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2017 Report Digital Assets .pdf

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February 18, 2017

2017 Global Outlook:

Decentralized digital assets
as equity investments
Initiating Coverage Report February 2017

Dan Briere | Technology & Equity Research


February 18, 2017

Advances in the function and adaptation of blockchain technology have forged a new
class of assets that are purely digital. These “cryptocurrencies” establish the grounds
for an evolution in the way investments are evaluated, executed, and managed – a
disruption that garners unprecedented opportunity for financial institutions who
are educated, and widespread concern for those who are not. Interest surrounding
blockchain technology has surged over the past two years, with leaders across a wide
array of sectors exploring the feasibility of its future applications.
Propelled by nearly unregulated fundraising, cryptocurrencies such as Bitcoin have
generated unparalleled returns for early participants. Capital raised in the “initial
public offerings” of blockchain tokens exceeded $200 million dollars in 2016 alone1.
The depth of opportunity in the cryptocurrencies, however, extends far beyond their
initial offerings, with speculations of the technology’s future applications embodying
an entirely new way of living through tokenized transactions.
With US federal regulations still fluid on their classification of blockchain “tokens” in
relation to securities, now marks an ideal time for investment groups to capitalize, and
in doing so, open the doors to a new era of asset management.

Dan Briere | Technology & Equity Research


February 18, 2017

Key Findings
Pressured by efficiency forces on costs and capital, the emergence and adoption of blockchain
technology places the existing asset management sector in a position easily susceptible to disruption.
With prominent groups already taking notice of the rapidly-developing technology, the financial services
sector must immediately initiative efforts towards better understanding the technology and the effects
of its potential disruptive capabilities.
Blockchain tokens will continue to utilize ICO’s
Initial Coin Offerings, or “ICOs” are organic fundraisers employed by many blockchain
projects to raise initial capital and disseminate ownership of the incipient pool of
tokens. ICOs raised more than $200 million in 2016 alone, and investment of this
nature is expected to grow in coming years.
ICO’s will be challenged by constricting regulation
US Securities and Exchange Commission regulations are still nascent in response to
the rapidly growing market for digital assets. Meanwhile, the general lack of public
knowledge surrounding blockchain and its congruent technologies augur tension in
the future. The most eminent question is whether digital assets should be considered
securities, and therefore, be subject to the harsh the laws and regulations that follow.
Developer groups are working proactively to devise frameworks and establish a set of
best practices on navigating this regulation.
Digital asset pricing will follow non-traditional behaviors
Despite similarities between the appearance of the digital asset (“cryptocurrency”)
markets and traditional currency or commodity markets, digital assets have a unique
classification based on their inherent holding of technological value. Furthermore, the
forces of pricing fluctuations strongly differ from those of traditional markets. Examples
include the positive relationship between prices and supply in cryptocurrency markets,
which defies the Quantity Theory of Money itself.

Next steps for adoption
With a few highly-educated groups already proving sustained investment in digital
assets to be feasible, it will not be long before the financial sector takes notice.
Protocols which foster open trading and investment in digital assets are already
present, with more refined systems scheduled to be unveiled this year. The potential
disruptive power of blockchain presents a new set of opportunities and concerns for
the financial services sector, and participants must no longer remain uneducated.
Dan Briere | Technology & Equity Research


February 18, 2017

Made public by the popularization of cryptocurrencies such as Bitcoin, blockchain is a decentralized
ledger system used for the recording and verification of transactions. Though similar systems were
seen as early as David’s Chaum’s “blinding formula” derived in 1983, the term “blockchain” was
generally coined during Bitcoin’s rise to public attention in 20082.
By nature, the trading of monetary instruments between entities, either commercial
or non-commcerial, requires a third party member to facilitate the transaction. Any
such transaction, whether it be through checking, digital, or cash is conducted
through a participating bank which acts as a middleman. These transactions are
typically dominated by the third parties, who are tasked with
verifying the legitimacy of the transacting parties and making
corresponding changes to a central ledger system - in return,
charging a fee. Blockchain technology eliminates this inefficiency
by eliminating the need for a third party, and therefore, allows the
two principal parties to retain complete control.
At its core, blockchain technology is a distributed ledger made up
of a continuously growing list of transactions which are verified
by participating nodes. This ledger is public, and furthermore,
decentralized, providing network participants with an indefinite list
of all previous transactions. It is this transparency that champions
the system’s resiliency itself.

