Crypto Theses for 2019

Cryptocurrency • January 6, 2019, 12:31PM EST
  Photo by Christian Nielsen on Unsplash

 

The following piece originally appeared on Medium. It was written by The Block technical advisor Arjun Balaji and is republished here in its entirety with Arjun's permission. If you would like to receive regular updates directly from Arjun, you can subscribe to his e-mail newsletter here and Medium here.

As another year wraps up, I started writing an email to close friends and investors on the “state of crypto” and my forecasts. As it got longer, it turned into this sprawling post. A few notes:

  • This write up contains wide-ranging theses and obvious biases (my own) and is by no means authoritative. Please don’t nitpick.
  • Where I make predictions, I try to be as specific as possible (inspired by SlateStarCodex’s format). Not all predictions are quantifiable. Some will be off and many will likely be directionally incorrect. That’s OK.
  • Unless otherwise specified, my criteria for a liquid, actively-traded project “dying” is either (1) < $100k volume/$20m market cap or (2) primary development abandoned, whichever comes first.
  • None of these predictions are normative; in many cases I see momentum in products or approaches I consider fundamentally flawed. C’est la vie—this is an attempt at a descriptive 2019 outlook.

Index

  • Bitcoin
  • Ethereum
  • Other Tokens
  • Private Projects
  • Stablecoins
  • Crypto-funds
  • Product Potpourri
  • Crypto Companies
  • Regulation
  • Closing thoughts on prices and adoption

Bitcoin

1) After a strong launch in 2018, I see Lightning Network growth continuing into 2019. I predict the number of Lightning nodes with channels will be ≥ 10,000 from ~2,100 now (60% confidence) due to the proliferation of node hardware and hosted solutions (e.g. Nodl.it, Casa’s node) and easy-to-deploy GUIs like Pierre Rochard’s node launcher. I predict network capacity will increase even more from ~$2m notional to ≥ $25m+ notional (75% confidence) due to the lifting of maximum channel limits, dual-funded channels, etc.

2) At least one major exchange will launch a Lightning Network hub for their users as confidence in the stability and security of the network grows over 2019 (50% confidence). If this occurs, my money is on Binance given their iteration speed and product chops or Coinbase, due to increased focus on adoption and “usage” of cryptocurrencies. I’m particularly excited about Cash App’s potential here given 1) they’re a business that understands Bitcoin 2) Jack sees Bitcoin as a path to “financial inclusion” and 3) Jack’s investment in Lightning Labs’ 2018 seed round.

3) A working implementation of Schnorr signatures, for which Pieter Wuille released a draft BIP in July, will make its way into Bitcoin via soft fork by the end of 2019 with ≥ 5% node adoption (75% confidence).

4) Low volatility and lower prices always attracts concern trolls and people who believe they can “change” Bitcoin for the better. The last two years have seen a lot of forks where the codebase is changed but the UTXO set is kept intact. In 2019, I expect to see the opposite: forks with technology kept intact (to merge future upstream changes) where the monetary policy or UTXO set is modified; an example being the Zclassic team forking Zcash to remove the Founder’s Reward). I predict 2019 will see a major fork proposal from Bitcoin OGs “fixing” post-block reward fee market sustainability either by re-appropriating Satoshi’s Bitcoin (e.g. my tongue-in-cheek tweet-proposal for “Bitcoin Freedom”) or by adding predictable, low inflation in favor of the fee-market (50% confidence).

5) 2018 was a big year for Bitcoin privacy and fungibility R&D, with proposals for Taproot and Graftroot from Gregory Maxwell in Q1, a draft BIP for theDandelion protocol in May, and an emergent path for a soft fork upgrade to Schnorr-based signatures. By the end of 2019, there will be a clear roadmap for “good enough” fungibility and privacy on Bitcoin’s base layer across a meaningful set of trade-offs (e.g., speed, confidence level, etc.) (50% confidence).

6) 2018 saw plenty of promising experiments building products around, with, and on top of Lightning. I anticipate 2019 will see significantly improved UX for developers who want to build with Bitcoin, including web3/Truffle-likeJavascript wrappers, hosted node services, better docs, tutorials, etc. which makes me very excited about the potential for new products.

Ethereum

7) 2018 was a big year for proof of stake research with June’s deprecation of EIP 1011 (Hybrid Casper FFG), scrapping the hybrid PoW/PoS step in favor of moving to pure PoS. The next phase for Ethereum—first termed Shasper(Casper + Sharding), now called Serenity (Ethereum 2.0)—has six distinct phases, which stretch over several years. There are 8+ dev teams working on independent implementations including:

Despite seeing major setbacks and changes to the Ethereum 2.0 roadmap, I think the first phase will ship some time in Q4 2019 (70% confidence), albeit with friction.

8) Augur, whose launch everyone awaited with bated breath, seems to have gained little traction (outside of niche markets around the election). I suspect it will be the breakout dApp of 2019, leaping from ~$1.5-2m notional at staketo ≥ $10m (70% confidence). My bullishness is due to (1) a full year elapsing with a working product (2) improved UX/choice of clients (3) increased brand awareness (4) demand in the market for a non-custodial prediction market (5) stablecoin integration and (6) better market-making and liquidity provisioning.

