The Rake Review: October 2020
Welcome to the Stormrake Monthly Australian crypto market & education update.
For sophisticated investors who want to expand their crypto knowledge.
The Devil's Advocate
The month of October has been associated with tough conditions in Financial Markets since The Bank Panic of 1907 & the Stock Market Crash of 1929 which preceded the Great Depression. Black Monday 1987 also happened during the month of October leading to the coining of the term "The October effect". So, in honour of those events I am dedicating this edition of the Rake Review to bringing you the case against Bitcoin investment. This month we will play "The Devil's Advocate".
An idea not challenged is not worth anything so this month we will challenge the idea that Bitcoin is a technological revolution. In any case, we've been told that we're too Bullish, so this will be a nice change.
An interesting thing I've noticed while talking to people about Bitcoin is that the majority of objections to buying Bitcoin seem to be baseless or rooted in misinformation. There are however genuine issues, as there are with any new technology and I want to go through them here. But first the standard objections:
Unfounded Objections
1. Isn't Bitcoin just a Fraud?
Well, no. Bitcoin is not a fraud because it is a tool with a genuine use. Also, Bitcoin it is a verifiable public code that can be tested, and no one has discovered a fraud within the code. However, frauds do exist in the crypto space and many coins were actual frauds. That's why it's important to do your research before committing funds and that's why Stormrake's view is that beginner investors should always start with Bitcoin.
2. Hasn't Bitcoin been hacked many times?
No, Bitcoin itself has never been hacked. The code has been publicly available for 12 years and no one has been able to break it despite a $200 Billion incentive for hackers which is the total value of the coin. That 12-year history gives Bitcoin investors extra comfort over investors in smaller coins that don't have a tested track record. Exchanges and 3rd party holders of currency have been hacked many times. Bitcoin storage is a huge topic so we won't go into it but if you trust a 3rd party to manage your money then a hack could see you lose funds. The Binance hack of $40 Million worth of BTC was fully covered by the exchange which is why you need to choose providers carefully.
3. Why can't miners just mine more Bitcoin?
Mining BTC unlocks a predetermined amount of coins for the successful miner. That is governed by the code. The amount being unlocked halves every 4 years and the vast majority of Bitcoins are already in circulation. There will never be more than 21 Million though so supply can not be artificially inflated like it can with the Australian dollar can. Digital Scarcity is really the main invention within Bitcoin.
4. Only Criminals use Bitcoin
This one came about after the website Silk Road which sold illegal products was shut down. Products on that site were paid for with Bitcoin. At the end of the day Bitcoin is a tool and various people can use it including criminals. If a criminal uses Facebook it doesn't mean Facebook is criminal. Likewise, this is not a Bitcoin issue. In fact, most transactions for drugs and other illegal uses is done through dollars (cash). Bitcoin is a public ledger that everyone can see meaning it is a very poor tool for illegal activity. By definition, you are creating evidence that can't be erased.
Real but mitigated objections:
1. Electricity cost is too high
Yes, the Bitcoin Network uses a significant amount of electricity, but that is one of the factors that gives Bitcoin value. It costs money to mine so no one can get Bitcoins cheaply. Also, the race to have the lowest cost of mining means miners are solving the efficiency of electricity problem themselves. For example Miners can be set up where electricity is almost free such as on site of large generators that often get forced to waste energydue to constraints. Lots of industries use more energy than Bitcoin provides a very important service that makes it worth the energy it spends.
2. Bitcoin is too Volatile to be a store of value
Bitcoin is Volatile. That is a fact. However as an investment it still stacks up because it's Sharpe Ratio is still better than any traditional asset class. Essentially its risk vs reward and Bitcoin has been providing a lot of reward. I'm ok with volatility in my investment as long as it increases in value the long run. Volatility over the 12 years of Bitcoin has been closely studied and the results show volatility is decreasing and markets are efficient. As Bitcoins market capitalisation grows Volatility will continue to fall.
3. Bitcoin will stop governments ability to manipulate the economy
Yes monetary policy will lose its effectiveness if the majority go on the Bitcoin standard. However, I would argue that this is a very good thing. We pretend we live in the Capitalist west where we have free markets and trade but on the other hand, we have a centrally planned monetary system run through central banks that the USSR would have been proud of. If the central banks lose their power than that will likely improve long term efficiency and economic growth although market cycles could be more severe.
Objections people don't mention that they should consider
1. Scalability
Bitcoin has completed half a trillion transactions without an issue, however how many transactions are needed if everyone were to jump on board and use Bitcoin for payments? Visa for example processes 65,000 messages a second. Bitcoin can only process up to roughly 5 transactions a second. This is a real issue, and many are trying to solve it before that type of volume is required. One solution is off-chain transactions for low value i.e. lightning network. Blockchain wasn't designed as a faster processor. It was designed for security and scarcity. Bitcoin is not meant to be used to purchase your cup of coffee, but it is rather more useful as a long term, secure, trust-less store of value.
