);
Smart Contracts

Smart Contracts

Smart Contracts

These irrevocable computer programs generally deployed on a blockchain and which automatically execute a set of predefined instructions offer considerable leverage to a multitude of contractual relationships. Their applications are very numerous.

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Smart Contract : a definition

The ‘smart contracts’ are computer protocols that facilitate, verify and execute the negotiation or the execution of a contract. They usually have a user interface and emulate the logic of contractual closes. Most of the time, they deploy on a blockchain.

Behind this concept of smart contract, the key idea is to guarantee the contract power, no longer by law but directly by computer code. As with every computer program, the complexity is variable from one smart contract to another. Some are implementing simple conditions, like a « IF » Excel function (if such a condition is met, then the contract is executed-or “if this then that”) while other smart contracts are much more complex. In fact, smart contracts have ambition to replicate all the clauses and rules that allow companies to operate. Then we talk about DAO, acronym of Decentralized Autonomous Organization’ (read our article published February 7).

History 

Often associated to the Ethereum protocol which is positioned as a Bitcoin programmable version which widens considerably the field of decentralized applications, the word « smart contracts » was invented by the computer scientist Nick Szabo in 1993, to highlight the importance to bring “highly evolved practices” to the contract law, but was inspired by some researchers like David Chaum. Nick Szabo thought that the specification, the verification and the operation, thanks to cryptographic protocols and some other digital security mechanisms can make a big improvement compared to the traditional law that supervises the contracts associated with their different clauses. Some researchers emphasized the interest that smart contracts can bring in terms of security. This was done in parallel to David Chaum and some other researchers of the financial cryptographic community that have emphasized the interest of cryptographic protocols in order to ensure digital money confidentiality, the identification information and the digital signature of the contracts. Development of smart contracts is also and finally coming from a lot of efforts for improving operations in several industries using digital technology. 

With the advent of the distributed consensus protocols and crypto currencies created to allow borderless, secured, resistant to censorship and programmable digital assets trades, it is a whole technological sector that is opening to smart contracts coding. Ethereum is the best known protocol dedicated to smart contracts coding, but it is not the only one anymore, and smart contracts can now be deployed with a lot of other competing blockchains (EOS, Tezos, NEO ,…).

Smart contract operation

A smart contract is proposing a digital equivalent to the paper contract. During the smart contract operation, all the steps of validation are recorded in the blockchain (the most used being Ethereum nowadays). This process allows to secure all the data by preventing their modification or their deletion ex post.

In practice, an overwhelming majority of the smart contracts are used to automate security trades under the form of crypto assets. All accounting entries relative to digital assets trade operations are systematically recorded in the blockchain. Then, all assets transfers are both public, predictable and irrevocable. Anyone can check on the blockchain the correct execution of the contract and determine who owns the asset.

So, smart contracts guarantee an extremely loaded set of performance conditions that leave no room for doubt or confusion. Conditions are very clearly set and the code interpretation is unequivocal, on the contrary to human interpretation that let room for negotiation or the discovery of a legal vacuum. Indeed, the blockchain aims to eliminate uncertainty and randomness as much as possible, or the contingent, so that substitute to the confidence, confidence that is always correlated to the system fallibility, the notions of insurance and guarantee. Insurance and guarantee are produced by calculation iteration whose results are considered statistically satisfactory. Therefore, it is the human domain that is gradually disappearing to the benefit of automated processes, not based on deliberation but on certification. 

Most of the smart contracts are standardized (like for the paper contracts), for which we have the possibility to use templates. The smart contract standard the most widespread is known under the ERC-20 name, and its main function is to allow tokens creation (digital assets, crypto currencies) on the Ethereum network.

Strengths and weaknesses

Strengths

Public blockchains offer strong opportunities to deploy smart contracts in an extremely secured way. Today, it does exist hundreds of ERC20 tokens (as for example crypto currencies created by a ERC20 ‘smart contract’) for which the total valuation represents several billions of dollars.

Strengths (advantages) of smart contracts are multiple. They allow to :

  • Secure an agreement between two counterparts (or several) thanks to the transparency and immutability of blockchains
  • Automate payments and eliminate unpaid risks, often observed in the context of a traditional contract 
  • Drastically reduce the costs for elaborating, the follow up and the contract signature (example of contracts with lawyers or notaries

Weaknesses

However, smart contracts have disadvantages (weaknesses) for which experts are working on. The major one remains the risk of failures inherent to each computer program.

Smart contracts code is very often ‘open source’, but if the code is poorly designed, it gives room to hackers to take advantage at the expense of other users. 