9) The “crypto-collectibles” narrative which gained major steam in Q1/Q2 (peaking in March’s $12m raise for Cryptokitties) will lose traction despite the orthogonal interest for tradable in-game items. While collectibles are interesting, they feel like a solution looking for a problem (though worth noting: I’m not a tastemaker) and gamer adoption feels like a pipe-dream as companies are unlikely to replace their existing monopolies. I suspect several of 2018’s niche “X-for-Y” Cryptokitties imitators that are less well-funded will shut down next year (85% confidence).

10) Despite the hype going into the new year, consumer adoption of decentralized exchanges (DEXs) have materially lagged expectations.Relayers leveraging 0x — viewed by many as the best exchange protocol — in aggregate have traded < $2m notional most days in 2018. I predict December 2019’s aggregate volume on 0x will lag a single day’s volume from Coinbase (90% confidence). The big problem with DEX adoption in 2018 is that it's unclear who the target user is.

While non-custodial trading feels like a boon, the trade-offs presented (e.g. in matching/execution speed, the potential for front-running, decreased privacy, the difficulty of accounting, etc.) make it an unappealing product for institutional investors, not even considering the UX curve. Whether retail investor participation will be sufficient for long-term sustainability remains to be seen. In addition, many DEX protocols with fee-based tokens will get forked (like 0x has by their top relayer), though I predict we'll see a surge in cross-chain swaps and similar non-custodial trading options sans token.

11) A lot of early prominent projects promised new types of markets, e.g. forcomputation or storage. Along with the “utility token” narrative, demand for these solutions appears dead, as it’s unclear whether (1) demand for un-censorable XYZ is compelling enough given increased cost relative to centralized alternatives or (2) any of these new marketplaces will be sufficiently bootstrapped to hit the economies of scale necessary for their adoption. Not a single one of the new decentralizing marketplaces promising to marshal distributed or idle resources pose a threat to AWS, Microsoft, Dropbox, etc.

12) I anticipate we’ll see major pushback from disenfranchised ETH miners, who will propose a contentious hard-fork (60% confidence). Ethereum’s roadmap is already relatively antagonistic to miners: January’s planned Constantinople upgrade (which, among other changes, reduces block rewards from 3 to 2) hurts miners currently at the margin, likely putting them out of business. While a supply reduction is generally bullish, the upgrade may be short-term bearish (given increased miner inventory sales) if it’s not already priced in.

13) “Governance tokens” will be less popular than ever by the end of 2019. To me, they appear misaligned incentive-wise: in practice, it feels like rational token holders should be oriented around (1) entrenching existing power structures (as original token holders have out-sized sway in future protocol decisions, including future value-capture design) and (2) maximizing token value rather than what’s often cited as the goal (maximizing token utility). The excitement around the governance token (e.g. “We don’t need to worry about value-capture, we just need to build something worth governing.”) was a by-product of a never-before-seen crypto bull market and will warrant meaningful skepticism in 2019 (60% confidence).

14) On the face of it, decentralized finance (a.k.a. “DeFi” or “Open Finance”), a dominant narrative of Ethereum in 2018, is compelling to me in spite of my Bitcoin bias. A goal of the cryptocurrency movement has always been to increase financial inclusion and the core premise of the “DeFi” movement—to provide crypto-native financial products to the unbanked—has obvious appeal. However, I don’t understand what product market fit looks like for the vast majority of “DeFi” products.

If these products (in many cases, novel non-custodial derivatives or leverage-oriented lending products) are designed for institutions, I struggle to understand how they’ll achieve product market fit for many of the reasons posed in 10 on DEXs. Bootstrapping liquidity will be extremely difficult (i.e., I don’t want to trade an exotic non-custodial derivative with no liquidity and it’s unlikely a marginal trader will want to do the same— the classic chicken-and-egg problem). If these products are designed for retail investors, I don’t understand the product market fit either. The long-shot thesis may be that the globally unbanked are looking for easy entry points that DeFi can solve, e.g. exposure to US capital markets/equities with synthetic on-chain CFDs, but I am doubtful. Most consumers in the world don’t have meaningful savings, mirroring Vanguard-type indices or more complex derivatives doesn’t feel like the right entry point for global adoption.

I believe some of the US-based teams working on the DeFi stack are taking on material risk and will face regulatory scrutiny in the US (70% confidence) given their move into structured products. This will test the runaway killer app of Ethereum: regulatory arbitrage (first with the offering of unregistered securities offerings and now with quasi-legal structured derivatives), as teams“move fast and break [the law].”

While engineers are discussing “compounding financial primitives,” I’m worried about compounding technical (or legal) risk.

Other Projects

15) Two years after pseudonymous Tom Elvis Jedusor posted a paper outlining the Mimblewimble architecture to the #bitcoin-wizards IRC channel, 2 different implementations, Grin and BEAM, are set to launch in Q1 2019. Both subscribe to different design philosophies, from Grin’s Bitcoin-like immaculate conception to BEAM’s Zcash-like foundation model, in addition to differences in monetary policy, stance on ASICs, etc. I expect both will be meaningful in 2019’s privacy wars, with Grin seizing the lion’s share (≥ 70%) of market interest in Mimblewimble (75% confidence). Though its monetary policy isn’t ideal for early adopters due to high early inflation, it wouldn’t surprise me if it finishes ≥ $250m market cap (60% confidence).

16) Given both comments from Zooko about both PoS and the Zcash Founder's Reward and rumblings from the community, I think it's possible that (1) Zcash plans a multi-year transition to propose a move to a hybrid PoW/PoS system (50% confidence) or that (2) a change to the Founder's Reward (30% confidence) takes place. As the Founder’s Reward runs out in 2020, with a lot of research and engineering work left, I can see a proposal to extend it (or lengthen the reward beyond 2020) emerging.

