network value is equal to the number of connected users^2 …

…give an indication that w/o resolution of the scaling issue BTC price should be around US$2,000 80

US$bn

BTC/US$ Mcap

Network

Peers

Connections

Value

5,000

Matcalfe's law 4,500

70

4,000 60 3,500

2

1

4

50

3,000

40

5

10

25

2,500 2,000

30 Average mining cash cost/ BTC

1,500

20 1,000

12

66

144

10

500

Jan-13

Aug-13

Mar-14

Oct-14

May-15

Dec-15

Jul-16

Feb-17

0 Sep-17

Source: RCP Research

It seems that market is already pricing the resolution of the technical issue on the back od SegWit implementation, but it is not the case yet and therefore ST price correction to US$1,500-2,000 is possible

20

III. DApps - Would we see Social Media, Messaging and other apps in a decentralized form?

21

As Ethereum and DApp platforms persist, the DApp ecosystem is able to roll out

Prediction markets

Augur REP

Gnosis GNO

Gaming

GameCredits GAME

FunFair FUN

First Blood 1ST

Data Storage

Siacoin SIA

Storj STORJ

Asset Managers

Iconomi ICN

Melonport MLN

Filecoin File

Capitalization of DApp ecosystem has exceeded US5.5bn in 2H2017. It is below 10% of the total CryptoEconomics capitalization, but has the highest potential

22

ICOs – an objective was and is to introduce a funding tool for open software development projects… Token’s functionality can vary… Asset

Peers

Connections

Value Network utility

Token

ETH

IOTA

STORJ

REP

0x

Overview

DApp platform

IoT currency

Storage platform

Prediction market

Decentralized exchange

ICO date

07/22/14

11/25/15

7/18/14

08/01/15

08/15/17

ICO price

$0.311

$0.000

$0.009

$0.602

$0.048

x Debt / Equity

Real life asset holder

x

x

Ethereum DApps account for 5% of its Mcap 25.6

Current price

$283.350

$0.537

$0.552

$18.009

$0.194

US$ ROI

+90,886%

+123,511%

+6,021%

+2,890%

+305%

BTC ROI

+522%

+1092%

+749%

+794%

-7%

1.6 ETH

ETH DApps

Source: RCP Research

Ethereum was funded via ICO in 2014 and probably is the best up-to-date example whereby developers team delivers its ICO promises

23

… today 95% of the ICOs is a dog fight between greed and fear in a wild-wild west Everyone irrespective of business niche or needs…

Source: @VladZamfir | Twitter

… is doing or thinking about ICOs these days…

Source: @VladZamfir | Twitter

Current state of the ICOs mania is harmful to the CryptoEconomics. External regulation which is being introduced by SEC and other global regulators is a positive news for the crypto community

24

IV. Infrastructure – gate from fiat to crypto world

25

Blockchain infrastructure is evolving with a fast pace together with CryptoEconomics Infrastructure

Crypto Exchange

Wallets

Payment rails

Mining

Facilitating payments using cryptocurrency

Folks that hold, secure and add new blocks to blockchain

$

Function

Purchase, sale and trading of cryptocurrency

Storage of crypto currencies and assets

Examples

Source: RCP research

26

Crypto-exchanges are an investor’s gate from fiat to the crypto world …and as anticipated Bitcoin and Ethereum are dominating the trading volume

More than US$2bn worth of assets are daily changing hands on the crypto-exchanges… US$mln

484

Bitcoin

Ethereum

Bitcoin Cash

Litecoin

Other

481 453

26.0% 40.28%

262

180

168

160

6.98%

159 135 111

8.78% Bithumb KRW

Bitfinex US$

BitMEX US$

Bittrex Crypto

GDAX US$

Poloniex US$

Source: https://coinmarketcap.com/exchanges/volume/24-hour/all/, as of Sep-22,2017

Kraken Coincheck HitBTC EUR

JPY

Crypto

Coinone

17.97%

KRW Source: https://coinmarketcap.com/exchanges/volume/24-hour/all/, as of Sep-22,2017

Top-tier crypto exchanges are located in a jurisdictions with crypto-friendly environment such as Japan South Korea or in USA whereby they are licensed by the local state authorities

27

You would need a wallet to store cash/asset, even if it is a digital one Wallet type

Security Score

Clint has access to private key

Cryptography work

Transaction validation

Hot wallet

0

No

Third party

Third party

Light dependent

1

Yes

User’s computer

Third party

Light independent

2

Yes

User’s computer

SPV

Hardware wallet

2

Yes

User’s USB stick

SPV

Full client

3

Yes

User’s computer

Full node

Paper wallet

3

Yes

Client side

Computer is needed

Example

Source: RCP research

To draw the analogy – public key is a debit card and private key is the pin, so the objective is to control and keep private keys in the safe place

28

Crypto exchanges and wallets are relying on the software and therefore are subject to malicious hacker’s attacks Hack

MtGox

DAO

Parity

Date

2012

2016

2017

Asset type

Exchange

DApp

Wallet

Size

US$450mln

US$60mln

US$32mln

Why?

Exchange wallet was compromised

Vulnerability of smart contract

Code of multi sig wallet was compromised

Hack Consequences

MtGox bankruptcy and bitcoin price recession

ETH hard fork

-

Investigation results

Some funds were returned

Funds are not returned

Funds are returned by White Hat Hackers

Source: RCP research

Source: @VladZamfir | Twitter

Malicious hacker’s attacks have had significant impact on Bitcoin and Ethereum infrastructure, but never effected underlying blockchain networks

29

Pace of payment infrastructure roll-out would depend on the resolution of the scaling issue and regulators view on the cryptocurrencies Bitcoin to Business

Source: https://coinmap.org/

30

V. Contacts

31

Please let us know should you have any questions. You feedback is much appreciated… → Nikolay Vasilkov [email protected] → Marina Alekseenkova [email protected] → Igor Mazilin [email protected]

…as well as donations if you find materials beneficial to you: 1GYtmdJmwEMDTL7QrXSDJonPrcssMucvWk 32