Cryptocurrency activity shifted into overdrive in the second half of this year.
The combined market capitalisation of all cryptocurrencies has exploded, now exceeding $US600 billion, and exchanges are struggling to keep up with demand.
It’s all taking place amid high volatility, suspicions of market manipulation, and warnings from central bankers about the speculative nature of the market. There’s also questions as to how cryptocurrencies will deal with increased regulatory oversight as the market matures.
We spoke to Ryan Taylor, the CEO of Dash Core, which is currently the eighth biggest cryptocurrency in the world by market capitalisation.
Here’s a quick summary of what he had to say on some key issues:
Speculation is still rampant as the new market seeks to determine value. Growth is unlikely to continue at its current rate unless the use-cases of cryptocurrency become more tangible. To this point, cryptocurrencies have been used mainly to replace existing technologies, but the incremental value they can add lies in the creation of new payment methods. Right now, it makes sense to value crypto assets based on fiat currency because the market still only makes up a tiny portion of the global financial system. The Bitcoins owned by that network’s founder, Satoshi Nakamoto, have never moved. Taylor said that factoring in locked and missing coins means some of Bitcoin’s market cap may be “phantom”. Taylor expects the market for cryptocurrency exchanges to consolidate, and said large incumbent exchanges which already operate in regulated financial markets have a competitive advantage.
The full interview is below.
Sam Jacobs: There’s increasingly divergent views among finance professionals about where the market for cryptocurrency is headed. Given your involvement and belief in it, do you have a vision over the next 12-24 months as to where this new market goes?
Ryan Taylor: Given the current set of use cases, I think there’s a chance the market could stagnate here. I don’t see how it could keep growing as it has been.
In many ways the speculations is warranted, because these currencies have incredible value in terms of solving real-world problems.
But the real-world use needs to catch up with the speculation if the speculation is to continue holding.
I think 2017 will be seen as the year that the market started looking past Bitcoin, to all these other tokens and assets out there to determine where value might lie.
I don’t think the market has figured that out yet — I think most of these projects are highly likely to fail.
But it has started looking beyond Bitcoin and that mere fact is what will allow innovation to start to flourish and I think in 2018, you’ll start to see some of the first practical real world uses of some of these tokens.
So I’m hopeful that the benefit is large enough, and the value to some of these use-cases that can be pursued, will quickly be able to justify the valuations – or at least close the gap between reality and speculation.
I think there is likely to be a correction at some point, because regardless – it’s really tough to keep the speculation and real-world use in close proximity to each other, at such an early stage of the industry.
So I do think there’ll be corrections along the way but I also believe in the enormous potential that these technologies hold.
The use cases haven’t even begun to be explored for something that facilitates immutable transactions at near zero cost if you can scale it.
At that point, money turns into flows. They’re no longer monthly payments – you can pay for things as you use them. You can literally pay for a page as you scroll down it.
You can even imagine your car could have cryptocurrency in it and pay a road tax to the city it’s driving in based on the current congestion rate.
You could buy a cell phone with cryptocurrency in it and it could negotiate one-minute contracts with a telecom provider – whoever you’re in proximity to – and buy one minute of air time at a time in the very data stream that makes up your voice.
Largely they’ve been used up to this point to replace an international money transfer, or as a bank account.
They’re replacing existing things, but that’s not where incremental value they can bring to the market lies.
Jacobs: So the use-case of crypto isn’t just to replace traditional fiat currency for buying goods and services. In effect it’s aiming to create a new paradigm for monetary transactions?
Taylor: It’s the same thing that happened with information, when the cost of information dropped to near zero and become instantaneous, you now get the news on your phone live as it occurs.
You no longer tune into the evening news or buy your encyclopedia – information flows to and from you just as freely, and that’s what will happen to the digitization of money. If you digitize money it can flow anywhere freely around the world.
If you can imagine a world where money is in the background and you don’t even notice it – as I said, scrolling down some online content and paying for it as you scroll.