“Our insight is
that blockchain
represents the next
evolutionary jump
in business process
-PwC, 2016

The emergence of publically-available “opensource” blockchain protocols has
fueled the launch of hundreds of token systems which establish monetary value
not tied to a fiat currency. Such currencies, generally called “cryptocurrencies” have
flooded the public domain in recent years, raising over $1 billion USD in “Initial Coin
Offerings” and opening the eyes of many speculative investors who view the trade
of such tokens for their financial gain. This newly-labeled “crypto-economy” is an
“economic system, which is not defined by geographic location, political structure,
or legal system, but which uses cryptographic techniques to constrain behavior in
place of using trusted third parties”3.

Initial Coin Offerings
Also referred to as “network token presales”, ICO’s are public events where blockchain projects sell
digital tokens in exchange for other currencies in order to fill the initial token pool. Originally devised
with the intent of funding marketing and product development costs, ICO’s are now viewed as a
lucrative market for investors seeking financial gain.
Dan Briere | Technology & Equity Research


February 18, 2017

Digitally-Backed Asset Behavior
Drivers of Market Prices
Recent developments have created markets for the trade of digital currencies which, from a structural
perspective, appear similar to traditional securities markets. Despite the infancy of the former, research
indicates that many of their behaviors closely represent those of more mature markets (while still being
radically different than those of traditional currencies).
Generally stated, digital tokens, or “coins”, are not tied to a fiat monetary instrument or physical asset.
As a result, scarcity is created through their embedded cryptology - generating value by limiting
supply. Unlike traditional monetary systems, supply in digital token markets is generally dictated by
an underlying code. This means that patterns and fluctuations in supply are largely predetermined.
Although some forces related to the speed at which new coins are added to the market, through a
process called “mining”, can affect short term supply, long-term supply stays relatively constant. For
this reason, change in demand explains most of the fluctuations in digital currency value over time.

“Our findings show that cryptocurrencies do not behave like traditional currencies or
commodities - unlike what most prior research has assumed - and depict an industry that is
much more mature, and much less speculative, than has been implied by previous accounts.”
-PLoS ONE, 2017

Understanding these behaviors
Resilience to fluctuations caused by negative publicity
Despite the rational assumption that association to fraudulent activity would have
an adverse effect on the demand for a digital asset or currency, a recent, in-depth
regression conducted by PLoS ONE actually shows no substantial relationship (p <
.001) between negative media attention and weekly returns4. Even when controlling
for separate, sentiment-related variables such as “public interest”, bad press does
not seem to have an effect on digital currency returns.
Negative relationship between growth and exterior media “buzz”
Similarly perplexing is the effect of media “buzz” on weekly returns. When controlling
for other variables in the study, the PLoS ONE regression shows a negative correlation
between public interest and weekly returns. The most reasonable explanation of this
behavior is that sudden increases in media attention correlate to increases in volatility
in the eyes of digital currency traders. Analysis on the behavior of such traders reveals
their consistent aversion to volatility and gravitation towards opportunities with
lower risk premiums4. These two behaviors, together, explain how spikes in media
attention can cause investors to expect lower volatility, and therefore, decreased
returns in the future - applying a negative pressure on demand.
Dan Briere | Technology & Equity Research


February 18, 2017

Exhibit 1: Correlation Between “Public Interest” Variables





Public Interest





Negative Publicity





Media visibility (robustness test)





Community interest (alternative measure)





Source: PLos ONE4

“Bitcoin represents
an innovation that
does not easily fit
into a superordinate
-Jean-Philippe Vergne

Increasing returns correspond with increases in supply
Contrary to traditional market supply and demand
mechanisms, increases in cryptocurrency prices have been
shown to correlate with increases in supply. This directly
contradicts the Quantity Theory of Money, and must be
examined closely in order to understand its implications.
The two possible explanations for this counterintuitive
economic behavior involve short-term coin-holder behavior
and increases in mining intensity. Following upward
movements in supply, digital currency shareholders have
historically been shown to aggressively “reinforce their
position[s]”: an action which spurs investment from new,
outside investors4. Speculation of a similar nature may
also occur when token mining (the increase in the supply
of tokens) increases, creating a “feedback loop” which
encourages outside investment.

