crypto- · 7/16/2018 · off-chain projects. ethereum’s erc-20 protocol is the most well-known,...

Cryptocurrencies have intrinsic valuePotential of USD5,600bn+As we continue our journey of investigating endless number of crypto-currencies, Coinone believes certain cryptos clearly have intrinsic value. In this initiation report, we focus on two main groups: payment tokens and consumption tokens. Payment tokens including BTC show the potential to penetrate a USD5,300bn+ market under different scenarios as it replaces certain fiat currencies, in our view. Meanwhile, in case of ETH which is a platform blockchain within the consumption token group, we attempt to assess it by comparing it to the cloud computing market and also try a pricing exercise viewing it as a simple tangible computer. As a result, we see the platform blockchain market possibly tapping a USD300bn+ level market.

Three magical questions to assess existence of intrinsic valueAfter reviewing the technological feasibility of a specific blockchain project, we ask three questions to assess the existence of intrinsic value in the associated crypto. First, is there a reason to own the crypto regardless of the existence of a crypto exchange? Second, does the value of the crypto increase proportionally with its associated platform’s usage? Third, is there additional utility to becoming a major holder of the crypto? If the investor can answer “yes” to all three, the crypto most likely has intrinsic value and the next step is to develop a valuation methodology and analyze the market size.

Four functions of money is an overkill: Bitcoin leading the payment hordePayment tokens may be looking at a market sized anywhere between 0 to USD5,352bn. The bear case is that the market loses faith due to different events and prices drop to 0. On the other hand, the USD5,352bn figure is the size of fiat currencies which may be replaced. The opposition mainly argues that these cryptos do not satisfy the four functions of money. We agree. But our interest is on fiats which do not fulfill the four functions themselves. We see the possibility of payment cryptocurrencies becoming a strong alternative to countries operating an imperfect fiat currency.

How much is this computer worth: Consumption tokens with Ethereum at the helmThe opportunity of platform blockchains, a part of the consumption token group led by Ethereum, may be in the range of 0 to USD302bn. These projects may penetrate the IaaS cloud computing market considering its striking similarities, in our view. What makes platform blockchains further intriguing is the potential to apply existing equity valuation methods. If we view platform blockchains simply as a powerful computer as Ethereum argues, then we can ask “how much is this computer worth?”. To calculate the price, we need to understand the economic benefit of possessing it. First we derive estimated revenues and costs to land at a profit number. For Ethereum, the equivalent of revenues are tx fees and block rewards while costs include hardware, utility, etc..

DISCLAIMER | Coinone does not take any responsibility for any investment done in accordance with the contents of this report.All opinions expressed in this report are the personal opinion of the authors and are provided without external influence or interference. Under all circumstances, this report cannot be adopted as a legal evidence of investment results. Copyright of this report belongs to Coinone. Neither this document nor any copy thereof may be taken or rented or redistributed, directly or indirectly, without prior written permission of Coinone.

1CRYPTOCURRENCY2018/07/16 COINONE RESEARCH

DATE

16 JUL 2018COIN CATEGORY

CRYPTO-CURRENCYMENTIONED COINS

BITCOIN TICKER BTC

ETHEREUM TICKER ETH

PURPOSE

COVERAGE INITIATIONRESEARCH ANALYST

Dan Kong CAIA Riley Na

[email protected]

MARKET PRICE & CCDEX

BTCUSD $6,263.62KRW ₩7,040,370 JPY ¥705,719CCDEX 1932.85

*As of 13 Jul 2018

ETHUSD $438.55 KRW ₩492,934 JPY ¥49,411CCDEX 1932.85

*As of 13 Jul 2018

CRYPTOCURRENCY 22018/07/16 COINONE RESEARCH

Cryptocurrencies have intrinsic valueThe foundation of the argument on the utility of cryptocurrencies lies in the existence of intrinsic value. In the process of assessing numerous projects, we ask projects three questions to set our view on this debate. First, is there a reason to own the crypto regardless of the existence of a crypto exchange? Second, does the value of the crypto increase proportionally with its associated platform’s usage? Third, is there additional utility to becoming a major holder of the crypto? Also, we classify each crypto into three different categories by analyzing the answers: payment, consumption, and security tokens.

Is there a reason to own the crypto regardless of the existence ofa crypto exchange?The crypto of interest requires a clear usage even if crypto exchanges seize to exist in order to have intrinsic value. In other words, the associated ecosystem must be able to generate bidirectional flow of the crypto between consumers/investors and the issuing party even without a crypto exchange.

Crypto value flow of a successful project Crypto value flow of an unsuccessful project

Source: Coinone Research Source: Coinone Research

We first go through a successful ecosystem. Consumers/investors will receive crypto in return for utilizing the blockchain platform, and will use the crypto to purchase goods and services in the same ecosystem while buying more crypto from exchanges when needed. In case of the platform, it will buy from exchanges if there is insufficient balance to reward usage. While the best scenario would be to minimize the role of exchanges through perfect supply-demand forecasting, this is an unrealistic assumption.

Meanwhile, crypto selling to exchanges will be minimal by both consumers/investors and the platform. The only reason to sell for fiat will be for some amount of speculation and platform maintenance reasons. Successful projects like this tend to be well decentralized smart contract platforms, those which connect a decentralized supply of goods and services to a decentralized demand source, and universally accepted payment tokens.

On the other hand, unsuccessful cryptocurrency projects are those which provide insufficient options for consumers/investors to spend crypto for


valuable goods and services. This situation inevitably leads to both consumers/investors and the platform itself mainly only selling to exchanges. Many reverse ICOs inherently have this problem, in our view.