Jacobs: Theoretically, say global central banks scaled a solution to digitise fiat currencies. And I could then transfer, say, AUD to the US instantly with low transaction fees. Conceptually, does that limit the use-case of cryptos, while maintaining a link to traditional fiat currencies?
Taylor: Well that’s a marriage of the two – it captures some of the benefit of cryptocurrencies, but not all of them.
One major one is, given the choice between two digital currencies, one that can inflate into infinity in supply and the other that is capped at 18 million (the limit of Dash) which one would you choose? The one that devalues over time or the one that increases in value with the size of GDP?
So I think there are advantages to digitizing money, but that’s not the only application of cryptocurrencies that make them great.
I think there’s a real advantage there for digital currencies and the consensus around supply, that gives them better value than any fiat could even if it’s digitized.
Jacobs: Just mainly based off their scarcity?
Taylor: Yes, there’s no scarcity behind the US dollar except to the extent that the government restrains itself. And history proves that when countries go into debt, that restraint quickly goes away.
Jacobs: So the strength of the cryptography behind certain digital currencies, and the finite aspect, is part of the value proposition in your mind?
Taylor: Oh, definitely. There’s a clear and distinct advantage around the public utility model versus a centralised issuing authority.
Jacobs: Can you discuss the recent forks of the Bitcoin blockchain in that context? Because in a sense cryptocurrency forks reduce their scarcity – it seems like creating money out of thin air.
Taylor: Well, there could actually be value created in a fork. When Bitcoin Cash forked from Bitcoin, the effective capacity of the bitcoin network before and after the split significantly increased, and therefore the cost of transactions on both networks reduced. So that did introduce value into the market place.
If that hadn’t occurred, all of the transactions would have been forced to stay on the original Bitcoin network.
If not, fees go up and where do those fees go? To miners, and in response they build more electricity and equipment to capture more of the market because its profitable. That is a complete waste it offers no value to the end user.
There’s no benefit to having more hash power than Bitcoin already has. It doesn’t become incrementally more secure, it’s already incredibly secure as far as its hash rate is concerned.
So in a sense you’re right, there is value created out of thin air. But it’s value is created from the incremental capacity.
The issue is, Bitcoin cash can’t scale to infinity either, so when that network fills up it will be split again, and again, and again. We’ve already seen Bitcoin Gold and Bitcoin Diamond.
So at what point is it actually eroding value? When people get confused, there’ll be mistakes made where people send Bitcoin to the wrong address, the wrong chain. So there’s problems with it, it’s not an elegant solution. It’s a solution being driven by this need for capacity, but it’s not by design.
So my conclusion is that ultimately one split might be beneficial – five splits, not so much – a better solution is needed than continuing to split that blockchain.
Dash incentivizes the nodes so they can afford better hardware so we don’t need to split the chain.
We’re conducting research with Arizona State University to determine what is the best route to scale these technologies to keep transaction costs low as a payment network.
So I think that’s the right solution, it’s not to have reddit debates, get pissed off at each other and start new coins.
Jacobs: Right now if we talk about the value of Bitcoin or other cryptos, the figures are always derived from existing fiat currencies. In other words, fiat is still central to the valuation metric – will that change at some point?
Taylor: Cryptocurrencies are tiny in comparison to the rest of the economy. The amount of economy that is running across crypto networks is still minuscule.
So right now, it makes absolute sense to price these things in terms of fiat because fiat is more stable in terms of the value of real goods and services, and it’s the majority of the world’s economy.
But if more of that economy shifts over to cryptocurrencies, then at first the discussions will be around cryptocurrencies’ rise against the dollar. But if they do end up performing the way that some people predict – I don’t know if they will — but if they capture a huge portion of the economy, then eventually you’ll be talking about the devaluation of the dollar against dash coin, for example.
I think as the government measures this stuff, and measures the value of a dollar against a basket of goods and services, if you start to see deflation at the same time that you see enormous value increases of cryptocurrency – then I’d say there’s a responsible culprit.
