Cryptovaluation

Innovation and Cryptoventures
Cryptovaluation
Campbell R. Harvey
Duke University and NBER
January 27, 2018

Campbell R. Harvey 2018 2
Money
Purposes of money:
Primary
• Unit of Account: A way to compare the value of various goods and services
• Medium of Exchange: Allows for non-barter transactions.
Secondary
• Store of Value: Allows value to be retained – even if partially – rather than complete
decay (e.g. storing food).
• Transfer of Value: Ease of transfer of value and to defer value.
Original vision of bitcoin was for a technology that would make

transactions more efficient (the Campbell
transfer of value motive)
R. Harvey 2018 3
Acquiring Cryptocurrency
Three ways to obtain an existing cryptocurrency
• Win a block.
• Receive a gift or be paid for goods or services
• Buy on an exchange
– Currently 109 exchanges that trade bitcoin
You can also obtain cryptocurrency through an Initial Coin

Offering (ICO). New currency can also be obtained via a hard
fork.
Exchanges
https://www.coinhills.com/market/exchange/rank-for/btc /

Exchanges
Will have more to say

later about Coincheck
https://www.coinhills.com/market/exchange/rank-for/btc /

Exchanges
Beware of exchanges
• Largely unregulated. This is the reason that the SEC has blocked the
formation of ETFs based on “physical bitcoin”
• Exchange often holds your keys and they pool all the keys – acting like
a bank. In a usual crypto trade, every transaction generates a new
private key. If “off-chain”, then private keys are shifted between
owners in the exchanges’ database.
• Holding the keys invites hacking attacks.
• We have already talked about the 850,000 BTC theft of Mt. Gox
*In the future, exchanges may become more distributed.

Campbell R. An atomic
Harvey 2018 swap is a cross chain transaction. 7
https://www.cryptocompare.com/coins/guides/what-are-atomic-swaps/
Exchanges
Beware of exchanges
• There are advantages to these off chain transactions. They can be
done instantly and at every low cost (no miners no delay in writing to
a blockchain). This is what Coinbase.com does. Their exchange is
GDAX.
• Many worry that exchanges are a centralizing force
• In the future, exchanges may become more distributed. An atomic
swap is a cross chain transaction*

*https://www.cryptocompare.com/coins/guides/what-are-atomic-swaps/
Exchanges
Beware of exchanges: Bitfinex

• Approximately 10% of all bitcoin trading; registered in BVI
• History of multiple hacks. May 2015: 1,500 BTC stolen. 2016: 119,756
BTC stolen – customers forced to take a 36% haircut on deposits;
• Bitfinex does not use fiat currency wire transfers – it uses a
cryptocurrency called Tether (USDT)

Exchanges

• Tether is supposedly backed 1:1 with USD; capitalization is $1.6 billion

Exchanges

• Tether hacked in November 2017 for $30 million.
• Once you have a tether, the value is stable and you can use that on
many different exchanges to quickly trade (wire transfers could take
days)
• If you receive a tether, one dollar is deposited in your vault
https://www.coindesk.com/tether-claims-30-million-stable-token-stolen-attacker/
Exchanges

• Supply of tether has increased dramatically
https://qz.com/1149772/the-murky-relationship-between-bitfinex-and-tether-is-raising-suspicions/
Exchanges

• Tether based in British Virgin Islands
• How do we know that the dollar deposits match the outstanding
tether?
• November 21, 2017 Nathaniel Popper of NYT breaks story that
Bitfinex and Tether are operated by the same people. This was
revealed in the Paradise Papers. Why is this an issue?
https://www.nytimes.com/2017/11/21/technology/bitcoin-bitfinex-tether.html
Exchanges

• First, Bitfinex was not transparent about its relationship with Tether
• Second, read the fine print for tether
https://www.nytimes.com/2017/11/21/technology/bitcoin-bitfinex-tether.html
Exchanges

• Third, if not fully collateralized, it is possible that Bitfinex is creating
money that could artificially increase the price of cryptocurrencies like
bitcoin. “Bitfinex appears to be creating Tether coins out of thin air
and then using them to buy Bitcoin and push the price up.”
https://tether.to/wp-content/uploads/2017/09/Final-Tether-Consulting-Report-9-15-17_Redacted.pdf
15
Campbell R. Harvey 2018
Exchanges
Beware of exchanges: Bitconnect

