PBS Economist Squad Bitcoin vs Ethereum: $1M to invest across these two blockchain technologies - The Economist

 
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PBS Economist Squad Bitcoin vs Ethereum: M to invest across these two blockchain technologies - The Economist
PBS Economist Squad

  Bitcoin vs Ethereum: $1M to invest
across these two blockchain technologies

                 October 2016
                                Francisco Cudell
                                Pedro Vilas-Boas
                                Rui Rosas
PBS Economist Squad Bitcoin vs Ethereum: M to invest across these two blockchain technologies - The Economist
Introduction

   We’re living in a world driven by technology. Existing business models keep

challenging absolute truths we had for granted in the past, disrupting well established

industries and monopolies thus our global economy. For the last decades, since the

appearance of the internet in 80/90’s up to now, the rate of change driven by technology

and innovation has forged a new type of economy, the digital economy. Advancements

in computer processing power, data storage solutions and chip evolution in addition with

network’s backbone infrastructure continuous development in parallel with cultural and

operational shifts not only on companies modus operandi but in society in general, in a

continuous virtuous cycle of innovation and raise of challenges, have unfolded

numberless opportunities, both technologically and economically impossible in the past,

that go beyond our imagination.

   More than 3.5 B1 people are currently connected to the internet at a distance of a click,

which can be translated into a huge opportunity for entrepreneurs, newcomers and SMEs

and a remarkable challenge for established companies in many different sectors. Business

that fail to get digitally connected will become excluded from the global market as

business are going digital.

                                 Figure 1 - Internet users in the world - June 2016

   1
       Source: Internet World Stats - www.internetworldstats.com/stats.htm

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PBS Economist Squad Bitcoin vs Ethereum: M to invest across these two blockchain technologies - The Economist
We’ve already experienced the disruption of well-established industries such as public

transportation and hospitality business, just to name a few, and more will certainly follow

them in the future.

   Shared economy platforms, automation and robotization in the industry, the so called

industry 4.0, smart cities and smart grids, IoT and machine learning in addition with the

amount of data generated by, and that can be accessed from, every single

person/consumer (big data) unfolds huge challenges in terms of data mining, contract

management, finances and cybersecurity within what can be considered a borderless

digital world. This ever growing intersection between digital technology, financial and

non-financial services fostered new ecosystems to flourish.

   The need to improve digital financial economy efficiency, either by reducing its costs

and/or increasing its speed, while shoring up its security and at the same time increase its

exposure by reaching people that were previously excluded from the formal financial

service, led to the emergence of many FinTech applications and start-ups, as the VC

funding of more than $21B in the past two years and up to $7.4B during the first two

quarters of 2016 in FinTech start-ups is a clear sign of.

                  Figure 2 - Annual global financing trend to VC-backed Fintech companies

   This digital need, associated to society’s rising lack of trust in fiat currencies, mainly

due to recent past financial crisis and scandals, and denoted dependence on government

                                                                                            2
PBS Economist Squad Bitcoin vs Ethereum: M to invest across these two blockchain technologies - The Economist
policies (exchange rate, treasury notes and measurement against foreign exchange

reserves) created the perfect ecosystem for the growth and birth of cryptocurrencies.

  Mandatory to the rise of this trend is cybersecurity and this helps to explain why a

number of FinTech subsectors like blockchains started gaining more traction. Some

global banks and financial institutions increased their bet in blockchain technology,

public ledger system, and during Q2’16 started focusing in proof-of-concept pilot tests

while at the same time, several significant funding rounds concerned blockchain focused

companies (3 in the top 15)2. The impact of blockchain technology within the bank sector

could allow huge savings in its operations (ex: remittance, transactions, etc…). Santander

Bank estimates that the adoption of blockchain technology could reduce its infrastructure

cost by US$20B/year3.

