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Monday, January 29, 2018

Bitcoin and Cryptocurrencies: Fundamental Analysis

After the 2008’s Great Recession the world was avid for new solutions and alternatives to face the economic crisis. Since then we have seen how Central Banks applied non-traditional policies and send interest rates into historic lows.

At the same time, we have seen how technology has evolved at an unstoppable pace. Terms such as social media, investing algorithms, quantitative finance or even artificial intelligence are more common every day.

While the world was worried about the causes and consequences of the economic crisis, looking for answers and solutions to it, few people saw that the economy was changing. In fact, in 2008 the first patent for a digital currency was registered by Satoshi Nakamoto, under the name of Bitcoin.

Ten years later, Bitcoin has reached a price above the $10,000, and leads the raging new world of cryptocurrencies. Now we are getting used to terms like miners, Blockchain or forks. Yet most developed countries still show certain reluctance to this kind of asset, asserting that the lack of regulations could cause economic instability and attract illicit activities to it.

In this paper we try to explain the economic behavior that underlies, and boost, the digital currency industry, adding some explanations on how they work. We study what could be the main causes behind the rise of cryptocurrencies and how countries have been dealing with them.

Also we studied the main differences between fiat money and digital currency, focusing on the crypto’s supply and the global demand for it. We don’t ignore the influence that countries like China and Venezuela have in the crypto market.

Finally, we offer some views on how the future of digital currencies should look.  

Starting point

Before we start our analysis, we should remark two concepts:

1- What is money?
Money is defined as a medium of exchange, which must follow three attributes: store of value, unit of account and widely accepted as a method of payment. In other words, you might expect that the value will be hold tomorrow, and that can be used almost everywhere.

2- What is a Reserve asset?
Basically are external assets that are readily available. Investopedia (2017) define it as an external physical asset that is, in some part, controlled by policymakers. The asset should be easily transferable. For example: gold, dollars, SDRs.[1] 

Consequently, we must ask ourselves what is a Cryptocurrency.

A cryptocurrency is a digital medium of exchange, that works through a decentralized network around the world known as Blockchain. Bitcoin represents approximately 65% of total crypto’s capitalization which is almost 280 billions of dollars but, is not yet accepted around the world as a payment method. Also, its extraordinary price increment established a new paradigm as ‘digital gold’, which creates a dualism in order to define this new kind of asset.

Regarding to its value, as every asset the interaction between a limited supply and increasing demand is the friendliest explanation of bitcoin’s value. Nevertheless, price dynamics indicates a perception that the value in ‘t’ is the expectative of a higher value in t+1 which drives up price considerably. Also, and we have to use the word ‘expectative’ again, behind every crypto there is a technology which has an incredible potential to change our lives.

When Bitcoin became mainstream?

The history begins in 2008, it is said that was created by Satoshi Nakamoto. Its popularity started growing astronomically in the last 12 months. To illustrate this, let's make a comparison, ‘Kardashians’ searches in Google have been overlapping Bitcoin in a 5 years’ framework, reaching a peak in November 2014, when a magazine showed a peculiar picture of Kim. However, Bitcoin popularity in 2017 showed that a digital asset could be in the mind of millions around the world.

Source: Google trends, 2017.

On the other hand, Bitcoin has been alone in the top, while others important cryptocurrencies in terms of market capitalization as Ethereum and Litecoin remain far from the big contender in google searches.

June 2017 was almost the exception through the whole year, Ethereum overtook 30% of total market capitalization, which corresponded to the slight increment in google searches (red line).

Source: coinmarketcap, 2017

On December 16, Bitcoin reached its peak of 19.666 USD/BTC which translates into approximately 326 billion dollars on market capitalization. Just to draw a picture it is more than the technological giant Intel or Norway nominal GDP in 2016.

