Crypto Market Commentary
23 June 2019
Doc's Daily Commentary
Make sure to watch Doc’s 6/21 Trade School session on “Prepping for Volatility,” which is posted in the “Trade School” archive.
Our most recent “ReadySetLive” session from 6/19 is listed below.
There is no question that distributed ledgers are going to change the way the world financial and coordination system works. This technology banks the unbanked, takes back our privacy, security and self-sovereignty, enables the machine economy and AI and provides an monetary medium which is immune to political intervention.
However all this comes with necessary trade-offs.
Decentralisation is expensive. In a system where data is replicated across thousands of devices, it is not the most efficient way to store data however it does make for extreme redundancy of information and thus censorship resistance.
The most accurate description of a decentralised ledger in my mind is a slow but secure time-stamped database. Blockchains like Bitcoin and Ethereum are very good at recording an objective and factual record of what happened and when. What they are not very good at is reversing a transaction if a mistake is made or processing a transaction quickly. This is the trade-off where security and decentralisation take precedence over scalability and flexibility and is sometimes referred to as the scalability trilemma.
The trade-offs for DLTs doesn’t just stop at scalability and security. It covers monetary policy, social contracts, game theory, upgradability, functionality and governance. The foundation of your investment thesis in this industry should look at what blockchains are good for and whether the trade-offs that were made justify the coin or token. In many cases, the centralised systems we have today work just fine.
Project specific examples
Bitcoin for example has made many difficult trade-offs such as simplicity and non-flexibility in return for predictability and an unrivalled degree of trust. Coupled with the fixed supply monetary policy and deterministic supply curve, Bitcoin has thus attracted the ultimate monetary premium and it is coming for Gold whether Peter Schiff likes it or not. Nic Carter covered Bitcoin’s trade-offs in great detail in this article (link) which I highly recommend giving a read. Bitcoin will be the first major project to calcify (where the base layer becomes encased in concrete, never to change again) which represents the ultimate end goal for cryptocurrencies in order to reach maximum trust.
Decred is very similar to Bitcoin in that it is coming for sound money although traded the extremely complex and difficult to change governance of Bitcoin for a more flexible stakeholder owned and operated development system. This is a project to watch because I personally see it has made extremely rational trade-offs given it cannot replicate the origin story of Bitcoin and has therefore taken governance and security to a whole new level as a unique offering. The calcification of Decred may be further away than Bitcoin however the ability to adapt in an uncertain world may well be a long term advantage.
Ethereum has targeted flexibility in the code base and adaptability as a software platform at the expense of a fixed monetary supply and a perpetual inflation rate. This has diminished the intrinsic monetary premium and predictability of ETH which the platform aims to combat with the modular financial dAPP system built on top. It remains to be seen if this trade-off will pay off in the long run however the similarities to the fiat monetary system are clear and perhaps it is the natural evolution of Keynesian economics. It must be recognized that ETH is slowly attracting a monetary premium, certainly over other platform coins and is indeed worthy of the #2 spot as of today.
EOS is an example of a platform which traded decentralisation and immutability for scalability and fee-less transactions…although to date has failed to deliver more than 100TPS which may well result in a few unhappy investors as time goes on. If we imagine a world where EOS was able to deliver on the 1million TPS that was promised, I would question whether it offers much of an advantage over the legacy systems. A centralised database will always operate faster and quite frankly, 21 nodes is easily captured by nation states. This is an example where the trade-offs are unjustified in my mind and the use case would be better applied off chain. EOS is drawing attention from the gaming industry for owned items. Valve’s Steam platform has had these a lot longer than blockchains have been around so I’m yet to be convinced.
Projects which use DPoS such as Ark, NEO, ICX and ONT or Federated BTF consensus like XRP and XLM fit into a similar category as EOS where they have traded decentralisation for scalability, immutability and upgradeability. Whilst there is advantages for the likes of NEO, ONT and ICX based on their home nations, they are unlikely to capture the global system and they may exist solely as a smaller subsets of the distributed economy where government oversight is encouraged. The payment networks XRP and XLM have both had significant problems regarding their issuance schedule with XRP a complete mystery as to how many coins actually exist and XLM having a severe inflation bug that was not disclosed. Jed MacCaleb was at the helm of both of these projects so the similarities here are obvious. I think their lifespan is overdue (especially with Libra in the mix) simply because the destroyed trust in monetary policy is unlikely to ever be rebuilt.
