Cryptocurrencies have become increasingly popular since the introduction of bitcoin in 2009. In this paper, we identify factors associated with variations in cryptocurrencies’ market values. In the past, researchers argued that the “buzz” surrounding cryptocurrencies in online media explained their price variations. But this observation obfuscates the notion that cryptocurrencies, unlike fiat currencies, are technologies entailing a true innovation potential. By using, for the first time, a unique measure of innovation potential, we find that the latter is in fact the most important factor associated with increases in cryptocurrency returns. By contrast, we find that the buzz surrounding cryptocurrencies is negatively associated with returns after controlling for a variety of factors, such as supply growth and liquidity. Also interesting is our finding that a cryptocurrency’s association with fraudulent activity is not negatively associated with weekly returns—a result that further qualifies the media’s influence on cryptocurrencies. Finally, we find that an increase in supply is positively associated with weekly returns. Taken together, our findings show that cryptocurrencies do not behave like traditional currencies or commodities—unlike what most prior research has assumed—and depict an industry that is much more mature, and much less speculative, than has been implied by previous accounts.
What is the role of social interactions in the creation of price bubbles? Answering this question requires obtaining collective behavioural traces generated by the activity of a large number of actors. Digital currencies offer a unique possibility to measure socio-economic signals from such digital traces. Here, we focus on Bitcoin, the most popular cryptocurrency. Bitcoin has experienced periods of rapid increase in exchange rates (price) followed by sharp decline; we hypothesize that these fluctuations are largely driven by the interplay between different social phenomena. We thus quantify four socio-economic signals about Bitcoin from large datasets: price on online exchanges, volume of word-of-mouth communication in online social media, volume of information search and user base growth. By using vector autoregression, we identify two positive feedback loops that lead to price bubbles in the absence of exogenous stimuli: one driven by word of mouth, and the other by new Bitcoin adopters. We also observe that spikes in information search, presumably linked to external events, precede drastic price declines. Understanding the interplay between the socio-economic signals we measured can lead to applications beyond cryptocurrencies to other phenomena that leave digital footprints, such as online social network usage.
This is a list of some resources we have found valuable and think you might, too. It’s a selection of our favorites rather than an attempt to include everything. The resources extend from quantitative tools like ours to long-form research and academic papers. This list, like our website, is probably more useful for investors rather than anyone looking for particularly technical resources. We were not paid to include anything on the list – the only organizations we have formal partnerships with are listed on our sponsors page. This list is subjective and not intended to be complete or exhaustive.
We discuss the pros and cons of indexing strategies in this post, now slightly outdated. We still think Bletchley Indexes offer the most thoughtful and consistent approach to index construction. They have recently added a useful total market index. Keep an eye on them. Smith + Crown and a team of academics at CRIX also run indexes; we cover them in the blog post.
Also worth noting is the Bitwise Hold 10 Index. It incorporates some of the innovations that have been publicly discussed over the last few months. True to the name it tracks 10 large caps; but it weights them by 5 year inflation.
Vaneck has a comprehensive selection of indexes which are worth looking at. Digital asset indexes are a much more crowded space than when we first started looking at them!
We like CryptoCompare for extractable historical data. They have a great API too.
CoinGecko creates very interesting quantitative rankings. They offer a refreshing alternative to the CoinMarketCap school of ranking which is rather uncritical at times, and promotes the misleading “market cap” indicator. CoinGecko grades cryptoassets on developer activity, the strength of community, and the amount of public interest, building a quality indicator which can help investors avoid dead or stagnating projects.
OnChainFx is a great product. OCFX does a few interesting things; it focuses on the impact of monetary policy on valuation, which has been a sorely overlooked topic until now. Most interestingly, it lays out clearly the float and pending supply of a set of major cryptoassets, and extrapolates network value to 2050, assuming no change in unit price. This lets investors very easily measure the impact inflation will have on various cryptoasset networks. Another interesting indicator that holds a lot of promise is the ‘Vladimir club cost;’ or what it would cost to own 1% of 1% of the asset’s eventual supply. Onchainfx integrates some Coinmetrics data – we suggest using them for your rankings. (Full disclosure: OnChainFx is a Coinmetrics sponsor.)
