The Berk case v Coinbase

Which Exchange You Use Matters.....A LOT

Unless you are a miner, most of us use exchanges to buy our cryptocurrency whether we HODL or trade or sell. But where you buy your Bitcoin matters, and not just because of price.

This week we look at the developments for Coinbase and crypto exchanges in the US from the arbitration decision in the Berk lawsuit. Bloomberg describes the origin of the suit pretty well in this short article.

The Background

In August 2017, Bitcoin Cash (BCH) forked off the Bitcoin blockchain. Any and all holders of Bitcoin (BTC) were entitled to the same number of BCH due to something called Replay Protection. Replay Protection means that transactions on one fork BCH, are not valid in other fork BTC (and vice versa). This is to protect transactions from posting on both chains.

Since BCH wanted to start operating right away, they awarded all BTC holders with the same amount of BCH to trade on their own chain. This is a common practice for forked chains. So if you had 10 BTC in a verifiable wallet on this date, then you would get 10 BCH as well when you claim them.

So What About if You Hold Your Coins on an Exchange?

This is one of the first questions that comes up in this case. And before we go any further, this one point is vitally important:

If you leave your coins on the exchange, they are vulnerable to ANYTHING that can happen on that exchange including hacks and thefts. The only way to protect your investment is to hold them in your own private wallet.

So does holding your coin at Coinbase or Kraken mean you get BCH too? At Coinbase, at first, the answer was No, leading to a big uproar.

Finally, in December almost 5 full months later, they awarded the BCH to account holders while ‘briefly allowing trades for more sophisticated investors’ per the Bloomberg article. That trading lasted only a few minutes when Coinbase stopped it for significant volatility.

And what about non-sophisticated investors at Coinbase? They didn’t get their BCH in August, only in December. And when they got it, they couldn’t trade it on the Coinbase platform.

A group of investors filed suit for negligence and fraud for

  • this preferential treatment of sophisticated investors

  • the inability for other customers to trade it and

  • the speculation around the announcement of BCH availability connected to insider trading

Coinbase and their mishandling of the BCH launch on their platform is the basis for the suit.

The Motion to Dismiss

This week, the judge in federal court in Northern CA declared that Coinbase was incompetent but not fraudulent in his decision. This arbitration decision said that Coinbase botched this launch to the detriment of customers but there was not enough evidence to prove they were trying to manipulate markets or insider trading.

The judge’s decision, outlined briefly in this CCN.com piece, means that cryptocurrency buyers, but NOT sellers, are able to move ahead with their negligence suit against Coinbase since as buyers they had to pay artificially higher prices for BCH during the limited time BCH trading was open for them.

So the trial moves forward. Some claims dismissed on the seller side and for market manipulation, but the negligence claim remains.

The Legal Analysis

I’m not a lawyer and I don’t play one here either. Thankfully, there are a few excellent legal minds in the cryptoeconomy who did have something to say on this decision and its impact for Coinbase and for exchanges operating in the US.

David Silver, a securities fraud attorney, called this decision ‘a landmark decision for crypto users’ while starting a long, informative thread about what this decision really means.

According to Silver, these are the highlights:

Exchanges that think they can hide behind voluminous Terms of Service may be in for a surprise.

As summarized by Stephen Palley, securities attorney (and more from him coming up):

So tort liability attaches itself to crypto exchanges based on this decision.

Silver sums up his thread, which is well worth a read, here

Now we see more about what Palley has to say on this decision

This dysfunction marketplace piece is important. As a crypto exchange and marketplace, for Coinbase to create this dysfunction is the source of the negligence.

In other words, these exchanges have responsibilities on this and we as exchange users have some rights on what to expect from them.

We talked about the Kik case and Defend Crypto in a previous edition and Palley mentions it here as they recently answered the latest inquiry from the SEC.

Securities attorney Drew Hinkes sums up a couple of these important parts in his thread.

This is where Coinbase may be liable in spite of its user agreement, which Silver also said will likely be altered in the future in Tweet #5 of his thread above.

Clickwrap here means when you click on an agreement indicating you understand so you can use that platform whether its Google, Dropbox, Salesforce or Coinbase.

How Do You Protect Yourself?