• Begins in January 2017
• Launches with Bitconnect Coin (BCC). You needed to send bitcoin to
the exchange and they would convert it to BCC
• With the BCC, you were guaranteed “up to 120% return per year” and
users were earning interest by holding their coin for “helping maintain
the security of the network”
https://cointelegraph.com/news/bitconnect-ponzi-scheme-no-sympathy-from-crypto-community
16
Exchanges
17
Exchanges
Coin rises to $437.31
18
Exchanges
Coin rises to $437.31
19
Exchanges
Social media campaign attacks Bitconnect
20
Exchanges
Blows up January 17, 2018
21
https://twitter.com/3PSboyd/status/954140748135383040
Exchanges

• January 17, 2018 exchange closes following warnings from Texas and
North Carolina regulators. Drops 87%.
https://cointelegraph.com/news/bitconnect-closes-virtually-its-entire-operation-bcc-token-drops-87
22
Exchanges
Current price = $18
23
Exchanges
24
https://bitconnect.co/system-news/95/bitconnect-update-regarding-the-changes-to-lending-and-exchange-functions/
Cryptocurrencies: Trading
25
https://bitconnect.co/system-news/95/bitconnect-update-regarding-the-changes-to-lending-and-exchange-functions/
Exchanges
https://youtu.be/kbR1SXIje1U
26
Exchanges
https://www.reddit.com/r/Bitconnect/
27
Exchanges
28
Exchanges
29
Exchanges Only bitcoin???
(Thanks Nikhil Arun)
30
https://coincheck.com/
Exchanges
https://www.wsj.com/articles/cryptocurrency-worth-530-million-missing-from-japanese-exchange-1516988190
31
Exchanges
32
Exchanges
33
Exchanges
Mechanics of the hack

• Website says that bitcoin is held in cold storage (off line and
untouchable via the Internet – and considered safe from hacks)
• However, each exchange also has a “hot wallet”. Think of this as float.
It allows for very fast and cheap transactions
• It was the hot wallet that was exploited and the details are unclear
34
Exchanges
35
https://cointelegraph.com/news/coincheck-stolen-534-mln-nem-were-stored-on-low-security-hot-wallet
Exchanges
Mechanics of the hack (some analysis from Marc Toledo)

• Coincheck uses “smart hot wallet system” which was exploited
• Supposedly, they used a machine-learning based dynamic hot
wallet based on volumes of transactions, for easier access and
faster transactions
• Hackers gained access to the server where the keys were and
stole all the NEM via unauthorized transactions
36
Exchanges
Mechanics of the hack (some analysis from Marc Toledo)

• Speed was important. It happened in a couple of seconds. NEM is
known for being one of the fastest blockchain platforms
• Within Coincheck, everything appeared to be operating as usual
• Coincheck signaled thumbs up for 250,000+ transactions
• 8 hours later they discovered the hack
37
Exchanges
38
Exchanges
• 532m NEMs stolen

• 260,000 customers affected
• Promised to return 90% of the value
• Company has the address where the
funds went
http://www.bbc.com/news/world-asia-42850194
39
Exchanges
Heist larger than Mt. Gox which was $450 million

• NEM (coins) were lost (other cryptos were not lost)
• NEM short for New Economy Movement
• Launched in 2015 and similar to bitcoin but less energy intensive.
They use “Proof of Importance”.
40
Exchanges
Proof of Importance (PoI)

• Certain “supernodes” exist with considerable computing power
• Each account as a PoI score.
• If you account has 10,000 NEM or more and is “vested” holding that
amount of a few weeks, you can lend your PoI score to a supernode
and that increases the chance that the supernode “harvests” a block
• Harvest includes coinbase plus transaction fees
41
Exchanges
Proof of Importance (PoI)

• They argue PoW gives advantage to those that have the most
computing power – and there is an excessive amount of energy spent
• They argue PoS gives advantage of “coin hoarders” – more coins the
more you earn.
42
Exchanges
Proof of Importance (PoI) looks at three factors (see pages 34-

35 of technical document):
• PoI only counts coins that are in the account for a number of days
• 10% of the unvested, vests every day
• The higher number of vested coins the higher the PoI score
• Need a minimum of 10,000 vested coins to start harvesting
https://nem.io/wp-content/themes/nem/files/NEM_techRef.pdf
43
Exchanges
Relatively little impact on NEM price –
because the hack was not a hack of the
NEM blockchain
44
Exchanges
History of exchange hacks:

