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Adam Thiesen DigitalTechnicalities.com

May 27, 2019

Thoughts on the new Cryptocurrency Cycle

“But how could you live and have no story to tell?” Fyodor Dostoevsky

“Under free market capitalism, well-regulated and well-ordered trading activity is considered a forum of human self-expression and economic advancement. Freedom to act in the marketplace is a part of freedom itself. Billions of consumers, following their own self-interests and individual needs, make the decisions that direct the future, not have it directed for them.

For an emerging generation fascinated by crowdsourcing, free capital markets are the ultimate in crowd-sourced decision making. Free market capitalism is not a source of misery and oppression; free market capitalism is the antidote. It is unmatched in alleviating global poverty and unlocking human potential.

We must disabuse ourselves, our peers, and future generations of the notion that there is anything attractive or aspirational about political control of markets and human enterprise. Everywhere it has been tried, it has been a fraud and a failure. It crushes human liberty and society. It steals power from individuals and families and gives it to government and government elites. It enables abuse by a select few who exercise unbridled power over many.

For innovators, controlled economies are dream destroyers. Free markets should be the natural choice of today’s innovators, who today are striving to build bright and better futures.”

-Chris Giancarlo, Chairman of the Commodity Futures Trading Commission

Coin Desk

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Salient News for this Bull Run:

● TD Ameritrade offering Bitcoin trading ● Microsoft building on Bitcoin ● AWS integrating Ethereum ● William Hinman, head of the division of corporate finance at the SEC,

states that Bitcoin and Ethereum are sufficiently decentralized and therefore likely not securities

● Fidelity continues to emphasize and grow its digital asset team ● Bakkt, backed by Intercontinental Exchange, is launching a Bitcoin

custody and futures trading platform How is Bitcoin Different?

To begin, it is necessary to explain why Bitcoin is inherently and critically different from competing blockchains, and why this might be important information for the impending bull market.

Bitcoin, like other strong forms of money1, has a mystical and compelling origin. The “immaculate conception” of bitcoin centers around the anonymous Satoshi Nakomoto, who acted as an essential creator and prophet for the bitcoin network. Satoshi achieved immortality not only by creating the codebase responsible for powering the bitcoin network but also by spreading knowledge and awareness through online forums and email servers, essentially “boot-strapping” the bitcoin network.

Why is this important? Since the network creation ten years ago Satoshi has not moved or sold his fortune of bitcoin holdings. The steadfast belief of the creator, whether intentional or not, creates a subconscious belief among all of those exposed that there is a soundness and integrity to the network.

1 By “money” I am referring to both a store of value (SoV) and a monetary unit of exchange (MoE). In “Man the Economy and the State” Murray Rothbard describes money as, “[a] commodity that comes into general use as a medium of exchange”.

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Unlike other founders or cryptocurrency creators Satoshi never asked

or demanded funding to begin or continue the project. Rather, Satoshi made Bitcoin an absolute positive value for society, through both the open source software as well as the network itself.

Most significantly, Satoshi vanished from all forums and email servers after a couple years. This allowed the project to grow and develop in a decentralized way. While conflicts arose without one centralized voice, the network pushed through all tests and tribulations, leading many to say about bitcoin that “it just works”.

Aside from the mystical origins of bitcoin genesis, the value for bitcoin can be seen in the network protocol. Bitcoin has the most predictable, auditable, and trustless money supply. There will only ever be 21 million bitcoin in existence, and the issuance rate until the max supply is reached is completely transparent and written in code.

These attributes, along with the first mover advantage that bitcoin has of being the original cryptocurrency, make it by far the safest investment in the sea of cryptocurrencies. To emphasize this point, bitcoin also has the most robust node network2, as well as the greatest hash rate3 which is a signal for mining strength and network security.

In biology there is a tenet stating that “function follows form”. Indeed,

this phrase applies fittingly to cryptocurrencies as well. In the case of bitcoin, its secure and bulky proof of work form indicates that its function is to be used as an ultra-secure settlement layer, where irreversibility and trustlessness are valued most strongly.