What we can see in this analysis is that Coinbase is open to a negligence suit. We can also see that it may have tort liability (be liable for a wrong they’ve committed) to buyers of crypto on their exchange and that maintaining function/lack of dysfunction is considered an important part of their job as a marketplace.

Here are the other pieces we learned:

  • Torts are independent of the user agreement customers sign. So unlike many tech companies that use their user agreement as a legal weapon, exchanges have less power in their agreements with customers.

  • Exchanges now take on greater risk of tort liability and have a tort duty to maintain their marketplace (this includes things like flash crashes that happen too and is the source of the lawsuit against Kraken)

  • Are exchanges going to have less limited liability from what they expected from their user agreements? It looks like this answer to that may be Yes and other tech companies can be affected as well.

And here is what else you can do to protect yourself

  1. Read the user agreement on the exchanges that you use and try to understand them especially for events like outages, flash crashes and other events that may limit your access.

  2. Hold all your coin you don’t intend to trade in your own wallet

  3. Track your trades, diligently. Exchanges track them for you but you need to track them for yourself. For instance, if you make a market order, which means to sell immediately at the market price, and your exchange does not fill the trade right away, this is something you need to note and be aware of. It could be manipulative behavior. Track your amounts, date, time of order, time order is filled and do so independently of the exchange doing it for you. This will help you during tax time as well.

  4. Follow your exchange and their support team on Twitter and Telegram if you can. Sometimes updates online are faster than over email and you can see in real time if the problem is just you or not

Exchanges have a tough but important role in the cryptoeconomy. They have to face securities regulation and compliance but still need to be easy to use to provide the gateway between government issued currencies and cryptocurrencies.

I believe some of them, including Coinbase, do a pretty good job. I use them myself. But that doesn’t mean that we shouldn’t be watching them and what they do. Every company makes mistakes and when their mistakes can cost you money, then you need to be diligent about watching for their mistakes too.

What exchanges do you use and how do you like them?

Bitcoin Valuation Techniques

Compounded Growth Rates & Scarcity

Yes, there is still news on Facebook Libra. No, I won’t be discussing it this week.

One interesting thing that came from the Congressional hearings is that Bitcoin is more respected and trusted for its lack of corporate centralized figure than Facebook and its Libra project is or will be.

This is good news for Bitcoin. And given that, I thought this week would be interesting to see 2 different models for valuing Bitcoin.

Method #1: Compounded Annual Growth Rates

Pantera Capital, a VC and long-time investor in the crypto-economy, gives us some analysis in their Quarterly newsletter in July. Check out the 3rd section entitled ‘Bitcoin Price Reverting to Long Term Regression.’

You can see from the tweet that they make price projections based on their analysis that include $42,000 per BTC in 2019, which would be a 4x jump from the current price and more than 10x from the low when they made this prediction in March 2019.

How Did They Get These Numbers?

First, Pantera explains that on a regular chart, returns for disruptive technology look like a hockey stick. In other words, no activity for a while and then huge growth, like this.

Image result for hockey stick graph

Then they say if you look at a chart of Apple’s stock price, it’s vertical. And that doesn’t help us when trying to analyze performance and valuations since nothing is vertical forever.

Enter Logarithmic graphs. They are often used to show percentage change especially in high growth environments like we’ve had in Bitcoin.

Pantera charted Bitcoin’s price and then drew a regression analysis or ‘line of best fit’ and that line corresponds to a Compound Annual Growth Rate (CAGR) of 235%. Investopedia defines CAGR as the rate of return necessary to get from the starting balance of near 0 for Bitcoin to it’s current price levels assuming profits and dividends are reinvested. It smooths out all returns over time into a number that tells us this is the growth annually if Bitcoin grew the same amount every year.

235% is a pretty sweet return huh? But that’s not a real rate of return as investment periods differ. After all, if you bought at the Dec 2017 high and only then, you’ve lost value on your Bitcoin.

This line of best fit on the chart above represents 235% CAGR and how returns seem to ‘revert to the mean’ or make their way back towards the line of best fit. With current prices below that trend line, then this MAY be predictive of future growth and this is where the price projections come from.

Regression analysis is a powerful statistical tool and we will see if this line of best fit holds up over time.