• Mt Gox 2011
• Mt Gox 2014 $350m
• NiceHash December 2017: 4700BTC
• Bitfinex $72m
• The DAO $70m
• Parity Wallet $30m
• Bitstamp $5m
https://cryptonews.com/news/coincheck-hacked-more-than-500-million-xem-stolen-1093.htm
45
Exchanges
Not all tokens associated with exchanges are fraudulent but we

always need to be aware of security.
• Supports about 50 coins
• Extremely low fees
https://en.bitcoin.it/wiki/Comparison_of_exchanges
https://techcrunch.com/2018/01/25/free-cryptocurrency-trading-app/
46
Exchanges
Announced January 24, 2018 allows trading of BTC and ETH

from Feb 2018
• No-commission stock trading app
• Buy and sell bitcoin and ethereum without any added transaction
fees. Other coins to be added.
• Not much information on security but recently they added
information.
47
Exchanges
48
Exchanges
49
Cryptoassets
Asset or Commodity or Currency or Collectible
• Asset : Asset generates or is expected to generate cash flows in the future.
• Commodity: A commodity derives its value from its use as raw material to
meet a fundamental need, whether it be energy, food or shelter. Value can
be established looking at supply and demand.
• Currency: A currency is a medium of exchange that you use to denominate
cash flow. Currencies have no cash flows and cannot be valued, but they
can be priced against other currencies.
• BTC is a currency and ETH is a commodity?

http://aswathdamodaran.blogspot.com/2017/10/the-bitcoin-boom-asset-currency.html
https://www.cnbc.com/2018/01/10/dean-of-valuation-buffett-paints-cryptocurrency-with-too-broad-a-brush.html
Cryptocurrencies: Valuation
Very challenging
• Most assets valuations are fairly narrow
• For example, to value the stock you need a forecast of future cash flows
and a sense of the risk (discount rate). There could be disagreement –
but the range of disagreement is usually narrow
• For fiat currency (which is closer to cryptos given there is no official
collateral), we usually look at the relative expected real GDP growth in
two countries and the relative expected inflation. Again, there is
disagreement but range is narrow.
• For cryptocurrency, the disagreement is extreme. Many believe the
value is zero. Others might believe the value is $1 million.
Many “theories”
• Scarcity. The idea is that just because something is scarce it must have
value. Bitcoin can be thought of as algorithmic scarcity (given the
supply of bitcoin is capped at 21 million). To me, this theory only
makes sense if there is a usefulness for the asset.

Many “theories”
• Assumes the cryptocurrency to be an asset i.e., cryptoasset
• Quantity theory of money. It is claimed that “There is a fixed supply of
tokens. As demand for the token increases, so must the price”.
However, this is problematic because it ignores the velocity.
• The key equation is MV=PQ. Let PQ be Total Transaction Volume. So
Average Network Value = (Total Transaction Value)/Velocity.
However, velocity is very high with cryptocurrencies. This high velocity
means that the Average Network Value should be small.
https://multicoin.capital/2017/12/08/understanding-token-velocity/
https://medium.com/@cburniske/why-i-like-the-term-cryptoassets-ab6b76e1ee33


Example : Simple Valuation Model of Storj
Year From Launch 2017 2018 2019

GB of Storage Available in the World Each
Year (GB) 6,444,290,465,101 8,106,917,405,097 10,198,502,095,612
Price per GB via Storj ($) 0.18 0.144 0.115
TAM for Storj ($) 1,159,972,283,718 1,167,396,106,334 1,174,867,441,415
TAM Growth 25.80% 25.80% 25.80%
%Share of market addressed by Storj 0.0001% 0.0002% 0.0003%
GB that Storj is storing each year (GB) 1,440,000.00 2,165,760.00 3,257,303.04
Amount required in Storj ($) 259,200.00 311,869.44 375,241.31
Utility value of Storj simulation
Year From Launch 2017 2018 2019
Number of new storj issued/yr 2,000,000 5,000,000 5,000,000
Number of Tokens issued 52,000,000 57,000,000 62,000,000
Consumption value ($) 0.00 0.01 0.01
https://medium.com/@cburniske/cryptoasset-valuations-ac83479ffca7
Many “theories”
• Replacement for Gold. Many similarities to gold:
– No centralized supply
– Costly to mine
– World currency
• Also, there are some advantages to cryptos:
– Easy to transport
– Cheap to store
– Not susceptible to a supply shock
• However, gold has direct usefulness (jewelry, technology, dental)
Many “theories”
• Mining cost benefit equilibrium. This mixes some of the other
theories. The idea is that people will not mine bitcoin unless it is
profitable to do so. So the cost of the marginal miner is the floor for
coin price.
• If price drops, then mining decreases as it is not worth buying a
mining machine and paying the electrical cost
• However, in contrast to gold, decreases in hash power simply cause
the difficulty to decrease (it does not impact the coinbase supply)