                         Figure 3 - 30 Largest VC FinTech deals of 2016 (YTD)

  2
    Source: The Pulse of Fintech Q2 2016, Global Analysis of Fintech Venture Funding, KPMG
  International and CB Insights, August 17th, 2016
  3
    Source: https://letstalkpayments.com/an-overview-of-blockchain-technology/

                                                                                        3
In addition to the financial services applications, the non-financial use cases of

blockchain has been a significant trend in the recent past, where a considerable number

of Startups (50+) focused on asset servicing, IoT, identity and privacy management and

documentary trade, have come into life with brand new blockchain technology supported

business models.

   Hereafter, we’ll overlook the industry as a whole and both Bitcoin and Ethereum in

detail to assess the changes, trends and developments ongoing in order to understand each

cryptocurrency investment potential.

   POLITICAL

   The absence of external legislators in the cryptography industry is one of the several

great advantages the industry has. Up to now, there was no interference from central

governments in trying to legislate it. However, this industry is being followed by the

official entities (as the European Union), as it can take away the power and data strength

inherent of who manages currency and data. Central government pressure is expected to

be raised, as soon as the lobbying against cryptocurrencies gets followers.

   ECONOMICAL

   Trading markets have seen their liquidity flowing away over the past years. Adding to

this, the capital requirements and the multibillion dollar fines for market manipulation,

has been forcing the banks to implement more automation. Over the past 3 years, trading

in the spot market fall 19% to $1.7tn a day4. This gap has been taken by electronic

markets, as use faster and better technology, namely the blockchain technology. The latter

brought with it low frictional costs and is predicted to save around

   4
       Source: Financial Times, “Liquidity holes hold key to flash crash mystery”, 11th October 2016

                                                                                                       4
Bitcoin emerged as the first main digital currency with global acceptance. Even if

today has a market cap of $10 bn and a volatility standard deviation 30 days of 0.89% 5,

already had its volatility turmoil times, having more than 15% in the volatility index, at

the 30 days BTC/USD standard deviation.

                                     Figure 4 - Bitcoin volatility series

  Ethereum is a recent platform with 14 months of trading activity, has a market cap of

$1 bn already and still has a high volatility. Ethereum developed the blockchain

technology up to a point that can be considered the next big tech revolution after the

internet 20 years ago or the cloud 10 years ago. Some say that it came to “redraw the

internet as it should be”. The growth opportunities are uncountable, as it can be used in

such vast areas as financial service for faster, secure and cheaper transactions; in the

automotive industry, mainly in the autonomous cars; crowdfunding; voting; healthcare,

where patients' health information can be encrypted and then shared; in the vast world of

the IoT and so many other applications. A McKinsey study about the 12 disruptive

technologies6 assesses the economic value of IoT, Cloud Technology, Automation of

  5
   Source: https://btcvol.info/
  6
   Source: Disruptive technologies: Advances that will transform life, business, and the global economy.
  McKinsey Global Institute

                                                                                                      5
Work and Mobile Internet up to +$73.4 trillion by 2025, and in all of these, the blockchain

will be the key connection element.

   SOCIAL

   Global society has been divided about the blockchain technology adoption. While

some are truly focused on its benefits, others are concerned with the underground side of

it, mainly due to the usage of Bitcoin in “grey” transactions and also the fact that Bitcoin

didn’t became a global currency. In fact, more than 500 Altcoins have been created up to

date7. Another concern regards to cybersecurity, and Mt. Gox bankruptcy is a great

example (850.000 bitcoins stolen, equivalent to $450 million)8. Ethereum came to solve

this issue with the smart contracts development.

   Another important factor is that with the birth and expansion of this technology, the

central governments are being stripped of the big data they possess due to the control over

the currency and transactions. This loss of control will also possibly jeopardize the tax

laws in all the governments worldwide, with several reactions that will possibly be felt,

against the new and upcoming liberal and borderless currencies.

   TECHNOLOGICAL

   The world has seen the ground-breaking technology that has emerged with the birth of

the blockchains, at the time, when bitcoin was created, we assisted to an important leap

in terms of technology, which allowed for greater security and cheaper transactions. This

breakthrough has however been updated with the birth of new platforms such as

Ethereum, which corrected many of the Bitcoin issues.

