Innovation and Cryptoventures

Cryptocurrencies

Campbell R. Harvey Duke University and NBER

January 29, 2018 Campbell R. Harvey 2018 2 Opportunities

http://www.slideshare.net/RedChip/btcs‐201507 Campbell R. Harvey 2018 3 Long History of

Campbell R. Harvey 2018 4 Paypal started in 1998 as a software security company for handheld devices Long History of Digital Currency

Campbell R. Harvey 2018 5 Disruption 101

Campbell R. Harvey 2018 6 Disruption 101

1. Money transfer network is $500 billion per year 2. Average fee=10%. 0.01%* 3. Potential of $50b per year in hands of consumers 4. “Western Union and Moneygram will be the Kodaks of this decade”, Barry Silbert

See: http://www.mauldineconomics.com/lg/bitcoin *Currently higher due to congestion. promises much lower fees.

Campbell R. Harvey 2018 7 Disruption 101

Campbell R. Harvey 2018 8 https://www.bloomberg.com/news/articles/2018‐01‐12/kodak‐ceo‐plans‐to‐seize‐blockchain‐moment‐and‐win‐over‐skeptics : Coins vs. Tokens

• A coin has its own blockchain • A token is associated with an existing blockchain. For example, ERC20 is the token standard that is associated with the blockchain. • Initial offerings: – ICO = – ITO = Initial Token Offering

https://theethereum.wiki/w/index.php/ERC20_Token_Standard Campbell R. Harvey 2018 9 Cryptocurrency: Coins vs. Tokens

• Coinmarketcap.com lists 895 coins and 549 tokens • Almost all the tokens associated with Ethereum blockchain. Largest is EOS

https://eos.io/ https://coinmarketcap.com/tokens/views/all/ Campbell R. Harvey 2018 10 Cryptocurrency: Diversity

Many variations • Method: , , – There are even variations within Proof of Work, for example the PoW is different for Bitcoin and Ethereum; – Primecoin uses bitwin and Cunningham prime chains, e.g., Cunningham (double plus one) 2, 5, 11, 23, 47 [not 95 because not prime] • Block size and speed of approval of transactions • Transparency and anonymity • Ability to handle smart contracts https://theethereum.wiki/w/index.php/ERC20_Token_Standard Campbell R. Harvey 2018 11 An Overview: Public

Let’s initially focus on one of the first applications of blockchain: Bitcoin 1. Peer to peer network 2. Triple entry accounting with common that everyone shares called the blockchain 3. Introduces a protocol (rules for validating transactions) on the blockchain. Trust not required. 4. Unit of account: bitcoin a cryptocurrency

Campbell R. Harvey 2018 12 An Overview: Public Blockchains

The history of all transactions contained in ledger called the bitcoin blockchain • White paper October 2008. Genesis block January 3, 2009. • The miners solve computationally intensive problems to ensure the security of the bitcoin blockchain – the security is unprecedented. • Reward is currently 12.5 BTC and is cut in half every four years. Reward ends (cap on money supply) May 7, 2140. Total supply will be 21 million. • Miners also collect transaction fees. The plan is that these transaction fees will be enough compensation and no new bitcoin will be needed.

Campbell R. Harvey 2018 13 An Overview: Public Blockchains

Bitcoin blockchain • Blocks added about every 10 minutes. Difficulty (roughly the number of leading zeros in winning hash) is adjusted as additional computing comes on to the network. Note Ethereum block time is about 15 seconds. • Stack code is Turing incomplete. This means that do loops are not possible. This limits the ability of Bitcoin blockchain to do smart contracts. In contrast, Ethereum is Turing complete. • Bitcoin blockchain about 150gb https://blockchain.info/charts/blocks‐size https://en.wikipedia.org/wiki/Turing_completeness Campbell R. Harvey 2018 14 An Overview: Public Blockchains

There are significant barriers to entry to understanding bitcoin and other • These barriers to entry provide an opportunity for us that we will explore in this course

Campbell R. Harvey 2018 15 Solution

Any new product has to answer two questions: 1. What problem does this solve? 2. Is the problem economically important?

