PBS Economist Squad Bitcoin vs Ethereum: $1M to invest across these two blockchain technologies - The Economist
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PBS Economist Squad
Bitcoin vs Ethereum: $1M to invest
across these two blockchain technologies
October 2016
Francisco Cudell
Pedro Vilas-Boas
Rui Rosas
Introduction
We’re living in a world driven by technology. Existing business models keep
challenging absolute truths we had for granted in the past, disrupting well established
industries and monopolies thus our global economy. For the last decades, since the
appearance of the internet in 80/90’s up to now, the rate of change driven by technology
and innovation has forged a new type of economy, the digital economy. Advancements
in computer processing power, data storage solutions and chip evolution in addition with
network’s backbone infrastructure continuous development in parallel with cultural and
operational shifts not only on companies modus operandi but in society in general, in a
continuous virtuous cycle of innovation and raise of challenges, have unfolded
numberless opportunities, both technologically and economically impossible in the past,
that go beyond our imagination.
More than 3.5 B1 people are currently connected to the internet at a distance of a click,
which can be translated into a huge opportunity for entrepreneurs, newcomers and SMEs
and a remarkable challenge for established companies in many different sectors. Business
that fail to get digitally connected will become excluded from the global market as
business are going digital.
Figure 1 - Internet users in the world - June 2016
1
Source: Internet World Stats - www.internetworldstats.com/stats.htm
1
We’ve already experienced the disruption of well-established industries such as public
transportation and hospitality business, just to name a few, and more will certainly follow
them in the future.
Shared economy platforms, automation and robotization in the industry, the so called
industry 4.0, smart cities and smart grids, IoT and machine learning in addition with the
amount of data generated by, and that can be accessed from, every single
person/consumer (big data) unfolds huge challenges in terms of data mining, contract
management, finances and cybersecurity within what can be considered a borderless
digital world. This ever growing intersection between digital technology, financial and
non-financial services fostered new ecosystems to flourish.
The need to improve digital financial economy efficiency, either by reducing its costs
and/or increasing its speed, while shoring up its security and at the same time increase its
exposure by reaching people that were previously excluded from the formal financial
service, led to the emergence of many FinTech applications and start-ups, as the VC
funding of more than $21B in the past two years and up to $7.4B during the first two
quarters of 2016 in FinTech start-ups is a clear sign of.
Figure 2 - Annual global financing trend to VC-backed Fintech companies
This digital need, associated to society’s rising lack of trust in fiat currencies, mainly
due to recent past financial crisis and scandals, and denoted dependence on government
2
policies (exchange rate, treasury notes and measurement against foreign exchange
reserves) created the perfect ecosystem for the growth and birth of cryptocurrencies.
Mandatory to the rise of this trend is cybersecurity and this helps to explain why a
number of FinTech subsectors like blockchains started gaining more traction. Some
global banks and financial institutions increased their bet in blockchain technology,
public ledger system, and during Q2’16 started focusing in proof-of-concept pilot tests
while at the same time, several significant funding rounds concerned blockchain focused
companies (3 in the top 15)2. The impact of blockchain technology within the bank sector
could allow huge savings in its operations (ex: remittance, transactions, etc…). Santander
Bank estimates that the adoption of blockchain technology could reduce its infrastructure
cost by US$20B/year3.
Figure 3 - 30 Largest VC FinTech deals of 2016 (YTD)
2
Source: The Pulse of Fintech Q2 2016, Global Analysis of Fintech Venture Funding, KPMG
International and CB Insights, August 17th, 2016
3
Source: https://letstalkpayments.com/an-overview-of-blockchain-technology/
3In addition to the financial services applications, the non-financial use cases of
blockchain has been a significant trend in the recent past, where a considerable number
of Startups (50+) focused on asset servicing, IoT, identity and privacy management and
documentary trade, have come into life with brand new blockchain technology supported
business models.
Hereafter, we’ll overlook the industry as a whole and both Bitcoin and Ethereum in
detail to assess the changes, trends and developments ongoing in order to understand each
cryptocurrency investment potential.
POLITICAL
The absence of external legislators in the cryptography industry is one of the several
great advantages the industry has. Up to now, there was no interference from central
governments in trying to legislate it. However, this industry is being followed by the
official entities (as the European Union), as it can take away the power and data strength
inherent of who manages currency and data. Central government pressure is expected to
be raised, as soon as the lobbying against cryptocurrencies gets followers.