   7
     Source: https://coinmarketcap.com/all/views/all/
   8
       Source: www.thedailybeast.com/articles/2016/05/19/behind-the-biggest-bitcoin-heist-in-history-
   inside-the-implosion-of-mt-gox.html

                                                                                                   6
Cybersecurity has to be considered as one of the most important aspects of the

industry, being that it is vital to attract adopters and allow for safer transactions. Without

cybersecurity, the whole industry would collapse due to the fear of the general

populations.

   The fact that the world internet infrastructure has increased substantially the access to

internet worldwide, also with larger bandwidth, has allowed for greater developments in

terms of capacity. This new and improved infrastructure allows for high speed

transactions and increased security in the industry.

   ENVIRONMENTAL

   In terms of environmental impact, a rising concern has been seen related to the energy

consumption of transactions. Nowadays, the increasing size of blocks is demanding an

equivalent to 3 Gj/s for computation, an equivalent to Ireland consumption today.9

   In depth industry analysis

   Analysing the digital assets industry in some depth, several conclusions can be

understood. Regarding new entrants in the industry, the disruptive nature of the crypto

digitalization technology reduces the risk of new and strong cryptocurrencies being born

during the next 5 years.

   The risk of increasing competition is high, with the foreseeing entrance of new players

such as banks and financial institutions using blockchain technology to reduce frictional

costs and increase the speed in operations, one must also note that new cryptocurrencies

are bound to appear in the industry landscape, occupying different market niches, and

therefore increasing the competition.

   9
       Source: Bitcoin Could Consume as Much Electricity as Denmark by 2020,
   http://motherboard.vice.com/read/bitcoin-could-consume-as-much-electricity-as-denmark-by-2020

                                                                                              7
Large corporations are viewing cryptocurrency as an important opportunity with key

investments, as the digital assets management. The NASDAQ, Australian Securities

Exchange, MIT, Microsoft, IBM, Blockstream, Euroclear and so many other are just a

few examples of powerful corporations already investing and using this technology. And

the value behind this disruptive technology can be seen by the quick adoption and ongoing

developments from 42 major banks - Bank of America, Credit Suisse and HSBC are just

a few examples10.

   Regarding substitutes, the fiat currencies must be taken into account. Although the

fiduciary currencies are being outdated due to the inadequacy to the instant digital world’

requirements and its dependency on Central Governments, they still account for the large

majority of transactions worldwide, and must still be considered as the currencies most

use.

   For a detailed analysis regarding Bitcoin and Ethereum, please refer to the appendix.

   10
        Source: Deloitte - Blockchain applications in banking. 2016

                                                                                         8
PROJECTION (risk analysis)

  In order to further assess both considered digital assets and their possible projections,

several calculations were performed, which led to a clearer analysis and decision making

process.

  Bitcoin Projections

  The process started by analysing the historical values for Bitcoin from January 2012

until the 17/Oct/2016. In order to have a blunt projection of Bitcoin, a logarithmic

regression was performed, with a projection for the following five years, using the

logarithmic regression. This analysis shows the trendline for growth in value, until the

year 2021. There is a clear growing trend line, which by 2021 should be approaching the

$1.150/bitcoin as per projection. This is translated into an approximated growth of 81%

($635 in 17/Oct/2016 to $1.150 in 01/Jan/2021).

                                 Figure 5 - Bitcoin value projection

  In order to further assess the possibilities of Bitcoin, several Monte Carlo analysis were

performed. In order to reduce the volatility and the speculative forces of the market, the

starting date considered for the bitcoin analysis was the 01/Jan/2015. As can be seen in

                                                                                          9
the historical values, this is the period where the volatility of Bitcoin starts reducing,

enabling for a better projection for the 5 year period. Also the fact that in 2015, several

other competitors started to appear in the industry landscape leads to a better

understanding of the possibilities of the Bitcoin as a currency.