2 The current number of global full noes is ~9400 https://bitnodes.earn.com/ 3 Hash rate has recently reached an all time high of ~82,000,000 TH/s https://www.blockchain.com/en/charts/hash-rate

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Many have dismissed the use of bitcoin as a true currency based on its volatility and high fees. However the advent of the lightning network, which allows for timely microtransactions with minimal fees, makes the idea of bitcoin more palatable. Some may suggest that true money cannot be disinflationary or users will be motivated to hoard and not spend. This is an interesting economic experiment, but in this scenario the price of a good would simply reflect the opportunity cost.

Neither bitcoin’s form, nor its ultimate function have been decided at this point. There are questions to be answered in the future surrounding the bitcoin protocol, its governance, and potential use cases. But these problems have existed since its inception, and up to this point it continues to grow feverishly and still it just works. What value can Bitcoin add for investors?

Prudent portfolio managers should be constantly assessing the market to increase returns while lowering risk. The current geopolitical climate is highly volatile, and this volatility will certainly manifest itself within all financial markets.

The weakening of sovereign currencies combined with lower interest rates could mean that investors will look to commodities for safe haven during turbulent times. In this event gold would certainly benefit from its status as a safe and reliable store of value. However, bitcoin is another emerging commodity that might appeal to the masses due to its disinflationary supply. Those looking to protect their wealth will look to assets with hard supply caps and issuance schedules in the midst of market uncertainty.

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Bitcoin is a non-correlated asset to traditional financial investments

Lastly, bitcoin has no correlation with stocks, bonds, or real estate—making it an interesting addition to any portfolio. Additionally, a small percentage allocation to bitcoin can increase a standard portfolio’s Sharpe ratio and risk adjusted returns.

When will the bull market begin?

To begin I would highly recommend reading the Delphi Digital Unspent Transaction Output report here (Delphi) as well as Bitcoin in Heavy Accumulation by Adamant Capital (Adamant).

Both reports see Q1 of 2019 as a time when selling from long term holders began to slow, with a portion of these holders turning to net buyers. Additionally, the large sell off of November, which saw a crash from $6400 to $3200 after an already 70% drawdown, appears to have marked investor capitulation.

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Possible Capitulation occurring in November 2018

Other interesting models pointing to a possible “end of the bear” or

“beginning of the bull” markets also exist. One such model looks at Bitcoin in relation to its “stock to flow”, highlighting the importance of the halvening (Stock to Flow), which will be addressed below. What is the halvening?

In the Bitcoin protocol there is an issuance of a specific number of bitcoin during each mined block. Put simply, when a new block of data is mined and solidified into the Bitcoin blockchain, then the miner responsible for finding and validating this block receives a certain number of bitcoin as a reward. The reward is currently 12.5 bitcoin, but in less than a year that number will fall to 6.25. This will lower the supply of bitcoin entering circulation, increase the stock to flow ratio, and increase price if demand stays constant.

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Stock to flow is the ratio of the total stock of an asset to how much is being produced and placed into circulation. For example, the stock to flow ratio of energy would be infinite as there is an infinite amount in the universe, and more cannot be created. As a more tangible example, Gold has a fairly straightforward stock to flow ratio as the current supply of gold in the world is fairly high, and only a certain amount is mined and brought into circulation.

There are interesting models relating the price of bitcoin to how

motivated miners are to sell. If miners are not motivated to sell then this restricts the circulating supply of bitcoin, causing price to increase as demand stays consistent. If miners anticipate a price increase after the halvening and begin to hoard bitcoin, this could create a synergistic and powerful underlying factor motivating price increase. Preparing for the 2020 Halvening and Beyond

The most important question for any digital asset investor is: what percentage of my portfolio should I invest into Bitcoin, and how much of my portfolio, if any, should go into lesser known blockchains and tokens?

