NEO Is Overvalued Versus GAS

Jakub Rehor, CFA Jeffrey Alton, CFA Carrie Wang Chief Investment Officer Director of Research Investment Analyst [email protected] [email protected] [email protected] telegram: LucyLabs007 telegram: Lucylabs999 telegram: Lucylabs008

NEO Is Overvalued versus GAS

The NEO blockchain employs two different tokens, NEO and GAS. Both tokens are traded on public exchanges. We analyze the relationship between these two tokens and, under the current economics of the NEO system, find that the NEO token is significantly overvalued relative to the GAS token.

Investors should also note that the NEO Foundation is able to unilaterally change the economics of the NEO ecosystem at any time, adding another layer of uncertainty and raising governance risk for NEO and GAS token investors.

NEO Project Background

The NEO project began in in 2014 as “Antshares” with the whitepaper released in September 2015. Antshares’ goal was to harness the transparency and permanence of the blockchain to register the ownership of digital assets. The project encompasses a digital signature registration system through Chinese certificate authorities which would make asset transfers on the Antshares blockchain recognized by law. However, many aspects of this original project continue to linger, with no clear implementation date set for the NEO system.

Antshares also decided to incorporate the concept of smart contracts popularized by Ethereum into its code. The addition of a smart contract operating system created a sensation in the crypto community with Antshares being nicknamed, “the Chinese Ethereum.” Antshares launched its mainnet in October 2016.

Antshares took the idea of Ethereum gas to a new level and developed a two-token system: the Antshares token and a fuel token Antcoin. In June 2017 these tokens were rebranded as NEO and GAS respectively.

NEO Governance

The governance of NEO is completely centralized under the control of the NEO Foundation. The NEO Foundation is able to change the rules of the game at any time and token holders have no recourse.

The NEO Foundation maintains centralized authority through the consensus nodes. On the NEO blockchain, there are only seven consensus nodes confirming transactions. Six of them are owned and operated by the NEO Foundation and the remaining consensus node is managed by the City of Zion, which is funded by the NEO Foundation. All new consensus nodes must be approved by the NEO Foundation. Currently consensus nodes do not receive transaction fees and therefore there is no economic incentive for an outside party to become a consensus node.

1 Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/24/2021 Both the original Antshares whitepaper and the NEO whitepaper outline a system whereby NEO (Antshares) token holders vote to elect consensus nodes. Nodes receiving enough votes will process transactions, claim transaction fees in GAS, and exercise other rights granted to them by the NEO foundation at its discretion. The economic theory behind the system is that NEO holders would vote for the most efficient consensus nodes that charge the lowest transaction fees because it is in the economic interest of NEO holders. However, neither the voting system nor transaction fees have been rolled out on the blockchain and the decentralization of the system remains a promise for the future.

NEO (the token)

100 million NEO tokens were created in the genesis block. The first 50 million were distributed during the ICO, while the remaining 50% was held by the NEO Foundation to support long-term development of the project, with a maximum annual release rate of 15%. Currently, the NEO Foundation holds 35 million NEO tokens. The minimum unit of NEO is 1 and cannot be subdivided.

The NEO token cannot be spent to undertake tasks on the platform, that is the province of GAS.

GAS (the token)

GAS was not created in the NEO genesis block but is automatically being generated by the blockchain and distributed to NEO holders through a decay algorithm. Ultimately, GAS will reach a total supply of 100 million tokens around the year 2039. The remaining theoretical emissions curve is as follows:

Theoretical Total Supply of GAS (in millions)

120

100

0 Aug-18 Mar-21 Oct-23 Jun-26 Jan-29 Aug-31 Mar-34 Oct-36 Jun-39

The current supply of GAS is 17.2 million according to coinmarketcap.com. The circulating supply is about 10.1 million, which corresponds to the GAS held outside of the NEO Foundation.

NEO blockchain users are required to pay fees in GAS to make system calls, such as creating

2 Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/24/2021 or migrating smart contracts and registering or renewing assets. According to the current fee schedule on NEO’s official website, the deployment or migration of a smart contract onthe blockchain costs an average 500 GAS. The registration or annual renewal of an asset costs 5,000 GAS. A reduction in these fees is currently being considered under the NEO 3.0 roadmap.

The minimum unit of GAS is 0.00000001.

Relative Valuation of NEO to GAS

NEO Value is Tied to the Value of GAS (and Nothing Else)

With no voting function in the NEO ecosystem, the NEO token derives its value strictly by earning GAS. NEO holders earn GAS in two ways: First, through the emission of GAS tokens to NEO holders and second via the distribution of system fees generated by the NEO network.

The decay algorithm was initiated when Antshares went to mainnet and called for the initial distribution of GAS to NEO holders at a theoretical rate of approximately 0.246 GAS in year one for each NEO held, then decreasing over time. The remaining theoretical annual estimated GAS emissions curve per single NEO is as follows:

Theoretical GAS/NEO Emissions Curve

0.20 0.18 0.16 0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 Year Ended

In practice, the GAS distribution to NEO holders has been much slower because block time has been only about 60% as fast as originally theorized in the NEO whitepaper. The slower block time appears to be the result of inefficiencies in the NEO consensus system. Developers are silent as to when this gap between theoretical and actual block times may be closed.