ECONOMICAL
Trading markets have seen their liquidity flowing away over the past years. Adding to
this, the capital requirements and the multibillion dollar fines for market manipulation,
has been forcing the banks to implement more automation. Over the past 3 years, trading
in the spot market fall 19% to $1.7tn a day4. This gap has been taken by electronic
markets, as use faster and better technology, namely the blockchain technology. The latter
brought with it low frictional costs and is predicted to save around
4
Source: Financial Times, “Liquidity holes hold key to flash crash mystery”, 11th October 2016
4Bitcoin emerged as the first main digital currency with global acceptance. Even if
today has a market cap of $10 bn and a volatility standard deviation 30 days of 0.89% 5,
already had its volatility turmoil times, having more than 15% in the volatility index, at
the 30 days BTC/USD standard deviation.
Figure 4 - Bitcoin volatility series
Ethereum is a recent platform with 14 months of trading activity, has a market cap of
$1 bn already and still has a high volatility. Ethereum developed the blockchain
technology up to a point that can be considered the next big tech revolution after the
internet 20 years ago or the cloud 10 years ago. Some say that it came to “redraw the
internet as it should be”. The growth opportunities are uncountable, as it can be used in
such vast areas as financial service for faster, secure and cheaper transactions; in the
automotive industry, mainly in the autonomous cars; crowdfunding; voting; healthcare,
where patients' health information can be encrypted and then shared; in the vast world of
the IoT and so many other applications. A McKinsey study about the 12 disruptive
technologies6 assesses the economic value of IoT, Cloud Technology, Automation of
5
Source: https://btcvol.info/
6
Source: Disruptive technologies: Advances that will transform life, business, and the global economy.
McKinsey Global Institute
5Work and Mobile Internet up to +$73.4 trillion by 2025, and in all of these, the blockchain
will be the key connection element.
SOCIAL
Global society has been divided about the blockchain technology adoption. While
some are truly focused on its benefits, others are concerned with the underground side of
it, mainly due to the usage of Bitcoin in “grey” transactions and also the fact that Bitcoin
didn’t became a global currency. In fact, more than 500 Altcoins have been created up to
date7. Another concern regards to cybersecurity, and Mt. Gox bankruptcy is a great
example (850.000 bitcoins stolen, equivalent to $450 million)8. Ethereum came to solve
this issue with the smart contracts development.
Another important factor is that with the birth and expansion of this technology, the
central governments are being stripped of the big data they possess due to the control over
the currency and transactions. This loss of control will also possibly jeopardize the tax
laws in all the governments worldwide, with several reactions that will possibly be felt,
against the new and upcoming liberal and borderless currencies.
TECHNOLOGICAL
The world has seen the ground-breaking technology that has emerged with the birth of
the blockchains, at the time, when bitcoin was created, we assisted to an important leap
in terms of technology, which allowed for greater security and cheaper transactions. This
breakthrough has however been updated with the birth of new platforms such as
Ethereum, which corrected many of the Bitcoin issues.
7
Source: https://coinmarketcap.com/all/views/all/
8
Source: www.thedailybeast.com/articles/2016/05/19/behind-the-biggest-bitcoin-heist-in-history-
inside-the-implosion-of-mt-gox.html
6Cybersecurity has to be considered as one of the most important aspects of the
industry, being that it is vital to attract adopters and allow for safer transactions. Without
cybersecurity, the whole industry would collapse due to the fear of the general
populations.
The fact that the world internet infrastructure has increased substantially the access to
internet worldwide, also with larger bandwidth, has allowed for greater developments in
terms of capacity. This new and improved infrastructure allows for high speed
transactions and increased security in the industry.
ENVIRONMENTAL
In terms of environmental impact, a rising concern has been seen related to the energy
consumption of transactions. Nowadays, the increasing size of blocks is demanding an
equivalent to 3 Gj/s for computation, an equivalent to Ireland consumption today.9
In depth industry analysis
Analysing the digital assets industry in some depth, several conclusions can be
understood. Regarding new entrants in the industry, the disruptive nature of the crypto
digitalization technology reduces the risk of new and strong cryptocurrencies being born
during the next 5 years.
The risk of increasing competition is high, with the foreseeing entrance of new players
such as banks and financial institutions using blockchain technology to reduce frictional
costs and increase the speed in operations, one must also note that new cryptocurrencies
are bound to appear in the industry landscape, occupying different market niches, and
therefore increasing the competition.