Need help making better investment decisions in crypto? Do you need actionable information about the crypto-economy? For only $7/month you get this analysis in your email. No nonsense, just news you can use.

Method #2: Scarcity as Measured by Stock to Flow

Many people make the argument that Bitcoin is valuable because it is scarce. This is a common argument made for Gold. But even with the 21 million coin fixed supply, Is Bitcoin really scarce?

The mysterious Bitcoin quant analyst and investor Plan B takes a deeper look at scarcity by looking at stock and flow in this Medium article. Stock is the current supply available and flow is the annual addition to supply. So for gold the flow is the amount mined and produced each year and for Bitcoin that number is how many Bitcoins are produced each year from all the ~10 minute block rewards. This article came to my attention this week from this tweet.

To review, here are the current numbers:

  • Block reward: 12.5 Bitcoins

  • Time: Every 10 minutes

  • Bitcoins created annually until the next block halving in May 2020: 657,000

So that’s where we are now.

Stock to Flow Compared to Gold & Silver

The first argument Plan B makes is that only Gold and Silver among precious metals are scarce enough to be considered money. For example, palladium is valuable but can’t have monetary properties because it’s stock to flow is 1.1. That means that average annual production of palladium is equal to 88% of the current supply of the metal.

It’s just not scarce enough. Gold and silver have stock to flow ratios (Stock/Flow) of 62 & 22, respectively. This means they are scarce. In the case of gold, it would take 62 years of production to replace (or double) all the current stock. This is VERY scarce.

Bitcoin scores well on this front with a stock to flow ratio of 25. The calculation is 17.5 million coins over a 700,000 annual supply (the number is just a hair higher than our 657,000 as some blocks are found faster than 10 minutes). The 17.5 million makes an assumption of 1 million lost coins.

The Halving Effect on Stock to Flow

After detailing where Plan B got his data from, he goes into financial quant mode and crunches some numbers. Again, enter the logarithmic chart, this one courtesy of Plan B’s Medium post.

R squared is equal to the variance or how much of the chart can be explained by the relationship between the two inputs of market value and stock to flow based scarcity. You see on the graph that this number is 94%, meaning that stock to flow and market value are definitely related, or more accurately that the chances of them NOT being related are close to Zero. Interestingly, this seems to apply to gold and silver as well both sit very close to the regression line or line of best fit.

After the May 2020 halving, the supply will be cut in half and the stock to flow will increase from 25 to 50 and the predictive market value for Bitcoin after the halving is $1 trillion or a little more than 5x where we are today or a price of $55,000 per Bitcoin.

This chart shows a vertical line between 0-12 months after the halving in both 2012 and 2016 with the projection for 2020 with Stock to Flow in black and actual price in color dots.

Plan B’s discusses Power Laws and how they in combination with a 94% R squared make it highly likely that Stock to Flow based scarcity is why Bitcoin has the value it does.

Here is a podcast episode where Plan B talks about this strategy and valuation method in more detail.

Conclusion

To conclude we have the following price predictions based on 2 different models:

  • 2019: $42,000

  • 2020: $55,000 Or $122,000

  • 2021: $356,000

Both are obviously bullish on Bitcoin for the short term and long term. What do you think about these methods?

Mr. Marcus Goes to Washington

Facebook Libra meets Congressmen on 2 committees

Facebook is the story yet again in the cryptoeconomy this week as project lead David Marcus testified in front of 2 committees: one in the House and one in the Senate.

People have many questions about Libra including from Facebook’s own shareholders and managers, congressmen, the crypto industry, and the public. Facebook’s terrible reputation with data means that Congress is really looking to see if FB is attempting to become a corporate central bank coin issuer or not.

Some Questions From the Hearings

Nikhilesh De of Coindesk live tweeted many of the more interesting questions and exchanges between Marcus and the various congressmen including these, but first a link to the entire thread

Marcus states that

In a question about what Libra is (or will be) and the resulting follow-up of who would be regulating it here in the US, Congressman Patrick McHenry (who is bullish on crypto)

An interesting question about other platforms owned by Facebook

On regulation for Libra and other cryptos

Like many hearings, there was some grandstanding by some on the committee but there were many excellent questions that show they are truly researching and trying to understand both what cryptocurrencies are and what Libra is trying to accomplish.