2. Transaction Costs
Transaction costs on the Bitcoin network vary with demand and in times of extremely high demand prices for transactions can go up significantly. This issue is linked to the one above, but it also shows that small transactions become uneconomical when there is a rush. We saw this recently with high transaction volumes (yield farming) on the Ethereum blockchain, where transaction fees temporarily skyrocketed from a few cents to $10. Etherium is also working on a fix (proof of stake) but that is a little way off.
3. Development disagreements and Splits
In Bitcoins history we've seen several hard-forks, most notably the creation of Bitcoin Cash. With no central authority developers can disagree on direction and we can get issues. Crypto can become a bit tribal if everyone is pushing their own agenda and I see this as a risk because hard-forks reduce network value and distort the message for newcomers to the space. Despite all this Bitcoin itself has still emerged as the market leader. For further information read up on Metcalfe's Law and the Lindy Effect.
So, let's get into it.
Video of the month
A classic video this month of one of the most important debates in Bitcoin's short history with Peter Schiff arguing Bitcoin is NOT the future of Money. This fits in perfectly with this months theme. Peter is often maligned in the crypto community for supporting Gold over Bitcoin but I have a huge respect for him. Certainly, I respect his right to have an opinion even if it's different from my own. So, this is a great way to review some of the objections I raised above and have them explained by people that can deliver it clearly and simply. You decide who is right and wrong.
Markets
Unfortunately for our topic this month the market has actually improved. Bitcoin has seen consecutive upward breakouts currently sitting at circa $11,450USD. It has already made MicroStrategy over $30Million USD since they converted $425Million USD to Bitcoin. Chainlink and Polkadot slipped behind Binance this month while DeFi coins got smashed and are starting to recover.
* Top 8 Coins by Market Cap thanks to Coin Gecko
In the NEWS
Firstly the unavoidable positive news in short:
1. Squarebecomes latest company to convert USD into Bitcoin buying $70 Million USD worth.
2. Over 500 members of congress receive Bitcoin deposits. Bitcoin donations changing the face of political fund raising?
3. Stone Ridge reveals $115 Million USD Bitcoin investment
Now we focus on the negative:
$200Million KuCoin Hack
A huge hack perpetrated late September on Crypto Currency exchange KuCoin took a massive $200Million which is more than double the Binance hack. Various coins were stolen, however the hackers messed up and $130Million has been recovered with hope of more. As hackers dumped their winnings markets actually held up which is a good sign for liquidity.
UK Bans Crypto Derivatives for Retail investors
The FCA has made a ruling banning retail investors from using crypto derivatives such as futures on Bitcoin and Ethereum. It seems the regulator is concerned retail investors are using these products without understanding them and losing money.
BitMex executives charged with violating the Bank Secrecy Act.
Several key people from BitMex (One of the worlds largest exchanges - largely focused on derivatives) have been charged. BitMex has historically had lax policies around KYC (Know Your Customer) and the regulator is concerned about Money Laundering on the exchange. However no actual cases of any money laundering are alleged and BitMex specifically excludes US customers which is where the execs are being charged.
Here's a visual of money leaving BitMex after the announcement. BitMex managed to absorb these withdrawals without too much difficulty.
MainNet Launch of Filecoin (FIL) - Zero Brokerage Fees until 20/10/20
One of the biggest launches in recent history hit the markets with a bang yesterday. Filecoin (FIL) aims to be a safer, decentralised, blockchain secured, cloud filestorage system than Dropbox.
It's launch has seen the price rocket and settle at around $60 per coin making it the 25th biggest currency in the crypto space. Can FIL be the Chainlink or DOT for storage and make the top10 as more coins are released?
We are offering free brokerage for amounts over $2,000 AUD worth, for anyone that wants to add it to their portfolio. To be clear this is not a reccommendation and you will need to do your own independant research before placing an order.
For more depth and information you can check out this review we posted on our Facebook page. If you want regular updates subscribe on Facebook or twitter @stormrake.
Bitcoin Network Utilisation
Some points of note on the dash below. Check out the Lightning Network stats which I mentioned in the opening. That is improving Bitcoins scalability with 1,000 BTC moving around amongst over 36,000 channels. Over 18.5Mil BTC has already been mined meaning less than 12% of Bitcoins supply is left to mine. Supply is tightening. All time transactions is approaching 600 Million.
Stock to Flow Valuation:
Current Long-Term Stock to Flow (StF) Price: $16,900 USD vs Current Price - $11,500 USD. Market price is lower than the historical trend suggesting that Bitcoin is undervalued today. However, the StF model also shows an increasing price every day for the next year to $100,000 USD. According to the efficient markets hypothesis, a rational investor would buy today and wait for the $100,000 USD price to materialise if you trusted the model. That’s why we rate Bitcoin as a Strong BUY
Crypto Class: Information & Education
Bitcoin “Layer 2” and the technical roadmap.