We are inspired by BitInfoCharts; they offer an absolute treasure trove of blockchain data.
CoinDance do valuable work to illuminate the bitcoin ecosystem, especially when it comes to decoding what the miners are up to.
Blockchain.info have a fantastic assortment of data and charts, and we wish this sort of information existed for every cryptocurrency.
For tokens (something we don’t spend very much time on), Tokendata is a clean and minimalistic data source evidencing that most large tokensales have been fairly poor investments thus far.
Statoshi.info is a very thorough service which collects incredibly detailed Bitcoin data from a full node. We wish this level of detail existed for other blockchains.
Shabang.io is a very cool new service that catalogues lightning network nodes and segwit usage.
Tools and visualizations
Sifrdata is a really unique resource. People with a finance or statistics background will really appreciate it. It covers rolling correlations, sharpe ratios, correlation clustering, the distribution of returns, and volatility of major cryptocurrencies, among other things.
If you like mean-variance optimization, and want a dynamic correlation tool with a lot of choice, play around with this excellent correlation matrix, developed by Jonas Verhoelen.
MapOfCoins is a very cool evolutionary graph of a huge number of cryptoassets, and lets you easily determine their history. It’s sadly not being updated at present, but nevertheless still very interesting.
CryptoMaps is a real-time visualization of the market heavily inspired by Finviz. It’s currently somewhat flawed due to odd segmentation decisions, and a lower limit on the size of the rectangles representing small-caps, which results in the inclusion of many ultra small caps that probably don’t merit consideration in the sample. Nevertheless it’s an easy way to picture how the market is faring in real time. You’ll notice that it’s heavily correlated.
The Bitcoin Volatility Index is a nifty site. Since so many finance professionals insist Bitcoin can’t be a store of value since it’s too volatile, it’s nice to have a visualization on hand. The site also does Ethereum and Litecoin.
Cryptovoices is a really interesting site – mainly oriented around a podcast – which also boasts some very thoughtful ratios, graphs, and indicators. We particularly like the network price-to-sales ratio which they run for a variety of public blockchains. This is a very clever ratio which models blockchains a bit like typical rent-extracting assets. Keep an eye on cryptovoices.
Transactionfee.info creates some interesting charts aggregating Bitcoin payments, rather than just transactions (which can bundle many payments). Counting outputs as payments is a far richer picture of Bitcoin development than simply looking at transactions. Due to higher batching rates, the relationship between transactions and outputs has inflected. This is a useful analysis that our data doesn’t account for presently.
Flipside Crypto runs a github index which blends together github data for cryptoasset projects and synthesizes it into a single indicator. If you click through to individual projects, the data is presented in digestible form. (Full disclosure: Flipside is a Coinmetrics sponsor.)
Blogs we read
Willy Woo doesn’t just write a blog. His indicators, visualizations, and models are incredibly influential. I’d classify almost every post on his page as a must-read. His charts page in particular is very illuminating. To the best of our knowledge, Willy devised the market to transaction value (MTV ratio), which he now calls the network value to transactions ratio (NVT ratio).
Ari Paul hasn’t been active in the cryptoasset space very long since migrating from traditional asset management, but he has become very influential. Now launching a cryptoasset fund, Ari may become more limited in what he has to say, so treasure his posts while you still can.
Matt Levine doesn’t exclusively cover cryptoassets, but his popular daily column for Bloomberg has become dominated by the topic of late, or as he calls it, “blockchain blockchain blockchain.” Matt is continually entertained by the stories of ICOs, hacks, novel financial products, and market manipulation, and he expresses his generally skeptical view in a fairly good-natured way. The main lesson from his column is that there is nothing new under the sun; only new ways to do old things. Bonus: a Coinmetrics founder was quoted on Levine’s blog at length recently! Tweet us if you find it.
I don’t have much to say about Elaine Ou’s fantastic blog aside from the fact that it’s an absolute gem.
