1. Duke University and NBER
Innovation and Cryptoventures
Cryptovaluation
Campbell R. Harvey
Duke University and NBER
Campbell R. Harvey 2019

2. Campbell R. Harvey 2019

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 2019

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.
Campbell R. Harvey 2019

5. Exchanges Campbell R. Harvey 2019

6. Exchanges Will have more to say later about Coincheck
Campbell R. Harvey 2019

7. Example Begins in January 2017
Launches with Bitconnect Coin (BCC). You needed to send bitcoin to their 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 2019

8. Example
Campbell R. Harvey 2019

9. Example
Coin rises to $437.31
Campbell R. Harvey 2019

10. Example
Coin rises to $437.31
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11. Example
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12. Example
January 17, 2018 exchange closes following warnings from Texas and North Carolina regulators. Drops 87% to about $30.
Campbell R. Harvey 2019

13. Example
Note
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14. Example

15. Exchanges
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16. Exchanges
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17. Exchanges Only bitcoin??? https://coincheck.com/
Campbell R. Harvey 2019

18. Exchanges
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19. Exchanges
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20. Exchanges
Campbell R. Harvey 2019

21. 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
Campbell R. Harvey 2019

22. Exchanges
Campbell R. Harvey 2019

23. Exchanges Mechanics of the hack
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
Campbell R. Harvey 2019

24. Exchanges Mechanics of the hack (some analysis from Marc Toledo)
Speed was important. It happened in a couple of minutes. 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
Campbell R. Harvey 2019

25. Exchanges
Campbell R. Harvey 2019

26. Exchanges
Analysis
They tested at 10:02:13 on January 25 and got 10 XEM to destination account NC4C.
They then moved 523,000,000 in 7 transactions from 10:04:56 to 10:21:14 to NC4C.
They then start moving to other addresses.
From 12:57 to 13:29, they do  8 transactions moving the 532,000,000 to different addresses.
There are then seven transactions from 13:35 to 6:37 (next day) that appear to be other funds that they have that moved to the original destination of the hack the NC4C 3,800,000.
At 9:42 on the 26th, they move 300,000 from the original NC4C to another address. There is are a bunch of dust transactions too. The NC4C account still must have (at least) 3,500,000 in it.
Campbell R. Harvey 2019

27. Exchanges 523m NEMs stolen 260,000 customers affected
Promised to return 90% of the value
Company has the address where the funds went
Campbell R. Harvey 2019

28. Exchanges
Campbell R. Harvey 2019

29. 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; Coin is XEM
Launched in 2015 and similar to bitcoin but less energy intensive. They use “Proof of Importance”.
Campbell R. Harvey 2019

30. 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
Campbell R. Harvey 2019

31. 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.
Campbell R. Harvey 2019

32. Exchanges
Proof of Importance (PoI) looks at three factors (see pages 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
Campbell R. Harvey 2019

33. Exchanges POW POS POI (“POW+POI”) Definition
POW
POS
POI (“POW+POI”)
Definition
Algorithm rewards mining power.
The more coins you hold, the more mining power you are allowed to do.
Algorithm rewards based on number of coins hold, but also based on loyalty and effort
Reward system
First to find a solution, wins.
Network fees (“new block winner” is chosen deterministically).
Network fees (each operation earns you a fraction of currency)
Pros
Fair and competitive. Centralized powers unable to gain too much voting power.
Much more energy efficient.
Incentivizes users who do not only hold currency, but “contribute” by creating transactions, compensating those who interact with “reputable” counterparts.
Cons
Expensive to enter the game (many players, incredible amount of power invested on the system). More of a lottery than a race.
Rich becomes richer faster (risk of monopoly and centralization of power). ?
Currencies using it
Bitcoin, Ethereum (POS soon), Litecoin.
DASH, NEO, PIVX, Nxt, Lisk.
XEM.
Campbell R. Harvey 2019
Created by Marc Toledo

34. Exchanges
Even though NEM blockchain not hacked, lack of confidence leads collapse of coin value
Campbell R. Harvey 2019

35. Exchanges History of exchange hacks: Mt Gox 2011 Mt Gox 2014 $350m
NiceHash Dec. 2017: 4,700BTC
Bitfinex $72m
The DAO $70m
Parity Wallet $30m
Bitstamp $5m
Campbell R. Harvey 2019

36. 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
Campbell R. Harvey 2019

37. 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 2019

38. 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 2019

39. 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 2019

40. 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 2019

41. 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 :
Campbell R. Harvey 2019

42. Cryptocurrencies: Valuation
Convenience yield
Campbell R. Harvey 2019

43. 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 2019

44. 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 2019

45. 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, …
Campbell R. Harvey 2019

46. 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 2019