Crypto Biz Models - Market Analysis for Jun 10th, 2019

[From FA Trader.com]

When you’re thinking about Crypto from a fundamental standpoint, it is important to understand the business, development, and economic model behind the coin, which may ultimately affect value of the coin, and risk underlying your assets. I hope one day to write more deep on the subject, but wanted to give an intro to my thinking here. I don’t see any other asset class challenging old notions of economics and business models like crypto.

Note, I don’t want to shill the new crypto economy.  I recall the new internet economy was oversold before the tech wreck of 2000, when I started trading and investing. I don’t want to sound like one exclaiming, ‘this time it is different’ as the sellers of now defunct internet companies said in those days. To the contrary, I believe crypto has the opportunity to transform old business models, invent new ones, enhance hold ones, but likewise leave companies trying to force fit crypto onto old models reeling. And the volatile nature of crypto value behooves involved companies to consider their business model deeply.

We’ve seen many crypto businesses fail during the bear market of 2018, and some business that survive may never flourish.

Decentralized vs. Centralized

Whether a crypto is truly decentralized depends on who controls the coin. This may range from Bitcoin which has no truly controlling party, to EOS which has 21 elected block producers, to the Facebook coin, which appears to be heading toward a truly centralized system beholden to Facebook’s foundation, if rumors prove correct.

Crypto purists may tell you that a centralized coin may be called blockchain but not crypto. While I understand this sentiment, I prefer to be more specific, and I’ll let the market vote with price. That said, what is important to understand is the link between decentralization and counterparty risk.

With respect to Facebook, it appears to me that if you own the FB coin, or Global coin as it will supposedly be called, your asset value is only as good as Facebook’s platform growth, gains in adoption of the Global Coin and Facebook’s ability to remain viable as a company. Given the graveyard of early social media efforts from AOL Online, to MySpace, now in ICU, this is no trivial matter.

With decentralized coins, your main concern is adoption, both from users and traders. In a true decentralized coin, there is no counterparty risk as long as the internet is up and running, and you hold your private keys.  One reason I consider Bitcoin to be the anchor of any crypto portfolio is adoption is evident in its transaction rates, the amount of vendors taking payments, credit cards backed by Bitcoin, and the acceptance by institutional traders.

A partially decentralized coin like EOS may depend on its block producers who are voted by holders and expected to be ‘good actors’. But what constitutes ‘acting good’ is not well defined in such a community based system. There are no set rules.

Platforms and Smart Contracts

Are you considering a coin that is a platform (a coin that has smart contracting ability), or is itself a smart contract? While there are many platform coins, the two leaders in marketcap and use are Etherum and EOS.

Ethereum is the platform coin with the largest market cap, and has hundreds of coins running as smart contracts on its chain. The smart contracts themselves follow their own model. The fundamentals of Ethereum itself depend on the size of the economy running on its chain. It is fair to assume a reduction in use and size of the economy of Ethereum, would result in devaluation.

The bottom line is that you must know what you are buying. If you are buying a platform, you want to look at the desirability of that platform for developers. Ethereum has proven heavy and difficult but up until EOS came onto the scene it had few competitors. However, EOS is not truly decentralized, and technically it is possible for The EOS block producers to roll back transactions on a business’ token. This is disconcerting to many despite the speed of EOS.

Theoretically if the platform is desirable for developers, you’ll see the economy running on its chain grow over time..

Typically when a coin leaves one platform for another, say Ethereum for EOS, there is no risk to the holder, as long as they keep up on news. Usually there is a swap process for one coin for the other. And, typically, except on rare occasions, the market grants that coin price continuation. I have personally been through many swaps. What this means is that if you are evaluating investment in a coin on one of these platforms, making your decisions may be independent from evaluation of the platform itself.

Utility vs. Security

I’m using SEC legal definitions here. A security, by SEC definition, is an asset that gives the holder the right to profits of an organization, like a stock or bond. There are coins that fit the classification of a security. The SEC forbids them being offered to anyone in the US that is not an accredited investor. Obviously, if you are buying a security coin or token, you want to track the profits of the company that issued the token, and often that information is either not transparent, or very transparent, being tracked on the blockchain. Obviously, the counterparty risk in this situation is high as a failure of the company may hurt your investment.

Other coins, while being issued by a company, might be a ‘utility coin or token’ and not a security. For example, coins put out by Crypto.com, are used to gain access to their innovative credit cards and the discounts they offer but not the profits of the company. A utility token has a use, but not the right to profit. While the value of the token may or may not be tied to the profit of the company, it certainly is tied to the viability of the company and with respecdt to crypto.com its credit card business. So, when a coin is issued by a company, your risk is tied to the risk of the company, and more so if a security token or coin.

Gluing it Together

I’m going to end this with the tale of STEEM. STEEM is the coin that powers the reward system on the Steemit social media site. It was the cocreation of Dan Larimer, a blockchain idol of sorts, who’s recent creation is EOS.

STEEM is partially decentralized. Those that verify the blockchain are called witnesses and there are 100. These witnesses verify transactions, and some do development on the chain. However, Steemit Inc. is a corporation that keeps steemit.com up and running, and produces some of the key software interfaces that keep STEEM up and running. Because Steemit Inc. survives on funds in the form of STEEM coin it went into duress when STEEM the coin declined in price from $8.88 to  21 cents. This occurred in parallel to the bear market in 2018 where Bitcoin fell from $19K to $3K.

As Steemit Inc. was in restructuring, the witnesses, a group of otherwise unrelated individuals and companies took up slack to see STEEM, the blockchain successful. This is an example of the weaknesses and strengths of blockchain models. Steemit Inc. relied on price strength of STEEM, an extremely volatile asset. However, STEEM, the coin’s existence is not threatened by the duress in STEEMIT Inc because it is open source code, and partially decentralized. This gave opportunity for others to take up the slack and see STEEM  and STEEMIT live on in its community.

To users and holders, STEEM has some aspects of a security token. If you own STEEM you don’t have profit from a company per se. However, you can take action to gain an income from the platform itself. This was described in one of my previous posts. Does this make STEEM, the coin a security. Well, I’ll leave it to SEC. And, I guarantee, if you they decide to take that on, it will take many hearings to figure it out.

The bottomline is that if you are investing in a coin long term you should study these dynamics. Know what you are buying, and that these assets come with a business model that may be untraditional, even bending the rules of traditional business models.  And, in the ‘atmosphere’ of these businesses and decentralized communities is a highly volatile asset class, the most volatile asset on the planet perhaps, which requires everyone be alert and on their toes.

These are concepts are heady indeed, so heady they are not yet taught in standard business schools. If you are a crypto investor, you are interested in an asset class where traditional valuation models break down so you will be a pioneer treading on fresh trails.