Source: bitcoinity, 2017

Bitcoin price major moves:

·      August 2008: Bitcoin creation $0
·      February 2011: $1
·      July 2011: reached first “bubble” top $30
·      December 2011: minimum after few months $2
·      April 2013: rally $266
·      June 2013: drop $100
·      November 2013: rally $1242
·      April 2014: Cypriot financial crisis $340
·      June 2015: beginning of China stock market instability $222
·      January 2016: Chinese stock market experienced a sharp sell-off of about 7% that quickly sent stocks tumbling globally. $464
·      November 2016: Chinese Renminbi depreciated against US Dollar, Bitcoin trading volume surpassed 100 million BTC $780
·      January 2017: rally $1150
·      May 2017: rally $2000
·      August 2017: rally $4400
·      September 2017: China's bitcoin ICO and exchange crackdown $2900
·      November 2017: CoinDesk said that the surge in BTC could have been related to Zimbabwean coup d'état. $8100
·      December 17, 2017: CME Group launched futures contract. $19666
·      December 22, 2017: The media said that “It looks like it's time to cash in the gains and spend the winnings on a bumper Christmas.” 50% drop in one night. $10400
·      December 31, 2017: price surges and keep steady. End of a year with a yield above 1000%. $14000
·      January 17, 2018: price declines after South Korea and China rumors. $10733

Behavior analysis:

A diffuse concept could become a powerful idea, because nobody can define in a proper and universally accepted way, which means that we assume our understanding regarding a specific phenomenon.
George Soros a well-known investor, which in fact has a horrendous reputation on media, proposed the idea of ‘Reflexivity’. It explains the moment when individuals try to understand situations creating an image that correspond to reality, in more ‘sophisticated’ terms a cognitive function interacts with a participative function, which models reality in relation to expectations. Consequently, through the participative function individuals could influence the situation, which they suppose is an independent variable from the cognitive function.
Just to keep in mind through the paper, the understanding of individuals is not objective. Thus, a gap between expectations and reality could be created. We can be wrong and that is part of our nature and limits.

Herding effect.

John Maynard Keynes once said that:
Is characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over may days to come, can only be taken as a result of animal spirits, of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. (Keynes, 1936, p. 161)
In fact, Behavioral economists such as Richard Thaler, who won the Nobel prize in 2017, have brought to the table how important it is to understand human interactions not based in classical assumptions like rationality.

In speculative markets, herding or crowd effect has been documented as a result of investors interactions, based on the idea that we can emulate behaviors commonly seen in animals. This irrational behavior explains that an individual takes a decision based on the observations of others, which subsequently have based their decision in other’s. Thus, this effect implies a massive bias on public media regarding a subject, because there is less information about it that gives a strong incentive to follow the consensus.

Sornette (2017) expresses that research on herding behavior can be subdivided in the following non-mutually exclusive manner:

1- Informational cascades: occurs when individuals ignore information and start mimicking the actions of individuals who acted previously. The total amount of information is so overwhelming that an individual's piece of private information is not strong or relevant to reverse the decision of the crowd.

2- Reputational herding:  individuals ignores private information and instead mimic the market leader, which has a reputation and strives to protect his current status and level of income.

3- Investigative herding: occurs when an analyst chooses to investigate a piece of information that they believe other also will examine (perhaps just as our essay!). Also, they can profit from an investment if other investors follow suit and push the price of the asset in the direction anticipated by the first analyst.

4- Empirical herding: it occurs when investors buy or sell following the same pattern that they did in the past.

Ivo Welch in 2000 provided empirical results to prove herd behavior in recommendations of security analysts. He used the Zacks database, which is a commercially compiled database of analysts’ recommendations from 1989 to 1994 with 226 brokers and 302,458 recommendations. Also, delimited analysts’ decision as: strong buy, buy, hold, sell, strong sell.

His study found that:

1- An analyst recommendation revision has positive influence on the next two analysts’ revisions.
2-  Also, the influence of these most recent revisions can be traced to short-lived information, that means influence is stronger when stock returns are accurately predicted by the revision and when the most recent version has occurred more recently.
3- The prevailing consensus has a positive influence on the recommendation revisions of the analyst.
4- The influence of the prevailing consensus is not stronger when it is a good predictor of subsequent stock returns. Analysts’ consensus herding is not the result of rational and efficient information aggregation.
5- The influence of the prevailing consensus is stronger when recent market conditions have been bullish. Welch found that the total number of recommendations (of any direction) starting from a previous “strong buy” is 14,682, compared to only 1,584 recommendations starting from a previous “strong sell”.