When we talk about buying/holding/sending bitcoin, we are talking about the underlying coin on the base layer of the bitcoin network (aka “layer 1”). But this is not the only way that bitcoin value can be transferred and we are seeing innovative ways that bitcoins “store of value” property can be utilized on other networks. These new methods unlock new use cases and opportunity for bitcoin.
The lightning network
The lightning network allows fast and cheap micro transactions over payment “channels”. In order to participate in the lightning network, you lock some bitcoin in a payment channel, and instead of sending the underlying bitcoin, you are able to transact with provable 1 to 1 bitcoin derivative tokens. You could compare this to putting your car in a valet service and trading the valet token over and over, except there is the benefit that the valet token is highly divisible (you can transfer just a fraction of your car), and you don’t need to put any trust in any centralised valet service. Anyone with the tokens can prove their position/ownership in the custody chain with the last holding the tokens able to redeem back to bitcoin at any time.
The lightning network is ideal for low value, frequent transactions. $4 for buying a coffee, 2 cents for reading an article. 0.001c per watt of electrical energy.
Federated sidechains.
Pioneered and launched by blockstream, the liquid network is an example of a federated sidechain and is useful for settling large amounts of funds between known entities.
Trust in the lightning network above is predicated on mathematics and keeping track of the custody chain of your coins, whereas the liquid network’s trust model utilises a federated network meaning the trust model is spread over a number of participating parties. The liquid network is idea for quickly settling large or frequent transactions in a trustless way. Think of this as swift on steroids.
Custodial Derivitives
There are some very interesting "wrapped" bitcoin derivites that allow tokens to be pegged to staked bitcoin and partipate in the DeFi space.
While this does present some counterparty risk, there is some facinating innovation occuring in DeFi including dentralised exchanges such as UniSwap, lending platforms such as Aave and many more innovative uses. This is rapidly expanding space and a facinating space to watch. Keep an eye out for Mark's DeFi corner as we bring you some of the highlights of this space. Meanwhile here is a graphic showing some of the wrapped bitcoin tokens. WBTC currently holds $1.2B USD worth of bitcoin.
Protocol developments
A number of technical developments are proposed for bitcoin base layer which, if adopted, will unlock even more potential. This includes Schnorr signatures, which are an improved cryptographic signature mechanism. Schnorr was under patent until just before the birth of bitcoin and therefore had very limited technical support at the time. The signature mechanism is significantly simpler and better than the ECDSA algorithm used in bitcoin today and will unlock further potential such as Taproot.
Taproot is a feature that utilises Schnorr signatures to create better multi-signature bitcoin wallets. Multisignature wallets allow custody of bitcoin to be shared between a number of people/keys such that it requires a number of them to approve any transaction. For example you can decide that it requires 3 out of 5 members to approve any transaction.
While multi-signature exists today, Taproot makes multi-signature easier and indistinguishable from regular transactions to any observers of the network.
Is all of this still confusing? Don’t worry. There is plenty of information on above to explain more if you’re interested but end users won’t need to understand any of this. New services are emerging every day and end users will just benefit from these amazing platforms without knowing or caring how they work under the hood.
Monthly Memes
Monopoly is one of my all time favourite games. No surprises there. But its amazing to see how that game understands banking and more specifically that the game may be rigged.
And Given our October Crash theme. Here's Mr Burns to show you why you should do your own research when choosing investments.
Were we too negative in this edition? Here are some words from Anthony "Pomp" Pompliano that call out a major bull case for bitcoin.
Until next month, Happy Investing!
Stormrake Team
custody@stormrake.com
General Advice Warning
The information provided in this newsletter is general in nature only and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information contained here you should consider the appropriateness of the information having regard to your objectives, financial situation and needs. Therefore, before you decide to buy any product or keep or cancel a similar product that you already hold, it is important that you read and consider the relevant Product Disclosure Statement (PDS) of the product provider to make sure that the product is appropriate for you. Before making any decision, it is important for you to consider these matters and to seek appropriate legal, tax, and other professional advice. You can get a copy of relevant PDSs from Stormrake by email custody@stormrake.com. Disclaimer
All statements made in this newsletter are made in good faith and we believe they are accurate and reliable. Stormrake does not give any warranty as to the accuracy, reliability or completeness of information that is contained here, except insofar as any liability under statute cannot be excluded. Stormrake, its directors, employees and their representatives do not accept any liability for any error or omission in this newsletter or for any resulting loss or damage suffered by the recipient or any other person. Unless otherwise specified, copyright of information provided in this newsletter is owned by Stormrake. You may not alter or modify this information in any way, including the removal of this copyright notice.Copyright © 2020 Stormrake Pty Ltd, All rights reserved