NANO and Radix are incredibly scalable systems using alternative data structures (DAG and Tempo respectively). These two protocols are fee-less, almost instant and can reach many thousands to millions of TPS with relatively decentralised ledgers. I suspect they will find use case in the machine economy and AI systems given fee models in Bitcoin and Ethereum are not suitable for machine micro-payments. The trade-off made here is security and finality. Whilst so far double-spends are theoretically extremely difficult to execute, the reality is that they are less secure than Bitcoin. For the same number of nodes as Bitcoin, they simply cannot be across the every single data shard and thus there are fewer eyes keeping things in check. The dispute resolution protocols of both still require a semi dPOS type arrangement although many times more secure than EOS’ 21 Block Producers.
At the end of the day
What we can see here is the experimentation of different trade-offs and approaches to technical, social and game theory elements of DLTs. Deep down, I’m fairly confident that there are only a handful of systems that will service the long run with the market telling us right now that Bitcoin is the alpha in the mix right now. It will be a case of right protocol for the right job and the more ‘currencies’ exist, the more friction will lead to consolidation to the few that matter.
When constructing your investment thesis, it will pay dividends to understand the trade-offs that are made by each cryptocurrency or token to achieve the goal as there is no free lunch. A few common trade-off pairs below may help to give some context if and when the altcoin cycle comes back around. Be careful, I think alt-cycles will become less powerful and more concentrated on premium projects as time goes on and those which get the trade-offs right and don’t promise to solve everything will emerge victorious.
Governance is interlinked with flexibility and monetary premium. Poor governance or misaligned incentives will be the #1 extinction event for most cryptocurrencies. Furthermore, as the world changes around us, the requirements and needs of a platform or cryptocurrency may need to shift but not so much as to destroy monetary premium and trust. A robust and incentive driven model for managing this progression is essential and on-chain vs off-chain governance is still very early in experimentation. If the incentives and game theory are not aligned, it won’t work out long term.
Scalability and Feeless comes at the cost of decentralisation and/or security. If decentralisation and security drop such that immutability is compromised, a centralized database is a superior alternative. Very few projects have or will make this trade-off successfully and Libra is probably the biggest attack vector. Coins that fight for scalability and feeless transactions need to offer something advantageous over centralized coins and in particular need to concentrate on the micro-payments and machine economy space.
Fixed Supply vs constant Inflation is a trade-off common for PoW and PoS coins and is a function of security. Fixed supply coins will always have volatile prices as only the demand side is elastic. Thus attracting the demand is essential to motivate miners to secure the network which is where the sound money principles must be front of mind. Fixed supply is the most intense and hostile environment and coins fighting for this space are competing with Bitcoin…not a fair fight. I expect one or two at most PoW coins to survive in this space and I don’t see other consensus mechanisms standing a chance. PoS coins require constant inflation to continue incentivizing security and are typical of platforms for software development. This is a delicate balance and maintaining a monetary premium and requires an ecosystem of useful applications for the base protocol coin/token. Ethereum clearly has this advantage. I see a few PoS coins surviving however I don’t see them taking the #1 simply due to the elastic supply and demand.
I suspect this industry will end up as a Pareto distribution with a very long tail of abandoned projects that couldn’t attract users or make appropriate trade-offs. With that said, if you pick the winners, its going to be a fun ride.
The DLT industry requires trade-offs. Until we have quantum computers solving our problems in micro-seconds, the physical limitations of networking, electrical demands and mother nature dictate that everything comes at a cost. There are many blockchain projects out there that profess to have solved all the problems and that the scalability trilemma is a thing of the past…
…Alright mate, at what price?
Blockchains are equal parts technological innovation as they are social contracts. A quick look into daily active users on Coinmetrics and on Crypto Twitter will show that Bitcoin (red) and Ethereum (purple) have by far the largest followers and applications, nothing else comes close and this is appropriately reflected in the market capitalisation. This represents a shared social contract and belief system that these two ledgers are delivering value to society. As time goes on, the Lindy effect will become increasingly important and the gap between those projects that understand and take ownership of the price of their decisions will bear fruit.
Figure 1 – Daily Active addresses (source Coinmetrics.io)
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An Update Regarding Our Portfolio
We are pleased to share with you our Community Portfolio V3!
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We intend on this portfolio being balanced between the Three Pillars of the Token Economy & Interchain:
Crypto, STOs, and DeFi projects
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Here’s our past portfolios for reference:
RSC Managed Portfolio (V2)
RSC Unmanaged Altcoin Portfolio (V2)
RSC Managed Portfolio (V1)