The most well known ‘hacking’ is ‘The DAO’ one which implied a loss equivalent to dollar 150 million (in ethers). Following this famous hacking, the Ethereum community decided to make the painful choice of rewriting ex post the transactions history in the Ethereum blockchain in order to dispossess the hacker of his booty and to restore the stolen ethers to the victims.

That kind of problem asks the question of blockchains immutability (« Code is Law ») facing the need to re-introduce human intervention, even in a smart contract framework.

A doctrine does exist, saying and upholding that it could be possible to introduce a sort of additional governance to blockchains, driven by a keen play on smart contracts in order to define some different possible arbitrage scenarios in case of emergency. On the contrary, pure Bitcoin enthusiasts are more keen to protect as much as possible these ecosystems from human and political intervention.

Smart contracts examples

Several blockchains let the possibility to deploy these contracts. Of course, the most well known is Ethereum, which already includes a large number of decentralized applications through the use of smart contracts. But some other promising protocols such as EOS, Tezos, NEO Cardano, Cosmos and some others are also conceived and able to compute smart contracts. 

For now, the most mature smart contracts are computed on Ethereum.

We can find out some of different types depending on economic sectors such : 

  • Decentralized monetary exchanges : 0x, OmiseGo, MakerDAO
  • Games on Blockchain : Cryptokitties, My Crypto Heroes, Etheremon 
  • Gambling : FCK, Playtowin, FunFair
  • Decentralized Cloud : Storj, iEx.ec
  • Predictive markets platforms : Augur, Gnosis

And many others…

Conclusion

The smart contracts economy is still embryonic but seems to have a very bright future. Numerous decentralized applications in the healthcare sector, in the insurance, or supply chains (pharmaceutical ones, food industry, cosmetics, etc…) are currently under development. In the coming years, it is actually probable to have proposals of significantly different organizations from today (with current versions of paper contracts and applications governed by trusted third parties). It will be an economy in which crypto assets will play an essential role.  

About the editor…

A passion : Economics, behavioural finance and emerging digital assets

Yves started his career in the asset management in 1986 where he worked at different positions as manager of equity funds and diversified funds. at Crédit Commercial de France and later, at Barclays group in Paris. In 1998, he took the lead of equity funds and diversified funds, then of the whole fund management business at the French team of the Dutch Robeco group  before joining Natixis Asset Management in 2012 as Director of the Equity Investment business unit. Yves left Natixis AM in 2018 to start as an independant player for professional investors and corporates (advisor and fund raiser).

He likes to engages in sports that test his endurance like running and swimming, Yves is also fascinated by social sciences, and more specifically by history and economics. But this is the economics mechanisms behavioural aspect and the markets behavioural analysis that are a constant source of thought and discussion. Since few years, the blockchain issue and emergence of crypto assets is a new field of passion and opportunities for him.

Yves Maillot

Financial markets and asset management

Yves Maillot

Financial markets and asset management

Understand ICO, STO and IEO

The ICO is a financial innovation that constitutes an important step in the transformation process triggered by the blockchain. It turns things up and down and especially the traditional relationship to property.In this article, for a second time, we are also going to analyse STO and IEO.

Real assets tokenization : use case in the real estate

Among all real assets, properties are very good candidates for tokenization, a mechanism that will facilitate democratization of investing on those assets. Because tokenization allows becoming a real estate owner for only a few hundred euros, without any loan.

Understand ICO, STO and IEO

Understand ICO, STO and IEO

Understand ICO, STO and IEO

The ICO is a financial innovation that constitutes an important step in the transformation process triggered by the blockchain. It turns things up and down and especially the traditional relationship to property. In this article, for a second time, we are also going to analyse STO and  IEO.

This article is intended for readers who have already acquired a certain level of knowledge in the field of Blockchain and cryptocurrencies. If the article seems indigestible, do not hesitate to choose another difficulty in the box below wink

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1/ What is an ICO ?

On the listed equity market, in the image of IPO (Initial Public Offering or what it’s called an equity issue for a company listing on the stock exchange), an ICO (Initial Coin Offering) corresponds to an entry of a digital token on the primary market. Even before setting up the promised service, at the very start of the project, the right of use is therefore sold in advance through the issued token. In this way, an entrepreneur can raise funds by selling in advance a future right of use.

Therefore, we can distinguish 2 different types of stakeholder for that kind of operation :

  1. a/ The project’s contributors who are rewarded through the token and the projects’ founders who keep a share of the tokens and who obviously get a business valuation
  1. The investors (who acquire the token in the quest of capital gains) and also consumers (they often play both roles) who buy a future ‘utility’.