Industry Reaction to the Hearings

The most comprehensive recap came from one of our best legal experts: Jake Chervinsky. This very long thread is worth an entire read.

Jake’s thoughts can be summed up as

  • Members understand the technology of cryptocurrencies better now

  • Most don’t have an opinion on cryptos but they all hate Facebook

  • Many Congressmen are able to see the differences between Libra & Bitcoin (to Bitcoin’s benefit)

  • Crypto is for criminals was a popular topic and cryptos will have to continue to take compliance and AML/KYC seriously

On fraud and what he believes to be a big step forward for cryptocurrencies and a good answer on Libra, former Fed cyber crime investigator on digital currencies had this to say as part of a thread

One of the stars of the hearings, Meltem Demirors made some excellent distinctions between Bitcoin and Libra

And Anthony Pompliano of Morgan Creek commenting on how Congressman McHenry is a full on Bitcoin bull after the hearings

Our CNON Take: We thought from the very beginning that Libra would be good for Bitcoin for the following reasons:

  • Libra is a stablecoin and Bitcoin is not

  • Libra is centralized and Bitcoin is not

  • Libra is Proof of Stake and Bitcoin is not (it’s Proof of Work)

  • Libra will used for payments and Bitcoin is not

  • Libra is not a real cryptocurrency and Bitcoin is

When people tire of the pretender (Libra), they will want Bitcoin.

But what we did not expect is that the results of this are already starting to form. Due to Congress’ deep dislike for Facebook, they are forcing FB to do all the heavy lifting regulatory wise which looks like it is helping clear the path for Bitcoin.

Thanks to Bitcoin’s decentralized nature, it’s starting to look more attractive to Congressmen who believe that Mark Zuckerberg is not trustworthy with Americans’ information.

Bitcoin can position itself as the more private, more trustless option to Libra and who will be more protective of your data, all things Libra will never be able to do in any form.

What are your initial thoughts on Libra?

Blockstack Gets Crypto's 1st Reg A+ Approval & Trump Tweets BTC

1st Crypto Reg A+ Approved While Trump Tweets About Bitcoin

Why Blockstack’s Offering is Such a Big Deal

Facebook Libra is still very big news in the cryptoeconomy. The last couple of weeks are mostly regulators and government officials in various countries telling them to stop or that Libra might be banned in their country. When something more concrete happens, we’ll be watching. Until then……

This week we have 2 big stories.

Reg A+ is something I’ve written about extensively on my blog P2PLendingExpert.com and most of that writing, including in my book is about the peer to peer lending world and less about cryptocurrencies. It’s known as the mini-IPO and it was part of the JOBS Act in 2012 to try to get more companies to go public by reducing the costs if they go public to raise smaller amounts of up to $50 million per year.

I’ve been curious for some time if a company in the cryptoeconomy would use Reg A+ as a way to raise money and stay compliant in the US without all the ICO/IEO/This token is a security but we are going to say it’s not nonsense that’s been going on.

And now it’s happened.

Story #1: Blockstack Gets SEC Approval for Reg A+ Offering

Blockstack’s Stacks token offering got SEC approval this week making it the first crypto project to use Reg A+ to raise funds. Blockstack is a decentralized computing network that enables the building of apps on top of it to run on their network. Here are some places you can read the announcement:

The announcement on Blockstack’s own blog gives the most detail where they will raise $28 million in cash via this offering starting July 11 (yesterday). This is the tweet announcing it from CEO Muneeb Ali.

They’ve raised money twice before: VC investment and a 2017 ICO token offering that raised $47 million under Reg D.

An additional $12 million will go into app mining, which is what they call their developer program. The combination of building of the apps and some maintenance of the network is covered in their app mining.

Reg A+ has 2 tiers and the Tier 2 offering allows them to raise up to $50 million per year. Tier 1 caps out at $20 million. To see the effect for retail investors in peer to peer lending platforms I suggest you read these 2 articles about Worthy and Streetshares.

Here is their Offering Circular, filed and approved by the SEC.