17) It's not a secret I've been hoping most un-differentiated “means-of-exchange” tokens (e.g. $IOTA, $DASH, $BCN, $XVG, etc.) will die for some time. With the exception of Litecoin (which has the benefit of an old brand, widespread integration, and Bitcoin “test-net” status) and Dogecoin (which will never die), I expect ≥ half these un-differentiated payment tokens will be flushed out over the next year (70% confidence) as (1) 2018’s price action shows they are subject to the same volatility issues as Bitcoin (2) growth of the Lightning Network dampens need for a “faster Bitcoin” (3) they don’t have interesting innovation keeping a large community engaged the same way other public blockchains do with privacy (e.g. Monero, Grin) or ecosystem products (e.g. Ethereum, EOS, Tezos).

18) From the days of the Silk Road, dark net markets (DNMs)—along with pornography—have been a hot bed for cryptocurrency innovation. DNMs have gotten more sophisticated than ever, moving from centrally-run sites with single points of failure (e.g. DNS shut-down) to decentralized infrastructures, spider webs of Telegram chats and bots, and better reputation systems. There are still problems: bitcoins are still the pre-eminent cryptocurrency of choice (given lack of customer awareness) despite the lack of better, more private options and the fiat-to-bitcoin conversion is a honeypot for law enforcement agents.

It’s no secret I don’t think there are many real use cases of “blockchain” outside of quasi-legal applications. While it’s directionally clear that the future of DNMs is in moving to a fully decentralized stack (with smart-contract-based escrows, etc.), the lack of privacy on most public blockchains makes this a pipe-dream for 2019. Despite this, DNMs serve as an important crypto mind virus entry-point for many—a painkiller rather than a vitamin.

19) With greater focus on the “fairness” of Bitcoin and other cryptocurrencies, it’s inevitable we will see new distribution-focused blockchain experiments. While I’m less enthused, 2019 will likely be the year a Valley-based blockchain project focused on the long-standing goal of “getting crypto in the hands of everyone in the world” comes out. This form of UBI (inb4 “universal blockchain income”) is compelling to many and will have some traction as cryptocurrency mind-share has exploded beyond its libertarian-anarchist roots to include ideologies across the political spectrum.

20) $XRP, err, I mean Ripple Labs, Inc. will get a small fine/slap on the wrist from the appropriate regulatory authorities, who will finally confront the fact that it’s probably an unregistered security (80% confidence). Thanks to the regulator-revolving-door, Ben Lawsky (a.k.a. Architect of the BitLicense: The World’s Worst Crypto Regulation) is now on their board. While it’s unlikely anyone’s going to jail, it’s hard to see Ripple’s egregiousness let them off scot-free.

21) Bitcoin Cash split in 2018, with factions ABC and Satoshi’s Vision (SV) emerging. While the ABC camp has kept the $BCH ticker, BCHSV lives on. With Bitmain potentially seeing internal issues (rumored layoffs, balance sheet issues, IPO delays) and Craig Wright willing to see “2014 prices” to win, this could continue on despite the fact that no one cares. I’m more optimistic about Bitmain’s business than most people, but think that Bitcoin’s dominance v. both forks will grow from today (80% confidence). I also expect ABC’s dominance v. SV (~64% right now) will grow to > 80% by the end of the year (70% confidence). Despite my qualms about Bitmain’s strategic decisions, “Don’t start a hash war with Bitmain” might be as prescient as “Never fight a land war in Asia.”

22) 2018 was a big year for Bitcoin forks with Bitcoin’s December peak sparking imitators like Bitcoin Gold ($233m market cap), Bitcoin Diamond ($140m market cap), and Bitcoin Private ($41m market cap). They're all currently Top 25 in market cap and have survived everything from 51% attacks and exposés of covert pre-mines, but I think they’re unlikely to stay in the top 25 by the end of the year (70% confidence, lest the crypto market's extreme inefficiency fails me).

23) Both EOS and Stellar have committed a significant amount of time to building out developer experience and core infrastructure over 2018. Despite my skepticism of their potential to be internet money, there’s interest from some dev teams globally to interface with these networks for decentralized applications. The groups hacking on both networks are extremely well-funded. While they aren’t seen by many in the crypto cognoscenti as “legit” projects, some SV energy might push them to meaningful developer adoption(50+ launched dApps) in 2019.

24) I’ve been whistling with schadenfreude on “masternodes” for some time. They were the perfect bull market trade: lock up more and more coins as prices go up (even more right-tail vol thanks to the smaller float) but we haven’t seen a true unwinding/liquidity crunch despite the drawdown. I would be very surprised if any masternode projects outside of DASH have the liquidity or community backing to extend life to 2020 (40% confidence…sigh).

25) Token curated registries, once the hottest “crypto-economic primitive” on the scene, make less sense to me now than they did before 2018. They strike me as a prime example of 2017’s excesses (and desire to tokenize everything).The model feels extremely convoluted and it wouldn’t surprise me to see the industry move away from the TCR en masse (60% confidence).

26) Formal on-chain governance, which saw significant hype in 2017 from projects like Tezos, Decred, and Aragon left a lot to be desired. While the goal of formal governance systems is to enable smooth upgrades with input from a range of stakeholders, most suffer from elementary issues, cementing plutocratic regimes rather than enabling open participation. Most experiments with formal governance feel primitive due to the lack of proper tooling (e.g. for anonymous voting). There were some new announcements, including Commonwealth Labs’ work with Edgeware (a chain on Parity Substrate) but the long-term viability of formal governance systems remains unclear. In 2019, I think we’ll see some non-trivial core protocol decisions decided on-chain for the first time.

