Key takeaways from Goldman Sachs' 58 page report on investing in digital assets.
Turning a 2 hour read into a 3 minute tidbit.
(Full report here)
Context:
Now we have >2000 cryptocurrencies, with a market cap of $1.6T. For context, market cap of global equities is $110T, S&P500 stocks is $35T, US treasuries is $22T
Market broadened from a few cryptocurrencies to now include stablecoins, utility tokens, NFTs, CBDCs (which most central banks are researching)
Currently over 400 crypto exchanges
MNCs are leveraging blockchain technologies. Walmart use to track food products to maintain safety standards, LVMH uses to combat counterfeits.
Section 1: Understanding the digital asset ecosystem: Bitcoin, blockchain and web 3.0
Objectives of Bitcoin laid out by Satoshi. (1) Avoid currencies of any one government, (2) on decentralised network, (3) transparent transactions while actual identities are hidden, (4) immutable transactions, (5) accessible to anyone where no entity can withhold permission
Summary of how it works: (1) Proposed transaction are broadcasted to the global nodes (2) Nodes accept/reject validity of all transactions in that block, prioritised by the fees paid by the user (3) Nodes use computing power to solve maths puzzle which generates a unique hash. The node that solves the puzzle first will broadcast its validation to other nodes. (4) If the nodes confirms the validity of the block, it is added to the "chain" of prior blocks
Has bitcoin fulfilled its purpose? (1) To being a P2P payments system? Speed to process transaction is too slow, 10 payments/s, compared to Visa which does 65,000/s. Price is too volatile as a medium of exchange, for people to spend or receive salary in. (2) Used as a unit of measurement? Can't quote the price of oil in crypto since it keeps changing, ranging from 43% to 178%. (3) As a long term store of value or an investable asset class for diversification? No inherent value.
Bitcoin blockchain supports only very simple transaction instructions, while Ethereum provides extensive functionality to build smart contracts. "Turing complete" - which allows the blockchain to run programs that operate like a computer
Algorand seeks to process 46,000 transactions/s later this year, Ethereum 2.0 expected to reach 10,000 transactions/s. Algorand supports Python, Java, Javascript and Go, while Ethereum mainly supports Solidarity. Average cost of a transaction on Algorand is 1/20 of a penny, while Ethereum is about $20.
More companies using private/permissioned blockchain.
Our transition to web 3.0:
Comparisons between private vs public payments
Section 2: The role of digital assets in client's portfolio
2 types of digital assets have currency-like characteristics:
First are digital coins: (1) cryptocurrencies (2) stablecoins - either through public blockchains like ethereum, or permission ledgers like JPM coin (3) CBDCs - represent fiat currency of that country's central bank, permissioned. Eg. Bahamas, Cambodia, China & Sweden have launched pilot projects
Second are digital tokens: grant whole/partial/potential ownership fo another asset. (1) Utility tokens - can be exchanged for some goods & services within a network egg. BAT on Brave browser (2) Security tokens - ownership in real estate or businesses, qualities as an "investment contract", thus considered a security. eg. Aspen Digital Token (3) Governance tokens: right to vote on policies within decentralised platforms eg. Use MKR to vote on MakerDAO (4) NFTs - unique rights to tangible or digital intellectual property . eg. NBA TopShot
Determining if Cryptocurrencies (specifically BTC) is a strategic asset class:
Needs 3 of 5 criteria. (1) generate steady/reliable cash flow eg. bonds (2) generate earnings through economic growth eg. equities (3) consistent & reliable diversification benefits to a portfolio (4) dampen volatility (5) consistent & reliable evidence of hedging against inflation or deflation as a store of value
Currently still lack extensive & accurate cryptocurrency data. First bitcoin mined in 2009, first ether mined in 2015, first ADA & BNB launched in 2017. In addition, studies by SEC and academias have revealed that high amounts of trading volume are faked. The percentage ranges between 19% up to 95%.
Based on their asset allocation model, to strategically allocate 1% of a portfolio to Bitcoin, bitcoin has to offer an expected return go 165% per annum. Since 2014, Bitcoin has provided an annualised return of 69% - far from levels required to justify an allocation.
Section 3: Risk to the digital asset ecosystem
5 most significant risks:
1. Regulatory risk: governments banning trading or mining of cryptocurrencies, and regulating cryptocurrencies as securities.
China banned ICOs in 2017, banned access to domestic & foreign crypto exchanges in 2019. In May 2021, banned financial institutions providing services related to crypto.
Inner Mongolia, which accounts for 8% of global mining, banned new mining projects and shut down existing ones. Warned telecommunication & internet companies that they might revoke their licenses if they were invovled in mining.
India in early 2021 proposed a bill to create an Indian CBDC, and ban private cryptocurrencies
USA: Ripple's case with SEC about unlawfully covering up financial losses. But Ripple disclosed that only 8% of reserves are in cash, T.Bills.
2. ESG concerns: related to energy consumption and usage in ransomware & cyberattacks
Mining energy consumption is in line with Pakistan or Netherlands. In context, energy to confirm 1 bitcoin transaction can power over 1 million Visa transactions.
3. Rapid innovation that could displace any major players in the ecosystem. Eg. Quantum computing might be able to derive a user's private keys
4. Eroded confidence due to cyberattack or major programming errors
5. Credit crises
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