Thaler & Sunstein (2008) studied many examples of this behavior, just to take few of them from others fields:
·      Teenage girls who see that other teenagers are pregnant are more likely to become pregnant themselves.
·      If your best friend is fat your risk gaining weight goes up.
·      The academic effort of college students is influenced by their peers.
·      In the American judicial system, federal judges on three-judge panels are affected by the votes of their colleagues.

Herding effect is just one kind of behavior that individuals may follow during a determined period of time. Bitcoin and cryptocurrencies have been showing a conduct that can emulate this principle, but, it is not a complete answer for the value and popularity of these new assets. However, recognizing a pattern is an important step in order to understand a phenomenon.

Back to Keynes, he remarked that in a beauty contest:
It is not a case of choosing those that to the best of one's judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. (Keynes, 1936, p. 156)
Thus, the ability to recognize objective beauty is not important at all, but is vital to recognize how other try to understand it. 

Is Bitcoin a Bubble? Can you feel a great disturbance in the Force?

Nowadays, “bubble” is one of the most commons things that you can see and hear everywhere. Let’s introduce ‘The Boom-Bust Model’ that George Soros elaborated to understand bubbles process:

He describes an initial stage when the trend is not recognized, then comes the period of acceleration. Second, the trend is recognized and reinforced by the prevailing bias, in that moment the process approaches far-from-equilibrium territory. A period of testing may intervene when prices suffer a setback. If the bias and trend fail to survive the testing, no bubble ensues. Eventually there comes a moment of truth, when reality can no longer sustain the exaggerated expectations, followed by a twilight period when people continue to play the game although they no longer believe in it. Eventually a crossover or tipping point is reached, the trend turns down and the bias is reversed, which leads to a catastrophic downward acceleration, commonly known as the crash.

Bitcoin has suffered many drawbacks, so it makes really difficult to recognize in which stage we are. First, we can feel the bias, short term investment, big money, the herding effect aforementioned has taken place which means that yes, we are just in front of a speculative bubble, which isn't bad. Second, some people would consider the abrupt fall of Bitcoin from $19,666 peak on 17th (Dec) to $10,775 a crash, but it appears that we are in a testing zone, price rebound above $16,000, then slipping to $14,000. The best part of the movie is coming, and as Star Wars fans we might wait until 2019.

Risk, uncertainty, a lifetime opportunity, is this time different?

It is not a secret that Bitcoin is the prettiest of the beauty contest of all cryptos. Just this year price increased approximately 2036%. However, we should remember that reward and risk have a positive correlation, if we expect a higher reward, higher risk must be taken.
In words of Frank Knight:

It is a world of change in which we live, and a world of uncertainty. We live only by knowing something about the future; while the problems of life, or of conduct at least, arise from the fact that we know so little… If we are to understand the workings of the economic system, we must examine the meaning and significance of uncertainty; and to this end some inquiry into the nature and function of knowledge itself is necessary. (Knight, 1921, p. 199)
We should keep in mind two concepts:

- Risk: it’s a measure, the possibility that a particular event could yield a known outcome.
-Uncertainty: implies a situation where the future events are not known. Thus, cannot be measured.

“There is a fundamental distinction between the reward for taking a known risk and that for assuming a risk whose value itself is not known,” Knight wrote. A known risk is “easily converted into an effective certainty,” while “true uncertainty,” as Knight called it, is “not susceptible to measurement”. (Knight, 1921, p.44)

Also, we do not perceive the present as it is and in its totality, nor do we infer the future from the present with any high degree of dependability, nor yet do we accurately know the consequences of our actions.

Cryptocurrencies have shown to us as a lifetime opportunity, something completely new that we must follow, we must take a part of this new world, a new era. Thus, many investors could have a bias that blind their horizons in relation to risk and understanding uncertainty.
Just to create a picture, Thaler (2008) created a short experiment in order to understand how we face risk. Initially,

Note: Supposing you are a fifty-year-old resident of the United States you will face a roughly 4-in-1000.