And important note in the Circular (p.2) and the first footnote is that 78 million of the Stacks voucher holders get a chance to convert their vouchers for 12c each while the general sale of the Offering is 30c each. The voucher holders are mostly those that received tokens in the 2017 ICO moving their ICO token to a compliant Reg A+ token. But if they want to buy more than their voucher then they pay the same 30c as everyone else.

One of the more interesting aspects of the Circular is footnote #3 that shows the costs.

For $40 million, they are spending $2.8 million in compliance fees. This is why more companies don’t use Reg A+.

But will Blockstack set an example of a way other crypto companies can offer securities in the US and be compliant with the SEC? No one knows but we can hope.

Save time on your crypto investment research by getting access, summaries and analysis right here for less than $2 per week. No nonsense, just news.

Story #2: President Trump Tweets About Bitcoin for the 1st Time

In what some people are calling the biggest buy signal ever created, President Trump tweeted negatively about Bitcoin for the first time yesterday in a 3 tweet thread.

The most telling part of the tweet in many people’s opinions, including mine, is this very last part where Trump states (without saying so) that Bitcoin is a threat to USD dominance as the global reserve currency. Gotta pump that Dollar.

The no real value out of thin air comment is easily refuted since the USD is only valued due to the US Government’s issuance, or as more succinctly put

Read through some of the other comments in this thread if you get a chance.

The Cryptoeconomy Responds

Here are some of my favorite responses from those in the industry. Let’s start with one of my favorite legal people in the cryptoeconomy: Caitlin Long in her own thread

She mentions in her thread about what Wyoming is doing in crypto (natch since she’s a big advocate there). Also, how crypto is the first payments innovation in decades so at the moment Government doesn’t need to choose between crypto and the USD. Use both.

and here’s Jesse Powell, CEO of exchange Kraken

Coincenter’s Communications Director Neeraj Agrawal responds with a link to an article about privacy and surveillance. Those that follow Neeraj know he likes to joke and might be the meme king of CryptoTwitter but this is clearly serious business.

Jeremy Allaire, CEO of exchange Circle

and last but not least in one of the funnier responses, it turns out that one of Trump’s hotels accepted Bitcoin as payment for the purchase of a condo way back in 2013.

So President Trump tweeting about Bitcoin does 4 things:

  1. He has 61.9 million followers that saw it as well as every news agency in the US and many in other countries. Great exposure

  2. He expressed fear of overtaking USD dominance by pumping the dollar

  3. Not to be too political but some Dems and Libertarians might buy Bitcoin just cause Trump crapped on it

  4. With his penchant for lying, some may start looking at Bitcoin just because Trump said it has no value. Others knowing he lies all the time might figure the USD is getting weaker (or will soon) and look for alternatives

What do you think this kind of exposure brings to Bitcoin and other cryptocurrencies? Hard to see how it’s anything other than good.

Are Bitcoin & Other Cryptocurrencies Money?

What Makes Money Money? Does Crypto have monetary advantages?

What Is Money?

We live in the age of fiat, government issued currency and have for decades now so it’s easy for people to be confused about what money is. The USD is not money because the government issues it, however, it is legal tender because the government says so. And right now, the government has a monopoly on what is legal tender and what isn’t.

Legal tender is important, but different from money, cause it means legal tender can be used to pay off all debts public and private and in the enforcement of contracts.

So can Bitcoin or Ethereum or Litecoin or DASH ever be money?

The Properties of Money

The reality of money is that there are 3 properties:

  1. A unit of account

  2. A medium of exchange

  3. A store of value

So how does the USD stack up as money?

  • Unit of Account- the USD is definitely a unit of account. Revenues, Expenses, Profits, Taxes, Items on store shelves in America are priced in USD.

  • Medium of Exchange- USD trades hands daily and often

  • Store of Value- here’s where we have some doubts. The Federal Reserve shoots for a monetary policy goal of 2% or less inflation per year. In other words, they are baking in a LOSS of value of 2% for you, the USD holder, every year. Maybe more in some years

How Does Bitcoin Stack Up?

One of my favorite leaders on cryptocurrencies and the law, Caitlin Long, explains in an article she wrote for Forbes Crypto about Price stability vs System stability.