9
Source: Bitcoin Could Consume as Much Electricity as Denmark by 2020,
http://motherboard.vice.com/read/bitcoin-could-consume-as-much-electricity-as-denmark-by-2020
7Large corporations are viewing cryptocurrency as an important opportunity with key
investments, as the digital assets management. The NASDAQ, Australian Securities
Exchange, MIT, Microsoft, IBM, Blockstream, Euroclear and so many other are just a
few examples of powerful corporations already investing and using this technology. And
the value behind this disruptive technology can be seen by the quick adoption and ongoing
developments from 42 major banks - Bank of America, Credit Suisse and HSBC are just
a few examples10.
Regarding substitutes, the fiat currencies must be taken into account. Although the
fiduciary currencies are being outdated due to the inadequacy to the instant digital world’
requirements and its dependency on Central Governments, they still account for the large
majority of transactions worldwide, and must still be considered as the currencies most
use.
For a detailed analysis regarding Bitcoin and Ethereum, please refer to the appendix.
10
Source: Deloitte - Blockchain applications in banking. 2016
8PROJECTION (risk analysis)
In order to further assess both considered digital assets and their possible projections,
several calculations were performed, which led to a clearer analysis and decision making
process.
Bitcoin Projections
The process started by analysing the historical values for Bitcoin from January 2012
until the 17/Oct/2016. In order to have a blunt projection of Bitcoin, a logarithmic
regression was performed, with a projection for the following five years, using the
logarithmic regression. This analysis shows the trendline for growth in value, until the
year 2021. There is a clear growing trend line, which by 2021 should be approaching the
$1.150/bitcoin as per projection. This is translated into an approximated growth of 81%
($635 in 17/Oct/2016 to $1.150 in 01/Jan/2021).
Figure 5 - Bitcoin value projection
In order to further assess the possibilities of Bitcoin, several Monte Carlo analysis were
performed. In order to reduce the volatility and the speculative forces of the market, the
starting date considered for the bitcoin analysis was the 01/Jan/2015. As can be seen in
9the historical values, this is the period where the volatility of Bitcoin starts reducing,
enabling for a better projection for the 5 year period. Also the fact that in 2015, several
other competitors started to appear in the industry landscape leads to a better
understanding of the possibilities of the Bitcoin as a currency.
Average 381
Average return (%) 21%
Std deviation return 47%
Time to retire 5
Inicial investment $ 1,000,000
Year Return Ending value
1 45% $ 1,449,170
2 15% $ 1,670,208
3 10% $ 1,839,463
4 -17% $ 1,533,657
5 -30% $ 1,076,985
Mean $ 2,480,113
Median $ 1,854,970
Std. Dev. $ 2,366,392
Percentile
5% $ 144,105
25% $ 824,707
Figure 6 - Rate of Return BITCOIN 01/01/2015
Also, in order to evaluate a period where both Bitcoin and Ethereum were present in
the market, another Monte Carlo analysis was performed for Bitcoin, starting in the period
of 01/01/2016.
10Average 517
Average return (%) 20%
Std deviation return 25%
Time to retire 5
Inicial investment $ 1,000,000
Year Return Ending value
1 29% $ 1,289,223
2 -24% $ 982,932
3 35% $ 1,322,994
4 6% $ 1,397,262
5 19% $ 1,665,800
Mean $ 2,478,533
Median $ 2,261,968
Std. Dev. $ 1,222,898
Percentile
5% $ 927,666
25% $ 1,611,279
Figure 7 - Rate of Return BITCOIN 01/01/2016
The results of these analysis show precisely what was previously discussed in the
qualitative part of the report, where the reduction in the volatility in the Bitcoin has led
to a slow but constant progression in terms of value, which makes Bitcoin a still valuable
cryptocurrency for the next 5 years.
11Ethereum Projections
An analogous process was performed for Ethereum, also with a logarithmic regression
that can be seen in the following graph.
Figure 8 - Ethereum value projection
The takeaways of the logarithmic regression can be seen as a fairly positive trendline
that shows the capacity and the numerous possibilities that the Ethereum platform shows.
By 2021, the value of Ethereum could be at $90/Ethe, showing a growth of 657% (from
$11.89/Ethe in 17/10/2016 to $90/Ethe in 01/01/2021).
As per the Bitcoin quantitative values, a Monte-Carlo analysis was performed using
the values from the beginning of the year of 2016. The same mind-set regarding volatility
of the beginning of the platform was considered, being that by blocking the time frame to
the latest developments, the analysis gives less speculative values, while taking into
account other competitors.