27) One thing to be more excited about: with more research in formal governance systems, DAOs could make a comeback over the course of 2019. Widely written off as a failed concept due to The DAO, two years later, there are new attempts. One DAO launch which looked cool this year is the Moloch DAO, which aims to contribute to Ethereum infrastructure and solve the tragedy of the commons problem in the ecosystem’s open-source (infrastructure) development. I’ve stated before that “crypto projects should have a plan to dissolve into some future decentralized governance model.” I see crypto projects re-architecting Swiss foundations into DAOs as the first potential “killer use case” and think we will see iterations of this in 2019.

Private Projects

Note: I'm not an investor in any of the projects or companies mentioned in this section.

28) Despite sustained drawdowns in public crypto markets, private valuations (particularly for projects coming from Silicon Valley) haven't quite adjusted. Fred Wilson recently noted the relationship between public market valuations in the equities market:

There is a big difference between the private markets and the public markets. They do not move in lockstep. For years now, the late-stage private markets have been trading at valuations that are well in excess of their public market comps. That is true for a number of reasons. First, private market investors have longer time horizons and are looking for a three to five year return, not an immediate one. Second, private market investors get a liquidation preference which in theory protects them from losses. Finally, deals in the private markets clear in an auction like environment where the highest bidder wins the deal. All of these factors mean that a hot company can raise capital in the private markets at valuations well in excess of where they can raise capital (and trade) in the public markets.

Most compelling for crypto is the last argument: starved for alpha, investors pattern-matched to find “the next Ethereum.” While several crypto-funds still have these investments marked at cost, it’s hard to believe investments made at ≥ $500m valuations (and in many cases, in excess of $1b) will represent gains for investors when the broad public crypto-market has drawn down so significantly. In 2019, I expect that many teams will re-raise at lower valuations or see material drawdowns when listing (90% confidence).

29) Some of these networks include Dfinity, Hashgraph, Algorand, Filecoin, Ncent, Thunder Token, etc. I anticipate less than 50% of these networks will launch in 2019 (70% confident).

30) The last quarter of 2017 and the first half of 2018 saw sky-high private valuations thanks to a potent combination of new crypto fund/whale money and a path to liquidity that divorced fundamentals and due-diligence in favor of memes and FOMO. As fast paths to liquidity have all but disappeared, I anticipate we’ll see projects return to more “traditional” approaches to raising money (read: equity) and focus on protocol-adjacent business models rather than building new base-layer protocols.

31) A launch of Handshake (technical overview) could be an interesting 2019 development. Though I’m skeptical of their need for a token, replacing the ICANN root server is an interesting problem and it’s clear the current DNS/Certificate Authority system is broken. One potential 2019 development: Handshake serves as a crude but effective solution for sites with regulatory or speech-related risk, which is enough to serve as an effective bootstrapping mechanism.

32) One thing I’m not looking forward to in 2019: the battle of messaging app crypto-tokens, with Telegram (TON), Signal (Mobilecoin), and even Whatsapp jumping into the fray. While none of them are interesting as a potential non-sovereign money competitor, I’m most interested in seeing what Facebook does: a stablecoin designed for remittance could make a meaningful impact while on-boarding millions of people to the cryptocurrency UX (as well as normalizing it in India, a country which has had 2018 legal boutsaround Bitcoin). I’m least excited for Telegram Open Network, who had a red-hot $1b sale on the backs of crypto mania, Telegram's traction, and many many pages of techno-babble.

Stablecoins

33) 2018 was definitely “year of the stablecoin” with Paxos Standard’s PAX, Gemini’s GUSD, Circle’s USDC, Carbon’s CUSD, and TrustToken’s TUSD; though none of these are true decentralized stablecoins (I prefer the term “price-stable asset backed token” or “fiat-coin” if that’s a mouthful).

Since these tokens allow traders to treat exchanges like banks, it should be no surprise that they are under KYC/AML-scrutiny, like banks. Fiat-coins are not permission-less, though aggregating demand for the product at the exchange-layer makes perfect strategic sense for exchanges. Even the briefest taint of an unsavory transaction can charge Tyler and Cameron to personally shut down your account.

Holding fiat-coins leaves you at the whim of the issuer to control your financial fate: we’ve just swapped one God for another. While Tether dominance has fallen to new lows due to concerns over credit risk and the emergence of these new projects, it’s unclear what product market fit for fiat-coins looks like. Is the use-case as an intermediary safe-haven or settlement currency for traders? Is it a new “digital dollar” with its own ecosystem of products?

In 2019, I anticipate Tether’s dominance of the fiat-coin ecosystem dips below < 50% (75% confidence) with total fiat-coin (counting TUSD, USDT, USDC, PAX, GUSD) exceeds 4b in market-cap from ~2.5b now (80% confidence).

34) Despite my reservations about the long-term viability of the model, MakerDAO saw serious growth in 2018 (with ~1.8m ether locked as of this post). While the system is robust—a by-product of excess collateralization in the system (currently ~370%)—use generally seems limited to demand for margin in ether, though the team has shared other use cases for CDPs. Continued deposits of ether in CDPs have affected ether price, it wouldn't surprise me to see ether in CDPs exceed 3% of total ether in 2019 (60% confident) though less volatile collateral or the emergence of centralized options like Compound Finance may be more appealing.

