- The crypto environment is going to need some level of privacy if cryptocurrencies are to become ubiquitous.
- Electric Coin Company has updated the roadmap for Zcash, aims to position as a Web 3 asset.
- Grayscale offers the easiest tax-advantaged exposure to Zcash through shares of ZCSH.
"I think we're entering an era where there's going to be a competition of monies. Because of the printing of fiat money and the depreciated value. There will be a competition of money and Bitcoin is part of that competition but they're will be many monies."
That was famed investor and asset manager Ray Dalio during his recent appearance on the Lex Fridman podcast. I happen to share this view with Ray and it's why I've covered numerous different cryptocurrencies on Seeking Alpha. I take the view that one of the core use cases for just about any cryptocurrency should be as a medium of exchange. Because of that, I see potential competition for Bitcoin (BTC-USD) when it comes to on-chain transactions. Now, I know crypto can be an unnecessarily dogmatic discussion for some, and that's just not how I view the space. I like Bitcoin. I have more of it than any other crypto asset. But I do like other assets as well. And Zcash (ZEC-USD) is the one that I'm, frankly, the most excited about at this time. In this article, I'll detail why I see a need for Zcash and why I think Grayscale's Zcash Trust (OTC:ZCSH) is an option to get exposure to the idea.
What is Zcash?
Zcash is a cryptocurrency founded by cyber security expert Zooko Wilcox-O'Hearn. Zooko is considered to be a Cypherpunk and previously worked for DigiCash. As far as cryptocurrency founders go, Zcash has a hall of famer on the mound.
The currency utilizes a zero-proof blockchain technology called zk-SNARK which is an acronym for “Zero-Knowledge Succinct Non-Interactive Argument of Knowledge.” What zero-knowledge proofs enable is information verification without revealing everything in the transaction. This zk-SNARK cryptography makes it possible to transact over the blockchain network without revealing the sender or recipient of the funds.
The Zcash network allows for transparent wallets or shielded wallets. They are entirely compatible and up to the user's discretion. Zcash wallets have the ability to transact between transparent addresses, from a transparent address to a shielded address, from a shielded address to a transparent address, or between shielded addresses for full privacy.
Why Should We Care About Privacy?
On a recent podcast episode with Lex Fridman, Ray Dalio was talking about his views on Bitcoin. He made headlines for suggesting that Bitcoin won't reach $1 million per coin. While that's certainly a justifiable opinion in my view, I found Dalio's Bitcoin and gold comparison to be more interesting. The reason why Dalio chooses gold:
"Gold is still my favorite because of certain qualities. For example, you can't trace it. In Bitcoin, you can trace who owns it, where it's going, and so on."
Privacy is freedom, pure and simple. Ray Dalio sees the issue with Bitcoin as a medium of exchange or as a store of wealth if one values privacy. I remember the days when the narrative around Bitcoin was that it was just for criminals to buy drugs and guns on Silk Road. We know better now. People can use Bitcoin for remittances and cross-border settlements. It doesn't mean those who are doing those transactions are criminals. The same logic applies for Zcash. People who want to shield their payment activity aren't guilty of a crime simply because they don't want the whole world to know what they're doing.
Here's an analog to hammer home the point; a few days ago I went to the grocery store to buy a couple of things that we needed in the house. Because of our rewards membership with this grocery store, my wife got an email with a digital receipt after I used our card. She knew what I bought and how much I had spent nearly instantly. What if I was trying to surprise her with a gift and forgot that my entire visit would be tracked? She'd have found out and the surprise would have been ruined. Was I doing something nefarious? No. But privacy would have been crucial regardless. Now pretend that this rewards platform isn't in a walled garden, but it's actually on a public blockchain and everything I buy can be easily tracked by anyone with a basic block explorer. That's a serious problem.
Now take it a step further. Think about the notion that people could be paid their salary in cryptocurrency. Or a business that is working on a confidential product could be buying materials from a distributor or a semiconductor in cryptocurrency. If on-chain cryptocurrency exchange is to truly become ubiquitous, there is going to have to be some level of privacy for businesses and users. While some might say there are protocols like Tornado or Blank that figure to address the traceability issue, I'd say keeping as many parties out of the loop as possible is the better way to keep secrets and to avoid accidents.
Privacy Coins Have Not Performed Well Historically
On my own site, I shared some details about why I like Zcash specifically over privacy coin competitors like Dash (DASH-USD) or Monero (XMR-USD). I won't get into it again here. Despite my assumed fundamental reasons for privacy coin adoption, none of the leading privacy coin projects have done very well compared to Bitcoin in the last three years.
Source: Seeking Alpha
However, when we shorten the view to just the one-year performance, we see that Zcash has been getting its footing a little bit against the comps.
Source: Seeking Alpha
In 2021, not only did Zcash outperform the two biggest privacy coin competitors, but it also outperformed Bitcoin.
Electric Coin Company, which is also led by Zooko Wilcox-O'Hearn, has taken the developmental lead on Zcash. Last month, Electric Coin Company provided an updated roadmap for its flagship crypto. The company announced the development of an official wallet and adoption campaigns. In my mind, maybe the biggest planned change for Zcash is a move away from Proof of Work to a Proof of Stake consensus. If this sounds familiar, it's what Ethereum (ETH-USD) is doing with ETH 2.0.
Electric Coin Company is trying to position ZEC as a Web 3 asset. From the roadmap announcement:
"The next generation of the internet, colloquially Web 3, is upon us. In this new internet, each individual is self-sovereign. There are no centralized gatekeepers to decide who can participate. There are no king-makers who determine who wins and who loses."