1- You will be exposed to a fatal disease, the chance to get it is 1 in 1000, there is only one antidote, what is the most you would be willing to pay for this antidote?
2- Researches needs volunteers, you will be exposed to a fatal disease, the chance get it is 1 in 1000. What is the least amount of money you would demand to participate in the research?

In the first version a typical answer was 2000. On the contrary, in the second case people ask for no less than 500,000. Just to remember, the chance to die in the first case is 4 in 1000 and in the second case is 5 in 1000.

How much are we willing to lose to earn an annual yield of 2000% rather than a ETF with annual year of 12% approximately? Selling your house and buying a ETF or government bonds does not sound attractive as buying the “new gold”.

But, according to Vishnu Varathan, the head of Economics & Strategy at Mizuho bank, Bitcoin is so volatile that an average bitcoin investor will have done less well than someone who put the same money into stocks in the post-Trump period. Using the Sharp Ratio concept, he calculated the returns adjusted for volatility described in the following graphic.

Source: Vishnu Varathan. Head, Economics & Strategy

In words of Varathan:
Admittedly, “bigger picture” investors argue (rather eloquently) that the value of Bitcoin is in its potential as the ubiquitous global currency set to supplant fiat currencies. And current volatility is merely “noise”; a minor speed bump for the Bitcoins locomotive. (Varathan, 2017)
While Bitcoin may be superior medium of exchange and unit of account (if volatility is reined in), it is not free of the deficiency of fiat currencies in terms of having no intrinsic value other than being “money”; unlike Gold or other commodities. Hence, like all other fiat currencies, its store of value must be derived from guarantee of exchange for Gold (or some other asset) from a central authority; which it now lacks.
Ironically then, the selling point of Bitcoin - being run by algorithms not subordinated to, or manipulated by, potentially corrupt authorities – is a double-edged sword that denies Bitcoin an identifiable guarantor that could substitute for intrinsic value.

Would you like to pay more for the antidote?

We have tried to construct many concepts in order to understand how difficult is to analyze something unique as Bitcoin. We must clarify that without no doubt cryptocurrencies will have an impact in our society and that many of them will become more valuable over the time and market selection mechanism will destroy those useless an obsoletes and reward the most efficient and useful one.
A lifetime opportunity implies risk, and it is impossible to go further with complete certainty about the future outcome. If our understanding as investor is biased, our results will influence future decision driving us into a false spectrum of understanding. It is possible that you, our reader could have made a lot of money buying cryptos, if is that the case, you should invest your new wealth in knowledge.

Creator nature and his creation:

Bitcoin has a creator and many people around it that made it possible. Every creation serves to his own master, as many people do in the pursuit of God whatever religions it is. Even if we suppose that Bitcoin’s creators have wonderful ideals and good intentions regarding to the future of our economy, perhaps that in fact could influence in a certain way the underlying asset.

If you were the mastermind behind this, you would try to maximize the profit due the fact that you would have spent time and money to bring to life your creation. At least, it works as a supposition, but how dangerous to us could that be if we do not know exactly who those invisible guys are?

The market capitalization has been growing faster, which could reject the hypothesis of deliberate manipulation that has spread on the media. Nevertheless, as a creator maintaining a considerable share of your creations it is not unreasonable, in fact, selling small fractions and using that money to finance huge campaigns that could increase popularity and thus it demands.

Bitcoin and so many cryptocurrencies have a limited offer, which means that its own nature is influenced by the scarcity principle. Less offer over the time, more valuable it would be.

Supply analysis:

The supply for most of cryptocurrencies does not behave the same way as for “standard” currencies, of course is if one can consider virtual currencies as such.
It is possible to illustrate considerable differences between money supply for usual currencies and crypto coins.

For example, fiat currencies are physical objects, at least a considerable part of it. Even though, money has a fiduciary behavior since the seventies, which implies that isn’t backed on any other asset except trust. On the other hand, crypto coins are virtual, one cannot have a wallet full of Ethereum or write a check on Bitcoins. That may seem as an obvious difference with no relevance. However, it has a strong impact on individuals’ economic decisions. It’s easier to trust in something physical, backed and regulated by formal institutions than in a virtual world, at least for modern society.

