Fundamentally, blockchain technology allowed the creation of digital assets. Digital assets are digital moneys which are:
- Decentralized: They are managed by a network of thousands of computers; as such, anyone with internet access can use the digital assets and no central authority can unilaterally control them (i.e. change their supply or interest rates)
- Programmable: They can automatically execute logic such as “when document is signed electronically, release money from the escrow”
As a result, for the first time in history, digital assets allow computers to store and move value without a central authority (e.g. a bank or PayPal). Digital assets disrupt traditional financial system by granting access to financial products to anyone globally, while removing costly back-office and rent-seeking intermediaries. The first digital asset was Bitcoin created 10 years ago. There are over 5,000 digital assets now. We split the use cases of digital assets into 4 application areas: 1. Trading, 2. Financial services, 3. Resource monetization, and 4. Infrastructure
Historically, trading has been the main use case of digital assets. Currently, $60bn worth of digital assets are traded daily on spot exchanges and $10bn on derivatives exchanges (source: coinmarketcap.com). In 2019, the trading volume has been higher than during the bull market at the end of 2017.
This time however, the growth is not driven by retail speculation, but by institutional investors. The main reason is the volatility of the digital assets. Traders use volatility to earn return. Bitcoin 30-day volatility (standard deviation of daily returns) is around 4%, which is 20x higher than USD/EUR volatility and 6x higher than Gold/USD volatility.
In addition to volatility, digital assets are traded to store value. For instance:
- Family offices or institutional investors add digital assets to their portfolio to improve its risk/return (i.e. Sharpe ratio) due to diversification effects stemming from low correlation between traditional and digital assets,
- Citizens from countries such as Venezuela, Nigeria or countries with conflict such as Hong Kong, store their wealth in “digital gold” by buying digital assets online to save their wealth from inflation effects of their domestic currencies.
The trading use case has created several cash-flow generating business models:
- Fiat-to-crypto exchanges: Allow converting Fiat money (e.g. USD) into digital assets and vice-versa. Examples include Coinbase, Kraken and Bitfinex. Coinbase generates ~1bn USD revenue per year and raised $300m at $8bn valuation. Kraken raised $120m at $5bn valuation. This category also includes peer-to-peer exchange platforms such as Localbitcoins.com and ATMs such as General Bytes.
- Crypto-to-crypto exchanges: Allow converting digital assets between themselves. Sometimes, they use their own token as a way for traders to get discounts on fees. Examples include Binance, Huobi and OKex. Binance generates $150m in profit per quarter.
- Derivatives exchanges: Allow purchases of futures, perpetual swaps and options on crypto assets. Examples include BitMex, Okex, Deribit, FTX, and Coinflex. Sometimes, they use their own token as a way for traders to get discounts on fees. BitMex generates $8bn daily volume. Deribit generates $500m daily volume.
- Market makers: Provide liquidity by inserting orders into the order book of exchanges. They earn the spread between the bid and ask prices, and sometimes charge monthly fees (approximately $50k to $100k). Examples include B2C2, QCP or GSR.
- Brokers: Allow buying and selling of digital assets. They can be either manual (i.e. OTC) or automatic by splitting the order across several exchanges. Examples include Crypto Broker AG, SFOX, Tagomi, Copper and Paradigm.co.
- Wallets: Provide a safe way to store digital assets. Examples of hardware wallets include Trezor and Ledger. Examples of software wallets include Trust Wallet (acquired by Binance), Rise Wallet, but also Revolut and CashApp.
- Custodians: Provide a safe way to store digital assets with 3rd parties, and contain features such as immediate availability, security (incl. armed forces), multi-sign and insurance. Examples include Coinbase, Bakkt (launched by NYSE’s owner ICE). Bakkt raised $180m at $750m valuation.
- Data providers: Retrieve real-time digital assets data: Coinmarketcap, Cryptocompare and information platforms such as Messari (raised $5m from Uncork and others), Kaiko (raised $5m from CoinShares and others) or Skew (raised $2m from Kleiner Perkins and others).