Does the value of the crypto increase proportionally with its associated platform’s usage?The value of the crypto under review must proportionally increase as its native platform’s usage grows in order to be a viable investment vehicle. This is easily understood from a price curve perspective.

Cryptocurrency price curve

Source: Coinone Research

Setting the X-axis as the cryptocurrency’s demand and Y-axis as the associated platform’s usage, it is obvious that the two must have a close relation. The steeper the price curve, the more appropriate the project is to instead utilize a private blockchain and remove the cryptocurrency aspect. As the slope flattens, the investor should look at the offering with a skeptical eye.

Is there additional utility to becoming a major holder of the crypto?From the standpoint of equity, this question is equivalent to what the additional value of becoming a “major shareholder” is. Also, it allows investors to determine how much ownership, when given unlimited capital, would maximize the investment’s value taking into consideration network effect.

Investor utility vs. ownership concentration


Type 1: Investor utility increases with higher ownership. This is mostly the case for payment tokens and security tokens not associated to equity. Both tokens


are easy to understand as it simply implies financial wealth.

Type 2: Excessive token ownership concentration in case of well decentralized blockchain ecosystems tend to result in a sharp decline in investor asset value as network effect diminishes. In old school terminology, the law of diminishing marginal utility comes into play. PoS(Proof of Stake) consensus algorithm blockchains are a perfect example. The same situation may occur for PoW(Proof of Work) blockchains when hashing power concentration increases to above a certain level.

Type 3: Tokenization of equity is also increasing. In such a case, the same equity concept of management premium may exist as ownership concentration increases.

Analyzing these three questions enables crypto categorizationBy analyzing the three aforementioned questions, it is possible to classify cryptocurrencies into different groups: payment, consumption, and security.

Category of top 10 market cap cryptocurrencies

Payment Token Consumption Token Security Token

Bitcoin (BTC) Ethereum (ETH) Tether (USDT)Ripple (XRP) EOS (EOS) -Bitcoin Cash (BCH) Stellar (XLM) -Litecoin (LTC) Cardano (ADA) -IOTA (MIOTA) - -

Source: Coinone Research, Coinmarketcap As of 5 Jul 2018

Payment: Aims to become a medium of exchange or store of value associated to goods and services universally to ultimately serve the same role as current fiat currencies. However, these tokens are yet to fulfill the function of medium of exchange due to significant volatility in price but are partially acting as store of value. Key examples include BTC (Bitcoin), XRP (Ripple), and BCH (Bitcoin Cash), etc.

Consumption: While with similarities to payment tokens in its function, the largest difference is that consumption tokens aim to become a medium of exchange or store of value related to a specific or limited set of goods and services. This is comparable to a gift certificate with a clear issuing entity. Furthermore, consumption tokens can be divided into two types, and have characteristics which allow application of traditional financial analysis methods:

1) Native coins on platform blockchains: Native coins which are required to use platform blockchains which offer similar functionality to cloud computing through smart contracts. Examples include ETH (Ethereum), EOS, and ADA (Cardano).

2) Tokens issued through smart contracts: Tokens issued through smart contracts on platform blockchains by dApps on the blockchain or other off-chain projects. Ethereum’s ERC-20 protocol is the most well-known, and a key example is OMG (Omisego).

Security: Equity, debt, real estate, and other traditional investment vehicles tokenized onto the blockchain which may directly regulated based on relevant law. Major example includes USDT (Tether).


Payment tokens: Four functions of money is an overkillPayment tokens have the potential to replace relatively unstable fiat currencies which may suggest a total market opportunity of USD5,352bn. Countries which operate ineffective fiat currencies such as Brazil and Russia are currently aggressively regulating cryptocurrencies. On the other hand, in case of Argentina, the country has started to understand the superiority of cryptos over its fiat and realized the difficulty of censorship which has resulted in certain banks leaving the SWIFT system and focusing on the Bitcoin network instead.

Recent cryptocurrency related key news

Date Source Title2018.01.13 Reuters Brazil regulator bans funds from buying cryptocurrencies

2018.03.30 Coindesk Report:Kazakhstan's Central Bank Wants to Ban Cryptocurrencies

2018.05.24 CCN Argentinan Bank Drops Dout of SWIFT, Favors Bitcoin and Cryptocurrency

2018.05.31 CCN Venezuela Bans Imports of Cryptocurrency Miniing Equipment: Report

2018.06.02 Bitcoin.com Russian Court and Customs Prevent Import of Crypto Mining Equipment

2018.06.29 Live Bitcoin News Turkey Leads Europe in Cryptocurrency OwnershipSource: Coinone Research, various press Sources

There is yet little visibility on which payment token will dominate. There is also no guarantee that there could be more than one that gain widespread adoption. However, in this note, we initially take a look at BTC (Bitcoin) which stands the largest market cap at the moment.

A viable alternative for unstable fiat currencies35 countries which payment tokens may penetrate firstThe common theory of money defining its 4 functions (store of value, measure of value, medium of exchange, and standard of deferred payment) has a contradiction when one attempts to apply it to this potentially new type of currency. Similar to many theories, the 4 functions of money was derived analyzing existing currencies, not the other way around. Furthermore, they were defined by scholars based in relatively developed countries which had political, economic, and social stability, which in result allow its currency to successfully entail the 4 functions.