Chris Burniske pushes the envelope on valuation models, which he generously publishes for everyone’s benefit. Chris also popularized the market to transaction value measure which we use here. He is also thoughtful about nomenclature; Chris is probably responsible for the shift to “cryptoasset,” and he’s leading the charge in leaving the misleading “market cap” behind in favor of “network value.”
If you are in the mood for a much more skeptical look at cryptoassets and tokens, Preston Byrne runs a blog which can safely be described as contrarian. Preston is a UK-trained lawyer with a penchant for unraveling some of the more extravagant claims made by founders and promoters. Investors owe it to themselves to consider tail risks and regulatory action, and Preston’s blog is an excellent starting point.
The well-known Bitcoin investor and industry critic Tuur Demeester doesn’t write very often, but when he does, it’s worth reading.
You may perceive the constituents of this list as too fond of bitcoin or overly skeptical; if any commentators emerge with a thoughtful defense of ICO mania, we will gladly include them.
The investment management firm Ark Invest posts frequently on bitcoin’s investable qualities. They were well ahead of the game, voicing this conviction and taking a public position in the troughs of the 2015 bear market, well before the recent market inflection. Their research can be found here but the essential reading is their white paper: Bitcoin: Ringing the Bell for a New Asset Class. The essential contention is that cryptocurrencies represent a radically new asset class, crucially different from commodities, currencies, and property (which they are commonly compared to) along three dimensions: politico-economic features, correlations of returns, and the nature of return profiles. This is vital reading for those crossing over from the traditional finance world of sharpe ratios and mean variance optimization.
The Digital Currency Group cannot be overlooked when it comes to digital asset markets. One overlooked contribution of theirs to the space is investment research. Grayscale released an excellent investment thesis for Ethereum Classic [pdf warning] to support the launch of their ETC fund back in May. Whether or not you agree with their criticisms of Ethereum, this may indeed become the template for cryptoasset investment theses. It describes key aspects of investability which are crucial for investors: history and launch; governance; economics and monetary policy; target market size; incentive structures.
The DCG subsidiary, Coindesk, boasts the most comprehensive and professional industry research setup in the space. Much of it is public but some key reports are paywalled, which isn’t surprising given the rigor and detail. One of the pitfalls of issuing research in such a fast-moving sector is the near-instant obsoletion of your work. Their Q1 2017 “State of Blockchain” looks curiously out of date now, boasting of the $25b cryptocurrency market cap and ICO funds totaling $36m. However, these reports are invaluable – especially if you’re an institutional investor needing to justify your investment to skeptical clients.
The excellent Smith + Crown win a spot for their contributions to research. They have created a searchable repository of digital currency-related publications which aggregates a huge amount of papers, tagged appropriately. Additionally, they have written a good number of currency profiles, covering even relatively obscure ones in detail.
And of course, you have good old academia. Last year, Ledger, a bespoke peer reviewed digital currency journal, was launched to publish some of the best work in the space. It is not exclusively technical in content, either. The inaugural issue had a refreshingly varied set of articles, from a largely impenetrable post on ring confidential transactions, to a work of political philosophy comparing governance structures on blockchains to the contract theory of Hobbes, Rousseau, and Rawls.
Recent articles that have caught our attention include the BlockSci working paper, created to accompany the open source BlockSci tool for blockchain analysis. This represents a significant improvement in the tools available to the public for answering difficult questions about popular blockchains. They use the tool to demonstrate an attack on Dash’s privacy, to show how multisig transactions hurt confidentiality, and interestingly, to make better estimates about the velocity of major cryptocurrencies.
Another paper we like is Buzz Factor or Innovation Potential: What Explains Cryptocurrencies’ Returns? by Wang and Vergne which unpacks the return drivers of major cryptocurrencies over a yearlong period. They find that, when accounting for various factors, that buzz is negatively associated with weekly returns. Attention should be given to their methodology which quantifies developer activity to try to capture innovation.