- Analytics tools: Ensure AML compliance and identify fraud: Chainalysis, Elliptic or Scorechain. Chainalysis raised $50m from Benchmark and Accel. Elliptic raised $35 from Octopus and Santander.
- Trading tools / order management systems: Allow to chart prices, trading strategies and are able to execute orders: Trading view, Coinigy.
- Portfolio trackers: Allow to track performance of digital assets portfolio. Examples include Blockfolio (raised $17.5m), Delta (sold to eToro), Blox.io (includes accounting) or Lumina.app (includes direct integration with exchanges, lending platforms, provides order execution and accounting reports).
- Asset managers, ETFs and funds: There are around 650 funds trading crypto (source: https://cryptofundresearch.com), ranging from index funds to market neutral quantitative trading funds to arbitrage funds. Examples include Fidelity and Grayscale ($2bn AUM, of which 70% from institutional investors). Bitcoin ETF are traded in Sweden (https://xbtprovider.com), but not yet in the US (SEC has been rejecting Bitcoin ETFs).
We believe the market for trading use case will grow. In addition to volatility, it will be driven by the intrinsic features of crypto assets (easy to trade, easy to hold, immutable and non-forgeable, digital gold to hedge against macro risks), by greater ease of use of the products and by professionalization of the service providers. This will allow main street institutional investors to join this asset class. How big can the trading be? Difficult to say, but the spot FX trading represents $6tn daily volume. Crypto assets are now at 1% of the FX trading market. The potential of derivatives is even bigger: in traditional markets, derivatives represent 4x of the spot market, in crypto markets derivatives currently represent 1/6 of the spot market.
2. FINANCIAL SERVICES
Blockchain enables the creation of globally accessible financial services, which can be used as alternatives to traditional financial system. We identified the following products as parts of the bank-less financial system:
- Lending/borrowing platforms: Allow anyone to lend and borrow Fiat money (e.g. USD) at 3–12% annual interest rate. The borrower collateralizes the loan using digital assets (e.g. Bitcoin) with 1:2 ratio. For example, to get a $100k loan, borrowers must deposit $200k worth of Bitcoin as collateral. If the price of Bitcoin declines, the collateral is automatically liquidated and the loan is paid back, eliminating borrower default risk. Typical borrowers are miners or crypto companies which do not want to sell their crypto but borrow cash to cover their expenses (e.g. energy, people). They are also traders who borrow to leverage their investment positions. The largest platforms currently hold over $2bn AUM: Compound ($100m), Maker ($500m), Dharma ($80m), Genesis ($500m), Blockfi ($300m), Nexo ($300m), Celsius ($300m), Torque and Fulcrum and dYdX, which also has an integrated decentralized exchange. The website loanscan.io compares interest rates across platforms.
- Insurance: Allow anyone to can become a stakeholder in a decentralized insurance company, and receive part of the insurance fee, but also share the risk — in a similar way to original Lloyd’s back in 19th century London. Today, such platforms ensure against risk of hackers attacking blockchains wallets, or against risk of your flight delay. In the future, the plan is to also cover real-word events such as hurricane risk. Examples include Nexus Mutual (has a capital pool of $2m available for insurance), Etherisc and CDx.
- Structured products: Allow anyone to invest into financial structured products that are automatically rebalanced (e.g. mix of 80% interest income of 7% via Fulcrum lending platform and 20% from Bitcoin long position) or programmed to follow a certain strategy (e.g. trend following, mean reversion). Examples include StructuredEth and Tokensets.
- Synthetic assets: Allow anyone to invest into synthetic digital assets of their underlying assets (e.g. an Apple stock NASDAQ:AAPL as a digital asset or a traditional Gold ounce XAU as a digital asset). This way, anyone can trade on that Apple stock, without holding it physically. Examples include Synthetix.io, UMA or Abra.
- Derivatives: Allow creating markets for derivatives. As such, anyone can invest globally into local derivatives, such as carbon emissions or exotic forex. Examples include Vega (raised $5m in a round led by Pantera Capital).