That said, we believe payment tokens may attract decent demand in countries which do not operate fiat currencies satisfying all of the 4 functions. In order to list up such examples, we analyze value volatility and delta of 131 different fiats vs. USD. The following table shows the top 30 (total of 35 countries including co-ranking). Additionally, we find it encouraging that most of these countries have meaningful mobile and internet penetration which operate as the backhaul for blockchain adoption.


List of countries with relatively unstable fiat currencies

# Country Currency Volatility score

Depreciation score Total score Mobile

penetrationInternet penetration GDP (USDbn)

1 Venezuela Bolivar 15 5 20 87% 60% 4822 Mozambique Metical 13 5 18 52% 18% 113 Ukraine Hryvnia 9 5 14 135% 52% 933 Lesotho Loti 14 0 14 104% 27% 23 Namibia Dollar 14 0 14 107% 31% 113 South Africa Rand 14 0 14 147% 54% 2953 Swaziland Lilangeni 14 0 14 74% 29% 48 Russia Ruble 8 5 13 159% 73% 1,2838 Congo (Dem. Rep.) Franc 8 5 13 37% 6% 3510 Belarus Ruble 7 5 12 121% 71% 4710 Malawi Kwacha 7 5 12 40% 10% 510 Sierra Leone Leone 7 5 12 85% 12% 410 Argentina Peso 7 5 12 145% 71% 54514 Ghana Cedi 6 5 11 136% 35% 4315 Zambia Kwacha 5 5 10 72% 26% 2115 Kazakhstan Tenge 5 5 10 142% 75% 13715 Suriname Dollar 5 5 10 145% 45% 315 Brazil Real 10 0 10 118% 61% 1,79615 Turkey New Lira 5 5 10 94% 58% 86420 Nigeria Naira 4 5 9 83% 26% 40521 Egypt Pound 3 5 8 102% 41% 33321 Uzbekistan Som 3 5 8 74% 47% 6721 Angola Kwanza 3 5 8 45% 13% 9521 Ethiopia Birr 3 5 8 50% 15% 7221 Seychelles Rupee 8 0 8 161% 57% 121 Chile Peso 8 0 8 130% 66% 24727 Uganda Shilling 2 5 7 55% 22% 2427 Iceland Krona 7 0 7 121% 98% 2027 Norway Krone 7 0 7 109% 97% 37130 Poland Zloty 6 0 6 139% 73% 47130 United Kingdom Pound 6 0 6 120% 95% 2,65130 Serbia Dinar 6 0 6 130% 67% 3830 Australia Dollar 6 0 6 110% 88% 1,20530 Korea (Rep.) Won 6 0 6 121% 93% 1,41130 Colombia Peso 6 0 6 121% 58% 282

Source: Coinone Research, World Bank, FactSet*GDP, mobile penetration, and internet penetration as of 2016

We lay out the countries in order of our scoring, with a larger score suggesting higher possibility of cryptocurrency penetration. Our scoring rules include: 1) +1 for every year during the last ten years when the specific fiat’s FX rate change vs. USD is larger than ±1 STDEV compared to the entire universe average delta over the entire period, 2) +2 in case it was ±2 STDEV, and 3) +5 if the specific fiat’s depreciation vs. USD was larger than -1 STDEV compared to the entire universe average depreciation over the past ten years.

Specific numbers are as follows: 1) ±1 STDEV annual volatility is higher than +7.1% or lower than -14.1%, 2) ±2 STDEV is higher than +17.7% or lower than -24.7%, and 3) -1 STDEV 10 year depreciation is lower than -52.9%.

Potential value of USD5,352bnWe assess the potential value of payment cryptocurrencies as the sum of GDP of the listed countries. Cryptocurrency’s substitution rate will be higher for those more unstable currencies, while the likelihood of co-existence is higher among lower ranked countries. Based on this approach, the final market cap may be in the range of USD386bn to USD5,352bn.


Despite acknowledging that GDP factors in the concept of credit and thus seeing the limitations of taking it directly as a sizing tool, we still see its usefulness as a benchmark for three reasons:

1) If all goods and services in a specific country can be exchanged for a cryptocurrency such as BTC, this can easily be viewed as the intrinsic value

2) There is a logical flaw in expressing a GDP number in excess of a cryptocurrency’s issuance hard cap which often exists along with deflationary characteristics

3) It is possible to gain de facto control of the financial market even when considering a credit system if a specific party physically possesses a large amount of M0 which cannot be further issued

Potential size of payment cryptocurrencies (USDbn)

# Sum of GDP to this rank

Payment token penetration as % of GDP20% 40% 60% 80% 100%

1 482 96 193 289 386 4822 493 99 197 296 395 4933 587 117 235 352 469 5873 589 118 236 353 471 5893 600 120 240 360 480 6003 895 179 358 537 716 8953 899 180 360 539 719 8998 2,182 436 873 1,309 1,746 2,1828 2,218 444 887 1,331 1,774 2,21810 2,265 453 906 1,359 1,812 2,26510 2,270 454 908 1,362 1,816 2,27010 2,274 455 910 1,365 1,819 2,27410 2,820 564 1,128 1,692 2,256 2,82014 2,862 572 1,145 1,717 2,290 2,86215 2,883 577 1,153 1,730 2,307 2,88315 3,021 604 1,208 1,812 2,417 3,02115 3,024 605 1,210 1,814 2,419 3,02415 4,820 964 1,928 2,892 3,856 4,82015 5,684 1,137 2,274 3,410 4,547 5,68420 6,089 1,218 2,435 3,653 4,871 6,08921 6,421 1,284 2,569 3,853 5,137 6,42121 6,489 1,298 2,595 3,893 5,191 6,48921 6,584 1,317 2,634 3,950 5,267 6,58421 6,656 1,331 2,662 3,994 5,325 6,65621 6,658 1,332 2,663 3,995 5,326 6,65821 6,905 1,381 2,762 4,143 5,524 6,90527 6,929 1,386 2,772 4,157 5,543 6,92927 6,949 1,390 2,780 4,169 5,559 6,94927 7,320 1,464 2,928 4,392 5,856 7,32030 7,792 1,558 3,117 4,675 6,233 7,79230 10,442 2,088 4,177 6,265 8,354 10,44230 10,481 2,096 4,192 6,288 8,385 10,48130 11,685 2,337 4,674 7,011 9,348 11,68530 13,097 2,619 5,239 7,858 10,477 13,09730 13,379 2,676 5,352 8,027 10,703 13,379