Also, there is a more relevant difference between both kinds of currencies, money supply. Standard money has an unlimited money supply; in a theoretical way any Central Bank can issue an infinite amount of money. In fact, most currencies have a positive growth rate on long horizons. However, relevant cryptocurrencies have a limited “money” supply. Virtual currencies such as Bitcoin, Litecoin and Dash hold the mentioned condition. Moreover, Bitcoin will reach its limit on the next century, nevertheless most of its supply will be available before the first half of the current century. This is a point that should not be ignored, especially because it provides Bitcoin –or any other e-coin with limited supply– the attribute of a precious metal. Applying the principle of scarcity, Bitcoin behaves as gold or silver will behave on the long term.

There is another considerable difference among virtual and standard money, which is the acceptance as a valid, and massive, method of payment. Although most currencies aren’t accepted worldwide, there is a handful that can be considered global currencies (US dollar, Yen, Euro and Sterling pound among few others), but almost every country in the world has its own currency, perceived as a valid method of payment by their own society. This is a crucial point that virtual currencies fail to achieve, at least for the moment. This is not an insignificant barrier for e-coins, fundamentally because one of the main conditions that any asset must fulfill to be considered money, is that it can be used as a method of payment and exchange.

At last, e-coins, but more precisely Bitcoin, aren’t regulated. While any standard currency its publicly issued by a formal institution, with known government or monetary officials, virtual coins are backed on a complicated element such as the Blockchain.
These aspects make the e-coins an asset that could be considered similar to money, but not quite as such. At least not yet. However, this has not proven to be a problem for many people around the world who are looking for an attractive asset to invest. Especially in socialist countries like China or Venezuela.

Now, the cases of China and Venezuela are both contradictory and curious. It is well known that both countries are main catalyzers of the Bitcoin boom. While China abandoned traditional communism in the mid-seventies, Venezuela has been embracing the idea of a planned economy since the beginning of the twenty first century. But, even considering the progress of the Chinese economy since they welcomed a pseudo free market policy, there are still some barriers imposed by the government. On the other side is Venezuela, who has been imposing innumerable government regulations on the economy, such as price controls or foreign exchange controls. Both countries share the last characteristic on their economies, however they have a complete different performance.

While China abandoned a fixed rate pledged to the American dollar on 2005, Venezuela has tightened their exchange policy in the last decade. Since 2005, Chinese Yuan (CNY) has been reducing its gap with the dollar, reduction based on a managed float rate controlled by The People’s Bank of China. This dynamic found a hiatus, between 2014 and 2016, when the CNY depreciated 15% and helped the current account balance surpass a 2% of China’s GDP. A GDP that has shown an average of around 9% increase per year since 2000.

However, not everything in the Chinese economy is ideal. The GDP has been slowing its pace for the last seven years, the Shanghai Stock Exchange (SSE) lost around 2,500 points in 2015 –50% of its value– and remained in a stagnant growth since then and on top of that the SSE still shows some reluctance to welcome free market while keeping strong barriers to foreign investors.

In the middle of the conditions just explained the Bitcoin makes its appearance, offering an alternative for Chinese citizens to avoid government regulations. Chinese Bitcoin –among other cryptocurrencies– exchanges reached an 90% of the worldwide trading volume of Bitcoin, raising concerns on public authorities.

The answer from the Chinese government came in September, in a form of tighter regulations, shutting down public exchanges. Government officials explain this measure as a way to isolate CNY from the volatility of the cryptocurrencies market and protect the economy from a potential capital flight.

Nevertheless, Chinese government is struggling to eradicate initial coin offerings (ICO) and Bitcoin trading, while people use private over-the-counter market methods to avoid regulations. Even though market volume of Chinese exchanges has been dropping the past year, to stabilize around a 9% of the world trading volume, the feared fall on the Bitcoin price due to the government actions is still on hold. Also the proximity with countries like Mongolia offers an attractive opportunity to Chinese miners, who face a relative low cost of electricity on these countries.

