When you hear the word cryptocurrency, do you immediately think “bitcoin”? If so, you’re not alone. While bitcoin is still the largest “crypto” by market capitalization, there are now some 9,000 cryptos in existence today. Despite our views on crypto as a highly speculative investment, we believe the world of digital assets has reached a critical mass that gives us confidence that it’s more than just a passing fad. Therefore, our aim is to help arm investors with knowledge of the crypto landscape and provide tools to evaluate the myriad crypto options.
As with other technological breakthroughs, bitcoin was born out of a technological revolution much longer in the making, specifically the dramatic evolution of the internet toward decentralization and the application of blockchain technology. Decentralization is what enables the lynchpin of crypto — blockchain technology — to come to life. So how did we get here? The story of crypto and blockchain technology goes hand-in-hand with the evolution of the internet itself. The crypto world has evolved dramatically since an anonymous author(s), under the pseudonym Satoshi Nakamoto, penned a brief white paper in 2008 detailing the mechanics of what we’d soon come to know as bitcoin.
The Building "Blocks" of Crypto
A blockchain is innovative technology consisting of complex cryptography and software that creates an immutable, decentralized database for whatever its application may be. In other words, the data cannot be changed, and there is no central authority over the records. The concept of blockchain technology dates back to the early days of the Internet, but it was not until the invention of bitcoin as a peer-to-peer payment network that it found a real-world use case (Figure 1).
View accessible version of this chart.
Blockchain technology is essential to crypto because it eliminates what’s called the double-spend problem of digital assets. Whereas physical assets, such as currency or even a physical gift card, can only be spent once, before Satoshi’s white paper it was difficult to prevent digital information from being duplicated or falsified, potentially allowing it to be used multiple times. Because blockchain cryptography supports a ledger that is decentralized and unalterable, once a cryptocurrency transaction is recorded, it cannot be erased, which provides a strong defense against the possibility of double spending.
Community Driven Networks
We’ve covered the building blocks (pun intended) of the what behind blockchain, but who keeps the decentralized network operational? Since no one is in charge per se, the decentralized system provides an incentive to users to self-regulate. In short, a crypto network’s security is supported by two highly important user groups: miners and node operators. Without these two groups working as a symbiotic, “trustless” community, the security of a decentralized blockchain could become vulnerable. Crypto miners are not out panning for gold in the Yukon River; rather, these groups and enterprises use high-powered computers to solve complex cryptography problems to generate new coins. In competition with one another to mine coins quickly, they also have a direct financial incentive to keep the blockchain functioning and validate existing coins (or blocks) as transactions occur. Node operators are the referees of the network, ensuring the accuracy and security of transactions. Most computers have enough power to run a node, but as this is the upside-down world of decentralization, there is no financial gain for this task. In other words, node operators are incentivized purely by their commitment to the cause.
Thus, a complete crypto network has traders and investors: miners all racing to find the next coin, and the volunteer node operators. In an internet-based, decentralized system, none of these groups have to actually know one another, and yet they all have a common interest to secure and maintain the network.
To assess the strength of this soft infrastructure, investors should turn to a common technology industry measure: network effects (Figure 2). Think about how Facebook surpassed MySpace, or Google replaced Yahoo; there was a clear winner between these similar applications because one had better scalability and stronger network effects. Similar to commonplace software applications, crypto networks can be measured by growth in their monthly active users.
We believe these concepts are the bedrock of crypto fundamental analysis. Without a committed community of miners and node operators validating transactions, a blockchain network could easily become susceptible to theft or fraud, which could render the cryptocurrency worthless in short order. In fact, we believe one of the key differentiators between one cryptocurrency versus another is the perceived strength of its network effect. Therefore, it is imperative to know what you own in terms of the underlying network strength of a blockchain (Figure 3).
Figure 3: Bitcoin vs. Select Bitcoin Forks and "Privacy" Coins
|Cryptocurrency||Description||Market Capitalization ($ billions)||Maximum Supply||Average Transaction Time||Node Operators||3 mo% Change|
|Bitcoin||Store of value||$782.6||21 million||10 min||11,304||9.6%|
|Litecoin October 2011*||Store of value||$9.7||84 million||2.5 min||1,355||1.7%|
|Dogecoin December 2013**||Store of value||$26.2||Unlimited||1 min||1,844||47.8%|
|Bitcoin Cash August 2017*||Store of value||$9.1||21 million||10 min||1,054||2.9%|
|Bitcoin SV November 2018*||Store of value||$2.4||21 million||10 min||110||-55.8%|
|Monero||Privacy coin||$4.2||Adjustable||2 min||Unknown||n/a|
Accessible Version of Charts
First, a transaction is requested. Then, the request is distributed to node operators who validate the transaction using known algorithms. The transaction then combines with others to form a block that is added to an existing blockchain. At this point, the transaction is complete.
This graph illustrates network effect by showing the value of a digital asset (Y-axis) and the number of digital asset users (X-axis). The value of a product increases when the number of people who use the product increases. The amount of users required for significant network effect is indicated as “critical mass,” it’s the point at which adoption grows exponentially.