Betting on the Currency of the Future: a Digital Asset Investment Strategy
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1 IN BRIEF BETTING ON THE CURRENCY OF THE FUTURE: A DIGITAL ASSET INVESTMENT STRATEGY How do you evaluate investments in an emerging technology? What’s the rational split for a bet on the two current leading blockchain-based currencies, Bitcoin and Ether, maturing in 2022? Key driver analyses to establish relative probabilities for future scenarios Regression analysis on historical data, plus coin supply forecasts and two models for market growth to establish a range of price forecasts Monte Carlo simulation to generate a probabilistic assessment of the potential returns for multiple investment strategies BEST BET Bitcoin: $0.7 million WHAT IS …? Ether: $0.3 million BLOCKCHAIN An open, distributed ledger used as the Estimated Median Value, 2022: base for many digital currencies plus $1.91 million more Estimated Maximum Value, 2022: BITCOIN $8.85 million The dominant digital currency built on a blockchain, since 2009 ETHEREUM A blockchain platform that uses the digital currency Ether and supports smart contracts and other distributed applications, since 2015 2 Investor Overview “The world's largest global Bitcoin exchange in euro volume and liquidity” ... “We believe in the potential for digital assets to bring about the long-overdue, dramatic and positive change to global finance and financial inclusion” – Jesse Powell One of the world’s leading Bitcoin exchanges,1 Kraken is taking an active role in the Kraken’s values include intuitiveness, development of the digital currency market, professionalism and focus. Jesse Powell, CEO pushing the envelope with “firsts” in the 3 and Co-Founder of Kraken, aims to make Bitcoin industry. Ethers have caught Kraken and the 4 and other digital currencies accessible to the industry’s attention in the past year. The world.2 burning question is: Which will be the currency of the future – Bitcoin, Ether or both? 5 3 The first digital asset exchange to have trading price and volume displayed on the Bloomberg Terminal, one of the first exchanges to offer leveraged bitcoin margin trading, the first to pass a cryptographically verifiable proof-of- reserves audit, and a partner in the world's first cryptocurrency bank. 1 http://blog.kraken.com/post/137588082707/kraken- 4 https://www.kraken.com/en-us/about launches-ether-trading 5 http://www.economist.com/whichmba/mba-case- 2 http://blog.kraken.com/about studies/investment-case-study-competition-2016 3 Market & Competitor Overview “Blockchain is gaining traction because it holds the promise to transform industry operating models” …”An enabling technology of the platform revolution trend” – Gartner Businesses always want faster, cheaper, more Since 2008 the market for digital currencies has efficient ways to transfer funds. The global grown immensely. Several hundred digital financial crisis spread distrust in financial currencies now exist, adding on average 80 new markets and their governance. In 2008 the idea entrants per year.6 Not all digital currencies are for an open, distributed ledger called a equal though. Of the current US$12 million total ‘blockchain’ emerged, which promised to market value, Bitcoin boasts an 80% share, address these concerns. It also enabled the followed by Ether with 8%. To date only two digital currency that came with it, Bitcoin, to other currencies, Litecoin and Ripple, have avoid the problem of double-spending. managed to make significant inroads into Bitcoin’s dominance. Bitcoin’s market share has slowly declined … just. 6 https://coinmarketcap.com/currencies/views/market- cap-by-total-supply/ 4 Market & Competitor Overview Success in this fast moving, sensitive market is heavily influenced by the level of consumer trust in the technology and its governance. Government regulations and support, the development of complementary services and ecosystems, and responses to security challenges within the currency network are critical determinants of growth.7 7 https://ripple.com/insights/2016-will-be-the-year-you- realized-you-dont-need-the-blockchain/ 5 Future Scenarios “The future is not a scenario written, which we only have to act out; it is a work which we have to create” – Roger Garaudy The outcome of this bet depends on the future Four scenarios of the apocalypse price of Bitcoin and Ether, which in turn depends on their adoption and success.8 Four scenarios that characterised distinctly different futures were created and described,9 and five key drivers were identified that together would be most likely to determine which future reality emerges.10 Based on the estimated strength of each driver and the likelihood that it would occur in the coming 5 years, a relative probability of occurrence was derived for each scenario. The future’s not obvious … which is good, as that would be boring. DRIVERS SCENARIOS RELATIVE RANK Government Competition Ecosystem Crises Technology Strength Likelihood Strength Likelihood Strength Likelihood Strength Likelihood Strength Likelihood Weight Probability Platform wins 0 0 1 1 2 1 0 0 1 1 4 20% The great leap 1 2 0 0 1 2 2 1 0 0 6 30% Brand wins 0 0 1 2 1 2 0 0 1 1 5 25% Locked out 1 1 2 1 0 0 0 0 2 1 5 25% 100% 8 Rating Likelihood Strength Currency exchange value depends on a dual supply- demand equilibrium. However, we consider that for the 0 na na next 5 years the adoption (demand) for the digital 1 possible weak currency will dominate. The impact of differential supply on the USD price forecasts has not been calculated. 