1. Duke University and NBER
Innovation and Cryptoventures
Cryptovaluation
Campbell R. Harvey
Duke University and NBER
February 1, 2018

2. Campbell R. Harvey 2018

3. 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 transfer of value motive) [B]
Campbell R. Harvey 2018

4. 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. [Section A]
Campbell R. Harvey 2018

5. Exchanges https://www.coinhills.com/market/exchange/rank-for/btc/
Campbell R. Harvey 2018

6. Exchanges Will have more to say later about Coincheck
Campbell R. Harvey 2018

7. 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. An atomic swap is a cross chain transaction.
Campbell R. Harvey 2018

8. 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*
Campbell R. Harvey 2018 *

9. Exchanges Beware of exchanges: Bitfinex
Approximately 10% of all bitcoin trading; registered in BVI
History of multiple hacks. May 2015: 1,500 BTC stolen : 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)
Campbell R. Harvey 2018

10. Exchanges Beware of exchanges: Bitfinex
Tether is supposedly backed 1:1 with USD; capitalization is $1.6 billion
Campbell R. Harvey 2018

11. Exchanges Beware of exchanges: Bitfinex
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
Campbell R. Harvey 2018

12. Exchanges Beware of exchanges: Bitfinex
Supply of tether has increased dramatically
Campbell R. Harvey 2018

13. Exchanges Beware of exchanges: Bitfinex
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?
Campbell R. Harvey 2018

14. Exchanges Beware of exchanges: Bitfinex
First, Bitfinex was not transparent about its relationship with Tether
Second, read the fine print for tether
Campbell R. Harvey 2018

15. Exchanges Beware of exchanges: Bitfinex
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.”
Campbell R. Harvey 2018

16. Exchanges
Campbell R. Harvey 2018

17. 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”
Campbell R. Harvey 2018

18. Exchanges
Beware of exchanges: Bitconnect
Campbell R. Harvey 2018

19. Exchanges Beware of exchanges: Bitconnect Coin rises to $437.31
Campbell R. Harvey 2018

20. Exchanges Beware of exchanges: Bitconnect Coin rises to $437.31
Campbell R. Harvey 2018

21. Exchanges Beware of exchanges: Bitconnect
Social media campaign attacks Bitconnect
Campbell R. Harvey 2018

22. Exchanges Beware of exchanges: Bitconnect Blows up January 17, 2018
Campbell R. Harvey 2018

23. Exchanges Beware of exchanges: Bitconnect
January 17, 2018 exchange closes following warnings from Texas and North Carolina regulators. Drops 87%.
Campbell R. Harvey 2018

24. Exchanges Beware of exchanges: Bitconnect Current price = $18
Campbell R. Harvey 2018

25. Exchanges Beware of exchanges: Bitconnect Note
Campbell R. Harvey 2018

26. Cryptocurrencies: Trading
Beware of exchanges: Bitconnect
Campbell R. Harvey 2018

27. Exchanges Beware of exchanges: Bitconnect https://youtu.be/kbR1SXIje1U
Campbell R. Harvey 2018

28. Exchanges Beware of exchanges: Bitconnect
Campbell R. Harvey 2018

29. 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
Campbell R. Harvey 2018

30. 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
Campbell R. Harvey 2018

31. 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.
Campbell R. Harvey 2018

32. Exchanges
Campbell R. Harvey 2018

33. Exchanges
Campbell R. Harvey 2018

34. Cryptoassets Asset or Commodity or Currency or Collectible?
Asset : Asset produces or is expected to generate cash flows in the future (bonds, stocks, options)
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.
Collectible: No cash flow and is not a medium of exchange but could have aesthetic value of value due to emotional attachment (painting or baseball card)
BTC is a currency and ETH is a commodity?
Description from Aswath Damodaran, Finance and Valuations professor at NYU Stern School of Business

35. 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.
Campbell R. Harvey 2018

36. Cryptocurrencies: Valuation
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.
Campbell R. Harvey 2018

37. Cryptocurrencies: Valuation
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.
Chris Burniskie treats Cryptocurrencies at Crypto-assets
Campbell R. Harvey 2018

