Before cryptos arrived on the scene, there were two generally accepted mediums of exchange: fiat currencies and store-of-value assets such as gold. Bitcoin and other competing crypto coins are more akin to gold than fiat currency, in our view. In fact, bitcoin and the like often assume the moniker of “digital gold” due to their similarities with the yellow metal. In the crypto world, there are also two other types of digital assets — DeFi tokens and stablecoins — that have their own unique characteristics that set them apart from digital gold (Figure 1). We discuss all three in more detail in the following sections.
Figure 1: Traditional vs. Digital Currencies
|Category||Fiat Currency||Store-of-Value||Digital Gold||DeFi Token||Stablecoin|
|Inception Date||1971||~600 BC||2009||2015||2017|
Gold by Any Other Name
Similar to gold, bitcoin is a finite resource, as the source code is programmed to stop generating coins after 21 million coins have been mined. With approximately 18.5 million coins already mined, at the current rate it is expected miners will reach 21 million by the year 2140. Similarly, other competing crypto coins also have limits in place.
For bitcoin in particular, another similarity with gold is its “often imitated, never duplicated” status. There are thousands of minerals, and yet gold has remained the primary store-of-value asset globally. Likewise, there are more than 30 cryptocurrency “forks” derived directly from the original bitcoin code, but bitcoin remains the dominant crypto coin. So, in the universe of more than 9,000 cryptos and 30-plus bitcoin forks, what separates bitcoin from the pack? How can an investor feel confident that bitcoin isn’t just the MySpace of crypto and some sleek blockchain in the future will replace it? It comes back to the strength of the network. While many of these digital-gold competitors have a loyal user base of miners, users and node operators, their networks pale in comparison to the bitcoin network.
Upside-Down World of DeFi
As we mentioned in the introduction, if investors solely focus on bitcoin and other digital gold coins, we believe they could miss out on the larger secular trend toward decentralized finance (DeFi) networks. Similar to how we believe the nomenclature cryptocurrency is somewhat misleading, the term “DeFi” is also ambiguous in that it is not specific to just the finance industry. And yet the name has already stuck. Thus, when we refer to DeFi, we mean any blockchain technology or application that does not rely on intermediaries such as custodians, exchanges and others to control the network. DeFi runs on smart contracts, which is a term used to describe a program that is coded to operate without the need for human intervention. Most smart contract innovation is currently focused on the financial industry; however, wide-ranging applications, from decentralized prediction markets to decentralized wireless networks, are beginning to emerge.
Additionally, DeFi and smart contract innovation has opened the door to collector items in the form of non-fungible tokens (NFTs). Through blockchain technology, NFTs such as cryptokitties, NBA Top Shots and even digital art that sells for millions of dollars, have seen significant interest, in part because of the reduced risk of duplication or theft.
Currently, the largest DeFi network by far is Ethereum, which was actually founded by a group of bitcoin enthusiasts looking to create additional blockchain use cases beyond digital gold (and yes, most of the popular NFTs reside on the Ethereum network).
Within a DeFi network like Ethereum are decentralized applications or dApps, which are smart contract applications performing a wide variety of tasks such as automated trading exchanges to securities lending. We believe dApps should be assessed through a similar lens as venture capital projects that are priced in real-time. We believe the growth potential in this area is quite promising; however, we caution it is still in its very early days. Like venture capital investments, not all dApps will survive. However, the ones that are successful have the chance to be extremely disruptive across a number of industries, while keeping in mind the one thing dApps all have in common is extreme price volatility.
Stablecoins: Digital Fiat Currency
These cryptos are pegged to a fiat currency, thus making them stable while still operating on a blockchain network. As such, stablecoins’ primary use case is collateral within the crypto ecosystem, and are therefore of limited value for investors seeking price appreciation.
That being said, the use of stablecoins for payments has grown just as swiftly as crypto prices in the last year or so. Stablecoins such as Tether, USD Coin and Dai collectively have a market cap of nearly $50 billion as of February 28, compared to less than $5 billion a year ago — a 10x growth rate. We believe such astonishing growth highlights the demand for fast and secure payments. Stablecoins are also used as digital cash reserves that stay in a DeFi blockchain rather than in a traditional deposit account. Crypto miners also use stablecoins to hedge price volatility and exposure to the coins they are mining. In short, we view stablecoins as a novel method of sending money, not making it.