Scaling, $6000, Emerging Markets & Wallets

Thank you for subscribing to The State of the Crypto Newsletter. Every two weeks I provide my insights and analysis of key technological, financial and market trends in the crypto asset space.

In this edition I discuss:


  • The challenges of scaling and growth of second layer networks

  • Bitcoin's challenge at $6,000

  • The ramifications of escalating crises in the emerging markets for crypto assets

  • My interest in the opportunities in the wallet space


Major Technology Trends


In the last edition, I addressed the importance of privacy and fungibility for the success of crypto assets. There is one other major technical barrier that these assets need to breach, scalability.


Scalability refers to the data capacity of a blockchain, typically the number of transactions or smart contract executions that it can handle within a period of time. We typically measure scalability in transactions per second (tps). The more capacity that a blockchain has, the more users, merchants and businesses can use it without encountering high fees and long wait times.


In terms of scaling goals, there are two major milestones that these blockchains need to reach. The first is global coverage for the world’s current population both for payments and decentralized application (DAPP) infrastructure. Secondly, for the longer-term, we need to be thinking in terms of the IoT economy and the demands that that imposes. In such an economy we will likely need the infrastructure to support billions and possibly trillions of transactions per second. To put this in context Bitcoin manages just a paltry 7 tps right now...


Traditional centralized systems do not tend to have major scaling problems. Due to their centralization, capacity can be added whenever it is needed with far fewer concerns.


Conversely, since open blockchains aim to be decentralized, they have to be accessible by pretty much anyone. In particular, it is important that you or I can run a full node and verify the entire chain. Achieving this degree of decentralization though almost always causes higher network latency and limits the size of the blockchain. In turn, we hit a scalability ceiling relatively quickly and the tps rate stalls.


With these problems in mind, there are two main avenues for such projects to scale. The first is through capacity increases to the actual blockchain while the second is building additional networks to handle the extra capacity. These networks, so-called second layer protocols are then connected to the underlying blockchain.


Right now we do not know whether on-chain or off-chain scaling solutions are the answer. All the arguments we have heard until now are theoretical and based on assumptions. There is only one way to find out which path works best and that is implementation and real-world testing.


We are now starting to move into this phase.


Off-chain Scaling


Today, I am going to look at the off-chain solutions being pursued by monetary assets.


Bitcoin and Litecoin are pursuing off-chain solutions like the Lightning Network and sidechains like Liquid. The long-term vision for these projects is to defer smaller and medium-sized transactions along with payment channels off-chain while using the underlying blockchain for large payments and settling channels. Payment channels are essentially tabs or IOUs between users that are kept off-chain. Only two blockchain transactions are required, one for the funds initially deposited to the channel and one to agree on the final receipt.

 

As you can see below Bitcoin usage on Lightning has been growing significantly over the past 12 months both in Bitcoin and Dollar terms.



Now that the fundamental infrastructure is being built out, the next milestone is to release user-friendly apps on Lightning for desktop and mobile that everyone can use to send and receive these assets. We are getting very close to that point now. Lightning Labs, the original and largest team behind Lightning, released their mainnet desktop app last week and is now looking to its release of a mobile version.


We are probably 6-9 months away from having a suite of products, desktop and mobile that are non-custodial (i.e. you control the funds), secure and easy to use. This kind of development is key to Bitcoin, Litecoin and other Lightning-focused crypto assets being used widely as currency, rather than just as a speculative vehicle.


If successful, Lightning will be able to process millions and possibly billions of transactions per second at near zero cost. This is the level of scale that could dwarf the current capacity of centralized payment networks like Visa and PayPal. On top of this capacity, Lightning transactions also offer a very strong level of privacy and fungibility. This is another essential characteristic of strong money and currency.


The other major benefit to Lightning is the level of interoperability that it offers. Interoperability literally means the ability for systems to work with other systems. In this case, it means the ability to send a payment in one currency, say Litecoin and choose to receive it in another, say Bitcoin. This technical wizardry is called an atomic swap and is supported by Lightning. Not only does this allow for the bypassing of exchanges but more importantly it allows for a frictionless world of multiple blockchains, all used where needed for their respective advantages with the ability to swap into any other instantly, cheaply and autonomously.