With this question in mind it is important to recognize that we are on the cusp of massive amounts of cryptocurrency regulation. In the United States, Bitcoin and Ethereum have already been decidedly stated as “not securities”, and both of these blockchains have been acknowledged to be sufficiently decentralized.

This is critically important, because it allows an avenue where investors and the US government alike could easily invest and support the adoption of these blockchains. If a token or blockchain is thought to be a security, then the SEC can regulate if the purchasing of a token is legal or

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illegal, and can also completely control the exchanges and issuance. If the tokens are deemed to not be securities then on- ramps will be easier, and taxation will (hopefully) be clearer. Bitcoin has a far greater number of over the counter trading desks (therefore more liquidity) and as such will be the first asset looked at by institutional investors.

Most importantly, however, is the tone and subtleties used when government officials speak about cryptocurrencies. Any comments where those in power recognize these blockchains without adding negative comments or hopes for increased regulation are relieving for those involved in the industry.

So where does this leave us with other blockchains and tokens? That is a huge question, which will probably be answered fully within the next few years. A lot of the answers will depend on Ethereum moving forward.

Fidelity, Bakkt, and the Cash App will custody and provide trading for

bitcoin exclusively, giving it a huge increase in liquidity and larger investing compared to other “alt coins”. This is one piece of evidence for the argument that there may not be a large “alt season” during this bull cycle.

In my opinion Ethereum could function as a “gateway altcoin”, fairly innocent in and of itself, but closely connected to many other more disingenuous coins and blockchains. Infamously, many “companies” used Ethereum to launch Initial Coin Offerings (ICOs) which allowed for money to be raised via the issuance of company tokens. This created an absurd environment where regular investors could pour money into these companies based solely on a whitepaper, in hopes that the token would have some future value and they would be able to sell for a profit.

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Ethereum’s wild run during the 2017 hype market. Price went roughly 100x from less than $10 to above $1000. As you can see, the greatest

returns against Bitcoin occurred very early in the cycle. As can be seen from the above chart, after its meteoric rise ending in July 2017, ethereum actually lost value in relation to bitcoin over the next 4 months before taking part in the historic end of 2017 early 2018 “alt season”. This is a prescient reminder for traders: if you can time the cyclical nature of other coins you may be able to gain against bitcoin, but often the optimal for generating alpha is simply holding bitcoin itself.

The United States government appears to view Ethereum favorably but has also been wary of initial coin offerings. At some point will legislation begin to conflate Ethereum with the wave of ICOs? How will other blockchains, even legitimate ones, be seen by regulators? I do not have answers to these questions, and do not mean to cause fear and doubt in the minds of holders. Rather, I believe that these are questions that any reasonable investor should ask themselves when weighing risk vs. reward of holding alt coins.

Contrast the questions from above with the growing legitimacy

surrounding Bitcoin, which is a truly decentralized and trustless protocol. Recognized financial institutions like Fidelity and Intercontinental Exchange are providing traditional investors with increased exposure to Bitcoin, and

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so it appears that the United States financial infrastructure is embracing the original cryptocurrency.

While custody and trading tools are being tested and unveiled, smaller institutions and money managers (including a plethora of digital asset hedge funds) will dominate the upcoming bull market. This collection of “smart money” will begin to enter the digital asset space, and the only network mature enough to invest in comfortably is bitcoin. Other alt chains and tokens simply lack the necessary liquidity and on-ramping to justify deploying investor capital.

To obtain a more lucid idea about the impending bull market it is important to understand what happened in the past cycle. During the last market run Bitcoin went parabolic for about 14 straight months, often leaving alt coins far behind until the very end of the cycle. At that point there was a “manic” run for altcoins from November to early January as Bitcoin began what would be a near 80% descent.

For ethereum, the 2017 hype cycle may have been catalyzed largely by the ICO craze. Indeed, Ethereum’s price jumped all the way from $10 at the start of the run to $1000 by the end—a 100x move. These ICOs raised funds using ETH, meaning the demand for ETH grew exponentially with number of launched ICOs.

