BETTING ON THE CURRENCY OF THE FUTURE: A DIGITAL ASSET INVESTMENT STRATEGY

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2 IN BRIEF BETTING ON THE CURRENCY OF THE FUTURE: A DIGITAL ASSET INVESTMENT STRATEGY How do you evaluate investments in an emerging technology? What s the rational split for a bet on the two current leading blockchain-based currencies, Bitcoin and Ether, maturing in 2022? Key driver analyses to establish relative probabilities for future scenarios Regression analysis on historical data, plus coin supply forecasts and two models for market growth to establish a range of price forecasts Monte Carlo simulation to generate a probabilistic assessment of the potential returns for multiple investment strategies BEST BET Bitcoin: $0.7 million WHAT IS? Ether: $0.3 million Estimated Median Value, 2022: $1.91 million Estimated Maximum Value, 2022: $8.85 million BLOCKCHAIN An open, distributed ledger used as the base for many digital currencies plus more BITCOIN The dominant digital currency built on a blockchain, since 2009 ETHEREUM A blockchain platform that uses the digital currency Ether and supports smart contracts and other distributed applications, since

3 Investor Overview The world's largest global Bitcoin exchange in euro volume and liquidity... We believe in the potential for digital assets to bring about the long-overdue, dramatic and positive change to global finance and financial inclusion Jesse Powell One of the world s leading Bitcoin exchanges, 1 Kraken s values include intuitiveness, professionalism and focus. Jesse Powell, CEO Kraken is taking an active role in the development of the digital currency market, pushing the envelope with firsts in the and Co-Founder of Kraken, aims to make Bitcoin industry. 3 Ethers have caught Kraken and the and other digital currencies accessible to the industry s attention in the past year. 4 The world. 2 burning question is: Which will be the currency of the future Bitcoin, Ether or both? The first digital asset exchange to have trading price and volume displayed on the Bloomberg Terminal, one of the first exchanges to offer leveraged bitcoin margin trading, the first to pass a cryptographically verifiable proof-ofreserves audit, and a partner in the world's first cryptocurrency bank

4 Market & Competitor Overview Blockchain is gaining traction because it holds the promise to transform industry operating models An enabling technology of the platform revolution trend Gartner Businesses always want faster, cheaper, more efficient ways to transfer funds. The global financial crisis spread distrust in financial markets and their governance. In 2008 the idea for an open, distributed ledger called a blockchain emerged, which promised to address these concerns. It also enabled the digital currency that came with it, Bitcoin, to avoid the problem of double-spending. Since 2008 the market for digital currencies has grown immensely. Several hundred digital currencies now exist, adding on average 80 new entrants per year. 6 Not all digital currencies are equal though. Of the current US$12 million total market value, Bitcoin boasts an 80% share, followed by Ether with 8%. To date only two other currencies, Litecoin and Ripple, have managed to make significant inroads into Bitcoin s dominance. Bitcoin s market share has slowly declined just

5 Market & Competitor Overview Success in this fast moving, sensitive market is heavily influenced by the level of consumer trust in the technology and its governance. Government regulations and support, the development of complementary services and ecosystems, and responses to security challenges within the currency network are critical determinants of growth

6 Future Scenarios The future is not a scenario written, which we only have to act out; it is a work which we have to create Roger Garaudy The outcome of this bet depends on the future Four scenarios of the apocalypse price of Bitcoin and Ether, which in turn depends on their adoption and success. 8 Four scenarios that characterised distinctly different futures were created and described, 9 and five key drivers were identified that together would be most likely to determine which future reality emerges. 10 Based on the estimated strength of each driver and the likelihood that it would occur in the coming 5 years, a relative probability of occurrence was derived for each scenario. The future s not obvious which is good, as that would be boring. SCENARIOS DRIVERS Government Competition Ecosystem Crises Technology RELATIVE RANK Strength Likelihood Strength Likelihood Strength Likelihood Strength Likelihood Strength Likelihood Weight Probability Platform wins % The great leap % Brand wins % Locked out % 100% 8 Currency exchange value depends on a dual supplydemand equilibrium. However, we consider that for the next 5 years the adoption (demand) for the digital currency will dominate. The impact of differential supply on the USD price forecasts has not been calculated. 9 Appendix 1 10 Appendix 2 Rating Likelihood Strength 0 na na 1 possible weak 2 likely strong 6

