I can highlight five main themes that I think will start to take hold this year.

Securitizing tokens and tokenizing securities
Institutional involvement in the cryptocurrency market
The halo effect of industries being built around blockchain
The future of stablecoins
The rise of Proof of Stake

1. ‘Securitizing tokens and tokenizing securities’

While most people agree that the 2017 ICO boom was largely frothy exuberance and speculation (most ICO projects never delivered what they promised) one good result was that it catapulted blockchain-based tokens to the front of people’s minds and awareness. Fundamentally, the nature of token-based assets holds a lot of promise; with benefits including reduced complexity of transactions, improved settlement times, democratisation of venture-stage investing, and greater liquidity for early investors who aren’t locked into their decision for 5–10 years. But of course, regulators are never far behind and what we can expect now is a greater amount of scrutiny and regulation of this new fundraising mechanism, to help ensure that investors (particularly consumers) don’t get burnt.

A key part of this trend will be the increasing prevalence of security tokens. However, I believe there are two sides to this coin; the tokenisation of existing securities and the securitisation of tokens.

In the former (tokenising securities), we would expect to see an increasing willingness of institutions and issuers to take existing securities and ‘wrap them’ in a blockchain-based token. This allows them to access some of the benefits mentioned above, but also allows for new and interesting capabilities such as divisibility (fancy owning 1/1000th of a Picasso or Berkshire Hathaway Class A share?) or new access (e.g. private REITs which currently have multiple rules preventing most investors from being able to participate in them).

Meanwhile, for the newer and more cutting-edge blockchain projects, we will see increasing clarity from regulators as to what constitutes a so-called ‘security token’ and under which rules they should/will be regulated.

In general those that are speculative and purchased with the defined expectation of returns will be classified as security tokens, while those that simply allow access to a new network as a type of ‘fuel’ for that network will be classified as utility tokens (albeit probably still with speculative potential). I predict more exchanges will appear that are built from the ground up as explicit security-token exchanges, with all the regulatory measures and controls that will entail. I also expect many existing tokens to increasingly fall under the definition of securities, as well as new projects and tokens being created with adherence to these new definitions.

The legal ‘grey area’ in which many unlicensed exchanges are still happily (and profitably!) operating will continue to shrink.

2. Institutional involvement in the cryptocurrency market

There is already plenty of institutional interest in the market; a lot is happening in the OTC market behind the scenes, for example, and the day trading space is becoming increasingly automated by specialist hedge funds. Now that it’s clear that crypto is here to stay, we will increasingly see larger pools of money beginning to get involved. Whether pension funds or asset managers, endowments or family offices, in the future I expect the question will not be a matter of ‘who is’ investing in crypto, it will start to become a question of ‘who isn’t’ investing in crypto. While the risk-reward profile of bitcoin and other blue-chip cryptocurrencies remains asymmetric, I think it will increasingly become seen as irresponsible of a fiduciary or fund manager to not put at least 1–2% of allocation into this emerging asset class. The arrival of ever-more instruments such as futures, ETFs, Security Tokens, and even fixed-income crypto-securities will accelerate this trend.

3. The halo effect of industries being built around blockchain

Just as the protocols of the early internet (TCP/IP, SMTP, FTP) were the building blocks for a wide range of emergent applications and uses — ultimately the global internet phenomenon that we see today — so is blockchain forming the building blocks for the next revolution.

While existing familiar industries are busy (and wisely) trying to understand, pilot, and adapt applications of this technology to their empires, meanwhile brand new industries are quietly starting to emerge. This is what I call the ‘halo effect’, whereby the world starts to realise and develop applications of blockchains and distributed ledgers that were previously not possible, and whole new concepts begin to rise and capture our imagination.

In the short term, we can expect to see emerging industries directly spouting from existing ones: new hardware wallets, custody solutions, insurance solutions, KYC technologies, tax companies, escrows, professional services etc. However, looking further into the future, the potential second-order developments could change the way in which we operate.. What about robot forensic detectives? Smart-contract auditors? Self-sovereign charging stations? Machine-to-machine marketplaces? Mesh-networks (WiFi by-the-second)? Micropayment processors? Smart-economies? Crowd-sourced hedge funds? The list is endless.

To quote Bill Gates, we tend to overestimate what will happen over the next 2 years and vastly underestimate what will happen over the next 10. No-one anticipated in 1995 what sort of new paradigms would be enabled by decentralised knowledge. Now we have decentralised value to add to the mix.

