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Should cryptocurrencies be considered as hard assets types of commodities?

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Cryptocurrencies in the current forms do not satisfy two essential criteria: authentication and liability, for being considered as a new financial instrument. Decentralized and self-regulated schemes just defeat the authentication process by creditable thirty-party financial institutions. Without authentication, it becomes hard to associate liabilities to cryptocurrencies. Authentication and liability are closely-related.

Since eliminating the need for third-party verification, Jamie Dimon is betting big on the technology behind ‘fraud’ bitcoin. Technically speaking, his saying is true. Digital currencies should be based on public-key cryptography. It can become useful only if the received digital currencies can be verified by third-party authorities and accepted by financial institutions such as banks.

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Posted by (Questions: 17, Responses: 153)
Posted on 10/18/2017 8:10 PM
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I think the hard asset analogy is a bad one. Hard assets are real. They’re tangible. They generally have some sort of measurable value. Gold weighs X amount and sells at Y price. A house is comprised of X materials that cost Y to build that get marked up by Z amount on the open market. This is all measurable. A crypto asset is more like a patent. What is a patent worth? Well, that can be really hard to measure. Many patents don’t even give you access to cash flows. They just give you the right to build something or claim ownership on an idea. Cryptos are a lot like publicly traded patents in this sense. Their value is sort of vague, but it’s based on the value of the underlying service that the patent would give you access to. So, imo it’s probably better to think of crypto assets like non-financial publicly traded patents that give you access to the equity of that patent.

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Cullen Roche Posted by (Questions: 10, Responses: 1771)
Answered on 10/19/2017 12:42 AM
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Currently IP is considered as a class of investment in NIPA. The value of IP is measured by replacement cost, not market value or cash flows. What is replacement cost for crypto assets then? $0?

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Posted by (Questions: 17, Responses: 153)
Answered on 10/19/2017 1:09 AM
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That’s part of what makes these things nearly impossible to value. Their replacement cost is unknown because the asset itself can become more or less valuable based on how it’s used and how its value changes. You can’t just say Bitcoin is worth $X based on the fact that it takes Y time to produce and Z miners to mine A time.

So I don’t believe the replacement cost method would work very well for these things. Honestly, I doubt there’s a very good way to value this intellectual property.

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Cullen Roche Posted by (Questions: 10, Responses: 1771)
Answered on 10/19/2017 1:27 AM
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There is no general way to value all kinds of non-financial and intangible capitals. I think we need to consider characteristics of each class of these capitals.

Characteristics of IP are specific usages, patent ownership and infringement protection. But what are characteristics of Bitcoins? I am not sure we can consider Bitcoins as IP. Receivers of Bitcoins do not own them and just have use rights for limited access.

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Posted by (Questions: 17, Responses: 153)
Answered on 10/19/2017 5:01 PM
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Hiya, long time reader, first time commenter.

I’m in crypto development and finance, and my opinion is that cryptocurrency tokens are American covered call options on a commodity. The option is unlimited, non-dilutive, and only expires once the chain ceases to exist. But, you don’t buy an option on a specified amount of a commodity, you buy an option on a specified PROPORTION of the commodity which any one protocol can provide.

The commodity on sale is determined by the protocol, whether that commodity is trust, transaction speed, disk storage space, computing power, community governance, etc. Your risk is limited to the money you put in and your upside is based on the future demand and scarcity of the underlying asset.

Protocols can have overlapping domains in the commodity space (eg Bitcoin, Litecoin, Dogecoin). This is like multiple oil companies offering options on their individual stockpiles of oil by the drum. But you’re not buying an option on 100 barrels. You’re buying an option on 1/100th of all barrels that will ever be produced by that company. Hopefully, you own options from the company that will have the largest supply of oil in a market where oil is scarce, and their barrels adhere to standards that third party merchants are willing to operate within.

You purchase an option and you can exercise it by spending the tokens and receiving the value of the underlying asset; you can let the option expire worthless when the chain becomes defunct; or you may choose never to exercise the option because your position is purely speculative, and you can wait to resell the rights of your option to another buyer.

So, when I buy 1 bitcoin, I’m buying an option on the ability to transact securely with an unknown second party and confirm the veracity of that transaction within 10 minutes. Specifically, I’m buying 1/21,000,000th of all transactions that can be made using that protocol, ever.

This ability is measured in block entries on the blockchain, which in turn is described by a variable amount of electricity, hardware investment, network connectivity, expertise, the number of transactions that can fit in a block, and the desire to be included on a block: which can then be converted to a cash value. My option can be exchanged at any time for the discounted future value of the underlying commodity, which is obviously highly discounted because time could theoretically stretch to infinity.

Now the promise underlying this option could change, affecting the value of the option: for a long period this summer, BTC could not execute a transaction within 30 minutes, let alone 10. Though there was more computing power in the network, this computing power only increased the security of the transactions, but not the speed. As a result the underlying value of my options decreased because people did not value security as much as they valued speed.

Imagine buying fractional non-dilutive call options on every startup from the last 20 years and indexing based on GAAP market cap. All of their data is openly available, including number of users, number of supporting vendors, product usage, etc. That is crypto. An indexing opportunity of a lifetime.