2 likely strong 9 Appendix 1 10 Appendix 2 6 Modelling Uncertainty “When nothing is sure, everything is possible” – Margaret Drabble The future is always uncertain, but never more uncertain than for a newborn. Prodigious Expected talents and serious deficiencies can come to light in the first few years of a baby’s life, and the same applies to digital currencies. In order to model the full range of potential outcomes for the Bitcoin and Ether price over the next 5 years, an expected value and a best- case value were calculated for their market capitalisation. The worst-case value is, of Best-case course, zero. For the expected Bitcoin value, a simple linear regression of historical market capitalisation formed the base. For the best-case value, a linear regression of the logarithm of the annual growth rate was used, to produce an ‘S’ curve projection commonly seen in technology adoption. 7 Modelling Uncertainty Expected The expected Ether value was then modelled on Bitcoin’s expected value, assuming that Bitcoin’s market share was maintained constant as it grew. Ether’s market share was assumed to grow only enough to take Ripple and Litecoin’s share (the current 8% share for other currencies was maintained). The best-case Ether value was Best-case based on the ‘S’ curve growth of Bitcoin but with Bitcoin’s market share declining according to the linear trend seen in the historical data. Summing up The probability of each currency under or over performing against its expected value was calculated based on the outcome of the scenario analysis. 8 Price Forecasts “Tonight’s forecast … a 99% chance of wine” – Anonymous Expected and best-case price forecasts were a Bitcoin simple calculation of the forecast market values for each currency in each case, divided by the forecast supply of each currency. Bitcoin has a reasonably predictable supply curve, built into the design of its blockchain.11 Ether’s supply will be affected by the imminent move to a proof- of-stake consensus model from the existing proof-of-work model. While the details remain unknown it is expected to be more efficient and Ether so the forecast supply is modelled to increase, based on a reduction of the block time to Ethereum’s 12 second target.12 11 https://en.bitcoin.it/wiki/Controlled_supply 12 https://blog.ethereum.org/2014/07/11/toward-a-12- second-block-time/ 9 Investment Strategies & Estimated Returns “I invest, you bet, he gambles” – Anonymous The available investment strategies range from The distributions were assumed to be triangular 100% Bitcoin to 100% Ether. Using Monte Carlo around the expected price forecast, limited at simulation, the estimated returns for 11 either end by the best-case and worst-case price strategies along that spectrum were modelled, forecasts. based on the calculated probabilities for each Price distribution (Bitcoin at top, Ether below) currency to under or over perform against expectations and an assumed distribution of prices in each case. Choose your own investment mix … $12 Millions $8 Maximum 75th Percentile 50th Percentile 25th Percentile Minimum $4 $0 0% 20% 40% 60% 80% 100% 10 Investment Strategies & Estimated Returns The Monte Carlo simulation produced a probabilistic estimate for returns from each of the 11 strategies. Model behaviour Bitcoin Investment Minimum Maximum 25th Percentile 50th Percentile 75th Percentile 0% $ 57,775 $ 6,474,488 $ 897,493 $ 1,268,215 $ 2,807,577 10% $ 178,605 $ 6,208,151 $ 1,062,520 $ 1,566,921 $ 2,798,223 20% $ 269,592 $ 6,387,788 $ 1,108,575 $ 1,858,953 $ 2,837,083 30% $ 319,402 $ 6,770,678 $ 1,119,831 $ 2,035,949 $ 3,043,240 40% $ 348,778 $ 7,289,875 $ 1,129,546 $ 2,126,010 $ 3,202,275 50% $ 353,229 $ 7,809,071 $ 1,141,992 $ 2,110,895 $ 3,338,715 60% $ 321,846 $ 8,328,267 $ 1,111,875 $ 2,075,522 $ 3,551,816 70% $ 290,463 $ 8,847,464 $ 1,095,170 $ 1,909,470 $ 3,844,938 80% $ 259,080 $ 9,728,695 $ 1,049,590 $ 1,760,194 $ 4,068,780 90% $ 153,859 $ 10,767,424 $ 969,408 $ 1,656,476 $ 4,357,258 100% $ 41,743 $ 11,806,153 $ 884,737 $ 1,639,838 $ 4,575,772 As a vocal market participant and active The estimated returns show risks of greater promoter of digital currencies, it was assumed losses for the two extreme strategies.