Average 12
Average return (%) 931%
Std deviation return 421%
Time to retire 5
Inicial investment $ 1,000,000
12Year Return Ending value
1 754% $ 8,537,672
2 483% $ 49,767,499
3 846% $ 470,924,704
4 1220% $ 6,218,498,711
5 482% $ 36,214,615,122
Mean $ 124,186,364,125
Median $ 80,916,646,765
Std. Dev. $ 137,894,882,427
Percentile
5% $ 3,595,975,276
25% $ 35,302,088,018
Figure 9 - Rate of return Ethereum 01/01/2016
These values portrayed in the previous tables show an impressive mean returns, but
also an impressive standard deviation, proving what was considered in the qualitative
analysis of the possible volatility and risk associated with a new digital asset such as the
Ethereum, which should be expected to fluctuate considerably during the following years.
But by combining both the qualitative and quantitative analysis, Ethereum is by far a
valuable investment, which should be seriously considered in any portfolio.
13Conclusion
Considering the qualitative evaluation performed, we consider that both bitcoin and
Ethereum are here to stay. Although they are currently facing difficult challenges and
threats, which will be kept in the near future, namely in what concerns legislation,
government and central bank pressures, society lack of trust and mediatic awareness,
given the lack of efficiency, high costs involved in digital transactions and the new needs
of today’s business models in particular and society in general, they have been able to
find space to thrive.
We consider that the decentralized platform model of Ethereum, based on blockchain
technology, will be spread as the backbone infrastructure of future business models and
its potential is still far from reaching its limits. As an open source platform, Ethereum
allowed developers to program and build applications on it, which is supporting its growth
strategy and rising adoption. Being able to call large tech and financials corporations’
attention and grant their support is a sign of Ethereum vitality and potential, and placed it
in the pole position of the most potential cryptocurrencies in the market.
Bitcoin reached the market in 2011 and six years later is still present. Although facing
some up and downs during this period, it has had the ability not only to survive, which in
the digital world is already a huge achievement, but more importantly maintain a positive
trendline and continue to increase its value year on year. Based on the blockchain
technology, Bitcoin can be considered the father of younger generations of
cryptocurrencies and benefits from mediatic recognition granted by the 6 years of
presence in the digital economy ecosystem.
Contrary to Ethereum, Bitcoin is not a platform and thus its use is limited to
transactions and deposits. Nevertheless due to its maturity, lower volatility, market
14valuation and limited number of coins, we believe that Bitcoin can positioned itself as a
digital commodity, the digital gold.
As per our quantitative analysis, which goes in line with the qualitative one, both
present themselves as good, yet high risk, investment options.
According to our projections based on historical behaviour, which we recognise
present some risks due to the volatility of digital environment, we’ve have reached to the
following forecasts in a 5 year period:
Ethereum
US$11.9 @ 17/Oct/2016
US$90 @ Oct/2021
Growth in value of 657%.
Bitcoin
US$635 @ 17/Oct/2016
US$1150 @ Oct/2021
Growth in value of 81%.
Given the inherent risk associated to projection making based on past behaviour with
digital assets we’ve complement our investment analysis running a Monte-Carlo
simulation using data from the 01/January/16 up till the 17/Oct/16 for a 5 year forecast
considering US$1 million investment made today..
Ethereum
US$1 million @ 17/Oct/2016
15Average mean of return of US$119 million with a standard deviation of US$126
million.
Bitcoin
US$1 million @ 17/Oct/2016
Average mean of return of US$2 million with a standard deviation of US$1.1 million.
Based on the previously seen analysis, and taking into account the spectacular
possibilities of the Ethereum, one could even consider the investment solely in Ethereum.
But the fact that Bitcoin shows less risk with a much smaller standard deviation, aligned
with the possibility of becoming a commodity analogous to Gold must be considered.
Therefore, with all the quantitative and qualitative analysis shown before, the
investment should be divided in the percentage of 80% for Ethereum ($800.000) and 20%
for Bitcoin ($200.000). This is without a doubt the division that most protects the investor
and ensures the greater outcome for the investment, with less risk.
16APPENDIX 1 – SWOT ANALYSIS
BITCOIN ANALYSIS
Bitcoin had the first mover advantage. Was able to develop and mature its structure by
exponentially increase the hashrate, increasing a secure blockchain production. Currently,
transactions are secured by 1.4 billion Gigahash/sec11.