While its inclusion is somewhat nepotistic, we believe this paper is also important. It is written by one of Coinmetrics’ creators. The 2017 paper A Cross-Sectional Overview of Cryptoasset Governance and Implications for Investors is a master’s thesis covering governance structures in the industry. It has a useful survey of the top 50 circulating cryptoassets by network value (as of July 29, 2017) with detailed analysis of the governance models on display. The paper is aimed at educating investors about the relative lack of shareholder (tokenholder) rights in the industry. It also discusses a few of the functioning models of cryptoasset governance.
Garcia et al’s 2014 paper The digital traces of bubbles: feedback cycles between socio-economic signals in the Bitcoin economy may be dated by cryptocurrency standards, but it is still a thorough exposition of the relationship between social sentiment and Bitcoin price. They cover an early period in Bitcoin’s history, but the relationships. Rather than naively correlating google trends and bitcoin price like other academics do, Garcia et al notice a feedback loop between social buzz and price. This means that search volumes combine with price rises to drive positive loops which cause reflexive bitcoin behavior – in both directions. A full awareness of these relationships is absolutely vital to unpacking sentiment data.
In our view, A Fistful of Bitcoins: Characterizing Payments Among Men with No Names by Meiklejohn et al (2013) is the canonical paper on serious empirical analysis of the Bitcoin economy. The researchers use a variety of techniques to determine how Bitcoin is actually used over time. This involves a robust and nuanced analysis of UTXOs, heuristic-driven transaction volume estimates, user clustering, and more exotic empirical techniques. They even transacted with 334 Bitcoin services — choosing a variety of exchanges, gambling sites, vendors, wallets, and other merchants to determine their addresses and estimate their impact on transaction volume. A Fistful of Bitcoins is a stunningly useful and informative paper, even 4 years on.
Coin Center is a nonprofit think tank based in Washington D.C. which seeks to educate policymakers about cryptocurrencies and advocate for reasonable and fair regulation. They also serve the dual purpose of educating members of the public about the latest regulatory developments. The US is only one among many countries that can regulate digital currencies and tokens, but given that regulators like to follow the leader, what happens in US Congress tends to reverberate worldwide. Coin Center boasts impressive access to Congress, and they produce pithy explainers for journalists and original research to boot.
Investors who know the history of alternative currencies know that regulators can be an existential threat. Bitcoin and its many descendants are decentralized and hence largely immune to being closed down by regulators, but they can still be hamstrung if, for instance, exchanging fiat for digital currency is suddenly outlawed.
The value of digital currencies and cryptoassets is evident to everyone involved in the space, but regulators and the media need a bit more convincing. Coin Center does very useful things like proposing a safe harbor framework for nodes, thus protecting users from being accountable for the money-transmitting implications of node traffic; clarifying whether or not cryptocurrencies should be treated as securities; and explaining why bitcoin isn’t to blame for ransomware attacks.
Many bitcoiners and digital currency enthusiasts would be surprised to hear that they have advocates in frequent contact with US Congress, helping establish a fair framework for eventual regulation. It’s a dirty word to many, but regulation does not mean closing down all digital currency activity, but could instead mean consumer protection, clarifying securities laws, simplifying money transmitter frameworks, protecting individuals from exchange failures, and so on. Coin Center has flown under the radar thus far but deserves to be a key element of your research if you care about the long-term health of the digital currency market.
There are a surprising number of books already published about this novel industry. Nathaniel Popper’s Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money is a very thorough look at Bitcoin’s history, pre-history, and political underpinnings. It is largely non-technical, but is essential reading for anyone seeking an understanding of why the digital currency is so popular. Everyone I have referred this book to has subsequently bought Bitcoin. It is about a year out of date, which is an eon in the cryptocurrency world, but it is still a very worthwhile read. Where else will you learn about the impact Mark Karpeles’ cat Tibanne had on the history of Bitcoin?
Chris Burniske and coauthor Jack Tatar jumped into the fray with their offering, entitledCryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond. This to our knowledge is the first book-length approach of these assets from an investment standpoint. Chris has great credentials in the space and this is a vital read. It is a nicely-paced read which enables investors with any level of expertise gain an understanding of the asset class. The sections on taxonomy and valuation are particularly valuable.