Source: Coinone Research, World Bank, FactSet*GDP as of 2016

Payment tokens have abundant room for growthThe sum of the market cap of payment cryptos within the top 10 market cap names is roughly USD156bn. Comparing this in different ways, it implies:


1) 36% vs. our minimum sizing of USD386bn and 3% vs. our maximum sizing of USD5,352bn, 2)5% of the top 10 ranked unstable fiat countries’ GDP, and 3)ranked between GDP rank #15 Chille and #16 Kazakhstan.

Current payment token market cap vs. potential size (USDbn)

156 386

2,869

5,352

0

1,000

2,000

3,000

4,000

5,000

6,000

Payment tokenmarket cap*

Min Median Max

156

2,820

6,089

13,379

0

3,000

6,000

9,000

12,000

15,000

Payment tokenmarket cap*

Top 10 country GDP Top 20 country GDP Top 30 country GDP

Source: Coinone Research, World Bank, Coinmarketcap, FactSet*Payment token market cap is the sum of payment tokens within top 10 market cap cryptos

**As of 9 Jul 2018

Current payment token market cap rank amongst unstable fiat countries’ GDP (USDbn)

Source: Coinone Research, World Bank, Coinmarketcap, FactSet*Payment token market cap is the sum of payment tokens within top 10 market cap cryptos

**GDP as of 2016

As implied in our approach, we do not make unrealistic assumptions where crypto currencies completely replace all fiat even in the long term. For example, in case of the USD which seemingly fulfills the 4 functions of money, there is likely little desire by both the government and its people to prefer cryptocurrencies which they do not have direct control over. In such cases, payment tokens are likely to be limited to a portion of the country’s foreign reserves.

Instead we are suggesting countries with unstable fiat currency systems will opt for cryptocurrencies as a better option compared to bearing the risk of holding majority of its fortunes in currencies such as the USD which is issued by a country where they have no rights in. That said, we foresee a future where payment cryptocurrencies obtain the status of a key currency alongside existing strong fiat such as the USD.

BTC (Bitcoin) the first-moverExpectations over platform usage growth driving priceBased on our intrinsic value test, payment tokens including BTC are still at a premature stage and its continuity cannot yet be guaranteed. While the number of merchants in the real economy accepting BTC is equivalent to the blockchain’s platform usage, its penetration is yet to reach critical mass. However, we remain positive on its trajectory based on the aforementioned


future market size and clear necessity. Current price of BTC is driven by such expectations, in our view. This suggests it will be key for investors to monitor newsflow related to payment cryptocurrencies growing its footprint to replace unstable fiat. Meanwhile, it is not difficult to understand that investor utility continues to grow with the investor’s crypto ownership concentration in case of payment tokens such as BTC.

BTC price curve BTC investor utility vs. ownership concentration


Expansion of real economy merchants accepting crypto is keyThe economic value flow of BTC starts from the miners (blockchain nodes). New BTC is issued every 10 minutes when a new block has been mined to the specific miner who has made the contribution as a block reward. This new issue batch is currently 12.5BTC per block, which has come down from 50BTC following 2 halvings.

BTC economic value flow


These miners head to cryptocurrency exchanges in the search for willing buyers such as consumers/investors. The consumers/investors transfer fiat to miners


through traditional banking systems and cryptocurrency exchanges in return for the BTC. Then investors may sell back through exchanges for financial gain while the average consumer will spend it at merchants. The merchants who have accepted BTC as payment will keep a certain portion while selling the rest through exchanges in return for fiat. The real economy, comprised of consumers/investors, investors, and exchanges will be paying BTC transaction fees to the miners in the process.

Countries with the most unstable fiat systems will be the first to see the role of the traditional banking system shrink in the domestic real economy. Banks in such states may gradually change to focus on simply exchanging and remittance of BTC to other key currencies such as the USD. Other countries will then start to hold BTC as part of their foreign reserves in order to trade with these counterparts.

Intrinsic value is based on replaceable fiat while price moves on hashrateThe intrinsic value of BTC is assessable based on the size of replaceable unstable fiat currencies. Its size will grow upon macroeconomic crunches, and vice versa. We are currently interested in what impact the trade war between the US and China could have. It may translate into a positive catalyst for the crypto market should it trigger a global economic crisis leading to another round of negative interest rates which further deteriorates trust in the fiat system, in our view.

In terms of short and mid-term price movement, hashrate is key. Here, we introduce HPT (Hashrate-Per-Toke) and P/H(Price-to-Hashrate Ratio) to further elaborate on this relation.