35) After marquee stablecoin project Basis returned money to investors, we lost one of the most interesting experiments in cryptocurrencies. Is it possible for a group of venture capitalists and clever twenty-somethings to bootstrap a price-stable currency based purely on belief (spoiler: probably not for now)? Despite the set-back, teams like Reserve are working on similar seignorage shares models with plans on decentralizing over time. I think it’s unlikely we see a a seigniorage shares-based stablecoin project launch with > $1b in total issuance in 2019 (80% confidence).

36) Fear over Tether’s backing was higher than ever in 2018 with concerns about banking relationships, enablement of price manipulation, and a constant stream of concerns over a proper “audit” of funds (though this may be impossible to provide in any conclusive way). The year ended with a Bloomberg story hinting that all the reserves may in fact be there. I predict it’s highly likely Tether in fact has all the US dollar deposits they claim they do (85% confidence) but that due to other investigations around criminal activity (e.g. money laundering, market manipulation, etc.), consumers may have their funds locked by authorities in a long withdrawal process, similar to online poker sites after the infamous “Black Friday” (30% confidence).

Crypto-funds

37) My favorite fundamental indicator is still price action. Earlier this year, I said about crypto funds:

Early in the cycle, many progressive funds will allocate to managers to “get smart” on the space (see: Passport Capital, Union Square Ventures, a16z, Sequoia, and others allocating to crypto-funds). This comes out of a recognition that the new asset class is different than the one that they're used to but could potentially become much more relevant to their strategy ... As initial hype subsides, a second generation of capital allocators will emerge who are more experienced, taking away capital from the gun-slinging fund managers who rode the first wave. It's highly unlikely that the very best fund managers in a new asset class were also the first to spot it. We're starting to see this now, with Matt Huang and Fred Ehrsam's new fund, a16z's newly announced crypto-fund, and several more unannounced funds raising money in today's crypto bear market.

This has roughly held up as new second-generation funds have raised from (1) more credible LPs [including the Yale endowment] (2) with longer lock-ups and (3) more credible GPs.

With that said, I think funding will slow down in 2019 given (1) lack of momentum in public crypto markets (2) limited investable opportunities given the size of the market and (3) proliferation of beta exposure vehicles. The third point is critical: many of the largest funds are overweight BTC/ETH, with capital allocators paying excessive fees for beta(particularly with long-only models). While experienced GPs will have no trouble raising and often argue that BTC/ETH allocation is a portfolio decision, I suspect many LPs will opt for exposure directly through low-cost single/multi-asset investment products.

38) With the blood this year, the opportunity for crypto fund differentiation finally emerged— though returns look less than stellar (Vision Hill's benchmarking was a positive development). More funds are starting to figure out where they “fit” in the landscape (e.g. fundamental long-only v. long/short v. “generalized mining” etc.) v. generically labeling themselves “crypto funds.” I expect we’ll see similar institutionalization in 2019 top-to-bottom of the entire crypto-fund pipeline, from back-office ops to custody. In addition, many funds will be one-and-done after the last year's price action and will see too many redemptions to continue (the death zone AUM-wise is probably ~$25m unless you skimp majorly on services/legal/salaries).

39) Concentration will become en vogue with consolidation of funds (due to shut-downs and re-allocation of LP capital) as “blue-chip” funds (of the fundamental long-only/long-short flavor) have heavy overlap with ownership in the same 20-25 names. I anticipate this will help greatly with decreased cross-asset correlation over the course of 2019.

40) Investing strategies from traditional capital markets like activist models, e.g. Layer1’s, have been extremely under-explored. While early models look something like Blockstream-meets-trading-firm and questions remain (e.g. is a model where wins are socialized but losses are not sustainable?), I’m excited about the development. One activist model I’m particularly interested in seeing: a fund pursuing legal arbitrage to attempt to secure treasuries from projects where the aggregate value of treasury funds exceed market cap. With the current market landscape, creativity is necessary.

Product Potpourri

41) I’ve been skeptical of enterprise blockchains and promised I wouldn’t spend any more time on them after my experience at a meet up last year. That said, it looks like corporate interest in capital-b Blockchain is slowing with depressed crypto prices using things like earnings call mentions as a useful proxy. Who would've thought? Turns out investment in enterprise or “permissioned” blockchain efforts were only cool while crypto prices (and corporate interest) was mooning.

In many cases, we’re in Year 3 or 4 of the “Blockchain, not Bitcoin” experiments that started in the aftermath of the 13-14 Bitcoin bubble. We've already started to see the first casualties as noted execs are abandoning projects ranging from R3, Hyperledger, and other efforts from Microsoft, IBM, etc. I expect most of these teams to see layoffs or shut down in 2019 (75% confidence) on the back of limited adoption and even more limited utility.

42) A positive development of 2018 is the number of new, cheap node-in-a-box hardware products, ranging from boutique consumer products like Coinmine’s to barebones hardware like Nodl.it’s. While costs range wildly based on feature-richness and form factor and there are concerns about commodification (from an investors’ perspective), this is undoubtedly good for users who want self-sovereignty when interacting with public blockchains. The average industry cost for a full-node box should trend to ~$150 USD (though it can be run even more cheaply on a Raspberry Pi).