A financing through an ICO intuitively applies more to the ‘services economy’, without being restrictive.  

 We have to however note that ICO is not a prerequisite for a successful  blockchain project.

For history, the first ICO took place in July 2013 with Omni (‘open-source’ platform), which was followed in 2014 by the famous Ethereum ICO USD18 million project.

Figures

It was in 2017 that ICOs emerged with increasingly raised funds, thanks to an enthusiasm drawn by the strong gains of Bitcoin and other crypto- currencies prices. In 2017, starting from USD 64 million distributed among ten projects in April, to USD 1.5 billion distributed among 197 different projects in December, the number of ICOs and the raised funds increased rapidly. According to Coindesk, at the end of 2017, the success of the blockchain projects was so strong that funds raised through ICOs greatly surpassed that raised through the traditional way (venture capital) with (USD797 million compared to  USD235 million).

 

                                                                                      NUMBER OF ICOs and MONTHLY AMOUNT RAISED – 2017- 2018

Following the sharp Bitcoin price drop during the first half of 2018, obviously, amounts raised in the second half decreased dramatically too with an average funding raised per operation close to UDS 3.3 million. However, the number of transactions remained high (see the chart – source Coindesk- Techcrunch), which shows the blockchain world dynamism.

Characteristics of an ICO

An ICO includes its own key features that distinguish it from other traditional financing :

  • Free circulation of tokens enables the market to directly value the associated use function
  • Financing through an ICO allows to raise funds for projects that might probably  never have seen the light of day through traditional financing channels and investors to intervene on stories they might not have access to. So, this type of financing (ICOs) are a virtual unfiltered form of Crowdfunding pushed to the extreme, but through its own ‘platform’ for each project carries, without any aggregator, and so; without any centralized interference.
  • ‘Peer-to-peer’ access to large amounts of money reduces the barriers to entry. Lower cost access to existing ‘open source’ infrastructures fosters competition.
  • Using tokens enables aligning interests in this new ecosystem. 
  • Finally, several existing issues inherent to capitalist business and traditional financing are avoided (conflicts of interests : between shareholders and debt creditors – let read research by Stiglitz and Weiss -1981) but some others are rising, especially the potential conflict of interest between tokens holders and consumers–users (of the same tokens).
  • ICO democratises risk capital. Furthermore, the investor can also benefit from the utility of the token and can also take profit from it as a user (early adopter). The barrier between professional investors and individual token holders is removed. But it raises important questions about wise projects selection, and above all, protecting individual investors.
ico
ICO risks:

  • Opportunities and money flooding in ICOs that multiplied in 2017 have highlighted  their limits and risks. The investors projects selection and the excessive enthusiasm due to all crypto assets prices increase made obviously appear the characteristics of a bubble mechanism :
  • Capitalizations surge attracted too many (too) ‘early stages’ projects to finance, projects which were insufficiently  prepared
  • This phase also generated an obvious overvaluation of too many projects and even pushed meaningless stories
  • To the extreme, numerous scams and frauds appeared and broke out, and,
  • The lack of regulation of these operations caused big disappointments

These periods never last long, the natural selectivity combined with price fall becomes one day a saving event which helps to clean up and professionalize the market.

 

What is a good ICO ?

As many scams somewhat tarnished the image of the blockchain and crypto-assets, it is needed to look at an ICO project’s financial and strategic analysis with seriousness and rationality despite the risk and uncertainties specific to high potential segments emerging projects.

 Here below few analysis key points which combined :

a/ traditional analysis key points of a start-up as :

  • Team composition and experience
  • Business model and market addressed
  • Technology competitiveness – barriers to entry
  • Competitive environment

b/ specific analysis key point of an ICO  start-up (with a ‘token financing’)

  • Analysis of the role of the token in the Business Model
  • Initial token offer : monetary policy, destruction mechanism (tokens ‘burning process’)            
  • Targeted  operations  ‘road-map’
  • Use of the funds raised
  • Visibility within the ecosystem and specialized media
  • Building and development of a community: a community can carry the project forward in difficult times. Building up a community around the initiative is essential.
2/ STO and IEO

Face to ICO issues that were sometimes hard lived during the euphoria period in 2017, and some disappointments, especially because of the lacking regulation and well adapted legal status, but also because of failures and frauds for some projects during this period (one estimate that only less than 10% of the smart and robust projects survived the purge phase of 2018), is flourishing ‘asset tokenization’ on the called  STO form (Security Token Offering) since 2019.