Many “theories”
• Bubble mentality. A bubble is an asset that has value because people
believe that it has value.
• Large speculative demand for cryptocurrencies is typical of bubble
behavior.
• “As investors join the bandwagon, they create their own truth – for a
while.” Warren Buffett
• Important. Bursting of a bubble does not necessarily take you to zero.
Consider history of bubbles like the housing bubble, tech bubble, …

Bitcoin Bubble is growing
Dotcom Bubble bursts
Housing Bubble bursts
https://www.marketwatch.com/story/heres-how-bitcoin-is-dwarfing-housing-and-dot-com-bubbles-2017-08-30
Data from Aug 2017 when Bitcoin price ($4,000) Campbell R. Harvey 2018 59
Many “theories”
• Relative value. The idea is that you fit a regression model to the price
of the crypto versus other cryptos.
• The model delivers a fitted price. If the fitted price is greater than the
market price, then the crypto is relatively “under valued”
• The key word is relative. It is possible that both are over valued or
both are undervalued

Cryptocurrencies: National
Central bankers have finally come to the realization that they must create
their own cryptocurrencies, like Fedcoin. It is obvious that “paper” money will
be a historical relic – in the near future. The advantages of a crypto are
substantial:
• Technology makes it far more difficult for criminal activity. 79% of all US currency is held in
$100 bills – yet the average person does not carry a $100 bill nor do retailers accept them.
• Crypto eliminates counterfeiting.
• Crypto allows for the efficient collection of taxes. You eliminate the “I prefer to take cash”
tax evasion. It is also straightforward to implement both a Value Added Tax (VAT) and a
Border Adjustment Tax (BAT). Efficient implementation of these types of taxes combined
with the decrease in evasion, would make it possible to substantially cut income and
corporate taxes.
Central bank cryptocurrency:
• Crypto allows for many people that are unbanked to become banked. There are
two billion unbanked in the world and, as a result, they have trouble accessing
the modern world such as internet transactions.
• Crypto eliminates all of the costs associated with printing, distributing and
securing, paper currency.
• Crypto allows monetary authorities to implement negative interest rates.
Today, negative rates are hard to implement because why would anyone buy a
bond with a negative interest rate when you can hold paper cash with a 0%
interest rate.
• Crypto retains all of the flexibility of the current system such as central banks
deciding how much currency needs to be “printed”.

Central bank cryptocurrency:

• Sweden http://www.newsbtc.com/2017/10/16/sweden-cryptocurrency-technology-cashless/
• Canada https://www.coindesk.com/bank-canada-demos-blockchain-based-digital-dollar/
• India https://economictimes.indiatimes.com/news/economy/policy/another-experiment-with-currency-rbi-is-looking-at-its-own-bitcoin/articleshow/60710700.cms
• Singapore http://www.trustnodes.com/2017/10/08/phase-two-tokenizing-singaporean-dollar-ethereum-blockchain-completed-monetary-authority-singapore
• Israel http://mashable.com/2017/12/27/israel-cryptocurrency/#rhDwvLfMuOqn
• China https://futurism.com/china-becomes-first-countrchina-becomes-first-country-in-the-world-to-test-a-national-cryptocurrencyy-to-test-national-cryptocurrency/
• Russia https://www.coindesk.com/official-russia-to-introduce-cryptocurrency-regulation-bill-next-week/

Cryptocurrencies: Digitization of Other Assets
In principle, any asset can be tokenized
• RMG is a collaboration between the Royal Mint Group and the Chicago
Mercantile Exchange
• Each RMG is backed by one gram of gold held in the Royal Mint’s vault