                      Average                                              381
                      Average return (%)                                  21%
                      Std deviation return                                47%
                      Time to retire                                         5
                      Inicial investment                   $        1,000,000

                          Year             Return           Ending value
                           1                45%            $ 1,449,170
                           2                15%            $ 1,670,208
                           3                10%            $ 1,839,463
                           4               -17%            $ 1,533,657
                           5               -30%            $ 1,076,985

                                 Mean              $ 2,480,113
                                 Median            $ 1,854,970
                                 Std. Dev.         $ 2,366,392
                                 Percentile
                                            5% $          144,105
                                           25% $          824,707

                             Figure 6 - Rate of Return BITCOIN 01/01/2015

   Also, in order to evaluate a period where both Bitcoin and Ethereum were present in

the market, another Monte Carlo analysis was performed for Bitcoin, starting in the period

of 01/01/2016.

                                                                                        10
Average                                              517
                      Average return (%)                                  20%
                      Std deviation return                                25%
                      Time to retire                                         5
                      Inicial investment                   $        1,000,000

                          Year             Return           Ending value
                           1                29%            $ 1,289,223
                           2               -24%            $     982,932
                           3                35%            $ 1,322,994
                           4                 6%            $ 1,397,262
                           5                19%            $ 1,665,800

                                 Mean              $ 2,478,533
                                 Median            $ 2,261,968
                                 Std. Dev.         $ 1,222,898
                                 Percentile
                                            5% $   927,666
                                           25% $ 1,611,279

                             Figure 7 - Rate of Return BITCOIN 01/01/2016

   The results of these analysis show precisely what was previously discussed in the

qualitative part of the report, where the reduction in the volatility in the Bitcoin has led

to a slow but constant progression in terms of value, which makes Bitcoin a still valuable

cryptocurrency for the next 5 years.

                                                                                         11
Ethereum Projections

  An analogous process was performed for Ethereum, also with a logarithmic regression

that can be seen in the following graph.

                                Figure 8 - Ethereum value projection

  The takeaways of the logarithmic regression can be seen as a fairly positive trendline

that shows the capacity and the numerous possibilities that the Ethereum platform shows.

By 2021, the value of Ethereum could be at $90/Ethe, showing a growth of 657% (from

$11.89/Ethe in 17/10/2016 to $90/Ethe in 01/01/2021).

  As per the Bitcoin quantitative values, a Monte-Carlo analysis was performed using

the values from the beginning of the year of 2016. The same mind-set regarding volatility

of the beginning of the platform was considered, being that by blocking the time frame to

the latest developments, the analysis gives less speculative values, while taking into

account other competitors.

                  Average                                                     12
                  Average return (%)                                       931%
                  Std deviation return                                     421%
                  Time to retire                                               5
                  Inicial investment                  $                1,000,000

                                                                                      12
Year           Return             Ending value
                            1             754%           $        8,537,672
                            2             483%           $       49,767,499
                            3             846%           $      470,924,704
                            4             1220%          $    6,218,498,711
                            5             482%           $   36,214,615,122

                            Mean               $ 124,186,364,125
                            Median             $ 80,916,646,765
                            Std. Dev.          $ 137,894,882,427
                            Percentile
                                        5% $          3,595,975,276
                                       25% $         35,302,088,018

                             Figure 9 - Rate of return Ethereum 01/01/2016

   These values portrayed in the previous tables show an impressive mean returns, but

also an impressive standard deviation, proving what was considered in the qualitative

analysis of the possible volatility and risk associated with a new digital asset such as the

Ethereum, which should be expected to fluctuate considerably during the following years.

But by combining both the qualitative and quantitative analysis, Ethereum is by far a

valuable investment, which should be seriously considered in any portfolio.

                                                                                         13
Conclusion

   Considering the qualitative evaluation performed, we consider that both bitcoin and

Ethereum are here to stay. Although they are currently facing difficult challenges and

threats, which will be kept in the near future, namely in what concerns legislation,

government and central bank pressures, society lack of trust and mediatic awareness,

given the lack of efficiency, high costs involved in digital transactions and the new needs

of today’s business models in particular and society in general, they have been able to

find space to thrive.