STO :

Simply said, a ‘security token’ is a digitalized and exchangeable share on a blockchain. A STO operation constitutes a first step to a larger scale financial (or real estate property) tokenization – see the article published March 31 about real asset tokenization.

The main advantage essentially lies in a connection with positive law, easier when it’s about a ‘security token’ instead of a standard crypto asset or a ‘utility token’ for example. Indeed, the nature of the rights associated with a ‘no blockchain security’ is well referenced on a legal basis. Under the French law, it is worth mentioning that through a blockchain, existing financial unlisted securities ‘peer-to-peer’ trades were authorized since 2018. This mechanism can enable increased assets liquidity and will improve the financial system’s operational efficiency, among other things thanks to the fluidity of operations and to the possible and large processing costs cutting.

Finally, let’s mention the IEOs (Initial Exchange Offering) which are growing for some time. It is about a kind of a token offering or an ICO but the operation is directly administered by a crypto platform (exchange). A facilitation (but also centralization in some extent) of the offering and information  mechanism is then brought by this way.

Conclusion

Following the innovative and highly speculative ICO, use and development of Security Tokens through STO are representing an important step in the ‘assets tokenization’ wave. Thanks to the creation of new rights, modular and ‘peer-to-peer’ exchangeable, these new models will allow emergence of new asset types and new business models.

About the editor…

A passion : Economics, behavioural finance and emerging digital assets

Yves started his career in the asset management in 1986 where he worked at different positions as manager of equity funds and diversified funds. at Crédit Commercial de France and later, at Barclays group in Paris. In 1998, he took the lead of equity funds and diversified funds, then of the whole fund management business at the French team of the Dutch Robeco group  before joining Natixis Asset Management in 2012 as Director of the Equity Investment business unit. Yves left Natixis AM in 2018 to start as an independant player for professional investors and corporates (advisor and fund raiser).

He likes to engages in sports that test his endurance like running and swimming, Yves is also fascinated by social sciences, and more specifically by history and economics. But this is the economics mechanisms behavioural aspect and the markets behavioural analysis that are a constant source of thought and discussion. Since few years, the blockchain issue and emergence of crypto assets is a new field of passion and opportunities for him.

Yves Maillot

Financial markets and asset management

Yves Maillot

Financial markets and asset management

Understand ICO, STO and IEO

The ICO is a financial innovation that constitutes an important step in the transformation process triggered by the blockchain. It turns things up and down and especially the traditional relationship to property.In this article, for a second time, we are also going to analyse STO and IEO.

Real assets tokenization : use case in the real estate

Among all real assets, properties are very good candidates for tokenization, a mechanism that will facilitate democratization of investing on those assets. Because tokenization allows becoming a real estate owner for only a few hundred euros, without any loan.

WHAT IS LITECOIN?

WHAT IS LITECOIN?

WHAT IS LITECOIN?

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Introduction and historical 

Following Bitcoin and its two main ‘Forks’, Bitcoin Cash and Bitcoin SV (see article published December 6, 2019 ), Ethereum and XRP (see article published January 23, 2020), ranked by the size, Litecoin is currently the sixth largest crypto currency now.

Litecoin has been created and coded through an ‘open source’ client on Git Hub, October 7, 2011 by Charlie Lee, formerly employed by Google. In fact, Litecoin coding comes from Bitcoin coding modification (a Fork of Bitcoin)

-In April 2017, the Litecoin foundation has been created in Singapore in order to promote Litecoin.

-February 18, 2018, Litecoin realized its first Fork, Litecoin Cash, which has been realized by a group of developers, independant from the Litecoin foundation.

-In July 2018, Google has added Litecoin to its currency exchange module.

Google shearch volume for Litecoin and Bitcoin Halving

Source : Google Trends

 

General characteristics

Litecoin allows instant payments all over the world for low costs (close to zero). Like with Bitcoin, Litecoin is also an ‘open source’ network, fully decentralized and without any central authority. Then, Litecoin users can control their own accounts, through a fully secured manner and also through a cryptographic system backed by a mathematical resolution.

But compared to Bitcoin, the Litecoin transactions are generated and confirmed faster; they also benefit from a much more efficient warehousing. Additionnally and compared to her ‘Grand sister’, Litecoin is a medium of payment and transfer that has proven himself.

But beyond the transactions efficiency and speed, the major points that characterized Litecoin conception are fully comparable with those of Bitcoin, as Litecoin is a Fork of Bitcoin. 