- Remittances: Allow the transfer of value across borders with transparency and lower fees, disrupting a $600bn traditional remittances market. Examples are XRP (Ripple invested up $50m into MoneyGram — second largest remittances firm) and Veem (raised $70m, and uses bitcoin as the channel to transfer value). Ripple is being used by 300 financial institutions and its xRapid product should reach $1bn in yearly volume by 2020. For more information on the remittances market, we suggest reading the primer by Proof of Capital.
- Payments: we split the payments use case into 2 categories:
→Cryptocurrencies for peer-to-peer payments: Allow anyone to pay and receive payments. This was the original intended use case for Bitcoin, Bitcoin Cash, Litecoin, Dash and others, but failed to gain traction. The population in developed countries does not have a payments problem. Recently, projects like Celo and Libra focused on the 1.7bn of unbanked people, of which 1bn own a smartphone. Other projects focus on a specific industry, such as Eco.com and Terra.money, eliminating charge backs and reducing fees for ecommerce and retail.
→Gateways: Allow to pay with cryptocurrencies in the real world (retail or online). Projects such as Bitpay (raised $70m), Flexa (raised $4m), Coinpayments.net (raised $1m) help traditional businesses accept crypto. Projects such as Bitwalla and Wirex (reaches over $1m monthly net revenue from transaction fees) offer a debit card, which allows to spend bitcoin in retail.
- Decentralized banks: Combine different decentralized financial services (lending/borrowing, insurance, structured products, payments) into one easy-to-use application. This way, anyone can easily use those financial services without using a traditional bank. Examples include Zerion.io, Instadapp, DEX Wallet, Argent and Wayrate.
- Asset securitization: Platforms that allow securitization of $700tn worth of traditional assets (equities, debt, real-estate), as well as investing in them and trading. Examples include Securitize, Harbor, Polymath and Brickblock with its ScalingFunds solution for real estate funds. We think it will take over 2 years for the asset securitization to take off, mainly due to lack of liquidity on security token exchanges and regulatory barriers (i.e. capital markets regulations in most countries limit offerings to accredited investors only). However, blockchain and smart contracts reduce cost and inefficiencies in the financial services markets. For example, Figure.com generates home equity loans and subsequently sells them to financial buyers on Provenance.io blockchain. Figure.com has $1bn worth of home mortgages under management, and raised $103m Series C at $1.2bn valuation from such investors as DTS Global.
3. RESOURCE MONETIZATION
Blockchain enables monetization of one’s resources. We find most of the opportunity in monetization of computing resources, storage, networking and data. In particular:
- Computing: Allow any user (person or enterprise) to monetize spare computing capacity by making their computers participate in a blockchain network. On the other side of the marketplace, if someone uses that spare capacity, the user gets paid. These networks can be used for machine learning calculations, for video rendering or, at a later stage, for creation of decentralized alternatives to Amazon Web Services. Examples include platforms such as Ankr, iExec, Livepeer, Fluence and Golem.
- Storage: Allow anyone to monetize their unused computer storage by joining a blockchain network for decentralized storage. Examples include Arweave, Filecoin, Swarm.
- Networks: Allow anyone to monetize their computer or server capacity by joining a blockchain for decentralized networking. Examples of such platforms include Top Network, Orchid Protocol, Oxio and Helium.
- Data: Allow anyone to monetize their data. For example, Brave browser allows users directly to earn income from seeing displayed ads. Steemit platform allows writers to earn income from the article they published. Projects such as Kara or Nebula Genomics allow owners of healthcare data or DNA to earn income, when pharma companies (e.g. Merck, Novartis) use those data for research (e.g. to accelerate clinical trials).
Infrastructure products and services that enable the operation of digital assets.
- Mining: Digital assets such as Bitcoin are operated by a network of miners. Miners earn rewards for validating transactions that are broadcast to be registered on the ledger by performing computer calculations. The best known mining companies are Bitmain and Canaan. Both also develop and sell mining hardware based on custom design chips (ASICs). Over the course of the previous 6 years, Bitmain has generated cumulative revenue of $10b and is planning an IPO. Canaan, the Bitmain challenger, generated $0.4 bn revenue in 2018 and raised $90m at $1.4bn valuation in its IPO on NASDAQ in November 2019. Additionally, smaller miners are pooled together through mining pools (to increase probability and generate more continuous stream of mining). Slush Pool, a Bitcoin mining pool from the Czech Republic, mines about 10% of Bitcoin and generates an estimated yearly revenue of $12–15m.