38. Cryptocurrencies: Valuation
Chris Burniske, partner at crypto asset venture capital firm Placeholder Ventures, who just came out with a book, "Cryptoassets: The Innovative Investor's Guide To Bitcoin And Beyond,"
Burniske previously worked at ARK Investment Management, which was the first public fund manager to invest in one of the only securities to offer exposure to Bitcoin, the Bitcoin Investment Trust in September 2015 and put GBTC, the Bitcoin Investment Trust, into two of ARK’s ETFs
Campbell R. Harvey 2018

39. 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%
%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 ($)
259,200.00
311,869.44
375,241.31
Utility value of Storj simulation
Number of new Storj issued/yr
2,000,000
5,000,000
Number of Tokens issued
52,000,000
57,000,000
62,000,000
Consumption value ($)
0.00
0.01
StorJ is platform that provisions users HDD to store data
By estimating Total Addressable Market for Data Storage and assuming Storj’s market penetration (Blue Cell), we estimate dollar of Storj required and given the Storj token in circulation , we arrive at a Consumption value for the token.
Once we Discount the future Consumption value, we can arrive at a Net Present Value and compare it against the current market Speculative value
The market penetration assumption is crucial. This is completely simplistic model for the purposes of the class. An example of a complete model can be found here :

40. Cryptocurrencies: Valuation
Add discussion of convenience yield
Campbell R. Harvey 2018

41. Cryptocurrencies: Valuation
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)
Campbell R. Harvey 2018

42. Cryptocurrencies: Valuation
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)
Campbell R. Harvey 2018

43. Cryptocurrencies: Valuation
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, … [A]
Campbell R. Harvey 2018

44. Data from August 2017 when Bitcoin price ($4,000)
Bitcoin Bubble is growing
Dotcom Bubble bursts
Housing Bubble bursts
Bitcoin bubble is much bigger than any we have seen
In 2016, 54% of Coinbase users were “holding” not using it to transact
Figure (6)
Data from August 2017 when Bitcoin price ($4,000)
Campbell R. Harvey 2018

45. Cryptocurrencies: Valuation
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
However, in a long-short strategy, you are only concerned with relative not absolute value
Campbell R. Harvey 2018

46. Cryptocurrencies: Valuation
Example trading strategy:
Gather daily (same time of day) data on top 10 cryptos say from This will be more than 10 because the group changes. I will call the cryptos C1-C10
Using a rolling 365 day regression, estimate
C1t = a + bC2t + … + jC10t + et (Jan Dec )
For the last observation, get the fitted value for C1t, call it E(C1t=365).  Calculate the percentage gap [E(C1t=365)- C1t=365]/C1t=365
Campbell R. Harvey 2018

47. Cryptocurrencies: Valuation
Example trading strategy:
Repeat the exercise for each of the 10, i.e.
C2t = a + bC1t + cC3t … + jC10t + et
Now at 365 you sort the percentage deviations. Go long the 4 highest and short the 4 lowest. This portfolio would be for January 1, 2015.
Move one day ahead and reestimate everything.
Consider variations like just going long the cryptos with positive deviations.
Campbell R. Harvey 2018

48. 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.
Campbell R. Harvey 2018

49. Cryptocurrencies: National
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”.
Campbell R. Harvey 2018

50. Cryptocurrencies: National
Venezuela's cryptocurrency will launch within days and be backed by 5.3 billion barrels of oil worth $267 billion
The launch is a bid to offset a deep financial crisis, the socialist government said on Thursday
Campbell R. Harvey 2018

51. Cryptocurrencies: National
Central bank cryptocurrency:
Sweden
Canada
India
Singapore
Israel
China
Russia
Campbell R. Harvey 2018

52. Cryptocurrencies: National
Campbell R. Harvey 2018

53. 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
Campbell R. Harvey 2018

54. 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?
Campbell R. Harvey 2018

55. Cryptocurrencies: Education
Challenges: Nobel Laureate #1
DECEMBER 28, 2013, 2:35 PM 
Bitcoin Is Evil
Campbell R. Harvey 2018

56. Cryptocurrencies: Education
Speaking of mind-bending, economics professor Cam Harvey of Duke University did a presentation this 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 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.
Cryptocurrencies: Education
Challenges: Nobel Laureate #2
Campbell R. Harvey 2018

57. Cryptocurrencies: Education
Challenges: Nobel Laureate #3
Campbell R. Harvey 2018

58. Cryptocurrencies: Education
It is important for educators to open the black box and to show students and the general public how blockchains work
Campbell R. Harvey 2018