Right now, even if you counted 100% of Bitcoin’s speculative value as economy-switching, it’s still a drop in the bucket and wouldn’t move the needle on any depreciation of the US dollar. But I think it’s extremely hard to predict at this early stage.
Jacobs: There seems to have been a move away from discussing Bitcoin as a means of exchange, the valuation argument has reverted to a store-of-value similar to gold. Dash is seen as more of a payments facilitator, so within that paradigm can you talk about the use-case for Bitcoin and Dash over the next couple of years?
Taylor: Bitcoin’s value proposition as far as a payment network goes has eroded as the network has run up against its capacity limitations.
The resulting competition for that capacity has driven transaction fees to the point where at least small value transactions haven’t been viable.
What you’re seeing right now is a reactive response from a lot of the companies that use bitcoin for small value or low-margin transactions beginning to migrate their business elsewhere.
It’s simply become economically unfeasible to run those type of transactions over the bitcoin network anymore.
What we’ve seen recently in Dash is that a lot of small-scale services like phone top-up services, POS retail, video game use cases, we’re seeing a rapid migration and interest in a payments focused network like Dash.
So we’re rapidly integrating a number of new services basically as the bitcoin network is losing them, mainly over economics.
Jacobs: And Dash has recently upgraded its transaction block size from 1 megabyte to 2 megabytes right?
Taylor: We recently went through a network upgrade and the max block size was increased from 1mb to 2mb.
It went through several stages of approval. First of all most of the miners needed to upgrade their capability and then a certain numbers of blocks for a certain period of time had to be mined on that version network to lock in the rule. And then the rule took effect two weeks later.
The other thing to note is we also have blocks 4 times as frequently – which effectively pushes us to 8 times the transaction capacity of Bitcoin. We’re every 2.5 minutes roughly and Bitcoin is every 10 minutes.
Jacobs: There’s around 18 million dash coins on the network. How many have been mined?
Taylor: I think it’s around 7.8 million.
Jacobs: There’s reports that around 1,000 bitcoin holders hold 40% of all Bitcoins mined. So in a way its decentralized, but it’s also top-heavy. So I’m wondering what the format is for Dash.
Taylor: Our top 100 wallets control about 15% of Dash coins.
That declines over time – we have our master nodes and if those large holders owned master nodes they’d get a payment, but that payment is only 45%. The other 45% goes to miners and 10% goes to a communal fund.
So even if they’re master node holders they continue to get diluted over time as a percentage of the total coins in circulation. These holders would have to keep buying in order to maintain their ownership of the Bitcoin network.
That’s the case with Bitcoin as well, those early holders would have to keep buying in to maintain their share of the network. These networks are designed to dilute the people that get in early the most.
I know there’s some people who invested early in many of these networks and have done quite well, and if they’re smart they should diversify.
With the case of Bitcoin, there’s certain wallets where it’s unclear if they’ll ever get cashed in. Satoshi Nakamoto’s coins have never moved. So it’s unclear if that person is still alive, and if they are, if they still have access to those coins. So in that sense, some of Bitcoin’s market cap might be phantom.
In the sense that, they’re unlikely to ever be used. They’re basically burned, for all practical purposes.
Jacobs: Most Bitcoin mining appears to be based in China, which has lower electricity costs. Do you know much about the physical location of Dash miners?
Taylor: I don’t know the exact setup. I can tell you that we have significant mining operations in North America. We do have significant mining operations in China as well.
At conferences I have a lot of these guys that mine come up to me and talk about what they’re doing, so I have a sense that it’s probably more dispersed than what you see with bitcoin.
There are some differences with the Dash network as far as energy consumed. We are a lot smaller of a network so the value of coins being created is lower, therefore the amount going towards electricity is also lower. Secondly, only 45% of the block reward is kept by the miner, the other 55% goes somewhere else.
So as the Dash network grows, the amount that goes towards mining is not 100% like it is with Bitcoin, which gives us some efficiency.
And the third component is based on an Algorithm – X-11 – strings together 11 different algorithms, which makes the equipment run cooler because the calculations can’t run as quickly.