HPT: Spot hashrate divided by number of issued tokens

P/H: Spot token price divided HPT

BTC price vs. HPT BTC P/H trading band

1

10

100

1,000

10,000

1

10

100

1,000

10,000

100,000

Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 Jul 18

BTC px (USD) HPT (Giga-hash/ token, RHS)

Correlation: 0.76

0

5

10

15

20

25

Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 Jul 18

P/H Average +1 STDEV -1 STDEV


BTC price has historically shown a 0.76 correlation to hashrate. We realize there may be questioning on the causality as it is arguable that hashrate increase is simply a result of investment into equipment due to BTC price increase. Yet, it can also be logically defended as higher hashrate is equivalent to increase in network security and immutability which is a significant property of BTC.

Along this line, it is also interesting that it was historically possible to forecast with some reliability fair P/H based on 6 month forward hashrate growth. Some examples of events that impact hashrate may include new Antminer series releases, change in electricity price, and natural disasters.


P/H vs. 6 month forward HPT growth


Network continuity yet to be guaranteed due to tx fee revenue ceilingThe main revenue source for miners must become tx fees in order for the BTC network to exist in perpetuity. However, BTC currently has a clear limitation as tx fees are difficult to grow beyond a certain limit due to scalability issues. As a result, Bitcoin miner revenue may drop materially in 2021 when the next block reward halving likely happens. While the impact can be mitigated if BTC price itself doubles, it still does not provide a solution in the long term when block rewards end.

Aggregated BTC miner revenue forecast

Source: Coinone Research *BTC price assumed at USD6,500

Based on our analysis, tx fees as a portion of aggregated miner revenue will only increase to about 15% levels over the next 5 years. The sole way for tx fees to post meaningful growth at a fixed 7 TPS is for average tx fees to skyrocket, but this is unrealistic. If we compare BTC to other store of value such as gold, the utility of BTC would decrease significantly if the cost of transferring the crypto becomes similar to moving gold bullion of the same value.


BTC miner aggregate net profit sensitivity (USDmn, ex-block reward, 2021E)


Our calculations suggest average tx fees would have to increase to USD11 levels under a 7 TPS cap in order for miners to reach BEP as a whole.

How Bitcoin WorksBitcoin is a new payment system and network made of two key technologies: 1) cryptography, and 2) a decentralized network, with an associated blockchain-based cryptocurrency.

Bitcoin Technological Workflow


The Bitcoin network records peer-to-peer transactions on a distributed ledger which all participants maintain a copy of. A more detailed composition is as follows:

1) Any transaction recorded in the public ledger can be viewed by anyone. Bitcoin uses a UTXO (Unspent Transaction Output) based model to show the sum of the results of the transactions as a balance.

2) A digital signature is used to prove ownership of the transaction.


A public key and a private key are a pair, which can be signed on transactions using a private key. Therefore, transactions can be confirmed using signatures and public keys.

3) Transaction history is also recognized on the network. A network consists of a number of nodes, and each is considered a participant. Each node shares all transaction history.

4) The transaction record is added to the block through the verification of the nodes, and these blocks are continuously connected as a chain which is called a blockchain.

Bitcoin can be obtained through mining. It is issued as mining compensation to a miner who creates a new block, and it is done through PoW (Proof of Work). This is a task of finding a target value required by the system calculating a necessary hash value for generating a new block.


Consumption tokens: Focus on the replaceable industryThere are two types of consumption tokens. First, native coins that are required to utilize a platform blockchain offering a smart contract logic. Key examples include ETH (Ethereum), EOS, and ADA (Cardano). Second, tokens issued via smart contracts on these platform blockchains, associated to specific dApps or off-chain projects. These include tokens such as OMG (Omisego). Traditional company analysis methods can be applied to both groups of consumption tokens. In this report, we first focus on ETH (Ethereum).

A new paradigm of cloud computingWe think about smart contract platform intrinsic value using two methods. First, a top-down approach where smart contract platforms take a slice of the IaaS cloud computing market which holds striking similarities in its service. Second, a bottom-up approach by calculating the IT spending of industries where dApps may be adopted before others.

An SOTP (Sum-Of-The-Parts) valuation comparing these platform blockchains as holding companies and dApps as subsidiaries was also considered. However, we do not dive into this option yet as this would only be possible when swaps between native coins and dApp tokens are much more common than what current technology provides.

Platform blockchains may unleash a USD302bn opportunityBefore we discuss dApps replacing Facebook and winning against Google, we prefer to focus on the realistic first step where platform blockchains lay the foundation of dApps and look at the IaaS cloud computing industry as the initial target.

This industry size we refer to can be understood as aggregate revenue of different platform blockchains. Our analysis suggests these blockchains could have a margin profile of 40-50% which is higher vs. existing IaaS services due to superior cost structure. Taking a simple valuation approach, this may suggest a total market cap of USD302bn. (Key assumptions: USD84bn market, 50% market share, 45% profit margin, global IT services industry historical average P/E of 16x)

Global cloud computing market size (USDbn)

Source: Coinone Research, Gartner


IaaS is the upstream service among different cloud computing offerings where users are provided pay-as-you-go services such as servers, VM (virtual machine), storage, and network. Users rent virtual hardware while bringing their own middleware and software. Downstream cloud computing offerings include PaaS, SaaS, and BPaaS, which are services that provide middleware and software.

Applying this concept to Ethereum, dApp developers and users are required to pay ETH as commissions in a pay-as-you-go method to Ethereum miners in order to run or use specific services. Meanwhile, Ethereum itself does not provide any software. However, projects such as LOOM Network are attempting to improve accessibility to Ethereum and can be compared to concepts such as PaaS, SaaS, and BPaaS.