   We consider that the decentralized platform model of Ethereum, based on blockchain

technology, will be spread as the backbone infrastructure of future business models and

its potential is still far from reaching its limits. As an open source platform, Ethereum

allowed developers to program and build applications on it, which is supporting its growth

strategy and rising adoption. Being able to call large tech and financials corporations’

attention and grant their support is a sign of Ethereum vitality and potential, and placed it

in the pole position of the most potential cryptocurrencies in the market.

   Bitcoin reached the market in 2011 and six years later is still present. Although facing

some up and downs during this period, it has had the ability not only to survive, which in

the digital world is already a huge achievement, but more importantly maintain a positive

trendline and continue to increase its value year on year. Based on the blockchain

technology, Bitcoin can be considered the father of younger generations of

cryptocurrencies and benefits from mediatic recognition granted by the 6 years of

presence in the digital economy ecosystem.

   Contrary to Ethereum, Bitcoin is not a platform and thus its use is limited to

transactions and deposits. Nevertheless due to its maturity, lower volatility, market

                                                                                          14
valuation and limited number of coins, we believe that Bitcoin can positioned itself as a

digital commodity, the digital gold.

   As per our quantitative analysis, which goes in line with the qualitative one, both

present themselves as good, yet high risk, investment options.

   According to our projections based on historical behaviour, which we recognise

present some risks due to the volatility of digital environment, we’ve have reached to the

following forecasts in a 5 year period:

   Ethereum

   US$11.9 @ 17/Oct/2016

   US$90 @ Oct/2021

   Growth in value of 657%.

   Bitcoin

   US$635 @ 17/Oct/2016

   US$1150 @ Oct/2021

   Growth in value of 81%.

   Given the inherent risk associated to projection making based on past behaviour with

digital assets we’ve complement our investment analysis running a Monte-Carlo

simulation using data from the 01/January/16 up till the 17/Oct/16 for a 5 year forecast

considering US$1 million investment made today..

   Ethereum

   US$1 million @ 17/Oct/2016

                                                                                       15
Average mean of return of US$119 million with a standard deviation of US$126

million.

   Bitcoin

   US$1 million @ 17/Oct/2016

   Average mean of return of US$2 million with a standard deviation of US$1.1 million.

   Based on the previously seen analysis, and taking into account the spectacular

possibilities of the Ethereum, one could even consider the investment solely in Ethereum.

But the fact that Bitcoin shows less risk with a much smaller standard deviation, aligned

with the possibility of becoming a commodity analogous to Gold must be considered.

   Therefore, with all the quantitative and qualitative analysis shown before, the

investment should be divided in the percentage of 80% for Ethereum ($800.000) and 20%

for Bitcoin ($200.000). This is without a doubt the division that most protects the investor

and ensures the greater outcome for the investment, with less risk.

                                                                                         16
APPENDIX 1 – SWOT ANALYSIS

   BITCOIN ANALYSIS

   Bitcoin had the first mover advantage. Was able to develop and mature its structure by

exponentially increase the hashrate, increasing a secure blockchain production. Currently,

transactions are secured by 1.4 billion Gigahash/sec11.

                                      Figure 10 - Bitcoin hashrate TH/s

   A market capitalization of $10 billion and its maturity allowed the Bitcoin volatility

index to present a downward trend that should inspire confidence in Bitcoin as a currency

   The bitcoin network already ranges 200,000 daily transactions for approximately 9

million wallets, and is expected to be in the excess of 10 million users very soon.

                                      Figure 11 - Blockchain wallet users

   However, there are obstacles in Bitcoin’s way threatening its pole position.

   11
        Source: www.blockchain.info

                                                                                       17
Was designed as a digital cash system. As such, has limitations that other altcoins

identified as market opportunities, like media polarization, compliance concerns related

to money laundering - traceability, reversibility and privacy.