 Let see now a list of its main characteristics :

  • Maximum Quantity of coins to be issued : 84 000 000 units
  • Quantity issued : 62 983 450 units as of 08/05/2019 (or 74.9% of the maximum units to be issued)
  • Decimalization: each Litecoin is divided by hundred million smaller units, equivalent to 8 decimals (like the Satoshis for Bitcoin)
  • Algorithm : Scrypt
  • Type of proof : POW (‘proof of work’) equivalent to the mining process for Bitcoin
  • Halving every 840 000 blocks , or every 4 years
  • Last halving occured August 5, 2019 and halved the block reward to 12.5 Litecoins per block (from 25 previously).
  • End of mining : Year 2142 (during the previous halving, roughly 21 million Litecoins to be mined remained )
  • Unanonymous Crypto currency

 

What are the major differences with Bitcoin ?

Because we can find some differences between Litecoin and Bitcoin :

  • Litecoin network is targeting a block every two minutes and thirty seconds compared with the ten minutes needed for Bitcoin.
  • Transaction fees are very small, even compared with those of Bitcoin.
  • The modified interface allows coins mining from anywhere and any computer. Therefore, mining Litecoin is possible with a standard harware equipment. 
  • The mining algorithm can be executed and run simultaneously and with the same computers than those that are mining Bitcoins.
  • And above all, transactions confirmation is going much faster

About the transactions, they are recorded on a specific Litecoin blockchain.

Up until 2016, the Litecoin blockchain recorded an average of 7500 daily transactions, a daily volume of 10 000 000 Litecoin units and a confirmation time lapse of 2.5 minutes. 

In 2018, number of daily transactions rose up to 200 000 roughly.

 

Mining Litecoins

Similarities with Bitcoin are also clear concerning the mining, as Litecoin can be mined individually or by combined players, called pools (or polls of mining).

Identically, the rate of Litecoin units issued follows the same logic, that is a quadratic function that reduces by half every 840 000 blocks (Halving), or approximately every four years, and this up to a total of 84 millions LTC.

The SCrypt algorithm that is used by Litecoin was conceived in such a way that its memory consumption is high, and in such a way to hamper repeated new ASIC (hardware used to mine coins). Nvertheless, new ASICs have been launched in order to use the Scrypt algorithm, like with Bitmain L3.

 

At a price of $78.84 (as of 02/13/2020 – see chart ), Litecoin market capitalization is USD 5.051 Billion

 

Graphique du Litecoin depuis 2014

    About the editor…

    A passion : Economics, behavioural finance and emerging digital assets

    Yves started his career in the asset management in 1986 where he worked at different positions as manager of equity funds and diversified funds. at Crédit Commercial de France and later, at Barclays group in Paris. In 1998, he took the lead of equity funds and diversified funds, then of the whole fund management business at the French team of the Dutch Robeco group  before joining Natixis Asset Management in 2012 as Director of the Equity Investment business unit. Yves left Natixis AM in 2018 to start as an independant player for professional investors and corporates (advisor and fund raiser).

    He likes to engages in sports that test his endurance like running and swimming, Yves is also fascinated by social sciences, and more specifically by history and economics. But this is the economics mechanisms behavioural aspect and the markets behavioural analysis that are a constant source of thought and discussion. Since few years, the blockchain issue and emergence of crypto assets is a new field of passion and opportunities for him.

    Yves Maillot

    Financial markets and asset management

    Yves Maillot

    Financial markets and asset management

    Understand ICO, STO and IEO

    The ICO is a financial innovation that constitutes an important step in the transformation process triggered by the blockchain. It turns things up and down and especially the traditional relationship to property.In this article, for a second time, we are also going to analyse STO and IEO.

    Real assets tokenization : use case in the real estate

    Among all real assets, properties are very good candidates for tokenization, a mechanism that will facilitate democratization of investing on those assets. Because tokenization allows becoming a real estate owner for only a few hundred euros, without any loan.

    Bitcoin valuation and the Gold price (4)

    Bitcoin valuation and the Gold price (4)

    Bitcoin valuation and the Gold price (4)

    This article is intended for readers who have already acquired a certain level of knowledge in the field of Blockchain and cryptocurrencies. If the article seems indigestible, do not hesitate to choose another difficulty in the box below wink

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    Bitcoin is a medium of payment but its core price is based on the  store of value concept that makes it comparable to Gold

    Bitcoin  is not yet fully used as a medium of payment (number of Bitcoin users as a mean of payment is estimated at roughly and only 30 million people all over the world) because of somewhat high average transactions fees, especially for low criticality transfers and long validation periods (several minutes). In this article, we’ll be focused on a Bitcoin analysis as a store of value (see the article published 21 November 2019) and as a transaction value.