Bottom-up aggregate IT expense approach is also promisingOur bottom-up approach of aggregating IT expenses of industries which may be among the first to utilize dApps also suggests a possible total platform blockchain revenue of ~USD100bn. The most active Ethereum dApp ecosystem is currently led by decentralized exchanges, video game, and casino/gaming categories which can be viewed as industry groups such as finance, e-commerce, internet services, and casino/gaming.

Ethereum dApp DAU breakdown Ethereum dApp tx breakdown

Games

14%

Decentralized

exchange

65%

Casino/gaming

1%

Others

20%

Games

11%

Decentralized

exchange

69%

Casino/gaming

2%

Others

18%

Source: Coinone Research, DappRadar Source: Coinone Research, DappRadar

Various 3rd party research institutes including Gartner and IDC suggests corporates globally spend about 4% of their revenue on IT expenses. In case of the four mentioned industries, this ratio ranges from the lowest 3% of casino/gaming to the highest of 10% for internet services and e-commerce.

Revenue & IT expense ratio of corporates Corporate IT spending (USDbn)46,382

7,231

217 214 133

0%

2%

4%

6%

8%

10%

12%

1

10

100

1,000

10,000

100,000

Revenue (USDbn) % IT expense of revenue (RHS)

Potential blockchain

early adapters 1,855

506

22 21

4

1

10

100

1,000

10,000

Potential blockchain

early adapters

Source: Coinone Research, FactSet Source: Coinone Research, FactSet


This analysis suggests 2017 global IT expenses were USD1,855bn, and the sum of the four industries of interest was USD553bn. Even when considering that this number includes costs such as irreplaceable hardware and labor, and then zooming in on only the pure cloud computing applicable portion, the potential market still seems promising.

ETH (Ethereum), the world’s largest computerExistence of intrinsic value is already clearIt is much easier to understand the intrinsic value of ETH as it can simply be seen as cloud computing service usage coupons. Continued usage of dApps and smart contracts directly means growing platform usage, which in turn will drive ETH price upwards as ETH demand should increase to pay Ethereum blockchain usage fees called Gas.

We expect law of diminishing utility to apply for ETH and would not be surprised if it becomes more so as the blockchain converts to PoS. Of course there could be a scenario where a single killer dApp takes over the majority of ETH consumption and overall value is sustained, but this is a farfetched assumption. In other words, we foresee a future where network effect benefit grows with various dApps being developed to be more likely.

ETH price curve ETH investor utility vs. ownership concentration


Importance of a killer dAppEthereum was one of the first ICOs in the blockchain ecosystem, and thus started its economic value flow by issuing ETH to its initial investors. Ethereum currently issues new ETH in the form of a block reward to miners who add new blocks to the blockchain, following a PoW method similar to Bitcoin. While the overall value flow show similarities to Bitcoin, the key difference is in the existence of smart contracts and dApps.


ETH economic value flow


Users pay ETH as usage fees called Gas to Ethereum miners when using dApps interacting with smart contracts on the blockchain. The economic value flow chart above shows a model where the dApp (or its operating company) places a server (web server, app server, etc.) between the blockchain and the user in order to implement a receiver-pay model to optimize user experience by preventing users from having to calculate and pay fees for virtually every click. Through this model, dApps become another important ETH buying force in the alongside investors/consumers. These dApps, on the other hand, are paid fiat either directly or indirectly from investors/consumers in the form of subscriptions, ad viewership, etc..

Approaching Ethereum as a cloud computing serviceIt is possible to apply legacy valuation methods to ETH to a certain extent. Ethereum aims to become the “World Computer”. If Ethereum is simply a “very large computer” as it insists, all we need to ask is “how much is this computer?” To calculate the price of a computer, we need to understand the economic benefit of possessing it. In other words, we should first derive its estimated revenues and costs to land at a profit number. For Ethereum, the equivalent of revenues are transaction fees and block rewards while costs include hardware, utility, etc.

Aggregate ETH miner revenue forecast Aggregate ETH miner expense forecast

0

1,000

2,000

3,000

4,000

5,000

6,000

2016 2017 2018E 2019E 2020E 2021E 2022E

Block reward (USDmn) Tx fees (USDmn)

0

500

1,000

1,500

2,000

2,500

2016 2017 2018E 2019E 2020E 2021E 2022E

D&A (USDmn) Utility (USDmn) Others (USDmn)



Aggregate ETH miner net profit (inc-block reward, USDmn) Aggregate ETH miner net profit (ex-block reward, USDmn)

36

1,091

2,732

1,257

2,019

2,823 2,808

0

500

1,000

1,500

2,000

2,500

3,000

2016 2017 2018E 2019E 2020E 2021E 2022E

-62

-683

-1,772

-1,204

-442

362

1,168

-2,000

-1,500

-1,000

-500

0

500

1,000

1,500

2016 2017 2018E 2019E 2020E 2021E 2022E


From this perspective, the aggregate net profit of the Ethereum network’s miners can be calculated. This is comparable to a single cloud computing service provider. Our estimates imply Ethereum taking a mere 3% IaaS market share by 2021, and thus may be very conservative.