The relative low cost of electricity is a quality that Chinese miners share with Venezuela. By the end of 2016, the cost of a Kwh (that is a kilowatt per hour) was roughly $0,2 cents. On the same period, according to official data recently published by the SEC (Securities and Exchange Commission), inflation rose up to 274%, with a contraction of 16.5% in the GDP. These factors added to the political, and social, turmoil, the scarcity of food and basic services and the continue depreciation of the Bolívar Fuerte (VEF) –VEF has lost more than 90% of its value in 2017– have drawn the attention of thousands of Venezuelans, who are looking for alternatives to protect their wealth from the economic crisis Alternatives that includes turning into cryptos, especially Bitcoin.

The volume of Bitcoin trading has been rising abruptly in the last year. According to Coin Dance, the average trading volume showed an increase of 140% since 2016.

Source: Coin Dance

The “cryptomania” has become so popular, that even the socialist government announced the creation of an asset like-crypto called Petro. This asset, allegedly, will be backed in oil reserves and it will be similar to a sovereign bond. Although this was announced as an ICO, it has slowly become just a government strategy to avoid sanctions and find funds. It is important to remember that Venezuela hasn’t paid their obligations issued in bonds, due to the last quarter of the 2017, and currently has a ban to renegotiate the terms of the debt or issue new debt.

The limited options have encouraged the Venezuelan government to look for alternative ways to find liquidity.

Chinese attempts to elude government regulations and Venezuelan efforts to avoid the terrible effects of hyperinflation have become two main boosters of Bitcoin growth in the past year.     
Another factor to consider in the cryptos revolution is confidence. Since the Great Recession in 2008, economic confidence, in the main top markets in the world, have been in doubt.

We have been witnesses of the so called non-traditional monetary tools, such as Quantitative Easing (QE) and Forward Guidance. The first one, used for the first time in Japan in 2001, its focused on long term debt assets purchases and its main objective is to lower the long term interest rates. The second one, is a tool that central banks used to influence expectations on monetary variables. With Japan, United Kingdom, The United States, The European Union and Sweden have embraced this non-traditional tools, lowering in most cases theirs interest rates to historical lows.

The Federal Reserve (FED) ended in 2014 a $4.5 trillion in purchases of Treasuries and mortgage backed securities. This massive stimulus sends the federal funds rate from around 5% to nearly 0% -an average of 0.13% through the duration of the program- while the 10-Year maturity rate went from around 4% in 2008 to 2.17% at the end of 2014.
In the UK, the Bank of England (BoE) continues under a monetary stimulus, since 2009 the total amount of government and corporate bonds purchases has reached £450 billion. The British short term interest rates went down to around 0.50% in 2017, although this hasn’t been a steady downtrend on the UK’s interest rates, mostly because the BoE has been struggling with the inflation targeting policy, specifically on 2010 and after the depreciation of the sterling pound caused by the “Brexit”. The 10-Year government bond rate showed a similar path.

Thanks to the quantitative easing world macroeconomics have witnessed an interesting phenomenon, presented in the way of nominal interest rates below zero. This extreme version of the liquidity trap made its appearance on countries under a QE program, such as Japan, Sweden or the EU. In fact, only the US have officially ended their QE program.

 Source: Eurostat
The effects of the monetary stimulus are still in discussion. In most cases prices still show strong resistance to the increase in the money supply. Since 2012 inflation have been rarely above 2% in any of the countries under the monetary stimulus, even showing some periods with negative inflation, although prices are on an ascending trend since 2015. In Japan’s case inflation struggles to stay above the zero line.

             Source: Eurostat

            Source: IMF
Growth under quantitative easing moves around 2% in most countries, except for Japan. While unemployment, with the exception of the United States and Japan, behaves like an inelastic process showing values still distant to those showed before the crisis.
Factors such as the discrete economic growth, historic low interest rates and the sensibility of the exchange rates to the QE announcements could have a deep influence under people’s economic choices.

It is not casual that after the global financial, and economic, crisis and after the application of QE programs many stock indexes showed an upward trend while real economy was on a slow recovery track.