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Answered on 10/19/2017 5:18 PM
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Interesting comment Colton. The problem with comparing cryptos to call options is that there’s counterparties involved with options. They are pure financial assets. I think what Cullen is grappling with is the fact that cryptos don’t have a counterparty so they can’t be financial assets.

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Answered on 10/19/2017 5:54 PM
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The protocol and the miners are the counterparties. Just as the CBOE acts as a market-maker for all options holders, the protocol is the market-maker for its participants. Miners implicitly take the short side of the option agreement when they broadcast as a network node.

It’s the same thing as a farmer growing wheat and selling futures on the output of his harvest. The protocol matches a futures buyer with the farmer and awards the farmer some of his own futures to resell on the market for being on the value creation side of the transaction.

MPESA has been exchanging cellphone data minutes for years, and people use it just like cash. In this case, MPESA is the protocol and wireless providers are the miners. Is MPESA not a financial instrument anymore?

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Answered on 10/19/2017 7:11 PM
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Nice comments Colton. I thought about derivatives and other assets like that, but I don’t see how cryptos can be options. Options are just insurance. They are assets that protect against an underlying asset. In the case of cryptos your position in the coin reflects the actual value of the underlying protocol. In the case of something like Bitcoin the coin IS the value of the protocol as a medium of exchange. It’s not insurance or a leveraged position on the underlying. IT IS THE UNDERLYING. This might be slightly less true for something like Filecoin, but the coin in this case still reflects the actual value that can be derived from the underlying protocol. This is why it’s more like the direct equity position in my view.

Thoughts?

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Cullen Roche Posted by (Questions: 10, Responses: 1771)
Answered on 10/20/2017 2:49 PM
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I think that’s the point where you and I differ. The underlying asset is not the token itself, imo, it’s the utility of that token. The token merely splits up the commodity underneath into auctionable units.

Bitcoin is not just a tradeable asset, it is a set of cryptographic protocols which make it difficult for me to lie about the money in my account or lie about having sent you money which I never sent, and a network of individuals who are hashing for that protocol.

When I spend Bitcoin, I’m really spending my ability to use these cryptographic protocols and the network. In the case of Filecoin/SiaCoin/Storj, you are trading space on a distributed hard-drive. Just as when I trade a pig, I’m trading my ability to eat said pig.

This summer, when demand to exchange BTC was too great for the block sizes, it was not uncommon to hear about surprise $1,000+ transaction fees, a clear market inefficiency. This I think is emblematic of the derivative-ness of a token. You are buying insurance against the cost of a transaction going up, because as transaction costs go up, so does the value of the token. You own a proportion of all available transactions ever, regardless of the fiat price of the token.

The fact that these instruments are highly liquid can obfuscate the commodity-like nature of the underlying, because it gives the thing a high moneyness. However, at the end of the day it is still a commodity that has to be manufactured by willing entrepreneurs (the miners).

As you so frequently point out on this blog, the US government’s money is only backed by our trust in their ability to pay. The underlying asset of the US dollar is the military prowess and social capital of the US Government and its citizens’ willingness to acquiesce to the collective’s demands.

We’ve only chosen to tokenize all of our work in the US dollar because the perceived stability of the issuer was greater than any alternatives, and the money issued was more convenient to carry around than gold. The dollar didn’t need to be backed by gold, as long as we all agreed to tokenize our work by the same standard.

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Answered on 10/20/2017 4:04 PM
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Are you the guy that invented the acorns app and got Harry Markowitz on board ?

If so bravo !

Couple of questions…

1. Is there an intrinsic value that a coin holder ultimately receives as an asset that he can sell ?

2. When you say this is like multiple oil companies offering options on their individual stockpiles of oil by the drum. But you’re not buying an option on 100 barrels. You’re buying an option on 1/100th of all barrels that will ever be produced by that company.

Because there is no ultimate ‘conversion’ or dividend or any future ‘cash flow’ does the coin holder have that kind of equity interest ?

3. You say when you buy 1 bitcoin, I’m buying an option on the ability to transact securely with an unknown second party and confirm the veracity of that transaction within 10 minutes. Specifically, I’m buying 1/21,000,000th of all transactions that can be made using that protocol, ever.

It’s like saying buying a credit card is buying an option to use credit. Maybe true but does that make it a marketable asset ?

4.Is there ultimate demand for this costly bitcoin as bitcoins aren’t actually needed for bitcoin transactions ?

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Posted by (Questions: 5, Responses: 83)
Answered on 10/21/2017 1:32 AM
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Hey Derek,

I was on that team on the Acorns team in the early days, yes. So, thanks!

1. Is there an intrinsic value that a coin holder ultimately receives as an asset that he can sell?

Depends on how you define intrinsic value. I define intrinsic value as the end consumption: burning fuel, feeding hay, shaping metals into gadgets. The intrinsic value of equity is the product that comes off the line, or the services that are generated by humans, which are then transformed into profits, dividends, and capital gains. It is the product that is the intrinsic value, and the rest is just auction dynamics.

