Forget Cryptocurrencies, Invest In Platforms

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Includes: BITCF, BTC-USD, BTCS, COIN, GBTC
by: Lynn Sebastian Purcell

Summary

Total market capitalization for cryptocurrencies has surged 400% in just 60 days, while Bitcoin has mostly stayed flat since December.

The emerging story for 2018 is not Bitcoin; it’s everything other than Bitcoin.

This article lays out the map for the entire Alt-Coin universe. Surprisingly, there are just three kinds of ideas for the 1400+ coins in existence.

The analysis suggests an unpopular thesis: forget crypto-currencies, invest in crypto-platforms.

If the story of 2017 for the financial world turned in large part on the mainstream recognition of Bitcoin, then the story for 2018 in the cryptocurrency world has already changed focus to all the other coins, the “Alt-Coins.” This has come into focus recently with Ripple’s 1000%+ gain in the last month. While an outlier, most Alt-Coins in the top 150 have noticed gains between 300%-600% in the same period, and the total market capitalization in crytpocurrencies has surged 400% in just 60 days.

[Data Source: coinmarketcap.com]

With this picture in mind, the purpose of this essay is to give the reader something that has yet to appear here on SeekingAlpha, or anywhere else as far as I can tell, namely a roadmap to understand this jungle of ideas and technologies. It aims to explain in a coherent and succinct way just what this space looks like, and how one might think about investing (yes, really) in this space. To this end it provides a taxonomy for all cryptocurrencies, and suggests an investment are of focus. The taxonomy of the roughly 1400 “coins” presently in existence suggests there are only three types of “coins,” where these do not include unregulated (and quite dubious) securities. The investment focus may be put in a line: forget cryptocurrencies (from Bitcoin to RaiBlocks), and invest in platforms (like Ethereum). Let’s begin with the taxonomy.

[Data Source: Coinmarketcap.com]

Three Types of Coin

The terms “coin,” “token,” and “cryptocurrency” are often used interchangeably. To make the discussion that follows clearer, however, I reserve the term “coin” for the general class of technological ideas that are unique to blockchain-type technologies. I hope primarily to distinguish these, which appear as the first three ideas in the chart below, from the fourth, which is not a blockchain-type technology, but an unregulated security “gussied up” as a coin, and which might best be called a crypto-security.

Ideas

Paradigm

Other Examples

“Coins”

1. Currencies

Bitcoin (BTC)

LiteCoin (LTC), DASH, Bitcoin Cash (BCH), RaiBlocks (XRB)

2. Platforms

Ethereum (ETH)

NEO, Cardano (ADA)

3. Tokens

Ripple (XRP)

Sia Coin (SC), OmiseGo (OMG), Golem (GNT), IOTA (MIOTA)

“Cryptosecurities”

4. Securities

BitDice (CSNO)

BitDice (CSNO) is an example of a “cryptosecurity.” The company initially hoped to capture the online gambling market by enabling players to use Bitcoin (and other cryptocurrencies) to gamble on their games. Yet, since cryptocurrencies make up only 5% of online gambling, they sought to expand into traditional fiat currency gambling. To fund the technological expansion, they offered their BitDice “coin.” Owners of this coin are entitled to a proceed of net income on a regular basis, a little like a dividend, but the “coin” has nothing to do with any technology, blockchain or otherwise. Their games still run on traditional computer technology, since not all computer programs run well on blockchain. As a result, the Bitdice “coin” is effectively a security (even if the SEC has not yet decided on the matter).

This distinction is important because cryptosecurities are not required to register with the SEC, do not have the same legal status to recover losses (especially if the company is located in some place other than the United States), and imply no ownership over the equity of the company (quite unlike stocks and bonds). Moreover, because these companies are not publicly traded and registered with the SEC, they are under no obligation to file 10K or 10Q reports, disclosures about insider investments, and so on. One would be wise, then, to avoid all cryptosecurities (see the SEC’s general warning).

I reserve the term “cryptocurrency,” for coins like Bitcoin and DASH, which aim to replace existing currencies and use blockchain-like technology. This sort of idea is quite different from platforms, like the Ethereum network. Bitcoin uses blockchain technology to keep track of who owns which coin. The Ethereum network uses the coin, Ether, to power the blockchain technology as a sort of “gas.” The network itself is a global, decentralized virtual machine which runs other apps (called D’Apps because they are distributed apps). In short, a platform like the Ethereum network, is like an operating system, and while one of the D’Apps that could be run on it is a coin, almost anything else programmable could be too. There are really only three competitors for Ethereum: NEO, which is focused on China, Cardano (ADA), which is run by “academics” who implement only peer-reviewed ideas, and of course Etherum Classic, which is a forked version of the Ethereum network.

Except for the qualifications in the next section, everything else is a “token,” which is to say a blockchain-like technology focused on a specific idea. Ripple (XRP) is a paradigm case. Though not built on the Ethereum network, as most other tokens are, Ripple enables banks to send money internationally cheaply and quickly (within seconds), rather than waiting days for bank clearance (as has been the case with traditional transfers). The technology, moreover, can be “plopped” on top of the software infrastructure that most banks already use. While one might be tempted, then, to think of Ripple as a coin, its was a technology developed with a specific aim in mind: to solve a problem banks faced transferring money internationally with blockchain technology. This is the hallmark of a toke: it is a specific use case of blockchain technology for an existing problem.