Cryptocurrencies: Digitization of Other Assets
In principle, any asset can be tokenized
• RMG has the volatility of gold (about 15% per annum)
• Direct competitor to an ETF – fees are lower for RMG
• Ability to hold very small quantities and use gold to pay for regular
transactions
• Why not consider other assets?
https://dinardirham.com/blog/overview-commodity-backed-blockchain
-assets/

Cryptocurrencies: Education
• Challenges: Nobel Laureate #1
DECEMBER 28, 2013, 2:35 PM
Bitcoin Is Evil
Speaking of mind-bending, economics professor Cam
Harvey of Duke University did a presentation this
Cryptocurrencies: Education afternoon on the blockchain, which is the foundation of
Bitcoin. I have been friends with Cam for many years, but
it has been an online friendship. He was the first to do
• Challenges: Nobel Laureate #2 research and analysis of the inverted yield curve, and I’ve
learned a great deal from talking and writing with him.
Cam came over when the day session finished, and we
began to talk about some aspects of blockchain
technology. Harry Markowitz, the Nobel Prize laureate
who created Modern Portfolio Theory, walked over; and
after a few minutes he began to challenge Cam on the
mathematical impossibility of what he thought Cam was
talking about. It was fascinating watching these two
genius professors talk about math and ideas, and
eventually Harry got a handle on the process Cam was
describing.
But I will confess a small pleasure at watching one of the
greatest mathematical economists of our time wrestle
with the concept of the blockchain. I have to tell you it
took me a while to get my head around the concept, too,
and it took Harry only five minutes.
• Challenges: Nobel Laureate #3

• It is important for educators to open the black box and to show

students and the general public how blockchains work

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Cryptovaluation

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Innovation and Cryptoventures

January 27, 2018

Original vision of bitcoin was for a technology that would make

You can also obtain cryptocurrency through an Initial Coin

Campbell R. Harvey 2018 5

Will have more to say

Campbell R. Harvey 2018 6

*In the future, exchanges may become more distributed.

Campbell R. Harvey 2018 8

Beware of exchanges: Bitfinex

Campbell R. Harvey 2018 9

Beware of exchanges: Bitfinex

Campbell R. Harvey 2018 10

Beware of exchanges: Bitfinex

Beware of exchanges: Bitfinex

Beware of exchanges: Bitfinex

Beware of exchanges: Bitfinex

Beware of exchanges: Bitfinex

Beware of exchanges: Bitconnect

Beware of exchanges: Bitconnect

Beware of exchanges: Bitconnect

Coin rises to $437.31

Beware of exchanges: Bitconnect

Coin rises to $437.31

Beware of exchanges: Bitconnect

Social media campaign attacks Bitconnect

Beware of exchanges: Bitconnect

Blows up January 17, 2018

Beware of exchanges: Bitconnect

Beware of exchanges: Bitconnect

Current price = $18

Beware of exchanges: Bitconnect

Beware of exchanges: Bitconnect

Beware of exchanges: Bitconnect

Beware of exchanges: Bitconnect

Mechanics of the hack

Mechanics of the hack (some analysis from Marc Toledo)

Mechanics of the hack (some analysis from Marc Toledo)

• 532m NEMs stolen

Heist larger than Mt. Gox which was $450 million

Proof of Importance (PoI)

Proof of Importance (PoI)

Proof of Importance (PoI) looks at three factors (see pages 34-

History of exchange hacks:

Not all tokens associated with exchanges are fraudulent but we

Announced January 24, 2018 allows trading of BTC and ETH

• BTC is a currency and ETH is a commodity?

Campbell R. Harvey 2018 52

Campbell R. Harvey 2018 53

Campbell R. Harvey 2018 54

Year From Launch 2017 2018 2019

Price per GB via Storj ($) 0.18 0.144 0.115

TAM for Storj ($) 1,159,972,283,718 1,167,396,106,334 1,174,867,441,415

TAM Growth 25.80% 25.80% 25.80%

%Share of market addressed by Storj 0.0001% 0.0002% 0.0003%

GB that Storj is storing each year (GB) 1,440,000.00 2,165,760.00 3,257,303.04

Amount required in Storj ($) 259,200.00 311,869.44 375,241.31

Utility value of Storj simulation

Year From Launch 2017 2018 2019

Number of new storj issued/yr 2,000,000 5,000,000 5,000,000

Number of Tokens issued 52,000,000 57,000,000 62,000,000

Consumption value ($) 0.00 0.01 0.01

Campbell R. Harvey 2018 57