   The Bitcoin network hardly scales. It can only handle seven to ten transactions per

second, what is too low for a mainstream system requirement. As an example, Visa

processes thousands of transactions per second12.

   As it became popular, Bitcoin block size became larger. The average block size is now

around 700 kb, sometimes reaching 1Mb. As larger sizes delay the transactions, users are

forced to pay higher fees to prioritize their transactions. This cost increase is chasing away

users.

   Another concern, mainly for its stakeholders, is how Bitcoin model shall proceed for

the future. This is now a conflict of interests for developers, miners, infrastructure

providers and end users.

   The partnerships being done with commercial banks can be seen as traction indicator.

Recently, Bitcoin signed one with Barclays Bank, after the UK’ FCA granted Barclays

and e-money license, becoming the first tier 1 bank having accounts for a Bitcoin

business.

   As any other blockchain technologies, Bitcoin as a world of possibilities for its usage.

   Nevertheless, due to its maturity for being the first cryptocurrency, fixed issuance,

market acceptance and independency from governments, already serves as a store of value

- digital gold - and has been used to secure investment when financial markets lack

liquidity.

   However, there are new alternatives more flexible than Bitcoin. Companies are betting

on the Bitcoin weaknesses and attempting to perform better. These companies are

   12
        Source: www.fortune.com

                                                                                           18
innovating on the smart contract platform, sidechain technology to improve scalability,

clearing the risk associated and also in the interoperability of services.

   And what to say about the regulatory threats? As far as the cryptocurrencies growth,

higher the government's concern will be. The later can see this technology as a

revolutionary way to lose control of the markets, currency, data and lastly, the power. The

European Commission already expressed the need to regulate the digital currency.

   Related to regulatory threats, comes the media coverage about whether the digital

currencies are being used for.

   ETHEREUM ANALYSIS

   Ethereum came up to the market with a revolutionary solution of smart contracts,

powered by flexibility, diversification and its inherent capabilities of blockchain

technology development. Allied to it, are the tremendous drivers backing it up, as the

partnership with Microsoft Azzure, which will provide access to the software to millions

of basic users. Other drivers providing powerful traction are the partnership with IBM,

MIT and the latest one with R3, resulting in blockchain developments for 42 main banks.

   The improvements made to the blocks technology, allied to a truly independent

platform reduced the processing time from the needed 10 minutes at Bitcoin to an average

of 17 seconds per transaction at Ethereum.

   Also as a decentralized cryptocurrency, was able to improve and solve several

cybersecurity issues that were pending.

   Smart contracts are now in a great macroeconomic spot due to its potential capabilities,

being applied to financial services, automation of the workforce or public records, for

instance. The undoubtable future relation of smart contracts with IoT, AI and Industry 4.0

is one of the major factors for so many upcoming startups to have their Business Model

                                                                                        19
based on this technology. Knowing that the opportunities for this technology are beyond

imagination, one that can’t be disregarded is the potential disruptive power to eliminate

third parties - intermediaries or platforms, as AirB&B and UBER.

   Ethereum youth is followed by the typical high volatility and low maturity. And this

volatility represents one of the most representative risks in any investment on the

company. Being an independent platform, accountability and liability are important

subjects that must be accounted for. Will the core developers be accountable for any

issue? And if yes, who are they? If not, who will be accountable for any cyber breach?

   New entrants are always a threat. Knowing that there are high technological releases

every six months, potential new entrants are expected in the near future, mainly due to

the high number of start-ups developing this technology.

   In common with Bitcoin, Ethereum faces the fact that new regulatory principles need

to be integrated in order to make blockchain technologies an integral part of the market

infrastructure. Also, as an independent platform, Ethereum is a threat to central

governments and banks, as an answer to these threats, Governments are developing their

own blockchain platforms. Besides, the risk of more governments taxing Ethes or

consider it as an asset, as Australia does it already, is high.

   Concerning cybersecurity, the operational risk needs to be minimized. This move will

require a quick recovery of participants to revert to the traditional ecosystem as a fall

back.

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