In the case of Bitcoin, that intrinsic value is a decentralised trust system that confirms transactions faster than current global infrastructure. You have to corrupt at least 50% of the participants in the system to initiate a fraud. The more people that are using it, the harder it is to defraud the system. When you sell your Bitcoin, you are selling your access to that system.

In the case of Ethereum, it is access to a decentralized app store with automated, self-executing contracts (an automated software escrow agent is one example). In the case of the storage coins, that intrinsic value is hard-drive space. In the case of Golem, that intrinsic value is computational power and time. You are selling your access to these systems, which have intrinsic value, when you sell a coin.

2. Because there is no ultimate ‘conversion’ or dividend or any future ‘cash flow’ does the coin holder have that kind of equity interest?

Let’s propose a thought experiment. There is a company that issues shares in their enterprise, but they never issue a dividend and they are always cash flow negative. People buy their product, but they continue burning cash at a higher rate than which they can produce revenue. There is no expectation that anyone will ever acquire them, so there will be no liquidity event beyond the private/public market for their shares.

Is the equity in that company still equity? I think the answer is yes. I can still speculate in Twitter, can’t I?

3. It’s like saying buying a credit card is buying an option to use credit. Maybe true but does that make it a marketable asset?

An option is implicitly credit. The Black-Scholes model is entirely predicated on the idea that you borrow money now to make a trade, successfully execute the trade, then pay back your loan with the proceeds of your trade.

Technically mortgages qualify in your example above. You put money down for the opportunity to borrow and hope that the value of your home goes up faster than the loan does. Sure, a lot of people (and banks) speculate in properties and mortgages, but most people just want a place to sleep.

4. Is there ultimate demand for this costly bitcoin as bitcoins aren’t actually needed for bitcoin transactions?

I’m not sure I follow this question. If you’re saying that there are many Bitcoin clones that can do the same thing as Bitcoin, you’re right. But there are also many companies that sell oil, and advertising, and other services yet we don’t question their existence or the applicability of equity.

The marketplace will decide the value of Bitcoin, and even though Litecoin and Bitcoin Cash accomplish the same thing as Bitcoin, the market currently values Bitcoin higher than the other two. There are a number of reasons for this, eg. hashrate, number of miners, number of support services, notoriety; but the fact that Bitcoin could be abandoned tomorrow does not change its moneyness or derivativeness.

Was the Confederate grayback currency? If the US Dollar was no longer accepted anywhere, either tomorrow or in a century, would it still have been currency? If we started trading Alphabet stock with each other in a highly liquid medium, would Alphabet stock be currency? Would it still be equity?

I think the answer is that they are both. We are merely adjusting to an era of higher liquidity which makes all (digitizable) assets appear as currency.

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Answered on 10/21/2017 5:45 AM
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Interesting stuff Colton. Thanks for the replies.

Do you think that those developing the software are looking at creating a hierarchy in the network where ‘supernodes’ handle the clearing for lots of underlying blockchain transactions. As The transaction flow is increasingly becoming speculative rather than real.

Where basically supernodes are effectively banks in our world ?

https://medium.com/modern-money-matters/crypto-shilling-87995d1d89b0

If so how will the current commercial banks lobby their governments if they feel their banking licence is under attack ?

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Posted by (Questions: 5, Responses: 83)
Answered on 10/21/2017 7:17 AM
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“Supernodes” gives an inaccurate impression of the mechanics of Lightning Network/SegWit/Raiden. A supernode doesn’t have to aggregate 5,000,000 accounts like a bank. A supernode can aggregate transactions for as few as three people. It merely reports the net cash flows from within the supernode to the blockchain as one transaction.

More importantly, anyone who wants to compete in the mining marketplace can broadcast as a supernode, and each supernode is auditable by anyone who wants to run a fisher node, in addition to being auditable by other supernodes. There’s technically no barrier to entry, you are merely constrained by the random nature of being assigned a block based on your proportional hashpower.

So even if supernodes are banks, they’re banks with open auditability by the public, which can be owned and run by anyone. Due to the protocol in place, the banks are also required to be run in a very specific way, else the protocol will reject the node. So are we really talking about just another bank?

Banks can lobby the government, but the distributed nature of blockchain creates a door that can’t be closed without seriously damaging global networking infrastructure or burning a lot of cash to DoS or 51% attack a particular chain. And to your earlier point, if one network goes down another fork will simply pop up in its place. Just look at torrenting technology! Blockchains operate in a very similar manner.

In the end, I think all the smart people working in the space realize that cryptocurrencies will not replace banks due to the time constraints of creating distributed consensus. That is why many banks are betting on protocols like Ripple and Stellar, which shortcut consensus by having nodes declare explicit trust relationships. But these smart people also realize there is room for both, and the financial ecosystem is made stronger by having alternatives available in both the centralized and decentralized realms.

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Posted by (Questions: 0, Responses: 5)
Answered on 10/21/2017 3:51 PM
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Thanks once again,

I’m not so sure in Today’s world. When has ever anybody in power been smart, especially if the US continues to weaponise the $.

Will be interesting to see how it all plays out.

Will be interesting

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Posted by (Questions: 5, Responses: 83)
Answered on 10/21/2017 5:43 PM