Without getting into the philosophical, I'll just say that my broad social views align very well with this assessment of what Web 3 can provide the world.
The market reaction to the November roadmap update was wildly positive as evidenced by the rally from $150 on November 19th to over $300 just six days later. That rally unraveled just as quickly as it began and we now find ZEC lower than where it was when the roadmap was announced.
I think that market behavior is ludicrous based on the fundamental use case ZEC is attempting to provide the crypto investor. As of article submission, ZEC is hanging on to the 200-day moving average for dear life. I believe the market may want to test the 500-day moving average before deciding the long-term direction. That could put ZEC near $120-125 before turning higher.
Much has been said about the prospects for a spot Bitcoin ETF. While I'm very much in the camp that there should be a spot ETF, I don't think it's totally necessary for wider adoption of Bitcoin as an investment asset. There are numerous ways to buy Bitcoin in a tax-advantaged investment account already. If you want exposure that aims to track closely with the price, you can look to either the Grayscale Bitcoin Trust (OTC:GBTC) or Osprey Bitcoin Trust (OTCPK:OBTC). There are also companies that serve as tremendous proxies for the price of Bitcoin. Some examples would be Coinbase (COIN), MicroStrategy (MSTR), or Silvergate Capital (SI).
Despite how easy it is to get tax-advantaged Bitcoin exposure either through trust shares or crypto-focused equities, the same can't necessarily be said for all cryptocurrencies. Getting exposure to Zcash with those same tax protections on potential gains isn't nearly as straightforward. In my view, Grayscale's Zcash Trust is the easiest way to do it. Going long the trust shares allows an investor to move in and out of the asset in a tax-advantaged account without opening a crypto-specific IRA through a company like Regal Assets or Coin IRA (not an endorsement of either).
Like most of Grayscale's tradeable funds, ZCSH trades at discount to net asset value (NAV). However, when we compare the price to NAV between ZCSH and the other funds under Grayscale's management we see a slightly different story for ZCSH.
Source: Grayscale, pricing as of 4pm 12/31/21
The market is offering a much smaller discount on ZCSH than some of Grayscale's other assets. To me, this actually could mean ZCSH is about to underperform the underlying asset temporarily as it has hit discount lows similar to GBTC in the past.
Source: author generated graphic, data from Grayscale
We don't have a whole lot of premium/discount data for ZCSH shares because the fund started trading in October. While trading at a premium to NAV has generally been short-lived for ZCSH, we can see that when the discount gets to 20%, the gap generally closes quickly. When we eliminate the first three days of ZCSH trading as extreme outliers, the average discount to NAV for ZCSH shares has been 8.1%.
How Much Does Grayscale Own?
Grayscale now has nine investment funds tradable over the counter. While they have a large-cap fund that has exposure to several different assets, most of Grayscale's trusts are single asset funds. We can divide the AUM of ZCSH with the coin's total market cap to get a sense of Grayscale's client commitment to the currency.
|Fund||Symbol||AUM||Coin Market Cap||Grayscale Owns|
Source: Grayscale, pricing as of 4pm 12/31/21
While Ethereum Classic (ETC-USD) is a clear standout for Grayscale's ownership, largely because Grayscale has a development motivation, Grayscale's Zcash under custody is right in line with Ethereum. To me, this shows solid investment demand from Grayscale's clients. Coupled with ZCSH's pricing to NAV story, I believe the cryptocurrency investment community sees Grayscale as a viable way to get exposure to ZEC. So long as Zcash performs, ZCSH shares should perform as well.
Management fees and pricing to NAV aside, the biggest issue that some have with Grayscale funds is the fact that you can't take delivery of the underlying. This is something that I have struggled with regarding Grayscale since I started covering the company's funds. But I view it as a necessary trade-off to get price exposure to the assets that I want to buy and trade without creating a taxable event on each sale. Crypto as an asset class is already volatile. Risks include custodial hacks, regulation concerns, and declines in investment demand. These aren't the kinds of things to bet the mortgage on.
An additional risk with any Grayscale fund is the ending of lockup periods. In the case of ZCSH, the fund isn't currently reporting to the SEC. That means the lockup period on private placement for ZCSH is 12 months according to Rule 144.
Source: author generated graphic, data from Grayscale
There could potentially be some pressure on ZCSH shares between now and the end of March if holders of private placement shares decide to make those shares available. With a share price that has more than doubled in the last 12 months, private placement investors may look to lock in gains even at a greater discount to NAV. The question is will that discount look more like the discounts in Grayscale's Bitcoin, Bitcoin Cash (BCH-USD), and Litecoin (LTC-USD) funds or will it look like the discount in Ethereum. And will that discount be priced against a higher ZEC valuation or a lower one?
Cryptocurrency as an investment is polarizing. And even in the cryptocurrency community, privacy coins add another level of disagreement. It's an incredible debate, to be honest. I'm of the opinion that Zcash is one of the more risky cryptocurrencies. I'm also of the opinion that the upside in Zcash is substantially higher than many of the more popular digital assets and tokens. Finally, I believe that true adoption of cryptocurrencies as a peer-to-peer and business-to-business payment vehicle will require an asset with built-in privacy. I think Zcash solves the privacy problem and shares of ZCSH will do very well down the line. Picking my spots, I've scaled up my ZCSH position over the last two weeks. My average is $11.71 per share. And I'll be adding on dips when they come.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of ZCSH, ZEC-USD either through stock ownership, options, or other derivatives. 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.
I am not an investment professional or a tax advisor. Please do your own research.
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