Figure 10 - Bitcoin hashrate TH/s
A market capitalization of $10 billion and its maturity allowed the Bitcoin volatility
index to present a downward trend that should inspire confidence in Bitcoin as a currency
The bitcoin network already ranges 200,000 daily transactions for approximately 9
million wallets, and is expected to be in the excess of 10 million users very soon.
Figure 11 - Blockchain wallet users
However, there are obstacles in Bitcoin’s way threatening its pole position.
11
Source: www.blockchain.info
17Was designed as a digital cash system. As such, has limitations that other altcoins
identified as market opportunities, like media polarization, compliance concerns related
to money laundering - traceability, reversibility and privacy.
The Bitcoin network hardly scales. It can only handle seven to ten transactions per
second, what is too low for a mainstream system requirement. As an example, Visa
processes thousands of transactions per second12.
As it became popular, Bitcoin block size became larger. The average block size is now
around 700 kb, sometimes reaching 1Mb. As larger sizes delay the transactions, users are
forced to pay higher fees to prioritize their transactions. This cost increase is chasing away
users.
Another concern, mainly for its stakeholders, is how Bitcoin model shall proceed for
the future. This is now a conflict of interests for developers, miners, infrastructure
providers and end users.
The partnerships being done with commercial banks can be seen as traction indicator.
Recently, Bitcoin signed one with Barclays Bank, after the UK’ FCA granted Barclays
and e-money license, becoming the first tier 1 bank having accounts for a Bitcoin
business.
As any other blockchain technologies, Bitcoin as a world of possibilities for its usage.
Nevertheless, due to its maturity for being the first cryptocurrency, fixed issuance,
market acceptance and independency from governments, already serves as a store of value
- digital gold - and has been used to secure investment when financial markets lack
liquidity.
However, there are new alternatives more flexible than Bitcoin. Companies are betting
on the Bitcoin weaknesses and attempting to perform better. These companies are
12
Source: www.fortune.com
18innovating on the smart contract platform, sidechain technology to improve scalability,
clearing the risk associated and also in the interoperability of services.
And what to say about the regulatory threats? As far as the cryptocurrencies growth,
higher the government's concern will be. The later can see this technology as a
revolutionary way to lose control of the markets, currency, data and lastly, the power. The
European Commission already expressed the need to regulate the digital currency.
Related to regulatory threats, comes the media coverage about whether the digital
currencies are being used for.
ETHEREUM ANALYSIS
Ethereum came up to the market with a revolutionary solution of smart contracts,
powered by flexibility, diversification and its inherent capabilities of blockchain
technology development. Allied to it, are the tremendous drivers backing it up, as the
partnership with Microsoft Azzure, which will provide access to the software to millions
of basic users. Other drivers providing powerful traction are the partnership with IBM,
MIT and the latest one with R3, resulting in blockchain developments for 42 main banks.
The improvements made to the blocks technology, allied to a truly independent
platform reduced the processing time from the needed 10 minutes at Bitcoin to an average
of 17 seconds per transaction at Ethereum.
Also as a decentralized cryptocurrency, was able to improve and solve several
cybersecurity issues that were pending.
Smart contracts are now in a great macroeconomic spot due to its potential capabilities,
being applied to financial services, automation of the workforce or public records, for
instance. The undoubtable future relation of smart contracts with IoT, AI and Industry 4.0
is one of the major factors for so many upcoming startups to have their Business Model
19based on this technology. Knowing that the opportunities for this technology are beyond
imagination, one that can’t be disregarded is the potential disruptive power to eliminate
third parties - intermediaries or platforms, as AirB&B and UBER.
Ethereum youth is followed by the typical high volatility and low maturity. And this
volatility represents one of the most representative risks in any investment on the
company. Being an independent platform, accountability and liability are important
subjects that must be accounted for. Will the core developers be accountable for any
issue? And if yes, who are they? If not, who will be accountable for any cyber breach?
New entrants are always a threat. Knowing that there are high technological releases
every six months, potential new entrants are expected in the near future, mainly due to
the high number of start-ups developing this technology.
In common with Bitcoin, Ethereum faces the fact that new regulatory principles need
to be integrated in order to make blockchain technologies an integral part of the market
infrastructure. Also, as an independent platform, Ethereum is a threat to central
governments and banks, as an answer to these threats, Governments are developing their
own blockchain platforms. Besides, the risk of more governments taxing Ethes or
consider it as an asset, as Australia does it already, is high.
Concerning cybersecurity, the operational risk needs to be minimized. This move will
require a quick recovery of participants to revert to the traditional ecosystem as a fall
back.
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