Kraken Investment Case Study - The Economist

Kraken Investment Case Study

TABLE OF CONTENTS

INTRODUCTION....................................................................................................................................... 2 Objectives................................................................................................................................................. 2

ANALYSIS .................................................................................................................................................. 4 Technical Differences.......................................................................................................................... 4 Project Governance............................................................................................................................. 5 Community Value ............................................................................................................................... 8 Risks ................................................................................................................................................... 10 Our Answer ....................................................................................................................................... 12

Investment Portfolio ............................................................................................................................. 13 Probability Pricing Model ................................................................................................................ 14 Final Results ...................................................................................................................................... 17 Investment Recommendation........................................................................................................... 18

CONCLUSION ......................................................................................................................................... 19 APPENDICES ........................................................................................................................................... 20

Appendix A ? Appreciation Rate for Probability Pricing Model ..................................................... 20 Appendix B ? Depreciation Rate for Probability Pricing Model...................................................... 21 Appendix B ? Depreciation Rate for Probability Pricing Model...................................................... 22 Appendix C ? The Legality of Bitcoin in different countries ............................................................ 23 REFERENCE ............................................................................................................................................ 25

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Kraken Investment Case Study

INTRODUCTION

"...to boldly go where no man has gone before..." ? Star Trek

It was not too long ago when people used commodity money (gold and silver) or representative money (a claim on a commodity) as units of exchange. Today, we use currencies that are fiat money (by Government regulation or law). Imagine a world just 10-15 years later, when today's kids and teens start to buy things and enter into transactions. What will they use as a unit of exchange? Will it be similar to what we use now or something straight out of Star Trek? We already see glimpses of the future ? examples include social media, 3-D printing, Holograms. Cryptocurrencies or digital assets are examples of future of exchange and contracts. The future is already knocking at our doors and it is up to us to embrace it and "go boldly where no man has gone before..." Bitcoin and Ethereum are two main players in the field of cryptocurrencies. They are used as an internet-based currency allowing for instantaneously completed transactions across the globe. Bitcoin is the type of digital currency in which encryption techniques are used to regulate the generation of units of exchange and verify the transfer of funds, operating independently of a centralized bank. Ethereum, on the other hand, is a public blockchain-based distributed computing platform, featuring smart contract functionality. It can execute peer-to-peer contracts using a cryptocurrency called ether.

Objectives We have only one objective. Decide how to invest $1 million in bitcoin, ethereum, or both that will maximize profit with minimal risk. The caveat? We cannot touch our investment for 5 years.

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Kraken Investment Case Study To address such an objective, we must, first, answer the question "Which is the digital asset of the future?" After a crash course in digital assets, Green Eagle Investments has arrived at a unique investment strategy using our own price model with best and worst case scenarios. The future holds unknown risks. To minimize these risks, we considered a litany of perspectives: technical differences, project governance, community value, risks, supply and demand, and government regulations (Appendix C).

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Kraken Investment Case Study

ANALYSIS

Technical Differences Bitcoin uses blockchain technology, which has features and characteristics that set it apart from conventional databases. There is no central location for storing data and blockchain distributes data among a network of users running bitcoin software. A cryptographic algorithm checks any transaction against the historical transactions to detect and eliminate any potential hack. People exchange bitcoin with a "trust protocol" as users are anonymous.

Figure 1. Bitcoin Blockchain (connected to Block 1 ? Genesis Block) (Source: tech.eu) Bitcoins are acquired in three ways: exchanging currency (i.e. from US Dollar to Euro), providing services to others and being paid in bitcoins, and mining. Mining is solving a set of complicated calculations which creates a new block in the blockchain. Miners receive 25 bitcoins as a reward. Ethereum allows users to create their own operations with the complexity they wish and not just in cryptocurrency. Ethereum, in short, is a "programmable blockchain". Moreover, Ethereum innovates in Turing-complete "smart contracts" where if-then scenarios execute specific terms of an agreement. It is suitable for automating direct peer-to-peer interaction or facilitating coordinated group actions across a network.

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Kraken Investment Case Study

Figure 2. Ethereum Smart Contract example (Source: ) Ethereum uses a "ghost protocol" where the block time is 14 to 15 seconds compared to 10 minutes for Bitcoin, which gives it faster transactional power. Ethereum does have a more complex way to calculate transaction costs. In Bitcoin, it is simpler where transactions compete equally with each other. Project Governance Project governance comes down to who makes the decision. Bitcoin and Ethereum highlight decentralization as the "game changer" in digital currency. In theory, each will eliminate the need for financial intermediaries, which will speed up transactions and minimize fees. Each will rely on network and platform users to maintain the integrity of the system. In reality, each has experienced challenges in keeping a true decentralized format. In the end, who makes the decision? Is it the network users? Is it the platform developers? More importantly, what are the foreseeable impacts?

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Kraken Investment Case Study In a decentralized environment, a simple decision is like climbing a mountain. 100% unity of users is needed 100% of the time. Imagine the amount of energy needed to sustain that. Illustrating the conundrum, let's review the reaction to one security breach each has experienced. As recently as August 2016, hackers stole $65 million from Bitcoin which made Bitcoin's value drop 15% before recovering to its pre-hack value (Nakamura & Chen, 2016).

Figure 3. Bitcoin's plunge after being hacked in August 2016 (Source: )

In June 2016, hackers stole $50 million from Ethereum. The impact on Ethereum's value was just as severe (Price, 2016).

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Kraken Investment Case Study

Figure 4. Ethereum's value in US Dollars dropped after being hacked (Source: )

Decentralization prevents each from quickly and effectively addressing successful security breaches, slowing the growth and acceptance of each. How each responded to the loss of its digital currency has set each on a path on how it will be perceived in the future by investors and consumers. Bitcoin reduced balances by 36% to distribute losses amongst all users regardless if it the network user had money stolen (Tepper, 2016). By comparison, Ethereum created what is known as a hard fork, which is a permanent separate path in the block chain platform (Popper, 2016). By creating a divergent path reflecting the digital currency in each user's account prior to the hack, each user now has their money back. What are the foreseeable impacts of Bitcoin and Ethereum's actions? Bitcoin's action of reducing network user balances will open it up to regulatory oversight and could seriously affect its future growth in international markets. With Ethereum, a small vocal minority opposed the hard fork and chose to stay on the original Ethereum platform, calling it Ethereum Classic. This minority argued the decision made was without agreement from all network users and sets a bad

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