43) Security tokens saw extreme hype going into 2018 with hundreds ofmillions of dollars in investment to exchanges, token standards, issuers, and more. My thesis remains steady that nearly all value generated by tokenized securities will be captured by 1) underwriters 2) asset holders [who benefit from the illiquidity premium] 3) early investors in STOs who can arbitrage sophistication 4) infrastructure providers.

A little STO inside baseball: as it stands, the space has little traction and is teeming with underwriters—who often stand to directly benefit from the deal from advantageous pricing as principal investors in addition to underwriting fees—hyping up future retail investor interest. Incentives are often misaligned.

Despite grandiose claims of $80T TAMs, I’m skeptical that security tokens have found investor-market-fit. It’s unclear who the “right” audience for STOs is. It’s not institutions, who lack any effective way to hedge or manage risk of these long-only products (or take custody, for that matter). Howard Marks' comment in a 2015 letter on liquidity comes to mind:

It’s one of my standing rules that “No investment vehicle should promise greater liquidity than is afforded by its underlying assets.” If one were to do so, what would be the source of the increase in liquidity? Because there is no such source, the incremental liquidity is usually illusory, fleeting and unreliable, and it works (like a Ponzi scheme) until markets freeze up and the promise of liquidity is tested in tough times.

With investor-market-fit uncertain, a potential macro cycle shift, and lack of institutional-grade infrastructure, and the roadmap to deployment looking uncertain, I’m skeptical the world will be tokenized in 2019. I would be surprised if the actively traded market of (novel) tokenized securities exceeds $2b in the next year.

44) There are a wide range of different institutional-grade custody offerings funded in Q4/Q1 of last year set to launch in 2019, either with direct self-custody products or by providing the technology back-end for other custodians. I suspect we’ll see a major custody product offering from a traditional sell-side firm (excluding Fidelity Digital Assets) by the end of the new year (60% confidence). I also think we’ll see the first crypto-native custody solution be granted broker-dealer/qualified custodianship status, a major step in the maturation of the asset class (75% confidence).

45) I’m bullish on efforts like Lolli and Cash App, beautiful products from companies who grok consumer UX and are making meaningful strides to help consumers understand and buy, earn, move, and store cryptocurrencies directly. I suspect these and new consumer products will lead to millions of people interfacing with a cryptocurrency for the first time in 2019.

Crypto Companies

46) As described earlier: Coinbase is fighting a multi-front war. Fidelity, Gemini, and a slew of Wall St. firms are competing for any institutional business. In the event there is an STO battleground to fight over, tZero, Templum, Harbor, Securitize, ASX/Malta/Gibraltar, and others are in fray. The profitable consumer business faces constant pressure from Robinhood, Circle, and Binance.

While their regulatory moat remains strong, Coinbase appears to be going into 2019 heavily focused on increasing consumer usage/adoption and aggressively expanding token listings (perhaps motivated by dampened trading volume in a crypto bear market). In 2018, Coinbase launched both their venture arm and expanded their M&A activity (acquiring Paradex,Earn.com, and acqui-hiring many smaller teams) in an effort to become the “Google of crypto.”

While I’m skeptical of the strategy to list tokens with dubious utility other efforts, a few facts remain true going into 2019: (1) Coinbase is still synonymous with “place to buy crypto” for millions of consumers. (2) They have a war chest to rival many of the largest companies in the space while (3) having a sizable regulatory moat in the US and (4) top-of-the-line product teams (at least relative to other crypto companies).

In 2019, I expect to see continued expansion into crypto-native consumer products that allow consumers to interface directly with protocols in addition to improvements to exchange infrastructure (as the bear market offers ample time to prepare for the next cycle of adoption).

Coinbase has already launched their Earn.com-based “education” service. Other product moves from them could include: a more consumer friendly wallet (Toshi refreshed) which allows customers to stake and interface with dApps/Lightning, increased focus on lending (Coinbase is a bank after all), and productization of the OTC workflows as they expand their institutional presence with sales and trading (other OTC desks lack the product and engineering chops).

I also strongly suspect that Coinbase shifts to a more Bitcoin-friendly position in 2019.

47) On the subject of exchanges, after a year spent acquiring fastest unicorn ever status, I suspect Binance will have a much tougher 2019. What Binance has in engineering chops they forego in regulatory attack surface area.

I suspect 2019 will see (1) Binance more comprehensively close access to US participants (75% confidence) after facing regulatory action (2) launch a full-on DEX (80% confidence) (3) launch multiple global fiat on-ramps (80% confidence) while (4) becoming the dominant exchange in Africa (90% confidence). While regulatory action will slow down growth from prospective US customers, I doubt they’ll see a full shut-down given their Malta domicile (30% confidence). I would peg a prospective shutdown of BitMEX (given shades of market manipulation/excess leverage) significantly higher (70% confidence).

48) 2018 was the year of the shitty exchange tokens following the runaway success of Binance’s token in 2017 (success always breeds imitators), with many resorting to shady “transaction mining” from companies like Fcoin, catex, ZBG, coinall, coinex, Cashierest, and abcc.

This is a new type of scam: instead of taking fees from customers, these shady third-tier exchanges choose to give back the notional value of trading fees to customers in the form of their native exchange token. This is clearly unsustainable, with a couple of these businesses already shutting down.

Many of these native tokens saw huge jumps in initial volumes from curious traders but are now cesspools of wash-trading given easy gamification. Not only does offering a token represent a serious liability, it represents major counterparty risk as the exchange-token scheme could collapse at any moment. I suspect ≥ 75% of the exchanges offering these trans-mining schemes will shut down in 2019 (85% confidence).