More of the 45% reward for miners goes to the improving the hardware itself, so it uses less relative elec.
We also have a path towards what we call collateralised mining, which can reduce the incentive for miners to engage in an arms race, as they are with bitcoin. It’s kind of technical, but basically we have a path and a roadmap to address this issue in the long run.
Jacobs: Cryptocurrency futures trading is underway on major exchanges. In addition to Bitcoin, do you see futures trading extending to other cryptocurrencies?
Taylor: We’re beginning to see the first of the mainstream financial products that are derived from these cryptocurrencies, and I believe there’s a use for them.
This issue is the extreme volatility of the underlying assets makes the futures even more volatile.
I’m sure it will settle but there will be times when volatility spikes.
Until market matures, probably much more useful as a hedge for people with exposure to bitcoin, and might want to short or want to invest in Bitcoin but don’t want to own it.
I don’t see why not. Bitcoin is the largest, but at times they’ve been less than half the market this year.
Case could be made for Ethereum, I’m sure there will be more. I hope that one day Dash starts to get integrated into financial systems as well.
Jacobs: Cboe futures contracts are only going to be based on the Gemini exchange, owned and operated by the Winklevoss twins. Do you have any thoughts on a futures market that’s based on one exchange in a relatively new market?
Taylor: On one hand, the argument to be made for using Gemini is, Cboe want to base their market on a highly regulated exchange. They don’t want to be based on non-regulated or loosely regulated exchanges in other countries, in order to set that Bitcoin price.
The argument against is, you’re taking a relatively illiquid product, and by only considering the price on one exchange you’re potentially exposing yourself to even less liquidity.
As we’ve seen, in the world of Bitcoin the price differential on different exchanges can be substantial. Gemini isn’t always representative of the broader markets.
So I know they have good intentions, but exposing themselves to a risk in the way they’re pricing that product, that could be more manipulated on a single exchange and might result in liquidity issues.
Over time, futures markets are likely to add other exchanges. There are others that are regulated extensively such as like Kraken and GDax would make good additions and I think regulators should move in that direction.
Jacobs: You mentioned the large discrepancy in price between different exchanges. Are there some exchanges that you think will eventually take market share as the crypto market consolidates?
Taylor: Well, I’m still uncertain as to whether cryptocurrency specific exchanges will remain the predominant players in this space.
I think there’s a huge opportunity for regulated exchanges that deal with ETFs and stocks to get into this.
They’ve got expertise not only around the regulation, but around the technology to really scale this stuff and they already have the existing connections into the rest of the financial world
So in many respects, it may be an easier lift for traditional exchanges to get into this category of asset and I think we’re starting to see that with NASDAQ and Cboe.
I think they’re going to dip their toes in the water in 2017, and probably if it continues to expand, they’ll expand their own separate services into 2018.
If given a choice between being a customer of an exchange that only deals with crypto compared to crypto and other asset classes, I’m not sure which model is likely to survive.
I think the first question you have to ask is, who’s gonna own this in the long run? And if it is cryptocurrency specific exchanges, then I think similar to the world of stock exchanges there’s likely to be consolidation and only a handful of players that really matter.
Because these are markets where liquidity is a distinct advantage, so I can’t imagine that there’ll continue to be these hundreds of currency exchanges across the globe.
There’s a lot of financial incentive for both the buyers and the sellers to gravitate towards more liquidity.
I think you’ll see dramatic consolidation in the market over the coming years. I don’t think it’s happened yet because there isn’t a lot of price competition right now. Most exchanges price the trades at about 20 basis points.
But I’m starting to see some more aggressive pricing structures where it’s 20 basis points for the market takers and -15 basis points for the market makers.
We’ve seen some other volume-based pricing models introduced into the market the last couple years.
There will be downward pressure on margins and that will force the consolidation to take place, and as that happens the pressure on smaller players only goes up.
I’m sure there’ll be room for smaller exchanges on local markets where regulation doesn’t easily allow the flow of funds across borders. But I think they’ll be the exception rather than the rule.