The NEO network has also generated system fees for NEO holders. Over the last 12 months ending August 1, 2018, 47 NEP-5 Tokens (tokens issued under the NEO blockchain technical standard and comparable to ERC-20 Tokens under the Ethereum system) have been created and 16 existing assets have been renewed on the NEO blockchain. Based on this activity, each of the total 100,000,000 NEO is estimated to have been allocated 0.001035 GAS in system fees over the last year.

3 Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/24/2021 Valuing the GAS Emission Stream to NEO Token Holders

Typical bond valuation tools, including the internal rate of return (IRR), can be used to assign a value to the GAS emission stream to NEO holders. Under the emission stream, GAS tokens are paid to NEO holders with each block created and currently, NEO holders are theoretically scheduled to earn approximately 0.175 GAS in the next twelve months through August 2019, then falling along with the GAS decay emissions algorithm. At the current (08/14/2018) dollar market price of NEO ($16.58) and GAS ($4.25), a single NEO can purchase approximately 3.90 GAS. Using this ratio and the GAS emissions chart, we calculated the current IRR of GAS emissions to NEO to be 1.12% over the remaining theoretical 21-year emissions period.

In our estimation, the 1.12% GAS return to NEO holders does not represent a competitive market return. First, the GAS/NEO IRR is well below the 2.96% ten-year US treasury yield, the world’s benchmark riskless rate. Even the most ardent believers in the NEO project should demand a higher yield given the risks of the NEO network, especially in a bear crypto market where the price of NEO has dropped about 85% since January highs. For comparison, masternodes serving the Dash blockchain currently earn around 6.9% annual return.

In fact, to get to a return similar to the Dash maternodes, NEO would have to trade at a 20% discount to GAS, which would result in an IRR of 6.96%. Thus, it appears that the NEO token should be valued closer to $3.40 using our model based on the GAS emission stream.

Valuing the System Fees Stream

To determine the value of the system fees accruing to NEO holders, we apply a growth stock type multiple to account for the fact that as the NEO ecosystem grows, NEO holders will receive additional system fee payouts in GAS. This past year, a single NEO accrued an estimated 0.001035 GAS in system fees. Applying a 100x multiple to the system fees to account for the potential growth of the NEO ecosystem over time would add only an additional $0.1035 to our theoretical value of NEO.

NEO’s Final Valuation

Thus, our model returns a theoretical value of $3.50 for NEO ($3.40 of GAS emission stream + $0.10 of system fees) at current prices. The historical chart below shows that NEO and GAS did trade close to parity as GAS was beginning the emissions process. Our model predicts a return to, or below, that general ratio.

4 Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/24/2021 NEO/GAS Price Ratio

5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 8/1/2017 9/30/2017 11/29/2017 1/28/2018 3/29/2018 5/28/2018 7/27/2018

Conclusion

The current opaque governance system employed by the NEO blockchain makes valuing NEO difficult. The NEO Foundation can change system parameters, transferring value between GAS and NEO as they wish.

At current prices, NEO token holders are not rewarded adequately for the risk inherent in a new technology such as the NEO blockchain, let alone a centralized system which appears constantly in flux, with little or no legal commitment to its participants.

Our analysis concludes that NEO holders are betting that system fees will grow at unprecedented rates, even for a blockchain, to significantly boost GAS system payments in the future. Under our model, NEO, which derives its value solely from the GAS token streams, should trade at a discount to GAS.

5 Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/24/2021 Disclaimer

Lucy Labs, Inc. is a crypto-currency merchant bank, publishing information about markets, industries, sectors and investments in which it believes subscribers may be interested. The information in this article is not intended to be personalized recommendations to buy, hold or sell investments. Lucy Labs, Inc. is not permitted to offer personalized trading or investment advice to subscribers. The information, statements, views and opinions included in this publication are based on sources (both internal and external sources) considered to be reliable, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Such information, statements, views and opinions are expressed as of the date of publication, are subject to change without further notice and do not constitute a solicitation for the purchase or sale of any investment referenced in the publication. Readers should do their own research before trading in any investments referenced herein. Investing in crypto-currencies is highly speculative and may carry a high degree of risk. Readers may sustain significant losses in these securities.

Advisors to Lucy Labs, Inc. serve as investment advisers to clients, including limited partnerships and other pooled investment vehicles. The affiliates may give advice and take action with respect to their clients that differs fromthe information, statements, views and opinions included in this publication. Nothing herein or in the subscription agreement shall limit or restrict the right of affiliates of Lucy Labs, Inc. to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein or in any subsequent agreement between Lucy Labs, Inc. and the readers shall limit or restrict advisors to or affiliates of Lucy Labs, Inc. from buying, selling or trading securities or crypto-currencies for their own accounts or for the accounts of their clients. Advisors to or affiliates of Lucy Labs, Inc. may at any time have, acquire, increase, decrease or dispose of the securities or crypto-currencies referenced in this publication.

Lucy Labs, Inc. shall have no obligation to recommend securities or crypto currency investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

If you have received this communication in error, please notify us immediately by electronic mail or telephone. This disclaimer applies to all versions of publications for Lucy Labs, Inc.

6 Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/24/2021