49) Consensys has had a rough year with major drawdowns in ether and other ERC-20 tokens (held in treasury/launched by Consensys subsidiaries), ending the year with lay-offs and plans of spinning off most of their less-favorite children. This is a bearish sign and I suspect the majority of projects that are spun off will have trouble raising follow-on financing due to cap-table concerns and broader theses shifts in the ecosystem.

50) Given Consensys’ contributions to Ethereum infrastructure (includingInfura, MetaMask, Truffle, etc.), it raises meaningful questions about the sustainability of open-source development and how important non-core protocol-adjacent work (e.g. developer infrastructure, etc.) will be funded.Historically, we've seen a few different models:

  • A company like Blockstream or Lightning Labs (taking cues from Docker, Redis Labs, SUSE, and others), focused on delivering value-added services on top of an open-source protocol. While their primary orientation is profit-seeking, a large part of the company's resources is committed to maintaining the project. Historically, this has been seen as unsuccessful (if not on an absolute basis, certainly a questionable risk-adjusted bet) for clear reasons: (1) It was unclear for many years what, if any, services would emerge as potential profit centers. (2) Unlike other new technologies (e.g., a web framework or database), a bet directly on the technology, without layered execution risk, is possible. Despite this, some of the largest contributions to Bitcoin have come from similar teams, indicating that their work was integral.
  • An exploratory research group like Chaincode Labs (which I believe is entirely self-funded), which has free reign to work on anything they’d like. This sort of patronage model allows for intellectual freedom, including hosting “mercenary” contributors or community members like tenured professors. While the freedom is optimal, funding these types of initiatives is often quite difficult: it requires recurring charitable donation.
  • A formal “foundation” which has wider-ranging set of responsibilities, including interaction with regulators, organizing the network launch, etc. This is — of course — sub-optimal and unlikely to be of any interest to communities like Bitcoin’s (who have historically pushed back against any formal “Foundation” designation given the many charlatans who’ve attempted to profit).
  • Direct fees from a crypto-network used to support core protocol and protocol-adjacent work, the approach taken by teams like Decred and Zcash.

While economists like Elinor Ostrom have tried to answer this question in other domains, I suspect we’ll see significant iteration on different funding models in 2019.

51) While the news of Bakkt's launch (delayed twice) and the announcement of Fidelity Digital Assets were eagerly promoted by the broad crypto-community, I suspect their Q1 launches will have less demand than expected with adoption trickling in over the course of the year. It remains ambiguous to me who the anticipated customer is for Bakkt’s bitcoin-settled futures product. Fidelity’s DNA appears to be deeply-rooted around Bitcoin’s cypherpunk roots, they will go a long way to combating common worries around rehypothecation during the financialization of Bitcoin.

52) [Disclosure: I'm an advisor to The Block.] 2018 saw the emergence of a number of new media properties (and media-adjacent companies/projects) including The Block, Messari, BREAKER, Token Daily, and TruStory. While they have various flavors of ideology and differing goals, they all go a long way to legitimizing coverage of an industry plagued with fake news, disingenuous PR, and blatant scams. While regulators have their hands full with low-hanging fruit, these companies are often the first to expose foul play — they will continue to play an important role in uncovering the deep underbelly of long-tail crypto projects as the industry continues disciplined self-regulation.

53) Bitmain, once the unstoppable inspiration of 1000 “mining is centralized” thought-pieces (a behemoth staring at a $12b 2018 IPO price), doesn’t appear to be immune from crypto bear market woes. The bearish case for Bitmain is straightforward: they’ve suffered immensely from a costly bet on Bitcoin Cash (and an ensuing pissing contest, err, “hash war”), lost some top engineering talent (who are now competitors), and are victims of depressed crypto prices along with other miners. Bitmain has lost technological superiority — their latest, the S15 (23 TH/s) has formidable competition from both BitFury’s Tardis (80 TH/s) and Ebang’s Ebit 11+ (37 TH/s).

Despite additional rumblings that Jihan Wu and Micree Zhan will be replaced with new leadership, I believe Bitmain’s obituaries are premature. 2018 saw many people come at the king, though some early competitors are already shutting down due to the difficulty and prohibitive cost of 7nm ASIC manufacturing. Bitmain may never be Ghash but shutting down this year feels like a long shot (85% confidence).

54) I’ve been bearish on Overstock (and tZero’s) prospects for some time. I think it’s highly likely that Overstock successfully spins out their retail business (85% confidence) by 2019’s end but that their blockchain efforts continue to sputter given a lack of profitability and slower-than-anticipated adoption of security tokens.

55) After seeing the $1b in revenue some OTC trading desks were generating in 2017, banks leapt at the opportunity to capture juicy spreads and generous commissions, most notably led (and later supposedly shuttered) by Goldman. I suspect demand for Wall St. offerings for spot BTC trading will be ~0 given the existing landscape of institutional-grade options (which execute the majority of spot bitcoin trading). It would surprise me if any tier-one bank opened an OTC spot or derivatives trading desk in 2019 (50% confidence).

56) A large exchange (top-10 in volume) will be hacked in 2019. The bear market is prime time for hackers, particularly with more fringe exchanges laying off some staff amidst difficulties (50% confidence).

57) As part of broader market consolidation in the bear market, I think we’ll see strategic acquisitions by larger companies or early movers in both on-chain analysis (e.g. Chainalysis, Elliptic, Coinmetrics) and custody products like Anchor (60% confidence).