The beginning of this cycle will have some similarities, but instead of ethereum holders, the beneficiaries will be exchanges. We are seeing a prevalence of Initial Exchange Offerings (IEOs), which allow for premium features and increased liquidity for those holding the corresponding tokens.

In contrast, marketing for ethereum during this cycle will be focused

its newly formed decentralized finance (DeFi) layers and applications. Will these DeFi applications create the same fervor as the ICO craze of 2017?

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Will investors be hesitant to invest in ethereum based on its impending hard fork layer 2 upgrade4? Thesis 1: Initial Exchange offerings will lead to bigger gambles, greater liquidity in the classic “crypto casinos”: Bittrex, Bitfinex, Binance.

“I spent half my money on gambling, alcohol and wild women. The other half I wasted.” -W.C. Fields

Importantly, both Binance and Bitfinex are soon hoping to introduce margin trading to their platforms. The money flow from the Initial Exchange Offerings is open to interpretation but one guess is:

1. Buy IEO coins from corresponding exchange 2. Sell IEO coins for Bitcoin, driving the price of Bitcoin up 3. Buy “alt coins” using Bitcoin, driving the price of alt coins up

Some projects that participated in the Binance IEO

4 Fidelity has already shown skepticism regarding the layer 2 hard fork, and has admitted that it will not be integrating with Ethereum in the near future based on these concerns.

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What has been the other crypto buzzword the past few months? Ah yes, Stable Coins. Thesis 2: The stable coin movement will provide enhanced liquidity for these crypto casinos.

“Living systems are never in equilibrium. They are inherently unstable. They may seem stable, but they’re not. Everything is moving and changing.

In a sense, everything is on the edge of collapse.” -Michael Crichton

USDT, or US Dollar Tether, has been the most prominent stable coin in the cryptocurrency industry the past few years. Lately, Tether has been mired in controversy, as the parent company to both Bitfinex and Tether has been accused of using Tether reserves to make up for $850 million of lost Bitfinex funds. Investors should use caution when holding Tether or transacting on Bitfinex, but both are still running smoothly as of today. Based on the popularity of Tether, many other companies have ventured into stable coin creation. Maker Dao created the Dai stable coin, which is collaterally backed and assured its value through smart contracts on the ethereum platform through collateralized debt positions and autonomous feedback mechanisms. There is also USDC, created by Coinbase, which, according to Coinbase, is a stable coin that is fully backed by U.S. Dollars in a secure bank. USDC is also powered by the ethereum blockchain, and can be redeemed at any time for an equal amount of U.S. dollars. These stable coins will allow another on ramp and holding period for those who wish to keep money in, and exchange frequently, on exchanges. While increasing liquidity in the cryptocurrency markets is important, stable coins will also allow for more sophisticated and precise decentralized applications built on blockchains.

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Thesis 3: Bitcoin will still be king, and it is always safe to let Bitcoin run for a while before even considering diversifying into alt coins.

Bitcoin dominance over time. There were two major “alt seasons” during

the 2017 bull run, occurring in June and December.

Litecoin often lost value compared to Bitcoin, with a few “bumps” throughout the 2017 bull run

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Ethereum shows a similar pattern to Litecoin

A fractal to be wary of, are we simply experiencing a temporary bump, with a longer winter ahead?

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Bitcoin dominance over time. Rising sharply again; will it fall, or will this be

the run where Bitcoin officially “decouples” from other cryptos?

As you can see, Bitcoin’s dominance took a steep drop just prior to 2017 after gaining for most of 2016. After this steep drop the dominance rose up until the final manic “blow off top”. During this manic phase many popular exchanges, including Coinbase, stopped accepting new users. The mempool became congested and fees were (temporarily) exorbitantly high. As a result, many people used other blockchains, like Litecoin, to transact and liquidate their digital asset holdings.

Total Crypto Market Slowly rising

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As of 5/9/19, Bitcoin continues to lead the pack

The Importance of Schelling Points in Crypto: “Some of these things are true and some of them lies. But they are all good

stories.” -Hilary Mantel

The importance of schelling points in crypto cannot be overstated.