Assets like gold have showed an increase in 100% since the crisis. Dow Jones index has gained more than 10,000 points since the great recession. A similar path has been followed by the Euro Stoxx 50, FTSE and Nikkei.

Under this circumstances, and the Chinese stock bubble popping, the Bitcoin –and the Cryptos– made their appearance. The Bitcoin started it unstoppable upward trend after mid-2015, behaving as a reserve asset for those looking an attractive option to keep their money safe.

ICO’s world

Crypto investors have set their attention to an unregulated market which could be incredible profitable.
Investopedia defines an ICO as:
An unregulated means by which funds are raised for a new cryptocurrency venture. An Initial Coin Offering (ICO) is used by startups to bypass the rigorous and regulated capital-raising process required by venture capitalists or banks. In an ICO campaign, a percentage of the cryptocurrency is sold to early backers of the project in exchange for legal tender or other cryptocurrencies, but usually for Bitcoin[2].
ICO’s allows to almost everyone to invest money in projects that looks promising. However, one must emphasize that most of those projects only exists on paper -and that is why they are called white papers-. Thus, this implies that people invest for two main reasons, speculation and future development and outcome.
On the other hand, Putincoin, Evilcoin, Mao Zedong  and thousands more “Shitcoins” were nonsense ICO’s that somehow gained popularity and raised a considerable amount of money. This just creates a picture of how strange and dark ICO’s could be, in fact behind a whitepaper any criminal organization can be involved, corruption, money laundry, drugs and friendly guys just as Kim Jong Un.
However, many projects look so promising and many investors have put their money to see them growing in the long term. This market has become popular moving millions of dollars from Bitcoin to these new tokens and new cryptos.

Future of Cryptos: 

The future of Bitcoin, or at least of cryptocurrencies, shows great potential. While 2017 was the year where Bitcoin push the limits of rational economics, it appears to be that e-coins are here to stay.

However, many doubts have aroused around the actual utility, and future, of digital currencies. The gold rush that Bitcoin caused also brought with it high volatility in its price, becoming an extremely risky asset. Another factor against Bitcoin was the lack of instruments available, or legally accepted in developed markets, that allowed to take short positions on the asset. Most brokers only offer a contract for difference (CFD) that allows investors to take short positions in some cryptos. 

The first step into accepting cryptos as a new reality have been taken in the last few months. By the end of 2017, futures of Bitcoin started to trade. The main objective behind this action was to provide investors an instrument that increased the options of taking short positions. Another objective of the creation of Bitcoin futures was to reduce the volatility of the asset. In fact, in the past month Bitcoin price apparently found some sort of stability around $10,000 per BTC.

By contrast, Bitcoin options –and binary options– are still considered an non attractive instrument to investors due to the expensive prices of options. It is important to know that the price of an option is reflected on the premium that investors pays for the right to buy or sell the asset. The value of the premium is taken from the volatility of the asset associated to the option. Considering that Bitcoin, and most cryptos, have an important volatility, the price of its options will be high.

However, the application of new instruments and alternatives to trade Bitcoin, and cryptos, would probable lower the volatility and the cost of investing in options. The approval from the Commodity Futures Trading Commission (CFTC) of Bitcoin’s options trading in the U.S. is another step forward for the stability of cryptos.

Nevertheless, even considering the new variety of instruments for cryptos trading, there is still road ahead for any virtual coin in order to be considered a currency. The case of Bitcoin could be used as an example of this idea. We’ve been seeing progress in the financial instruments available to trade the e-coin, however it cannot be considered an actual currency for its not accepted as a universal method of payment in any country in the world. In the present, Bitcoin is more similar to a precious metal than a currency.

In order for e-coins to be considered as money they, or at least one of them, must be used not only by investors but by monetary and governmental institutions as a store of value and even as an international reserve. Commercial banks must start implementing methods of payments, that includes any given e-coin, and bank accounts denominated in cryptos. It is probable that some governments in the world could start imposing taxes on virtual currencies. 