Ethereum IaaS market share (USDbn)

Source: Coinone Research, Gartner

A key argument that may arise at this point is whether if it is possible to directly relate the network’s profitability and value to the ETH coin despite the fact it is different from equity. We believe it is possible for three reasons:

1) Ethereum plans to convert to PoS consensus method, and this will directly connect ETH to network operating rights

2) Even under current PoW, ETH holders gain a certain amount of control in the long term when block rewards discontinue as they would command the miners’ profitability

3) Also under PoW, while without operating rights, ETH is still a usage right of the Ethereum Blockchain that enables profit generation through dApp development and this may have similarities to preferred equity which have no voting rights but have profit sharing rights

Comparing ETH valuations to global internet stocksExact calculation of revenue, expense, and net profit allows us to attempt application of existing valuation methods. Thus we provide a valuation comp


between ETH and global internet stocks. ETH valuations show figures based on:

1) including block reward profits, and

2) only tx fee revenues, thus excluding block reward profits. We use 1 year forward valuations for the internet companies while showing 2020 onwards for ETH to allow time for adoption. ETH price is assumed at USD500.

P/E comp P/FCF comp

159

129105

5132 28 27 27 24 24 23 21 20 17 10 NM

0

30

60

90

120

150

180238

101

5642 40 31 30 29 28 23 22 21 21 17 11 NM

0

50

100

150

200

250


When including block rewards, ETH P/E already shows similar levels to current internet companies and continue to decline as tx fee revenues climb. However, P/E only comes within relatively common ranges from 2022 when stripping out block rewards.

But P/FCF looks much more sensible. Hashrate growth has begun to stabilize coming into 2018 leading to rational capex. While there is the possibility of another capex spike if ETH prices surge, we still see it will be relatively contained thanks to lower EHT price volatility and higher portion of tx fee revenue. Also, continued hardware cost decline from tech innovation helps capex management.

P/S comp PEG comp

37.1

24.6

18.613.912.212.0

7.9 7.3 6.5 5.0 4.9 4.1 3.1 2.8 2.5 1.6

0

10

20

30

40

3.93.5 3.5

2.7 2.52.3 2.2 2.0 2.0 1.7 1.6

1.3 1.2 1.1 0.90.5

0

1

2

3

4

5


P/S ratios hover above industry average for all periods. The main reason is because platform blockchains such as Ethereum tend to have much better margin profiles. Lastly, PEG is in-line with its comps from 2020.

We also note implementation of sharding and PoS may improve the overall profitability materially. Sharding will enable revenue growth by increasing maximum TPS while PoS can boost margins meaningfully by cutting costs.


We also provide 10 year P/E, P/FCF, P/S, and PEG trends for the World aggregate, IT services, and Internet Software/Services industries for better understanding.

Global P/E trend Global P/FCF trend

0

10

20

30

40

Jan 08 Jan 10 Jan 12 Jan 14 Jan 16 Jan 18

World World (Average)IT Services IT Services (Average)Internet Software/ Services Internet Software/ Services (Average)

World average: 14xIT Services average: 16xInternet SW/Services average: 23x

5

15

25

35



World average: 20xIT Services average: 16xInternet SW/Services average: 23x


Global P/S trend Global PEG trend

0

2

4

6

8



World average: 1.1xIT Services average: 1.4xInternet SW/Services average: 4.6x

0.5

1.0

1.5

2.0



World average: 1.1xIT Services average: 1.2xInternet SW/Services average: 1.1x


Short to mid-term price reacts to hashrate and transactionsTo analyze short to mid-term ETH price movements, investors should once again monitor hashrates considering the same PoW consensus algorithm at the current juncture. But in addition, number of transactions is also important for platform blockchains.

ETH px vs. HPT ETH P/H trading band

0

500

1,000

1,500

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 Jul 18

HPT (Kilo-hash/ token, RHS) ETH Px (USD)

Correlation: 0.96

0.00

0.20

0.40

0.60

0.80

1.00

Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 Jul 18

P/H Average +1 STDEV -1 STDEV


ETH runs on PoW similar to BTC and thus its prices shows high correlation of 0.96 to hashrate. We can also observe a clear trading band.


Number of transactions is another metric of interest. Considering the fact that Ethereum is a cloud computing type platform and not a medium of exchange or store of value, it makes perfect sense for its price and transactions to show correlation as it directly connects to how much this service is utilized. Hereby we introduce TPT(Transaction-Per-Token) and P/T(Price-to-Transaction Ratio).

TPT: Sum of transactions in a single day divided by number of issued tokens

P/T: Spot token price divided by TPT

ETH px vs. TPT ETH P/T trading band


This shows ETH price posting a 0.93 correlation with TPT and also a P/T trading band.

TPS improvement with PoS implementation is criticalEthereum’s single most important task is increasing its TPS limit. It is virtually impossible to replace cloud computing services with the current 15 TPS cap, and tx fee revenue growth is also difficult.

ETH eTPS forecast Ethereum average tx fee forecast (USD)


Ethereum has already officially announced its plans to convert to PoS in order to solve the TPS scalability issue. Based on this event, our modeling reflects implementation of Casper PoS from 2019. If not factored in, Ethereum would also require unrealistic hike in average tx fee similar to the Bitcoin example discussed in the previous section in order to achieve continuity. We also see upside risk to TPS if the transition is special. At the same time, lower average tx fees may lead to invigorating the dApp ecosystem, together forming a virtuous cycle.


The Ethereum community is developing Plasma as well for TPS improvement. However, we are cautious on Plasma as it may have a negative impact on miner revenue on the main blockchain as it is a solution to scalability which introduces side-chains.

How Ethereum worksEthereum is a blockchain-based platform that can run decentralized appli-cations called dApps (Decentralized Apps). The Ethereum platform is compared to an operating system (OS) like Android, and dApps to smartphone applications.