Satoshi made this clear, and may have started this trend, by introducing Bitcoin as a “Peer to Peer Electronic Cash System”. It was easy for people to realize the importance of this development even if they did not know how to read and analyze the source code. “Peer to Peer Electronic Cash” told a great story, and its value could be understood using just five words.

During the bull run of 2016-17 the space was dominated by these “stories” (or as some in the crypto space say memes). Bitcoin became

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“digital gold” which was extremely easy to understand, Litecoin became “digital silver”, and ethereum “digital gas” or “digital oil”. All of these assets had an extreme run up in price during this run.

So why did I mention schelling points in the title of this section? It is because I think that schelling points, stories, and memes are roughly equivalent, and in a network driven space like cryptocurrency they become extremely important. Let’s say that two people must decide to use the same digital currency, but they cannot communicate. They are both individually told that if they use the same digital currency, they will receive $1000. Again, they cannot communicate. Which digital currency will they choose when anticipating what the other will choose? Almost assuredly both will choose Bitcoin, because Bitcoin is the most prominent blockchain by far. This is the schelling point of digital currencies, but the meme and story of Bitcoin being “digital gold” and “digital cash”, the two largest stores of value and medium of exchanges definitely helps to develop this schelling point.

Now let’s give these two individuals the same parameters, but tell them to choose the digital cash which allows them to create the most advanced smart contracts and assets on top of the blockchain? Now, most people will choose ethereum.

What are the other major schelling points in the space? Well, if you have to choose a privacy blockchain it will most likely be Monero, with Zcash not far behind. Choose a governance blockchain and you will probably go with Decred. Choose a quantum resistant blockchain and it will either be the Quantum Resistant Ledger or Iota.

These schelling points and memes help potential investors and users of crypto currencies to build easy to understand narratives. This gives investors confidence (though it might be unfounded) that their investments are sound, and they may believe that they have an advantage over the market. Litecoin may seem like just another coin, but when described as “digital silver” or “lite weight bitcoin” it becomes much more “investable”.

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The next few years:

“Life is so full of unpredictable beauty and strange surprises. Sometimes that beauty is too much for me to handle. Do you know that feeling? When something is just too beautiful? When someone says something or writes something or plays something that moves you to the point of tears, maybe

even changes you.” -Mark Oliver Everett

Bitcoin recently passed its 10-year birthday. It seems that now we are on the verge of something with geopolitical implications. High profile banks are dipping their toes into the crypto waters, and it seems that this industry is filled with more innovation, intellect, and hard work than ever before. History is being written as we speak, and the efforts of users all over the world will be critical for this next step—which will likely be the most difficult.

True adoption, regulation, real use cases, and market legitimacy will not happen overnight. Hopefully the market learned from the last hype cycle, and while I am biased, I believe there is now more of a push toward developing real value and staying away from disingenuous projects (though I could be proven wrong).

In the near futures, centralized crypto gambling casinos will become

an edge case, not a norm. With Bakkt opening up a bitcoin custody and futures platform backed by Intercontinental Exchange, and Fidelity continuing its Bitcoin custody integration, major financial institutions will displace the current exchanges. More than anything, I am excited to see where the next few years take us. There is an inherent risk/reward when it comes to Bitcoin and cryptocurrency, and no one knows the risks more than long term holders and users. The rewards, though, could be something that even the most ardent supporters cannot anticipate.

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The next halvening, combined with the inherent increase in demand for Bitcoin as it becomes more institutionalized and more well-known, could create extreme volatility. The lindy effect may make miners more confident in their ability to hold on to Bitcoin instead of immediately liquidating. Each day that the Bitcoin blockchain stays secure make it more likely that the same blockchain will be part of our lives years from now. This may not be properly priced in by analysts, and again could lead to the volatility we are accustomed to in these markets. Disclaimer: I may own some of the assets discussed in this paper, but will not make trades immediately before or after paper release in case there is any market effect.