7 Modelling Uncertainty When nothing is sure, everything is possible Margaret Drabble The future is always uncertain, but never more uncertain than for a newborn. Prodigious talents and serious deficiencies can come to Expected light in the first few years of a baby s life, and the same applies to digital currencies. In order to model the full range of potential outcomes for the Bitcoin and Ether price over the next 5 years, an expected value and a bestcase value were calculated for their market capitalisation. The worst-case value is, of course, zero. Best-case For the expected Bitcoin value, a simple linear regression of historical market capitalisation formed the base. For the best-case value, a linear regression of the logarithm of the annual growth rate was used, to produce an S curve projection commonly seen in technology adoption. 7

8 Modelling Uncertainty Expected The expected Ether value was then modelled on Bitcoin s expected value, assuming that Bitcoin s market share was maintained constant as it grew. Ether s market share was assumed to grow only enough to take Ripple and Litecoin s share (the current 8% share for other currencies was maintained). The best-case Ether value was Best-case based on the S curve growth of Bitcoin but with Bitcoin s market share declining according to the linear trend seen in the historical data. Summing up The probability of each currency under or over performing against its expected value was calculated based on the outcome of the scenario analysis. 8

9 Price Forecasts Tonight s forecast a 99% chance of wine Anonymous Expected and best-case price forecasts were a Bitcoin simple calculation of the forecast market values for each currency in each case, divided by the forecast supply of each currency. Bitcoin has a reasonably predictable supply curve, built into the design of its blockchain. 11 Ether s supply will be affected by the imminent move to a proofof-stake consensus model from the existing proof-of-work model. While the details remain unknown it is expected to be more efficient and Ether so the forecast supply is modelled to increase, based on a reduction of the block time to Ethereum s 12 second target second-block-time/ 9

10 Millions Investment Strategies & Estimated Returns I invest, you bet, he gambles Anonymous The available investment strategies range from 100% Bitcoin to 100% Ether. Using Monte Carlo simulation, the estimated returns for 11 strategies along that spectrum were modelled, based on the calculated probabilities for each The distributions were assumed to be triangular around the expected price forecast, limited at either end by the best-case and worst-case price forecasts. Price distribution (Bitcoin at top, Ether below) currency to under or over perform against expectations and an assumed distribution of prices in each case. $12 Choose your own investment mix $8 $4 Maximum 75th Percentile 50th Percentile 25th Percentile Minimum $0 0% 20% 40% 60% 80% 100% 10

11 Investment Strategies & Estimated Returns The Monte Carlo simulation produced a probabilistic estimate for returns from each of the 11 strategies. Model behaviour Bitcoin Investment Minimum Maximum 25th Percentile 50th Percentile 75th Percentile 0% $ 57,775 $ 6,474,488 $ 897,493 $ 1,268,215 $ 2,807,577 10% $ 178,605 $ 6,208,151 $ 1,062,520 $ 1,566,921 $ 2,798,223 20% $ 269,592 $ 6,387,788 $ 1,108,575 $ 1,858,953 $ 2,837,083 30% $ 319,402 $ 6,770,678 $ 1,119,831 $ 2,035,949 $ 3,043,240 40% $ 348,778 $ 7,289,875 $ 1,129,546 $ 2,126,010 $ 3,202,275 50% $ 353,229 $ 7,809,071 $ 1,141,992 $ 2,110,895 $ 3,338,715 60% $ 321,846 $ 8,328,267 $ 1,111,875 $ 2,075,522 $ 3,551,816 70% $ 290,463 $ 8,847,464 $ 1,095,170 $ 1,909,470 $ 3,844,938 80% $ 259,080 $ 9,728,695 $ 1,049,590 $ 1,760,194 $ 4,068,780 90% $ 153,859 $ 10,767,424 $ 969,408 $ 1,656,476 $ 4,357, % $ 41,743 $ 11,806,153 $ 884,737 $ 1,639,838 $ 4,575,772 As a vocal market participant and active promoter of digital currencies, it was assumed that the profile of Kraken s risk appetite would be moderately aggressive. For marketing purposes, a subjective preference to support both currencies was also assumed, if supported by the financial modelling. The estimated returns show risks of greater losses for the two extreme strategies. The mixed strategies weighted toward Bitcoin show the best profile for median and potential maximum returns. Of these, while the median return is slightly lower than strategies that are more evenly balanced, a moderately aggressive approach would be to invest 70% in Bitcoin and 30% in Ether. 11