Key Takeaways
Perhaps the most promising finding throughout analysis of cryptocurrency market forces is somewhat
of a banal platitude: the main driver of cryptocurrency market prices is the technology itself. This is
difficult to explain in the lieu of traditional currency or commodity trading, as such instruments do not
enclose inherit technological value. Despite their seemingly similar qualities, the real value of blockchain
“coins” lies in the fact that they cannot be defined solely as a commodity or currency system, but rather,
as evolving technology platforms themselves.
This principle is a critical realization for potential investors in the digital asset markets. It explains
not only the lucrative nature of such investments, but the key driver behind their sustainable
growth in the future.

Dan Briere | Technology & Equity Research


February 18, 2017

Industry Outlook
Despite maintaining a generally low level of public awareness, the global blockchain industry has
attracted over $1.1 billion in VC and corporate funding, to date5. Perhaps more compelling, however,
is the nature in which blockchain products can perpetually self-fund. Through public, crowd-sourced
fundraising (see ICO’s) and the increasing market demand driving consistent appreciation in digital
assets values, many blockchain projects have operated totally dependent from outside investment. A
closer look at macro-level industry trends is entailed below.

Exhibit 2: Top Cryptocurrency Prices & Volume (12 mo)

Aggregated DATA from: cryptocompare

Despite increased volatility due to security concerns, top cryptocurrency prices
have proven to be resilient. Bitcoin (BTC), Ether (ETC), and Monero (XMR)
have all shown growth over the past 12 months. Volatility for the respective
currencies is indicated by line shading.

Dan Briere | Technology & Equity Research


February 18, 2017

Exhibit 3: Top ICO’s by USD Amount Raised (3 mo)

aggregated Data From: Crown & Smith

A series of successful ICO’s have defined the last three months in the blockchain
space. Among these are Chronobank (LH), which raised $5.4 million USD, and
Golem (GNT), which raised over $8.6 million in under a day.

Exhibit 4: Top ICO’s Over Time (3 mo)

Aggregated Data From: Crown & Smith

Consistent crowdfunding over the past three months validates speculation on
the industry’s continued growth into 2017. Above, top ICOs are displayed by
their respective campaign’s end date. Cumulative amount raised is portrayed by
the blue trendline. Compounded growth rate (%CGR) is shown by line shading.

Dan Briere | Technology & Equity Research


February 18, 2017

Legal Implications
The emergence of disruptive financial technologies sets the stage for a battle between two
distinct parties: developers and financial regulators. Developers of financial technologies have
a thorough understanding of their contrivance, and therefore, separation from traditional
regulations. Meanwhile, conservative, technology-inept regulators have been slow to act –
initially causing a “slack” in oversight that may soon rebound with strict codification. The
incongruence in motivations between these two stakeholders causes a nascent but glaring
tension that will dictate the very sustenance of cryptocurrencies in coming years.

Consideration of Blockchain tokens as securities
At the apex of this tension is the question of whether the sale of blockchain tokens, such as Bitcoins,
should be subject to US state and federal securities laws. If this is determined to the case, such
tokens would subsequently become illegal for purchase or trade to US residents (see SEC Compliance
Guidelines*). Although only SEC jurisdiction will be considered in this paper, the US hosts a variety
of consumer protection and anti-money laundering laws that may also affect cryptocurrencies (see
When adjudicating whether blockchain tokens should be classified as a securities, perhaps the most
relative precedent is the US Supreme Court case of SEC v Howey, which formally defines securities as
“document[s] that provide[] proof of a monetary investment in a common enterprise with profits earned
exclusively through the work of others7.” As can be inferred by this definition, the future of unregulated
token crowdsales is contingent the promotion of their “non-investment” purposes.
In reaction to the growing regulatory concern, industry leaders have rapidly disseminated information
aimed to protect emerging digital assets from the oversight of the SEC. One example is a modification
of the “Howey Test” developed by Coinbase, a leading digital asset marketplace, with legal oversight by
Debevoise & Plimpton, LLC. This test acts as a framework for digital asset projects approaching an ICO.
The Howey Test alludes to sensitivities in the SEC’s consideration of securities classifications that include:
Fundraising verbiage
The term “Initial Coin Offering” has become a red flag for regulators who believe
the term (and its similarity to the term “Initial Public Offering”) promotes buyers to
participate based on speculation. Any verbiage which markets token crowdfunding
as an investment opportunity is likely to raise concerns.
Selling tokens prior to their deployment fosters investments for the purpose
speculative profits. Although the majority of token crowdsales occur in this fashion,
Dan Briere | Technology & Equity Research


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