This is the first in a series of posts identifying the sources of value in cryptocurrencies
Image: Nikita Andreev
Shell: 100000+ yrs Gold wearable: 3800 Gold & silver coin: 2400 Paper IOUs for gold & silver: 250 Pure fiat: 47 Cryptocurrency: avail. now- Nick Szabo
The recent trend in coin offerings, including Tezos’ massive raise, has put a spotlight on cryptocurrencies. The valuation of the world’s leading crypto currency, Bitcoin exceeded US$ 100 billion recently. Are cryptocurrencies overvalued and due for a correction? Perhaps.
In this series (1/3), I will attempt to identify sources of demand of cryptocurrencies and to develop a framework for looking at their value. The source of demand for cryptocurrencies is derived from their attributes as a ‘medium of exchange’ and that as a ‘store of value’. They are not yet useful as a unit of account but that could change.
In this post, I will look at the value of cryptocurrencies as a medium of exchange, particularly, as an enabler of the internet of money and the implications of this on their value.
The rise of the ‘internet of money’
The most fundamental use-case of cryptocurrencies is the role they are beginning to play as a medium of exchange on the internet.
a. Peer to peer payments (VOIP:Talk :: Cryptocurrencies:Payments)
Cryptocurrencies are creating opportunities for a massive scale-up in peer-to-peer payments. Firstly, they can reduce the cost of transactions. They can do this by removing intermediaries and developing a lower-cost consensus system to validate transactions. This is opposed to the centralized ‘trusted’ payment infrastructure which has always been necessary for transferring value. This layered interaction involving multiple intermediaries adds costs to the transfer of value.
Source: Balaji Srinivasan/a16z
Secondly, they can remove friction from transactions — creating opportunities for seam-less transfer of value across peers. Come to think of it, the original Paypal innovation of being able to email money was at its heart about making payments frictionless (and secure).
In fact, the first ‘killer app’ for the mainstreaming of cryptocurrencies has already been international money transfers. It came to play in China when imposition of capital controls forced users to be creative and utilize crypto mediums to move money across borders.
Dejavu Napster? — the use of bitcoin to move money
Valuing Crypto’s value as a medium of exchange
Given the above context, we can now try to put a number on the total value of cryptocurrency coming from its attribute as a medium of exchange on the internet. For this purpose, let’s look at the global money transfer volume and try to see where cryptocurrencies can come in to capture value. We see that just cross-border remittances were close to US$ 600 billion globally in 2014.
Even if we assume no growth in the global remittances market and look at a fifth of global remittances being processed by a large cryptocurrency network in steady state, US$ 120 billion of value would be transmitted by the network on an annual basis. Today, the commission charged by the lowest priced intermediary is about 1%. If the cryptocurrency network is able to pocket even 0.1%-0.2%, the annual commission captured by the network would be US$ 120–240 million annually. This is just the global remittances market.
Now, let’s look at the volume of global digital payments. According to Euromonitor, the total card transactions expected in 2017 are likely to exceed US$ 30 trillion. Even if 10% of these transactions can be processed on one crypto network, that would mean US$ 3 trillion of value transfer. Again, assuming 0.1%-0.2% of commission on this volume, this could easily mean US$ 3–6 billion of commission for the largest crypto-network annually.
Source: Euromonitor
Therefore, just looking at 20% of global remittance volume and 10% of global card transaction volume in 2017, a single cryptocurrency can reach ~ US$ 3–6 billion in commissions. Even if one believes that the cash-flow associated with this crypto-network needs to be subject to a very high discount rate (~25%) and a growth of 15%, one can arrive at a network valuation of US$ 45 billion just for a single use-case (assuming US$ 4.5 billion commission). No wonder that there is excitement about cryptocurrencies. Below, a chart by Chris Burniske, an expert in crypto-valuations, looks at the correlation between transactions on the Ethereum network and the corresponding network value. Very logically, there is a strong alignment in the growth of transactions and value.