Other examples of tokens include SiaCoin (NYSE:SC), which uses blockchain technology to offer cloud storage services as a fraction of the cost of Amazon Web Services, Golem (GNT), which uses the advantages of distributed computing and blockchain to offer supercomputing services, and OmiseGo (OMG), which is a decentralized financial exchange (and payment service as a result). These tokens are legion, and make up the bulk of the coin universe.

Qualifications

My hope is that the above will prove useful in simplifying the jungle of alt-coins. Yet, any classificatory scheme needs qualifications so as not to mislead. To my mind there are two such principle qualifications.

A first concerns the (unhappy) phrase: “blockchain-like technology.” I have been writing “blockchain-like technology” because IOTA does not use blockchain, but instead uses the tangle (based on different mathematical principles, specifically directed acyclic graphs). A transaction is verified in this system when enough other transactions have gone through, so that it is caught up in the “tangle” of transactions. RaiBlocks (XRB) also uses directed acyclic graphs, but it verifies through (delegated) proof of stake. It is still a blockchain technology, then, but a rather different sort, which might be consider a hybrid. In any case, not all coins use blockchain technology, and recognizing technological innovations is crucial for understanding whether a new competitor is likely to oust a seated favorite.

[Image Source: Public Domain]

The second qualification concerns the possible class of coins that Venezuela’s proposed Petro represents. While details on the coin remain sparse, it does look as though Venezuela is planning to use blockchain technology to secure the leger for their proposed Petro. What is distinctive about this proposal is that the value of each Petro is to be indexed to the value of a barrel of oil in Venezuela’s oil fields. This would qualify, then, as a kind of currency coin under the present scheme. The additional advantage it looks to solve is volatility of price. While the price of oil moves rather more quickly that the world’s reserve currencies, e.g., the US Dollar, it certainly moves less quickly than Bitcoin or any other proposed cryptocurrency. This hybrid between cryptocurrency and a sovereign commodity might thus turn out to be just what is needed for a viable cryptocurrency (assuming they develop the technology correctly).

What this Means for Investing

Cryptocurrencies are entering the phase of mass adoption, and while I doubt that Bitcoin will fare poorly, given the established institutional support it has (by way of futures, exchange integration, even possible leveraged ETFs), 2018 is likely to see the largest gains in the Alt-Coin universe. Among the possibilities, the conceptual scheme already indicates where an investor should concentrate their focus: platforms.

Of the three sorts of coins, cryptocurrencies, like Bitcoin, take last place because they face an uncertain future. Even if Bitcoin were to fix its technological problems related to scale next week, so that it had low fees and could process as many transactions a second as Visa (about 1500), it would still be a poor currency because it would be too volatile to function as a currency (see: Forget Bitcoin, Buy Ether). What holds for this hypothetical Bitcoin holds for any related proposal, from LiteCoin to RaiBlocks (though perhaps not the Petro as noted). To outcompete fiat currencies, cryptocurrencies need to have lower fees AND roughly equivalent volatility. Presently, the only real advantages they have is with international transfers and the desire for anonymity, the last of which will face increasing headwinds from legal bodies.

Individual tokens, like Ripple, are likely to do well if they provide real solutions to real problems, and so as a group take second place. Not every technological problem is better solved on blockchain technology, as not all of them need a trustless, immutable ledger. But for the cases that do, and Ripple is certainly one, an investment in these technologies is in principle sound. As a group, I think that tokens are like to appreciate the most over 2018, but this is simply because there are so many of them.

Platforms, to my mind, take the top spot for long-term growth. The reason is obvious: they support the other tokens and cryptocurrencies and so have the status of operating systems rather than individual programs. The largest and by far the most dominant of these is Ether, and while I am enthusiastic about Cardano as a technology, the coin is still in its early developmental stages.

An interesting possible entry point is that the Ethereum Network is incorporating other coins as part of its “second layer.” This is to say that the Network is technologically dependent on them for its own operation, so that it will include not only Ether, but also RaidenNetwork and OmiseGo among other possible coins. This is somewhat Microsoft’s use of its platform dominance (Windows) to push some specific technologies into prominence, including the Office Suit and (for quite some time) Explorer. To continue the analogy, imagine that it is the late 1990s and you had the ability to buy into Microsoft Office as an independent company, knowing that it would be pushed to every user by Microsoft’s dominance. This is roughly the situation with the RaidenNetwork and OmiseGo. One way to buy into the future of Ethereum, then, might be to pick up a few of these related coins.

That’s it. Those are the reasons why you should forget cryptocurrencies, and buy platforms or at least look at tokens instead. Until a really good idea emerges that solves the volatility problem for cryptocurrencies, one should look to someplace other than Bitcoin for 2018.

I look forward to your comments as always!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own or trade basically everything mentioned. Of what was mentioned, at the time of writing, I own Bitcoin, Ripple, Ether, Neo, RiaBlocks, OmiseGo, Binance Coin, RaidenNetwork, and Enji Coin.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.