Right now, Lightning only really supports Bitcoin and Litecoin, although theoretically, with the right specifications, any crypto asset can join this second layer network.


Financial & Market Trends


Since the last edition, the crypto market has been relatively steady. I continue to believe that we bottomed on 14th December. The real question is whether Bitcoin can break above $6,000 and consolidate any gains. The $6,000 level was an area of huge support from February-November of 2018.



Typically areas of huge support that are then broken, as happened in November, become areas of heavy resistance on the way back up. The test at $6,000 will be significant for Bitcoin. If we see a successful breakout and consolidation, I will expect a healthy bull run for the remainder of 2019. If, however, Bitcoin fails to break out or cannot consolidate its gains, then we could again be range bound between $3,250-$6,000 for several more months.


I continue to treat the asset class as one when charting and positioning. As you can see in the chart below, there continues to be very little divergence between Bitcoin and the rest of the crypto assets. 



Global Macro


Last time, I addressed the problems in the Eurozone and the signs of a global pivot away from the tightening monetary conditions. Since then, little has changed at a fundamental level.


Emerging Market Troubles


In the meantime, troubles in emerging markets have surfaced again. Aside from the calamitous situation unfolding in Venezuela, there are three other emerging markets where I foresee both global ramifications and a likely surge in the adoption of monetary and currency crypto assets. These are Turkey, Argentina and Iran. All three nations are experiencing collapses in their national fiat currencies as well as runaway inflation. Inflation sits at 54.7% in Argentina, 47.5% in Iran and 19.7% in Turkey. Sanctions, fiscal and monetary mismanagement apart, all these countries problems are being exacerbated by a strengthening dollar.


I expect the dollar to continue to strengthen versus all other national currencies for the foreseeable future. This will only worsen problems in these three nations as well as trigger problems in other vulnerable markets such as South Africa, Egypt and Tunisia. Citizens of these nations have four choices.


  1. Continue to hold and spend their national currencies even as they devalue and lose purchasing power

  2. Convert most of their holdings into dollars

  3. Move into precious metals

  4. Adopt monetary crypto assets


I am extremely confident that an ever increasing number of these peoples will trend towards options 2-4 as these problems worsen. Depending on the punitive measures enacted by the governments of these nations such as currency controls and bans on precious metals and crypto assets, the exact ratio of these options will fluctuate. Of these three alternatives, crypto assets right now I would argue are the most flexible and least censorable. As such, they provide the greatest opportunity to maintain purchasing power and where necessary send the capital out of the country altogether, while of course providing the greatest upside potential.


Right now, the crises in these emerging markets are starting to rival the Eurozone troubles in terms of global contagion and the next wave of crypto asset adoption.


My Outlook & Positioning


My overall outlook for 2019 remains unchanged since the previous edition. As previously mentioned, I am looking to position myself into more smaller cap utility tokens towards Q3 and Q4 of this year.


One area that is particularly attractive to me is the wallet space. Wallets are simply pieces of software or hardware that store your keys. These keys provide you access to and control over your crypto assets. Wallets are an essential and immovable part of the crypto asset infrastructure. They are 100% required for crypto adoption and as such prevent a relatively low-risk, yet high-reward opportunity.


Specifically, my focus is on companies who build business ecosystems on top of and around excellent wallets. There are a number of highly valuable products and services that compliment a wallet and can build immense value such as crypto-to-crypto and crypto-to-fiat exchanges, personal data protection, online retail offerings and financial products like loans collateralised by crypto assets. These are just a few of the many such products that can complement and leverage the attention of high-quality wallets.


There are a few companies in this space right now such as Ethos and Pillar, with many others expected to join the market. Companies that offer utility tokens that can capture the value of these ecosystems are very attractive to me, and I will be monitoring the space over the next few months.


I hope that you found this edition useful and informative. As ever, none of this is investment advice, please do your own research!


If you know someone who could benefit from this information now or in the future, do please share it with them.

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