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Cryptocurrencies

Innovation and Cryptoventures. Cryptocurrencies. Campbell R. Harvey Duke University and NBER. January 29, 2018. Blockchain Opportunities. http://www.slideshare.net/RedChip/btcs-201507. Long History of Digital Currency. Paypal started in 1998 as a software security

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Cryptocurrencies

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  1. Innovation and Cryptoventures Cryptocurrencies Campbell R. Harvey Duke University and NBER January 29, 2018

  2. Campbell R. Harvey 2018

  3. Blockchain Opportunities http://www.slideshare.net/RedChip/btcs-201507 Campbell R. Harvey 2018

  4. Long History of Digital Currency Campbell R. Harvey 2018

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

  6. Disruption 101 Campbell R. Harvey 2018

  7. Disruption 101 • Money transfer network is $500 billion per year • Average fee=10%. Bitcoin 0.01%* • Potential of $50b per year in hands of consumers • “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. Lightning Network promises much lower fees. Campbell R. Harvey 2018

  8. Disruption 101 Campbell R. Harvey 2018 https://www.bloomberg.com/news/articles/2018-01-12/kodak-ceo-plans-to-seize-blockchain-moment-and-win-over-skeptics

  9. Cryptocurrency: 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 Ethereumblockchain. • Initial offerings: • ICO = Initial Coin Offering • ITO = Initial Token Offering https://theethereum.wiki/w/index.php/ERC20_Token_Standard Campbell R. Harvey 2018

  10. Cryptocurrency: Coins vs. Tokens • Coinmarketcap.com lists 895 coins and 549 tokens • Almost all the tokens associated with Ethereumblockchain. Largest is EOS https://eos.io/ https://coinmarketcap.com/tokens/views/all/ Campbell R. Harvey 2018

  11. Cryptocurrency: Diversity Many variations • Method: Proof of Work, Proof of Stake, • 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

  12. An Overview: Public Blockchains Let’s initially focus on one of the first applications of blockchain: Bitcoin • Peer to peer network • Triple entry accounting with common ledger that everyone shares called the blockchain • Introduces a protocol (rules for validating transactions) on the blockchain. Trust not required. • Unit of account: bitcoin a cryptocurrency Campbell R. Harvey 2018

  13. 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

  14. 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-sizehttps://en.wikipedia.org/wiki/Turing_completeness Campbell R. Harvey 2018

  15. An Overview: Public Blockchains There are significant barriers to entry to understanding bitcoin and other cryptocurrencies • These barriers to entry provide an opportunity for us that we will explore in this course Campbell R. Harvey 2018

  16. Solution Any new product has to answer two questions: • What problem does this solve? • Is the problem economically important? Campbell R. Harvey 2018

  17. 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 Material drawn from Jameson Lopp, The Multifaceted Nature of Bitcoin

  18. 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 Material drawn from Jameson Lopp, The Multifaceted Nature of Bitcoin

  19. Solution Family • Send remittances at minimal cost around the world Campbell R. Harvey 2018 Material drawn from Jameson Lopp, The Multifaceted Nature of Bitcoin

  20. Solution People in risky countries • Provides an alternative method to transact when a country is hit with hyperinflation Campbell R. Harvey 2018 http://krieger.jhu.edu/iae/economics/Venezuela_Enters_the_Record_Book.pdf

  21. 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 Material drawn from Jameson Lopp, The Multifaceted Nature of Bitcoin

  22. 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

  23. 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

  24. 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 Material drawn from Jameson Lopp, The Multifaceted Nature of Bitcoin

  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 a fundamental misperception. http://fortune.com/2016/03/15/apple-iphone-swiss-bank/ Campbell R. Harvey 2018

  26. 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

  27. Challenges • Cryptocurrencies are mainly used for criminal activity. • A lack of security plagues all cryptocurrencies. • Bubble because no fundamental value. • Mining is a waste of energy. • Cryptocurrencies are too small today to be an important economic force. • Cryptocurrencies are currently too risky to serve as a store of value. • The concentration in holdings perpetuates economic inequality. • Cryptocurrencies are just another currency. Campbell R. Harvey 2018

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

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

  30. Cryptocurrencies: Issues with cash – crime and tax evasion. 79% in $100 bills * https://www.federalreserve.gov/paymentsystems/coin_currcircvalue.htm 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) Campbell R. Harvey 2018 http://www.wsj.com/articles/indias-demonetization-debacle-1481851086

  32. 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) RaghuramRajan, Former RBI Governor, at the AEA/AFA Joint Luncheon, January 5, 2018 Campbell R. Harvey 2018 http://www.wsj.com/articles/indias-demonetization-debacle-1481851086

  33. Cryptocurrencies: Issues with cash – crime and tax evasion. • December 15, 2016 Venezuela scraps 100 bolivar bill Campbell R. Harvey 2018 http://www.wsj.com/articles/venezuelans-protest-over-worthless-cash-1481935897

  34. Cryptocurrencies: • Calls for digitizing $100 and $50 bills – but do you prevent perfect counterfeiting? • Answer: Use a blockchain Campbell R. Harvey 2018

  35. Cryptocurrencies: A lack of security plagues cryptocurrencies • Mt. Gox • On February 24, 2014, the site shut down with 850,000 bitcoins “missing” • Bitstamp closes (temporarily) January 4, 2015 • Section A • Section B Campbell R. Harvey 2018

  36. 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

  37. 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 secure. Dr. Sarah Meiklejohn, UCL “The hash rate is out of control” (November 11, 2016) Campbell R. Harvey 2018

  38. 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

  39. 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

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

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

  42. 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

  43. 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

  44. 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

  45. 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. Campbell R. Harvey 2018

  46. 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

  47. Cryptocurrencies: Bitcoin is currently too risky to serve as a store of value Innovation & Cryptoventures First offered! Campbell R. Harvey 2018

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

  49. Cryptocurrencies: Bitcoin is currently too risky to serve as a store of value Annualized bitcoin return volatility (1 year moving window) Illiquidity causing high volatility story not supported by data over the past two years Campbell R. Harvey 2018

  50. Cryptocurrencies: Bitcoin is currently too risky to serve as a store of value Annualized bitcoin return volatility (90-day moving window) Campbell R. Harvey 2018

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