Campbell R. Harvey 2018 16 Solution

Consumers • Transact without worrying about security practices of every merchant; no need for bank account; enables microtransactions; enables transfers of funds with minimal fees; worldwide use; ability to choose from full transparency to anonymity; immune to inflation;

Campbell R. Harvey 2018 17 Material drawn from Jameson Lopp, The Multifaceted Nature of Bitcoin Solution

Merchants • Saves on merchant transactions fees; gives customers an alternative way to transact; saves on need for security infrastructure; impossible to counterfeit; perfect transparency of all transactions • Example, Gasoline sales in US about $500 billion in 2015 means $17.5 billion in credit card fees (assuming 50% of payments by credit card)

Campbell R. Harvey 2018 18 Material drawn from Jameson Lopp, The Multifaceted Nature of Bitcoin Solution

Family • Send remittances at minimal cost around the world

Campbell R. Harvey 2018 19 Material drawn from Jameson Lopp, The Multifaceted Nature of Bitcoin Solution

People in risky countries • Provides an alternative method to transact when a country is hit with hyperinflation

Campbell R. Harvey 2018 20 http://krieger.jhu.edu/iae/economics/Venezuela_Enters_the_Record_Book.pdf Solution

People in less developed countries • Enables electronic transactions in areas that are not served by banks; also possible to save and store value; microtransactions • You do not need a bank account. There are 2 billion unbanked persons.

Campbell R. Harvey 2018 21 Material drawn from Jameson Lopp, The Multifaceted Nature of Bitcoin Solution Venture Capital: Blockchain

2009 ‐ 2011: $0 2012: $2.13M 2013: $95.05M 2014: $361.53M 2015: $490.48M 2016: $601.15M* 2017: $554.45M* *Surge in Internal VC as companies make large internal investments http://www.coindesk.com/bitcoin‐venture‐capital/ Campbell R. Harvey 2018 22 Solution

Overstock’s t0 is first to transact stock on a blockchain

However, they spent more than $5 million in legal fees dealing with SEC and FINRA.

https://www.wired.com/2016/12/overstock‐com‐issues‐stock‐via‐bitcoin‐blockchain/ Campbell R. Harvey 2018 23 Solution

Blockchain and beyond • New way to verify ownership • New applications to financial instruments • New ways to codify contracts, smart contracts (“if”, “then” statements) • Internet of Things • Mesh networks/decentralized storage • Supply chains • New way to vote

Campbell R. Harvey 2018 24 Material drawn from Jameson Lopp, The Multifaceted Nature of Bitcoin One Main Challenge is Lack of Understanding

President Obama at SXSW: “everybody’s walking around with a Swiss bank account in their pocket.”

This is a fundamental misperception.

http://fortune.com/2016/03/15/apple‐iphone‐swiss‐bank/ Campbell R. Harvey 2018 25 One Main Challenge is Lack of Understanding

President Obama, at SXSW: “everybody’s walking around with a Swiss bank account in their pocket.”

This is more accurate!

http://fortune.com/2016/03/15/apple‐iphone‐swiss‐bank/ Campbell R. Harvey 2018 26 Challenges

1. Cryptocurrencies are mainly used for criminal activity. 2. A lack of security plagues all cryptocurrencies. 3. Bubble because no fundamental value. 4. Mining is a waste of energy. 5. Cryptocurrencies are too small today to be an important economic force. 6. Cryptocurrencies are currently too risky to serve as a store of value. 7. The concentration in holdings perpetuates economic inequality. 8. Cryptocurrencies are just another currency.

Campbell R. Harvey 2018 27 Cryptocurrencies: Cryptocurrencies mainly used for criminal activity • Silk Road: Amazon of black market – priced in bitcoin

Campbell R. Harvey 2018 28 Cryptocurrencies: …are mainly used for criminal activity • Silk Road: Amazon of black market – priced in bitcoin

Campbell R. Harvey 2018 29 Cryptocurrencies:

Issues with cash – crime and tax evasion.

79% in $100 bills

* https://www.federalreserve.gov/paymentsystems/coin_currcircvalue.htm

Campbell R. Harvey 2018 30 Cryptocurrencies:

Issues with cash – crime and tax evasion. • November 8, 2016 India scraps 85% of its currency (1000 and 500 rupee notes) • Not the first time they have done this (1946, 1978)

http://www.wsj.com/articles/indias‐demonetization‐debacle‐1481851086 Campbell R. Harvey 2018 31 Cryptocurrencies:

Issues with cash – crime and tax evasion. • November 8, 2016 India scraps 85% of its currency (1000 and 500 rupee notes) • Not the first time they have done this (1946, 1978) Raghuram Rajan, Former RBI Governor, at the AEA/AFA Joint Luncheon, January 5, 2018

http://www.wsj.com/articles/indias‐demonetization‐debacle‐1481851086 Campbell R. Harvey 2018 32 Cryptocurrencies:

Issues with cash – crime and tax evasion. • December 15, 2016 Venezuela scraps 100 bolivar bill

Campbell R. Harvey 2018 33 http://www.wsj.com/articles/venezuelans‐protest‐over‐worthless‐cash‐1481935897 Cryptocurrencies:

• Calls for digitizing $100 and $50 bills – but do you prevent perfect counterfeiting? • Answer: Use a blockchain

Campbell R. Harvey 2018 34 Cryptocurrencies: A lack of security plagues cryptocurrencies • Mt. Gox – On February 24, 2014, the site shut down with 850,000 “missing” https://bravenewcoin.com/news/mtgox‐btc‐e‐and‐the‐missing‐coins‐a‐living‐timeline‐of‐the‐ greatest‐cyber‐crime‐ever/ – closes (temporarily) January 4, 2015

– Section A – Section B

Campbell R. Harvey 2018 35 Cryptocurrencies: A lack of security plagues cryptocurrencies • But Mt. Gox was a third party. • With any new technology, there will be good companies entering and bad companies entering. • Bitstamp experience was different

Campbell R. Harvey 2018 36 Cryptocurrencies: A lack of security plagues cryptocurrencies • Actually, it is the opposite. There is a historically unprecedented amount of security for bitcoin

• The hash rate is not out of control. It is a result of the incentive structure and it makes the bitcoin blockchain more Dr. Sarah Meiklejohn, UCL “The hash rate is out of control” (November 11, 2016) secure.

Campbell R. Harvey 2018 37 Cryptocurrencies: A lack of security plagues cryptocurrencies • Not all cryptocurrencies are the same • Bitcoin has the strongest blockchain • Securities determined by hashing power for Proof of Work blockchains

The current hash rate of Bitcoin is 13 billion gigahashes per second. https://blockchain.info/charts/hash‐rate Campbell R. Harvey 2018 38 Cryptocurrencies: Mining is a waste of energy • People perceived mining as a waste of energy • Bitcoin mining farms locating in areas with underutilized energy such as Iceland

Campbell R. Harvey 2018 39 Cryptocurrencies: Mining is a waste of energy

Campbell R. Harvey 2018 40 Cryptocurrencies: Mining is a waste of energy

Campbell R. Harvey 2018 41 Cryptocurrencies: Mining is a waste of energy • Mining ensures that the blockchain is secure • It eliminates the possibility of a breach such as Target losing 40 million credit cards.

Campbell R. Harvey 2018 42 Cryptocurrencies: Cryptocurrencies are too small today to be an important economic force • Bitcoin is very small

The $10bn birth of the trusted deletion industry Izabella Kaminska | Jul 31 17:47 | 6 comments | Share Nobody has been more annoyed by Alibaba’s potential upcoming valuation of Snapchat at $10bn than the Bitcoin community, since its own “world changing” technology currently has a market value of no more than $7bn.* [UPDATE: $500 billion]

Campbell R. Harvey 2018 43 Cryptocurrencies: Cryptocurrencies are too small today to be an important economic force • Currently running about $1.5T annualized trade volume (on chain) See: https://blockchain.info/charts/estimated‐ transaction‐volume‐usd • Global credit card volume running about $10T • Bitcoin can currently handle 7 transactions per second whereas Visa can handle 50,000 • But what counts is not necessarily the size today .. but the size tomorrow. The next layer (L2) is ready to go, called Lightning Network.

https://www.nilsonreport.com/upload/issues/1109_6392.pdf Also see https://www.worldpaymentsreport.com/download

Campbell R. Harvey 2018 44 Cryptocurrencies: Cryptocurrencies are currently too risky to serve as a store of value

• Bitcoin as a transaction method will not be viable until the volatility is decreased. Currently, it fails as a store of value.

Annualized Volatility Comparisons 100%

90%

80% BTC S&P500 Gold USD 70% 2011‐2017 100.0% 13.5% 16.3% 7.5% 60% 2014‐2017 73.8% 12.1% 13.6% 8.0% 50%

40%

30%

20%

10%

0% BTC S&P500 Gold USD Campbell R. Harvey 2018 45 2011‐2017 2014‐2017 Cryptocurrencies: Cryptocurrencies are currently too risky to serve as a store of value • Holding for one week: 95% confidence interval is – Bitcoin: +/‐ 25%[from 2011]; S&P500 is ‐4.3% to +4.3% • Worst S&P daily return since 1957 is Oct. 19, 1987 at ‐20.47% – Over last 6 years, bitcoin has had 8 days with less than ‐20.47% return • Second worst daily return since 1957 is Oct 15, 2008 at ‐9.03% – Over last 6 years, bitcoin has had 67 days with less than ‐9.03% return (15 alone in 2017 and 2018).