4. The future of Stable Coins

Whilst Stablecoins aren’t a brand-new addition to the Crypto ecosystem, I do predict they’ll solidify their place in the market in 2019.

There’s a lot of discussion around their usage and future within the market and in my opinion, a lot of people simply do not understand why they exist. Some even invest in stablecoins erroneously expecting crypto-level returns, which completely misses the point.

Stablecoins are trying to harness the ‘best of both worlds’; relative lack of volatility of government-backed (fiat) currencies, coupled with the technological benefits of crypto-currencies, which include speed of settlement, ease of transfer, and notably,circumvention of sticky, legacy banking infrastructure. This presents some interesting applications. On the one hand, Stablecoins allow those exchanges without a license to handle government (fiat) currencies to nevertheless implement pseudo-fiat markets, with crypto-stablecoin trading pairs (e.g. BTC/USDT) acting very much like crypto-fiat pairs (e.g. BTC/USD). This allows traders to trade in and out of crypto markets entirely even if the exchange they are using doesn’t support non-crypto assets, because it allows them to hold balances of traditional cash assets like dollars or euros in the form of digital stablecoins.

A common question then is what’s the point of going to all this trouble to use stablecoins when you could just use a licensed exchange which supports balances of actual dollars or euros?

The answer is that stable coins are blockchain-compatible and therefore able to be used in smart contracts. Smart contracts allow for flows of funds to be automated based on business logic and triggers that can be coded and decentralised, running without the need for expensive solicitors or trustees. While this opens up a whole new world of automation, it’s a safe assumption that we won’t see the first widespread smart contracts transacting in bitcoin or ether. People will seek to harness the potential of ‘programmable money’ smart contracts without the unpredictable volatility of the underlying assets or funds, and this is the fundamental value proposition that will put stablecoins on centre stage as a base layer for the next wave of blockchain innovation.

One interesting development will be whether the several existing projects for stablecoins of the same denomination (e.g. USD) will eventually consolidate, continue to fragment, or be re-monopolised by Central Banks who are also looking at stablecoins very closely (see IMF Report).

5. The Rise of Proof of Stake

A common criticism of Bitcoin is the energy it consumes. The sink of this energy consumption is an unbounded global arms race to feed computation (or hashing) power to Bitcoin’s consensus mechanism (known as ‘Proof-of-Work’) by miners that compete to find the elusive block solution and hence newly-created bitcoins.

Proof-of-Stake (PoS), as opposed to Proof-of-Work (PoW), is an alternative consensus mechanism that isn’t based on hash-based mining, and as such is greatly more energy-efficient, resulting in PoS being widely argued as a good alternative model for securing cryptocurrency blockchains.

Typically PoS blockchains haven’t been widely adopted due to their own different inherent flaws (inc. so-called ‘weak subjectivity’, ‘long range attacks’, or ‘zero opportunity cost’ problems). Recently however, a new generation of Proof-of-Stake projects have appeared, which build on previous lessons to be more carefully and elegantly designed in order to resolve or iron out most of these issues.

Projects such as Tezos are a good example, which not only seems to have considered and fixed the main objections to PoS, but it has already awakened investors to the wonders of staking rewards. Unlike PoW chains (such as bitcoin), where these days mining rewards are exclusively the purview of specialised facilities with millions of dollars of equipment, with PoS chains (such as Tezos) rewards become obtainable to anyone and everyone who owns coins. In such a scheme, the average Joe need only offer up his coins as a sort of collateral, and they can participate in the verification process needed to add new blocks to the chain. In this way, they can receive fresh new tokens as a ‘reward for being honest’, and they can do this while remaining in full possession of their funds; they don’t need to lend them elsewhere. In return they can earn compounding interest (Einstein’s ‘8th wonder of the world’).

Moreover, users can earn this compound interest denominated in crypto, not fiat. This means if the price of the token goes up in fiat terms, so does your regular income. This delightful reward scheme is a powerful incentive, as now we can own cryptocurrencies that earn a yield, which is just another step towards acceptance as a serious asset class.

My expectation is that as people begin to understand and experience investment yield in crypto, this will spark a new wave of interest in Proof of Stake blockchains, with main beneficiaries being the newer generation PoS projects that have been elegantly designed to address some of the earlier flaws.

(disclaimer: I am an individual small investor in the Tezos project)

Andy
December 2018