    Bitcoin and Gold are both stores of value – Pricing  Bitcoin compared it to Gold

    As a store of value and scarce asset (number of bitcoins issued limited to 21 million units by 2140), the crypto currency would then act as ‘Gold 2.0’ as we have mentioned in the previous article. By continuing to compare Bitcoin and Gold, let assume that the total value of all bitcoins in circulation   (equivalent to the market capitalization for securities) would equal the total value placed in Gold .

    Assuming this, the bitcoin’s value would then be the result of the following equation :

    = (Value of Gold x market share in %)/number of bitcoins in circulation

    Assuming that the total amount of Gold is close to USD 9400 billion  (on the base of a Gold price at $1550 as at January 3, 2020) and that the total number of bitcoins that have been created  is roughly 18 millions , we get the following figures (see the table below for different market shares) :

    In other words, assuming that the current market price  of $7450 and a market capitalization of USD136 billion , Bitcoin only represents a little bit less 1,5% of the total value of Gold (or 136/9400).

    As shown by the above table, and taking the assumption of a Bitcoin that would represent  5% of the total value of Gold (meaning that the Bitcoin and other crypto currencies investments would represent  an average 5% of all investments), the unit value of a bitcoin would be about 26 000$

     

    Bitcoin pricing if its use becomes transactional

    If Bitcoin becomes a transactional mean (largely used to carry out transactions) and combined the functions of storing value and the one of medium of payment, let’s have a look on how to price it by using the well known quantity theory of money equation :

                                                                     MV=PQ 

    with

    M : the quantity of money in circulation

    V : velocity of circulation of money  (the number of times money ‘changes hands’ over a certain period)

    P : the price of money

    Q : the quantity of money

    Through this equation, the Bitcoin value can be estimated by forecasting the demand generated by the underlying resource distributed by the network (product PQ could be equated to the network revenues), divided by the available monetary base (in bitcoins).

    Transactional value

    The former equation may be summarized by the equality Supply= Demand with supply consisting of available money multiplied by velocity of circulation of the money (MV) and the demand that is equivalent to the wealth produced by the network (PQ). So, the monetary mass should equalize the network value creation   (as for fiat currencies that should equalize the macro total Gross Domestic Product).

    About the Bitcoin velocity, it is difficult to estimate a good assumption given its very high volatility . It is therefore obvious that its velocity used to be higher than the velocity of traditional currencies (fiat) because of infatuation and strong speculation. Then, a velocity 7 to  8 times larger than one of Fiat monetary mass seems credible.

    Without elaborate too much about the needed calculation for this approach, but  :

    1/by combining a Bitcoin velocity level (assumption of 7.5x greater than the  dollar US velocity)

    2/ By estimating a share of the total GDP generated by the Bitcoin network,

    We do obtain a price of  $25 000 $ per Bitcoin unit, knowing that this value is very sensitive to the different parameters  

    Total value = Store of value  + Transactional value

    If Bitcoin becomes more widely used as a store of value and as a transactional tool, the approach is simply to add both valuations. By combining and give more details to the formula, one way to express is to calculate the average velocity for each of the two uses, weighted by the demand associated with each use respectively The Bitcoin’s velocity would then be expressed as follows :

     

    V= (storage value x demand ‘store of value’) + (transactional value x demand ‘ transactional value’)/ (demand ‘store of value’ + demand ‘ transactional value’) 

    The benchmark ‘store of value’ is expressed by a market share of 5% of the Gold value (hypothesis as mentioned before) equals to $ 470 billion.

    Assumptions for the transactional value are considering a network that represents 4% of the total GDP  ($3170 billion), given a Bitcoin network GDP (revenues) of $3550 billion with an average velocity of 3

    So,   V= (470+(3×3170))/3550=2.81 that gives Bitcoin market cap of 3550/2.81=$1263 billion  and, Considering the 18 million bitcoins in circulation , Bitcoin value must be equal to 1 263 000/18= $70 166   a superior price to the simple sum of the store of value (linked to Gold) added to the transactional value, as calculated before (26000$+25000$).