58) Rage over payment system censorship felt like it reached a tipping point in 2018 with Mastercard (downstream via Patreon), SWIFT, and even PayPal demonstrating that payment networks like other web-based messaging services are susceptible to top-down decisions to cut off free flow of money at any point. Bitcoin can potentially catch a lot of these leaks as we saw with late 2018 examples from fringe social-networks like Gab or controversial personalities like Jordan Peterson. I anticipate this trend will continue into 2019.

Regulation

59) 2018 also saw many different proposals (from the BIS, IMF, and others) around central bank digital currencies (CBDCs) peaking with this paper.

The core argument for CBDCs some economists make are that by moving private deposits to CBDCs, a more safe narrow-banking system system emerges replacing the current commercial and private banking infrastructure (which in turn allows central banks greater control of the economy). Other economists like Ken Rogoff have made historical arguments in favor of moving to digital cash systems (phasing out large bills) citing both financial efficiencies and greater oversight into money laundering (and downstream crime).

Personally I find CBDCs terribly uninteresting, another attempt to extend to the financial system’s Foucauldian panopticon. “CBDCs, not cryptocurrencies” is just the latest of the already-tiring “Blockchain, not Bitcoin” trend. However with the world largely trending towards digital payments, I think CBDCs in some form are inevitable though I doubt we see large-scale consumer-ready deployments in 2019 (75% confidence).

60) We’ve already started to see the first regulatory actions come to ICO teams in 2018, with the SEC going after low-hanging fruit, establishing a clear pattern through the process. While no large projects have faced serious regulatory scrutiny, I anticipate the SEC will shift focus here in 2019 with a top-25 project (by market cap) facing injunction (60% confidence).

61) 2018 saw more Bitcoin ETF proposals than ever with SolidX-VanEck Bitcoin Trust, ProShares Bitcoin ETF (they also filed a Short Bitcoin ETF), GraniteShares Bitcoin ETF (corresponding short ETF), and others, including more esoteric multi-asset ETFs from companies like Bitwise Investments. Despite outstanding concerns over market manipulation of BTC spot prices, I think it’s likely we see a Bitcoin spot ETF approved by the end of the year (70% confidence), with my bet on VanEck to grab first approval.

62) One place we’ve seen little regulatory action is with “crypto influencers” facing fines or other actions, though regulators have started clamping down on celebrities. Naming names is rude, but this SHA-256 hash has my list of influencers that are more likely to get rekd, with a reveal coming in 2020: a6c061624f97399d08fb58dbd23801ab9d03a9329128f5147a9873c9daf906a1

63) Along with excitement over CBDCs, I think it’s likely some country (likely smaller) will announce a pilot or experiment around a blockchain-based identity system (50% confidence).

Some closing thoughts on prices and adoption

With this year marking the start of a crypto recession, the focus for many technologists has been around adoption and usage.

In my view, the only thing that can drive crypto adoption is (1) bitcoins or other cryptocurrencies serving as an escape valve for people who are in uncertain monetary regimes (and willing to stomach Bitcoin’s volatility), e.g. Venezuela, Iran, etc., (2) people buying into the idea that Bitcoin is effectively a call option on becoming a future store-of-value, or (3) people buying the idea that Ethereum, Dfinity, Tezos, and other crypto-networks represent a radical shift in the way computing works (“Web 3.0”) ahead of what will likely be a multi-year validation process.

There may be others, but those three things represent to me the majority of factors that could “drive crypto adoption in the short-term.”

As people’s interest fade and near-term sell pressure drops off (which we’ve seen over the last several months), we’ll enter a prolonged phase of virtual boredom (read: this is right now) which lasts months, if not years, where many spend time speculating on what’s “next” for adoption (post-13/14 cycle this was new protocols like Ethereum, merchant/payment processing tools, etc.) while the majority of people involved in the previous bubble leave.

I don’t really worry about questions like short-term adoption drivers. People will buy cryptocurrencies for one of the reasons above, or they won’t. Gradually as the market bottoms out, prices becomes more appealing and perhaps renewed interest leads to another cycle, serving a self-fulfilling prophecy. Or maybe the price dips below a point of “no confidence” (i.e., BTC prolonged < $1k) at which point no one has faith and only HODLers of last resort are left (like we saw last cycle). Either way though, the digital sound money genie is out of the bottle.

As I’ve noted before, cryptocurrencies are still in the “risk basket” (along with venture capital) for institutional capital allocators. Particularly considering a broader macro “risk off” scenario over the next 12–18 months, I doubt bitcoin prices will make new all-time-highs in 2019 (95% confidence) and think there’s a strong chance we don’t break $8k BTC (60% confidence).

I think it’s unlikely that BTC will be a crisis alpha in the next recession the way many people are hoping (I’ve also noted my own signs of late-cycle behavior). That said, the flight-to-quality to bitcoin and other “blue chip” cryptocurrencies will likely continue into 2019.

Either way, I’ll be here studying, investing, and sharing my learnings. Whatever small role I can play in the experiments around non-sovereign money is among the most important projects I’ll work on in my lifetime.

“Every day that goes by and Bitcoin hasn’t collapsed due to legal or technical problems, that brings new information to the market. It increases the chance of Bitcoin’s eventual success and justifies a higher price.” — Hal Finney

Perhaps we can use some of Hal’s ambition going into 2019.


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