Lastly, Saifedean Ammous is publishing The Bitcoin Standard: Sound Money in a Digital Age in hardback early next year. He made early drafts available to the public, and if the finished product is anything like those, this book will be very influential. It’s a look at the economics of the system and how bitcoin can underpin a new era of sound money. Importantly, is plainly and comprehensibly written with no excessive ornamentation or jargon. Anyone can find value in this book; it’s not just for economists or technologists.
Other books aren’t on this list because I haven’t read them. If you have a burning desire to have them included in this list, feel free to send them our way. (Edit: still haven’t received any books…) (Edit2: still waiting…)
Proof of Work is a very cool newsletter from fund manager Eric Meltzer. It delivers weekly updates about cryptoasset projects directly from the founders and top devs themselves. Turns out there’s a fairly high correlation between the viability of a project and the transparency of the founding team. Funny that!
Token Economy is a weekly newsletter run by Stefano Bernardi and Yannick Roux that does an excellent job of distilling the most important developments in the space. It includes new launches, commentary, links to influential posts, and occasionally some criticism, which is useful.
Marty’s Ƀent is an entertaining daily Bitcoin-oriented newsletter detailing the latest thoughts of, well, Marty. It’s informal and occasionally vulgar, but it’s all in good fun. Marty deserves plaudits for being amazingly consistent. He will deliver something thought-provoking to your inbox every day, without fail.
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We hope you have found this list useful. If you think something deserves to be on here, get in touch at @coinmetrics. We can’t guarantee we’ll put it on there – this list is mainly for resources which we use and have actively benefited from. This list is actively curated.
The 2017 paper A Cross-Sectional Overview of Cryptoasset Governance and Implications for Investors is a master’s thesis covering governance structures in the industry. It has a useful survey of the top 50 circulating cryptoassets by network value (as of July 29, 2017) with detailed analysis of the governance models on display. The paper is aimed at educating investors about the relative lack of shareholder (tokenholder) rights in the industry. It also discusses a few of the functioning models of cryptoasset governance.
We theorize about the governance of blockchain organizations and empirically explore the phenomenon using panel data on cryptocurrencies. Our findings point to interesting effects of governance on returns (i.e. cryptocurrency price increases or decreases). Internally, while centralized governance design choices at the blockchain level decrease returns, centralized governance design choices at the protocol and the organizational levels appear to be more beneficial for returns. The results correspond to the idea that, on the one hand, investors value cryptocurrencies’ core value proposition, rooted in decentralization; but on the other hand, are suspicious of decentralized governance at higher levels in the organization because they could slow down strategic decision-making (e.g., regarding the introduction of new innovations) or create information asymmetries between investors and technologists.
NEW DELHI (Reuters) – India will move to stamp out use of cryptocurrencies, which it considers illegal, Finance Minister Arun Jaitley said on Thursday, launching a no-holds-barred attack on virtual currencies such as Bitcoin.
Financial services strategy consulting firm, Quinlan & Associates, has released a landmark 156-page report on the cryptocurrency space, the largest and most detailed examination of the industry to date [LINK TO REPORT PAGE].
The report, titled ‘Fool’s Gold? Unearthing The World of Cryptocurrency’, takes an in-depth look at the fundamental functions of cryptocurrencies and the surrounding ecosystem, powered by blockchain technology.
The report also seeks to demystify the ongoing debate in financial markets (and the wider economy) around the true value of Bitcoin and its future outlook through detailed valuation models.
Cryptocurrencies have been heralded as the revolution of the financial system since its proof of concept by Wei Dai and Nick Szabo in 1998, followed by Satoshi Nakamoto’s whitepaper detailing a ‘peer-to-peer electronic cash system’ and open source code, which is now known as Bitcoin.
Underpinned by blockchain technology, cryptocurrencies promised an end to third party institutions and barriers to financial transactions. And in recent years, they have exploded onto the scene at an exponential rate. At its 2017 peak, there were over 1,300 cryptocurrencies in existence, with a combined market capitalisation of nearly USD 650 billion, rivalling the GDP of nations such as Saudi Arabia. Bitcoin (BTC) itself, the most popular cryptocurrency, has touched market capitalisations similar to economies such as Malaysia and Vietnam.