Ethereum technological workflow


Unlike Bitcoin, Ethereum uses an account-based model to create an account. The account supports billing functions and smart contracts. The smart contract supports Turing complete programming language, so that the amount, object, condition, authority and method can be designed in any way imaginable. In other words, everything you can do with a computer can be equally implemented in Ethereum.

The composition of Ethereum is as follows:

1) Smart contracts are entered as codes on Ethereum using the language “Solidity”, and the smart contract is verified and executed on the EVM of each node.

2) The result of the contract execution in Ethereum is recorded on the blockchain as a state change, and the dApp is the subject of using the result of state change of Ethereum.

3) Each mining node is operated by an unspecified party and is thus expressed to be "decentralized" or "distributed". All of these nodes have full sets which are all considered original. They collect and validate transaction records to form a data bundle referred to as a “block” which is then added to the "blockchain". This process is called "mining".


The miner who finds the first answer of the PoW algorithm is compensated with ETH newly minted by the blockchain itself. Also, when running a smart contract in Ethereum, the user is required to pay a fee called Gas in the form of ETH to the nodes for using its computing power.

In order to prevent excessive concentration of wealth seen in Bitcoin, Ethereum aims to create balance by influencing ETH freefloat by chaining the ETH issue schedule on an annual basis. In the future, the mining model will gradually transition to PoS (Proof of Stake) and the supply growth rate will be revised to be within '0 to 0.05x'.


Appendix 1: GlossaryThe following is a description of the key technical terms used in the report.

Consensus Algorithm

PoW(Proof Of Work) Proof of work is a protocol that blocks cyber-attacks such as DDoS attack (Distributed Denial of Service attack) that paralyzes the service system by causing large-scale access traffic at a time. Also, in the blockchain, this algorithm is used to generate new blocks. Miners compute the hash values and find the target values required by the system to compete with each other to complete the transactions in the network and get rewards.

PoS(Proof Of Stake) Those who want to participate in a new coin issue stake a certain amount of coin and pay a next block reward (new coin) to one of the participants through a lottery. Since the coin held in the wallet (node) is compensated for contribution to the block creation and verification (network proof), the block creation right is given by the coin share ratio.

BFT(Byzantine Fault Tolerance)It is a field of research to create a system that can withstand any obstacles that may arise in systems called Byzantine disorders. This Byzantine fault not only includes faults such as the system stopping or issuing error messages, but also some of the more difficult-to-detect faults such as delivering false values to other systems. In a properly implemented Byzantine fault tolerant system, normal operation can be achieved in the absence of any form of disability beyond a predetermined level.

OthersWalletIt stores public keys and private keys that can receive or use cryptocurrency, and one wallet can have multiple public and private keys. Cryptocurrency is not stored in the wallet by itself, but is stored separately in the Public ledger. All cryptocurrency has a private key, which you can use to take ownership of the cryptocurrency stored in the open ledger.

UTXO(Unspent Transaction Output)UTXO is the result of an unused blockchain transaction and is used for new transaction input. Bitcoin is the most representative example of the UTXO model. For valid transactions, additional transactions can be created using only unused UTXOs. When a transaction occurs, the input UTXO is no longer available to other transactions and is used at the same time, and the remaining cryptocurrency is generated in UTXO format. This prevents double spending and fraud in future transactions.


EVM(Ethereum Virtual Machine)It is a huge decentralized computer shared by nodes in an Ethereum blockchain network. People can access a large number of nodes in the network and change their data, but at the same time, many people may crash when they connect. EVM is the mediator. It is also designed to pay a certain fee to prevent problems such as malicious code insertion and unnecessary use. EVM is measured by Gas and paid by ETH.

Solidity Solidity is a contract-oriented programming language used to create and implement smart contracts for various blockchain platforms. It is one of four languages designed for EVM and is now the main language of Ethereum. Anyone can use this language to compose smart contracts and decentralized applications, and create arbitrary rules for ownership, transaction formats, state transition functions, and so on.

Turing completenessIt is a programming language that can perform all imaginable calculations including infinite circulation. An example of the use of a representative block-chain is Ethereum. In order to prevent errors (attacks) due to infinite circulation, Ethereum introduced the concept of gas (gas, the cost to pay for calculation).


DisclamerThis report is provided for informational purposes only. It is not an offer or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy. The information herein is believed to be reliable and has been obtained from public sources believed to be reliable, and Coinone makes no representation as to its accuracy or completeness.

Therefore, such information is for your reference only. The reader should independently evaluate the investment risks and is solely responsible for their investment decisions.

Opinions, estimates and projections constitute the current judgment of the author as of the date of this report. They do not necessarily reflect the opinions of Coinone and are subject to change without notice. Coinone has no obligation to update, modify or amend this report or to otherwise notify a recipient thereof if any opinion, forecast or estimate contained herein changes or subsequently becomes inaccurate. Past performance is not necessarily indicative of future results. It may cause principal losses depending on cases. In addition, Coinone does not provide this material in advance to a third party.

All opinions expressed in this report are the personal opinion of the authors and are provided without external influence or interference. Coinone was not involve in the preparation of this report and the views expressed in this report may differ from views of Coinone. Therefore, Coinone may present a different opinion.

Under all circumstances, this report cannot be adopted as a legal evidence of investment results.

Copyright of this report belongs to Coinone. Neither this document nor any copy thereof may be taken or rented or redistributed, directly or indirectly, without prior written permission of Coinone. Upon any discrepancy between the Korean and English version of this report, the Korean version will prevail.

crypto- · 7/16/2018 · off-chain projects. ethereum’s erc-20 protocol is the most well-known,...

Documents