Source: Chris Burniske
Specialized crypto-currencies like zCash similarly might focus on money transfers for specific user groups or specific use cases and capture a portion of the value.
b. The evolving monetization model of the internet or the Machine Payable Web:
Cryptocurrencies as a remittance rail was the first “killer app”. However, in a recent talk, Balaji S. Srinivasan describes how the nature of monetization in the web is evolving. Today, the dominant monetization business model in the current consumer web is advertising. 88% of Google’s revenue and 97% of facebook’s revenue in 2016 came from advertising sales. Many of their APIs are public and monetization happens by exposing users (humans) to ads.
However, the ad-based monetization model is not suited for application programming interfaces (APIs). APIs can’t be compensated for “viewing ads”. Additionally, the current model disincentivizes commerce by adding friction (think of the onboarding and sign-up process) to(API) interactions. Cryptocurrencies have the potential to streamline commerce between APIs or indeed any agents. In a machine payable web, cryptocurrencies replace ads (or human attention) as the dominant currency of the web and allow API-to-API or indeed machine-to-machine transactions without human intervention based on contracts at a low cost.
What’s the volume of transactions which will happen due to API-to-API or machine-to-machine transactions? Estimating a defensible number requires another post but it will certainly involve many billions of transactions.
Structurally, the architecture of such a dominant crypto-network in the space might be split with lower ticket-size transactions facilitated through a less computationally intensive process to ensure that even very small ticket transactions are encouraged.
c. The Uberization of connected computational and storage assets
The third use-case for cryptocurrencies as a medium of exchange is that which comes from monetization of computational and storage assets.
While ‘uberization’ of assets is not a new phenomenon anymore, it is largely unexplored in the world of personal and even professional computing. Our computational and storage resources are quite underutilized. Currencies based on cryptographic proof offer a fascinating opportunity for unlocking under-utilized resources to work and earn an income out of it. This works on the ‘supply side’ and keeps a check on price by encouraging more and more users to jump on the supply side to provide mining and/or transaction processing. In the long run, one would expect that mining would be provided by a mix of super-specialized nodes and under-utilized assets. This helps build the supply side case for cryptocurrencies.
A typical PC is using only a fraction of its computational resources while active
Think of connected assets and specialized mining as roof-top solar and utility scale solar respectively. Utility scale solar is efficient and profitable on an ROI basis and continues to scale but roof-top solar is attractive for many users. The significance of this can’t be understated. We may be on the verge of a solar-type revolution in computing. As cryptocurrencies become more mainstream, many more truly decentralized computational and storage resources are likely to come online and compete with conventional cloud services.
Hash rate of the Bitcoin network (source: blockchain.info)
Given the excitement about bitcoins, it is not surprising that the hashrate (a measure of computational power in terms of calculations per second) of all cryptocurrency miners already exceeds the equivalent computational power of internet giants like Google. According to Bitcoinist, as of Jan ’17, the total computational capacity of the bitcoin network was over 43 thousand times than every supercomputer on the TOP500 list combined.
Hence, we see that the use case for demand for cryptocurrencies as a medium of exchange itself is quite high and arguably explains why people are betting that individual cryptocurrencies could be worth as much as US$ 100 billion.
Does that mean that the current values of all cryptocurrencies are justified? Not really. Instead, my point is to argue that the winners of the cryptocurrency play— the first currency (or currencies) to actually find product-market fit in some of the use-cases I mentioned (and others which I will cover in subsequent posts) would be big enough to be worth a lot. Maybe even GAFA big!
This post was on cryptocurrencies as mediums of exchange. I will cover cryptocurrencies as foundations of decentralized applications and contracts in the next post. Thanks to Edward Russell and Shaina Trotta for reviewing the manuscript of this post.
References
1. https://github.com/ethereum/wiki/wiki/White-Paper
2. https://bitcoin.org/bitcoin.pdf
3. https://stratechery.com/2017/tulips-myths-and-cryptocurrencies/
4. http://offers.worldpayglobal.com/rs/850-JOA-856/images/GlobalPaymentsReportNov2015.pdf
5. https://medium.com/@cburniske/cryptoasset-valuations-ac83479ffca7