Campbell R. Harvey 2018 46 Cryptocurrencies: Bitcoin is currently too risky to serve as a store of value

Innovation & Cryptoventures First offered!

Campbell R. Harvey 2018 47 Cryptocurrencies: Bitcoin is currently too risky to serve as a store of value

Daily BTC=BTSP 1/19/2016 - 3/5/2018 (GMT) BarOHLC, BTC=BTSP, Trade Price Price 1/26/2018, 11,140.01, 11,635.00, 10,263.32, 10,560.02, -568.42, (-5.10%) 18,000

16,000

14,000

12,000 10,560.02 10,000

8,000

6,000

4,000

2,000

Auto F M A M J J A S O N D J F M A M J J A S O N D J F M Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 Q3 17 Q4 17 Q1 18

Campbell R. Harvey 2018 48 Cryptocurrencies: Bitcoin is currently too risky to serve as a store of value

Annualized bitcoin return volatility (1 year moving window)

160%

140% Illiquidity causing high 120% volatility story not supported by data over the past two 100% years

80%

60%

40%

20%

0% 9/17/2012 9/17/2013 9/17/2014 9/17/2015 9/17/2016 9/17/2017

Campbell R. Harvey 2018 49 Cryptocurrencies: Bitcoin is currently too risky to serve as a store of value

Annualized bitcoin return volatility (90‐day moving window) 140%

120%

100%

80%

60%

40%

20%

0% 1/1/2016 2/1/2016 3/1/2016 4/1/2016 5/1/2016 6/1/2016 7/1/2016 8/1/2016 9/1/2016 1/1/2017 2/1/2017 3/1/2017 4/1/2017 5/1/2017 6/1/2017 7/1/2017 8/1/2017 9/1/2017 1/1/2018 10/1/2016 11/1/2016 12/1/2016 10/1/2017 11/1/2017 12/1/2017

Campbell R. Harvey 2018 50 Cryptocurrencies: Cryptocurrencies are currently too risky to serve as a store of value No correlation • But volatility is only one dimension of risk – do with S&P or Gold cryptocurrencies provide hedging benefits?

Campbell R. Harvey 2018 51 Cryptocurrencies: Cryptocurrencies are currently too risky to serve as a store of value No correlation • But volatility is only one dimension of risk – do with S&P or Gold cryptocurrencies provide hedging benefits?

Campbell R. Harvey 2018 52 Cryptocurrencies: Concentration: 0.01% own nearly 40% of bitcoin

https://bitinfocharts.com/top‐100‐richest‐bitcoin‐addresses.html Campbell R. Harvey 2018 53 Cryptocurrencies: Bitcoin is just another currency Ajay Banga, CEO Mastercard • “The world is not short of currencies, so what is this currency solving for?” February 17, 2014

Fuqua Tech Conference, November 2017

Campbell R. Harvey 2018 54 Cryptocurrencies: Education

• Challenges: Nobel Laureate #1

DECEMBER 28, 2013, 2:35 PM Bitcoin Is Evil

Campbell R. Harvey 2018 55 Speaking of mind‐bending, economics professor Cam Harvey of Duke University did a presentation this afternoon on the blockchain, which is the foundation of Cryptocurrencies: Education Bitcoin. I have been friends with Cam for many years, but it has been an online friendship. He was the first to do research and analysis of the inverted yield curve, and I’ve • Challenges: Nobel Laureate #2 learned a great deal from talking and writing with him. Cam came over when the day session finished, and we began to talk about some aspects of blockchain technology. Harry Markowitz, the Nobel Prize laureate who created Modern Portfolio Theory, walked over; and after a few minutes he began to challenge Cam on the mathematical impossibility of what he thought Cam was talking about. It was fascinating watching these two genius professors talk about math and ideas, and eventually Harry got a handle on the process Cam was describing. But I will confess a small pleasure at watching one of the greatest mathematical economists of our time wrestle with the concept of the blockchain. I have to tell you it took me a while to get my head around the concept, too, and it took Harry only five minutes. Campbell R. Harvey 2018 56 Cryptocurrencies: Education • Challenges: Nobel Laureate #3

Campbell R. Harvey 2018 57 Cryptocurrencies: Education

• It is important for educators to open the black box and to show students and the general public how blockchains work

Campbell R. Harvey 2018 58 59 Campbell R. Harvey 2018