In the present, cryptos are used as a speculative asset, people often buy a crypto looking for a future profit in dollars, euros, sterling pounds, etc. Another use for cryptos is to avoid some governmental regulations, as mentioned before. However, the potential value of the Blockchain could change this reality.

These elements could help burst the bubble of Bitcoin, in detriment of other e-coins such as Litecoin, Dash, Ethereum or Ripple. But also could bring stability around cryptos. Also, the fact that China played an important role on the rise of Bitcoin, it’s reasonable to think that they could have an influential amount of stock that could affect volatility.    
Another factor that must be brought in the discussion, about the future of cryptos, is the ICOs. As the BTC transforms into a more complex financial instruments, with future contracts, options and even ETF’s, other cryptocurrencies could imitate the recent growth of BTC.

The use of an open Blockchain is a common element among every attractive crypto, however not all cryptos share the supply rules that apply to the BTC. Some are available for miners to extract and sell the coin, but others have a limited and controlled supply. Some e-coins offer extreme privacy around transactions (like Monero), which is a desirable asset specially for illicit businesses.

Nevertheless, ICOs are often been used as a way for Startups to look for crowdfunding. Countries like Japan allow entrepreneurs to finance their enterprises with e-coins offerings. However, China or South Korea recently banned this alternative, arguing that ICOs are an extremely speculative asset that could have negative effects on their domestic markets.
Even though, many governments and institutions still are reluctant about BTC and cryptos, every day they become more important in our society. The elevated value that BTC has achieved shows that either for speculative reasons or the real value the token could have people are becoming more familiar around e-coins. And the fact that BTC reached an elevated price, makes other cryptos an attractive investment due to their relatively low prices against the BTC.

The future of cryptos will be shaped by the interaction between the feasibility and legality with the development of a technology that could improve the relations among economic agents.

The use of e-coins as a way to attract investors –using ICOs– would help startups, and the economic incentives behind innovation. Crypto currencies endow entrepreneurs with a non-traditional tool that could help democratize the conditions new enterprises face in order to find funds.

Finally, the application of the Blockchain simplifies economic interactions, and works as an online blueprint for economic transactions.

There is a long way down the road for cryptos and Bitcoin, as for society. Digital currency will shape under the people’s preferences. What is certain is that a new way to find profit, and the opportunity to be cautious, has arrived.      


The world has changed, we have changed, and there are so many things changing. New inventions come with many questions and just few answers. Bitcoin has awakened a strong force into the financial and economic system, decentralised operations, cost reductions and market freedom.
Bitcoin and cryptocurrencies have showed how profitable, risky and trendy they have become. Public opinion is completely divided between economists, businessman and politicians, some of them claim that is the biggest fraud and bubble in history and others seen it as an one-lifetime opportunity and a total breakthrough in our time.

In this paper we introduced concepts from behavioral economics and finance that could help to explain many characteristics of bitcoin and cryptocurrencies. However, it is necessary extend the analysis with an empirical model.

We have studied factors that could have influenced the exceptional growth of Bitcoin and the cryptocurrencies industry. Countries like China and Venezuela have been strong influencers on Bitcoin’s boom. In the Chinese case, the existence of strong economic regulations and a bearish stock market have put some pressure on the digital currencies market. In Venezuela’s case, the combination of a deep economic crisis and the relatively low cost of electricity and internet makes the Bitcoin mining and trading an extremely profitable business.

We also considered the influence of QE and recent monetary policies over the rise of cryptocurrencies. Historic low interest rates –negative in some countries– and the strong volatility showed in the principal currencies due to announcements in changes in the monetary policies could have work in favor of digital currencies. It appears that many people lost their faith in the banking system and governments, consequently this have raised Bitcoin and cryptocurrencies popularity, representing a new hope.

In relation to the future of cryptocurrencies, ICOs, regulated markets and instruments and massive use put themselves in the main objectives for the industry and regulators.
It is time to be prudent, wise and open mind. We cannot deny change, it is part of life, but also we cannot just assume things in order to understand complex things or situations.  

Fidel Álvarez
Luis Ojeda


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[2] https://www.investopedia.com/terms/i/initial-coin-offering-ico.asp

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