    Conclusion

    All the calculations tell that Bitcoin price  has a room to rise if we consider its potential to replace (or ‘co replace’) Gold, the traditional asset haven / store of value, and also the potential function of transactional value of the first crypto currency.  Obviously, one can bring criticism to the calculations given assumptions that are used, and can bring criticism because other competing protocols and crypto currencies are not taken into account.  

    Tough Bitcoin has a legitimacy and is now a benchmark in this new digital asset class, Bitcoin could be tackled with success by some other projects. It has been the case with Ethereum in some extent. Of course, this potential scenario could reduce the intrinsic and fundamental value of Bitcoin.

    About the editor…

    A passion : Economics, behavioural finance and emerging digital assets

    Yves started his career in the asset management in 1986 where he worked at different positions as manager of equity funds and diversified funds. at Crédit Commercial de France and later, at Barclays group in Paris. In 1998, he took the lead of equity funds and diversified funds, then of the whole fund management business at the French team of the Dutch Robeco group  before joining Natixis Asset Management in 2012 as Director of the Equity Investment business unit. Yves left Natixis AM in 2018 to start as an independant player for professional investors and corporates (advisor and fund raiser).

    He likes to engages in sports that test his endurance like running and swimming, Yves is also fascinated by social sciences, and more specifically by history and economics. But this is the economics mechanisms behavioural aspect and the markets behavioural analysis that are a constant source of thought and discussion. Since few years, the blockchain issue and emergence of crypto assets is a new field of passion and opportunities for him.

    Yves Maillot

    Financial markets and asset management

    Yves Maillot

    Financial markets and asset management

    Decentralized Finance in motion

    DeFi or Decentralized Finance gives opportunities. Recently, few traders took the chance of using this new financial system by realizing winning arbitrages on substantial volumes through crypto ‘flash loans’.

    Real assets tokenization : use case in the real estate

    Among all real assets, properties are very good candidates for tokenization, a mechanism that will facilitate democratization of investing on those assets. Because tokenization allows becoming a real estate owner for only a few hundred euros, without any loan.

    Bitcoin valuation and production cost (3)

    Bitcoin valuation and production cost (3)

    Bitcoin valuation and production cost (3)

    This article is intended for readers who have already acquired a certain level of knowledge in the field of Blockchain and cryptocurrencies. If the article seems indigestible, do not hesitate to choose another difficulty in the box below wink

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    CHOOSE ANOTHER DIFFICULTY
    confirmed

    After  having discussed about the Bitcoin pricing on the base of its Network value (article published  on 11/14/19)  and on the base of its ‘scarcity’ ( see article published on 11/21/19)-, let’s have a look now on an approach based on its production cost.

    Bitcoin is based on the Proof of Work (PoW)

    It’s necessary to remind that the proper functioning of the Bitcoin Blockchain requires the validation of transactions carried out on the network. These transactions are grouped into blocks where each added block is validated at regular intervals by ‘miners’ who should solve a kind of mathematical equation. The resolution of this mathematical problem is very computationally intensive. This consensus mechanism on which the Blockchain Bitcoin is based is called Proof-of-Work (PoW). The difficulty of the mathematical equation to solve for a block of transactions to be undermined is periodically readjusted. Nevertheless, this difficulty tends to increase constantly except during prolonged bear markets. It was the case in 2018, and at that precise moment, the difficulty decreased in front of the loss of financial interest of the miners for Bitcoin mining.

    (see the chart below showing the difficulty of mining a new block on the Bitcoin)

    The almost uninterrupted growth in the difficulty of mining Bitcoins inevitably leads to an arms race on the part of miners to obtain ever more computing power.

    Chart showing the constant increase of the Hash Rate   

    (Hashing : mathematic way to enable the security/ cryptographic process for mining Bitcoin)

    In this way, miners maximize their chance of receiving  the reward  which is paying the miner who is successful in solving the encryption problem and who is validating the block of transactions. The reward  is currently 12.5 bitcoins but it will decrease to 6.25 bitcoins in May 2020 (read our article published on 10/31/2019 about the  coming Bitcoin Halving ). This division of the reward will make the creation of new Bitcoins even rarer. This scarcity will inexorably increase the price of Bitcoin but also increase competition between miners who will continue to try to have ever more computing power available.

    The computational power of miners being obtained through the purchase of computer equipment specialized in Bitcoins mining. This type of famous equipment is called ASIC  (acronym for Application Specific Integrated Circuits).