The sudden rise of the cryptocurrency market has generated heated debate by both believers and critics alike for its value, future potential, and use cases. At the centre of this discussion is BTC, with its meteoric price rise capturing daily headlines in mainstream and social media alike, with speculators rushing to the market in the hopes of joining the wave of overnight millionaires. A plethora of inter-related industries have also spawned, including wallets and payment services, crypto exchanges, and mining, as entrepreneurs across the globe look to capitalise on new revenue pools that have opened up on the back of this technological revolution.
To appreciate the recent rise of cryptocurrencies and their future potential, one must understand the underlying technology, surrounding ecosystem, and the place of cryptocurrencies in financial markets (and the wider economy). Our report details the aforementioned criteria, utilising BTC as the exemplar for current cryptocurrencies in place at the time of writing. We also drew further insights from interviews with a wide range of industry stakeholders, as well as survey responses from over 1,500 individuals working predominantly in financial services, FinTech, consulting, and technology.
Most current iterations of cryptocurrencies are, at their core, meant to operate as currencies. However, currencies have, for many centuries, needed to meet a number of specific criteria to be recognised as such – namely, acting as a unit of account, a medium of exchange, and a store of value. Despite fulfilling most of the characteristics of a traditional fiat currency, cryptocurrencies are largely being utilised as speculative investment assets, leading to considerable volatility in their value. This lack of stability, together with soaring valuations, means they are rarely used for payments. In order to achieve status as a legitimate currency, the public must spend cryptocurrencies widely to determine a credible benchmark for their actual value, encouraging businesses to accept them as a medium of payment (hence making them more liquid in the long run). Until then, most cryptocurrencies, including BTC, will continue to exist in a speculative capacity, with all the undertones of being a bubble.
2017 saw the price of BTC surpass the asset price inflation of the 17th century tulip mania, while rendering “bubbles” such as dotcom a mere blip by comparison. Its strong – albeit slowly unwinding – correlation to alternative cryptocurrencies also indicates a collapse in the price of BTC could lead to a rapid downfall for the broader non-fiat cryptocurrency market.
A number of factors underpinned BTC’s price rise in 2017. In the earlier part of the year, many of the gains could be tied to ongoing discourse around its potential regulatory legitimacy. Since then, however, its popularity – and infamy – has appeared to fuel a widespread “fear of missing out” (FOMO), a classic characteristic of most bubbles. Yet, consensus regarding its future value remains literally non-existent, with valuations ranging from USD 0 to as high as USD 1,000,000. Moreover, the majority of these predictions do not appear to be based on any robust, quantitative methods, but are more a reflection of individual opinion.
To determine whether BTC is indeed a bubble, we looked to calculate its value using two overarching approaches: (1) as an asset; and (2) as a currency.
As an asset, we valued Bitcoin using a cost of production approach and a store of value approach, resulting in values of USD 2,161 and USD 687 respectively. To value BTC as a currency, we estimated its utilisation for both legal, retail transactions payments, as well as payments in the black market. After significant testing, we calculated the price of BTC 1 to be USD 1,780.
Irrespective of the valuation methodology employed, we found the price of BTC deviates significantly from its current price of ~USD 14,000. For the longer-term, we are even less optimistic around the future price of BTC and believe it will ultimately be ruled out as a mainstream form of payment. We see this exerting greater downward pressure on its price and forecast it to trade at ~USD 810 by 2020, if not even lower. We therefore believe that BTC, at its current valuation, is a bubble waiting to burst.
While our views on the price (and future applications of BTC) remain muted, our outlook for the broader cryptocurrency industry remains much more sanguine. Existing cryptocurrencies that were designed to replace fiat currencies, such as BTC, are unlikely to act as viable substitutes to the money or currency system we have in place today, due to their inherent challenge to central bank and government functions – namely, fiscal and monetary policy. However, cryptocurrencies with associated utility applications (such as Ethereum’s ETH), as well as fiat cryptocurrencies attached to a sovereign nation, are likely to grow in significance, given the ability of the underlying blockchain technology to provide meaningful enhancements to current payment systems, as well as their broader applications beyond being used as speculative assets (e.g. facilitating the execution of smart contracts).
