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 Currency exchange value depends on a dual supply- Rating Likelihood Strength 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 $4 Minimum

$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. The that the profile of Kraken’s risk appetite would mixed strategies weighted toward Bitcoin show be moderately aggressive. For marketing the best profile for median and potential purposes, a subjective preference to support maximum returns. Of these, while the median both currencies was also assumed, if supported return is slightly lower than strategies that are by the financial modelling. more evenly balanced, a moderately aggressive

approach would be to invest 70% in Bitcoin and

30% in Ether.

11

Appendices

Appendix 1

Scenario Description Ethereum's smart contracts and other complementary goods drive up Platform wins adoption (especially in the financial and government sectors) and value of Ethers, which come to dominate the market, leading to Bitcoin's decline. Encouraged by widespread government acceptance in the face of ongoing global crises, the large size of the potential market leaves room for both The great leap currencies to develop supporting ecosystems in particular niches, and both currencies flourish. Bitcoin's brand and position leads to large network benefits, which stifles Brand wins Ethereum's growth, leading to Ethereum's decline. Concerns over security as well as criminal use of the currencies leads to Locked out widespread government opposition (and regulation) for digital currencies in general.

Appendix 2

Driver Description Government support or opposition to digital currencies will be extremely Government influential, both in terms of public sector adoption of blockchain technology and in terms of regulation. Competition between digital currencies as well as with traditional and Competition electronic payment methods will be fierce. The development of supporting networks of complementary goods and Ecosystem services is frequently one of the determining factors in the battle between emerging technologies (e.g. VHS vs Betamax, Apple vs Android) International crises, especially financial and economic crises but also Crises geopolitical crises and health or environmental crises - if they occur - are likely to drive up adoption of digital currencies in a search for safety Problems with security and stability of the technology have repeatedly Technology derailed fledgling digital currencies

12

STEEPLED (PESTEL) ANALYSIS POLITICAL ECONOMICAL SOCIAL/CULTURAL TECHNOLOGICAL ENVIRONMENTAL LEGAL ETHICS DEMOGRAPHIC

- Financial - Banking - All the crises are - People are - New system - Governments information in cyclical and can increasingly technologies regulations - In 5 years the depends heavily the blockchain contribute to comfortable with are driving new could be global population on the financial is traceable the progress of virtual business adapted to help will grow 5% sector and cannot be digital transactions strategies or hinder digital deleted currencies currencies

- Almost all - The blockchain - More people in - Banks are financial crisis, offers the developing - Bitcoins and significant which affect - Digital anonymity of economies may Ethers can be - People are - The surge of institutions in primarily bank currencies cash, with be able to enter used as a store increasingly used new the legal, users and banks, require greater the Financial of value with to having personal technologies financial and also affect significant efficiency, market for the different information may threaten political Governments, energy inputs, which has first time if digital characteristics placed online the blockchain framework of who have to bail but these are made it currencies to fiat currency modern out at least part likely to be attractive to become economies of the banks. lower than criminal users mainstream current inputs required due to - Regulations of the reduction in the finance the parties sector are - Governments - Transactions involved regularly aimed - Government are potentially - Demographically with digital at protecting can support or - People big blockchain led changes can currencies can consumers oppose the increasingly prefer users, given the influence be faster, from bad implementation payments using number of financial markets cheaper and behaviour. and regulation of electronic systems public ledgers and, more efficient Digital digital to cash they maintain consequently, than traditional currencies may currencies. (e.g. land digital currencies currencies present a more ownership etc) effective non- regulatory alternative

13