    Bitcoin mining induces  High Power consumption

     Cambridge Bitcoin Electricity Consumption Index

    As mentioned, the process to validate a transaction’s block and create new bitcoins results in  very high power consumption. According to the Bitcoin electricity consumption index calculated and maintained by the Cambridge Centre for Alternative Finance (see the above chart), Bitcoin consumes 70 Terawatt-Hours per year to ensure the reliability and security of its network. This electricity consumption places the Bitcoin Blockchain just above Colombia, a country with a population of 48 million !.  

    Bitcoin Mining simplified microeconomic model

    A miner has an incentive to mine if, and only if, the total revenues generated  by the mining  activity on a given period exceeds  the total costs incurred by this activity.

    But it also must be taken into account the potential  increase capacity of mining and it gives the following equation :

    (1)      PBTC (Bitcoin price) >  A x Nm

    Nm is the number of miners in the network

    A is a constant number equivalent to the mining profitability equation (Revenues/Costs)

    The equation (1) shows us that the price of a bitcoin is affected by the number of miners in the network. The price of a Bitcoin depends on the demand for bitcoin in a context of limited supply.   An increase of the Bitcoin price gives the miner a greater incentive to mine, which leads to a rise in the number of miners in the network. However , this increase cannot exceed the network profitability threshold  (PBTC /A) that  implies mining costs larger than revenues.

    Therefore, it is clearly the price of Bitcoin the only factor that motivates  a player to mine and develop (or not) his activity. But the true economic reality is much more complex as the miners don’t all work  in the same conditions and do not have :

    1/ identical computing power

    2/ identical electricity cost

    As said,  miners can also maximize their production by buying  more sophisticated hardware, forming large mining pools (mining farms) that combine their computing power, and by setting up business in countries with the cheapest electricity costs.

    Mining cost in different countries

    As the electricity cost is the key parameter  of the mining cost , let’s now have a look on the different electricity tariffs depending on regions and countries. Elite fixures  gives information on electricity prices to provide Bitcoin mining facilities all over the world (see the map and chart)

    So, the miner ‘Holy grail’ is obviously based on cold weather countries (in order to refrigerate machines) and low electricity prices.

    At looking more in details the numbers , we can see that :

    South Korea  is the most expensive country to mine  Bitcoin (26170$), even if this country controls the majority of the capital invested in the Bitcoin industry at the same time

    Venezuela is the cheapest country to mine with a ludicrous cost of 531$, thanks to State subsidies.

    -In France, the cost level of 7930$ is in the average.

    And for countries with favorable (cold weather) conditions as:

    -the United States (at the world  ranking 41) the  average cost is 4758$

     –Russia and Iceland  have the respective costs of  4675$ and 4746$.

    For China, the country that is bringing together the largest stake of the mining capacity, has an average cost of 3100$.But low cost Chinese miners can pay even less , a cost estimated  by JP Morgan at roughly 2400$  per bitcoin, helped by deals with power producers. These miners take the opportunity of direct electricity purchase agreements, like with  aluminium shelters that are looking for selling electricity excess production.

    Conclusion

    Even if the cost to produce a good or a service is not an absolute determinant for a minimal price of this good (or service), economical  rationality says that an equilibrium is found at a level where the production cost gives at least a break even, as a ‘floor’ price. All things and costs being equal, (electricity  prices and amortization of the hardware ASIC machines), a global mining cost average is around 6000$/7000$ and seems to constitute a minimal price for Bitcoin.

    Below this price, supply would decrease (maybe except in China where the costs are much lower) , but based on this assumption, the reduced difficulty of mining would give a boost to new supply that would bring back an equilibrium later on.

    On this base, and at the current price, Bitcoin is justifying its production cost (but not much more) This current cost is probably offering a floor level to Bitcoin today.

    About the editor…

    A passion : Economics, behavioural finance and emerging digital assets

    Yves started his career in the asset management in 1986 where he worked at different positions as manager of equity funds and diversified funds. at Crédit Commercial de France and later, at Barclays group in Paris. In 1998, he took the lead of equity funds and diversified funds, then of the whole fund management business at the French team of the Dutch Robeco group  before joining Natixis Asset Management in 2012 as Director of the Equity Investment business unit. Yves left Natixis AM in 2018 to start as an independant player for professional investors and corporates (advisor and fund raiser).

    He likes to engages in sports that test his endurance like running and swimming, Yves is also fascinated by social sciences, and more specifically by history and economics. But this is the economics mechanisms behavioural aspect and the markets behavioural analysis that are a constant source of thought and discussion. Since few years, the blockchain issue and emergence of crypto assets is a new field of passion and opportunities for him.

    Yves Maillot

    Financial markets and asset management

    Yves Maillot

    Financial markets and asset management

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