She says early in this article that Bitcoin is ‘designed for systemic stability, not price stability.’ But what does that mean?

Caitlin argues that monetary systems probably cannot be both price and system stable.

The real world is not stable. Things happen. Unexpected things. But fiat currencies and stablecoins (like FB Libra will be) are designed to maintain price stability. It’s hard to pay for eggs with Currency X if it’s value keeps changing so that one day X buys 6 eggs, the next day 4 eggs and the next day 12 eggs. This is tough for people to manage. Just ask people in Venezuela, Zimbabwe or Argentina, all of whom have more than 30% annual inflation. In the case of Venezuela and Zimbabwe, it’s much, much more than 30%. People make this argument about Bitcoin too, and they have a point.

Bankers have to intervene and manipulate the currency to help keep it price stable when unexpected events like tariffs and a trade war take place. It’s a great article that you should read about how fiat systems seem stable, but are in fact fragile.

OTOH, Bitcoin is set up to be system stable. It’s security is the best and highest it’s ever been since the creation of the network. In 10 years, it’s never had a hack. The fixed supply of 21 million coins is another system stable feature. So let’s look at how Bitcoin scores on the money test.

  • Unit of Account-Bitcoin is the unit of account for the crypto-economy. With the exception of some stablecoins like Tether, nearly everyone who wants to buy an altcoin needs to have Bitcoin first and convert it. Many alts trade in relation to the BTC price.

Demelza Hays of the Crypto Research Report presents a different take on the GENTWO blog stating that both Bitcoin and Gold are too elastic to become units of account, yet too inelastic to be effective money.

What is Elasticity of Demand? Elasticity is the responsiveness of the quantity demanded when there’s a change in the price. Gas is one of the most famously inelastic goods. People need gas for their cars and machines and still buy even if the price moves up 10 cents a gallon. That’s being inelastic. Luxury goods like a Mercedes are more elastic. Some will buy a Mercedes (assuming they can afford it regardless of price), but at the margins, fewer people buy as the price increases because it’s not a necessary good.

Currencies need to be sufficiently elastic to be responsive to changes in the marketplace.

Hays argues that ‘stability of purchasing power and stability of the coin fees (for transactions) are mandatory for becoming a unit of account’ thus Bitcoin with its volatile price and changing transaction fees make it a poor unit of account.

  • Medium of Exchange- Of the 3, Bitcoin falls short the most here. People pay for things with Bitcoin or get paid in Bitcoin. I myself had a client pay me in Bitcoin a couple years ago. But payments in general, and small payments like paying for your coffee in particular are an area where Bitcoin falls short. In the regular economy, Visa and Mastercard do this great and in the cryptoeconomy, Litecoin and DASH are both more payments oriented than Bitcoin is. The Lightning Network is working on this problem too.

  • Store of Value-It’s tough to think of something where the price is so volatile as being a store of value, but Bitcoin really is a store of value. It does not correlate to traditional financial assets, yet it clearly has value on its own. The comparisons to Gold for long term value continue and I talked about the 4 year buy and hold strategy that has never failed to show a profit in a previous newsletter.

Bitcoin vs Gold

The 2 competing non-government issued monies are Gold and Bitcoin, and they are complementary assets with many Bitcoiners holding gold too. The Hays article goes into a more in-depth comparison of the two. Both are seen as inelastic, making them poor forms of money. The Hays article outlines the solutions to making gold more elastic so it’s useful as money include

  • Bimetallism-inclusion of silver, which is more elastic

  • The Real Bills doctrine-issuing bills backed by gold

  • Fractional reserve-like Central bankers around the world already do

Potential solutions to make Bitcoin’s inelastic supply of 21 million coins more elastic include

  • Altcoins especially stablecoins, whose supply is not fixed and determined by demand and the amount of assets available at any given time

  • The Lightning network, which enables smaller and micro payments. Known as a Layer 2 solution

Hays argues both are way too inelastic to be great money, but the Hal Finney Bitcoin banks argument that most adjustments would have to be Layer 2 or 3 solutions and not on the Bitcoin network itself (Layer 1) are already starting to form with the issuance of stablecoins.

What do you think? Do you think Bitcoin is a good form of money?

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