Although a sharp decline in the price of BTC in 2018 is likely to take the value of other nonutility cryptocurrencies with it, we see the correlation with utility cryptocurrencies being much less pronounced. While we anticipate valuations to decline in the short-term in response to the widespread unwinding of the digital currency space, valuations of utility cryptocurrencies are likely to recover and dominate the market in the long-term. We forecast total market capitalisation of private cryptocurrencies to be USD 407 billion by 2020. We also see fiat cryptocurrencies gaining momentum as governments accelerate their research and piloting efforts, with potential to be a USD 150 billion market by 2020.
While we believe BTC can largely be viewed as fool’s gold at present, digital currencies will continue to unearth major enhancements to the global payments system in years to come.
University of New South Wales (UNSW), UNSW Business School
Date Written: November 27, 2017
This paper examines the infusion of Cryptoanarchist philosophy in the construction and dissemination of cryptocurrencies, in light of the breakneck growth of these non-traditional financial instruments, and their perceived importance in transforming international monetary structures.
Ruprecht-Karls Universität Heidelberg; Heidelberger Akademie der Wissenschaften
Date Written: November 22, 2017
Cryptocurrencies, such as bitcoin and ethereum, have not only risen to public attention as novel means of payments. Rather, the current hype is fueled by financial applications built on top of these currencies that stand to potentially upend consumer and investment markets. The most remarkable and economically relevant of these applications are tokens sold via initial coin offerings (ICOs, also called token sales). In 2017 alone, the equivalent of more than $ 3 billion have been raised through ICOs. In these entirely online-mediated offerings, startup entrepreneurs sell tokens registered on a blockchain in exchange for cryptocoins traded on that blockchain (typically bitcoins or ethers). Investors receive tokens that can be understood as cryptographically-secured coupons which embody a bundle of rights and obligations.
In July 2017, the SEC released an investigative report that highlighted that such tokens can be subject to the full scope of US securities regulation. As a result, issuers increasingly structure ICOs such as to prevent US citizens and residents from obtaining tokens in order to exclude the reach of US securities regulation. However, for the time being, EU citizens and residents are free to invest in tokens. This raises the question to what extent EU securities regulation is applicable to ICOs and, particularly, whether issuers have to publish and register a prospectus in order to avoid criminal and civil prospectus liability in the EU. In conceptual terms, this depends on whether tokens are considered “securities” under the EU prospectus regulation regime. The question is of great practical relevance since, despite the high stakes involving more than $100 million in some ICOs, to our knowledge, up to now not a single token issuer has published or registered any such prospectus.
Against this background, this paper develops a nuanced approach that distinguishes between three archetypes of tokens: currency, investment, and utility tokens. It analyzes the differential implications of each of these types, and their hybrid forms, for EU securities regulation. While the variety of tokens offered necessitates a case-by-case analysis, the discussion reveals that at least some types and hybrid forms of tokens are subject to EU securities regulation. By and large, pure investment tokens typically must be considered securities, while pure currency and utility tokens are exempted from securities regulation in the EU. In identifying these archetypes, regulation and market oversight will have to put substance over form. Finally, we spell out criteria for the application of EU securities regulation to hybrid token types.
The paper closes by offering two policy proposals to mitigate legal uncertainty concerning token sales. First, we suggest tailoring disclosure requirements to the code-driven nature of token sales. Such an ICO-specific safe harbor would offer a clear and less burdensome path to EU law compliance for token sellers who suspect that their tokens may qualify as securities. This only requires the Commission to amend its delegated 2004 Commission Prospectus Regulation. Second, we propose that, on an international level, governments form a compact to bestow certainty about the application of their respective securities regulation regimes to token sales. This is, first, to avoid regulatory overkill on the one and regulatory lacunae on the other hand in online-mediated, global token sales. Second, overlapping, and partially contradicting, securities regulation regimes can nullify each other. In the end, only a joint international regulatory regime can efficiently balance investor protection and investor access in the face of the novel generation of decentralized blockchain applications.