12 Appendices Appendix 1 Scenario Platform wins The great leap Brand wins Locked out Description Ethereum's smart contracts and other complementary goods drive up adoption (especially in the financial and government sectors) and value of Ethers, which come to dominate the market, leading to Bitcoin's decline. Encouraged by widespread government acceptance in the face of ongoing global crises, the large size of the potential market leaves room for both currencies to develop supporting ecosystems in particular niches, and both currencies flourish. Bitcoin's brand and position leads to large network benefits, which stifles Ethereum's growth, leading to Ethereum's decline. Concerns over security as well as criminal use of the currencies leads to widespread government opposition (and regulation) for digital currencies in general. Appendix 2 Driver Government Competition Ecosystem Crises Technology Description Government support or opposition to digital currencies will be extremely influential, both in terms of public sector adoption of blockchain technology and in terms of regulation. Competition between digital currencies as well as with traditional and electronic payment methods will be fierce. The development of supporting networks of complementary goods and services is frequently one of the determining factors in the battle between emerging technologies (e.g. VHS vs Betamax, Apple vs Android) International crises, especially financial and economic crises but also geopolitical crises and health or environmental crises - if they occur - are likely to drive up adoption of digital currencies in a search for safety Problems with security and stability of the technology have repeatedly derailed fledgling digital currencies 12

13 STEEPLED (PESTEL) ANALYSIS POLITICAL ECONOMICAL SOCIAL/CULTURAL TECHNOLOGICAL ENVIRONMENTAL LEGAL ETHICS DEMOGRAPHIC - Governments depends heavily on the financial sector - Financial crises are cyclical and can contribute to the progress of digital currencies - People are increasingly comfortable with virtual transactions - New technologies are driving new business strategies - Banking system regulations could be adapted to help or hinder digital currencies - All the information in the blockchain is traceable and cannot be deleted - In 5 years the global population will grow 5% - Almost all financial crisis, which affect primarily bank users and banks, also affect Governments, who have to bail out at least part of the banks. - Government can support or oppose the implementation and regulation of digital currencies. - Bitcoins and Ethers can be used as a store of value with different characteristics to fiat currency - Transactions with digital currencies can be faster, cheaper and more efficient than traditional currencies - People are increasingly used to having personal information placed online - People increasingly prefer payments using electronic systems to cash - The surge of new technologies may threaten the blockchain - Governments are potentially big blockchain users, given the number of public ledgers they maintain (e.g. land ownership etc) - Digital currencies require significant energy inputs, but these are likely to be lower than current inputs required due to the reduction in the parties involved - Banks are significant institutions in the legal, financial and political framework of modern economies - Regulations of the finance sector are regularly aimed at protecting consumers from bad behaviour. Digital currencies may present a more effective nonregulatory alternative - The blockchain offers the anonymity of cash, with greater efficiency, which has made it attractive to criminal users - More people in developing economies may be able to enter the Financial market for the first time if digital currencies become mainstream - Demographically led changes can influence financial markets and, consequently, digital currencies 13