- Staking: Other digital assets, such as EOS, are operated by a network of stakers. Stakers earn rewards for validating transactions that are broadcast to be registered on the ledger, by locking their digital assets on the network. The website stakingrewards.com shows rewards (in yearly % interest rate) earned per protocol, as well as by staking providers. Examples of staking providers inlclude Staked.us (raised $5m in a round led by Pantera). Staked operates staking nodes and allows anyone to join their staking nodes. Other companies such as Bison Trails (raised $30m in a round led by Blockchain Capital with Kleiner Perkins) allow anyone to operate a staking node.
- Security: Software that allows to safely move funds across wallets, exchanges, custodians. Examples include Fireblocks (raised $16m from Eight Roads Ventures) and hardware security modules, such as Securosys.
- Banking services: Companies with banking license which can open accounts in traditional Fiat money, as well as in cryptocurrencies. Examples include Seba (based in Switzerland, raised $104m), Sygnum (based in Switzerland) and Founders bank (based in Malta, raised $10m from Polychain and Binance).
- World computers: Allow creation of digital assets that can be programmed (via what we call “smart contracts”). Examples include Ethereum (currently ~$15b market cap on coinmarketcap.com), EOS (currently ~$2bn market cap), Oasis Labs (raised $45m in a round led by A16Z), Solana (raised $20m in a round led by Multicoin capital) and others. This category also includes scaling platforms such as Bloxroute and Skaleabs, and platforms, which allow inter-blockchain communication, such as Polkadot and Cosmos.
- Developer tools: Allow programmers to simplify development of blockchain applications, make them more reliable, user-friendly and shorten time to market (i.e. blockchain APIs, monitoring tools, analytic platforms, oracles). Examples include Alchemyapi.io (raised $15m in a round led by Pantera Capital), Fabrx.io and Chainlink.
- Listing platforms: Allow digital asset companies to run and manage their token sales. Examples include Coinlist and Tokensoft.
- Enterprise: Digital assets destined for enterprise use-cases, such as supply chain. The main value proposition of a blockchain for enterprise is trustlessness. This means that using the blockchain technology only makes sense if there are multiple parties who do not trust each other. Blockchain synchronizes the information between them. These multi-party projects (e.g. trade finance, supply chain, loyalty programs) are lengthy and costly to implement. Examples of blockchains for enterprise include Aergo, Centrifuge, R3, Kadena and others.
- Government: Digital assets destined for government use cases. Value proposition of blockchain for governments is also trustlessness. This means that citizens can verify the correctness of transactions in public registries. Such implementation does not allow data forgery and reduces the risk of fraud (i.e. in land registry). Examples of companies that provide solutions for governments include Bitfury and Blocko.
Thanks to Paul Veradittakit from Pantera Capital, Kyle Samani from Multicoin Capital, Derek Hsue from Blockchain Capital, Tekin Salimi from Polychain Capital, Dean Tribble and Mike Jablon from Agoric for reviewing initial drafts of the article.
APPENDIX: Sources of data:
- Coinmarketcap.com, Coingecko.com, Cryptocompare.com for information on 5000+ digital assets and 400+ exchanges
- Bitinfocharts.com/comparison/activeaddresses-btc-eth.html for active addresses and Bitinfocharts.com/comparison/transactions-btc-eth.html for transactions
- Btcvol.info for volatility
- Blockchain.com/en/charts/my-wallet-n-users for Bitcoin wallets
- Defipulse.com for projects in Financial services
- Loanscan.io to compare interest rates across lending platforms
- Stakingrewards.com to compare interest from staking across blockchains
- Twitter.com/skewdotcom/status/1202911161395621889 on institutional investors in crypto