Why Bitcoin and Ethereum will drive the blockchain narrative in 2020 (and what to do next)
Bitcoin was first launched by Satoshi Nakamoto in 2009, and is now over 11 years old. It’s also nearly five years since Ethereum launched it’s network in 2014. Since that time both these public blockchains have steadily grown in adoption, security and market value. In 2020 Bitcoin continues to be the market leading blockchain and Ethereum follows closely as the leading smart contract platform.
Both Bitcoin and Ethereum are open, permissionless, transparent blockchain networks that anyone can interact with and use. It’s for these reasons, that in 2020 network effects will see these public blockchains continue to grow, capture value and developer mindshare. Development at the protocol and application layers of these layers has not ceased since the bubble of 2017-18. Bitcoin’s use case as ‘digital gold’ is growing stronger, as is Ethereum’s use case for decentralised finance, known as DeFi. This article explores both their narratives that will drive blockchain and crypto in 2020.
What is Bitcoin even being used for?
Bitcoin, like gold, a precious metal with an inelastic supply, is increasinly being seen as a store of value asset. It’s the world’s first digitally scarce asset due to it’s algorithmically fixed supply which increases as each new block is mined. Already 18.2m (86.7%) of 21 million coins having already been produced. Bitcoin’s block reward halves every 210,000 blocks, which is roughly every four year. This event is known as the ‘halving’ and is next projected to occur on May 12 2020. This means the rate of issuance for new bitcoin will drop from 12.5 bitcoin to 6.25 bitcoins per block every ~10mins. You can even track the countdown here.
Bitcoin is also increasingly seen by investors as an alternate hedge investment due to its low correlation with other asset classes such as bonds and equities. Like other asset classes, financial services are being built around Bitcoin. Major institutions are making the investment case to their clients for Bitcoin, or launching Bitcoin investment products directly.
Of all cryptoassets it has the longest track record and is the most secure. It maintains a network with the largest number of active nodes and hash power, whilst, by design has the lowest attack surface due to its limited scripting language. These are all key factors which reduce it’s risk compared to other cryptocurrencies, and make it the most attractive. As such, Bitcoin remains the most important digital asset and blockchain. With a total market value of $170bn this represents less than 3% of the gold market value, currently at $US7 trillion. As a new asset class, and ‘better digital gold’, Bitcoin has a large capacity to grow in the future.
In the US, VanEck, a global ETF provider, is making the case for Bitcoin investment. In 2019 the Grayscale Bitcoin Trust, the largest global Bitcoin fund, brought in $US600m in funds with more than 70 percent coming by way of institutional investors. The trend is not just in the US, but In Australia, DigitalX, has launched their own Bitcoin Fund too.
Not only are asset managers launching investment products, but there is a burgeoning derivatives market too. CME Group, the largest derivatives exchange in the world, offer bitcoin futures, and launched their bitcoin options contracts in January this year. This followed Intercontinental Exchange-owned Bakkt who rolled out their options product in December 2019. BitMEX, OKEx, and Huobi currently dominate the market, but new competition is helping improve liquidity for the underlying spot market. You can track bitcoin futures market data here.
Financial services around Bitcoin are maturing. Beyond trading and investing, custody solutions for secure storage of bitcoin (and other cryptos) are being built by exchanges, banks and traditional financial custodians. The lending market is also blooming with companies like Celsius and Genesis Capital offering collateralised crypto lending products. Celsius and Genesis both have seen strong growth with each reaching over $US4bn in loan origination to end of 2019.
One of the classic analogies for Bitcoin was that of the platypus. “The platypus is perhaps the most bizarre creature on the planet. It’s a venomous, egg-laying, duck-billed, beaver-tailed, otter-footed mammal. Those things simply aren’t supposed to go together.” The platypus was so unique they ended up creating a new animal family and genus for it. The same goes for Bitcoin. Bitcoin is so unique that we’ve create created a category for it.
Bitcoin has many technologies that make up its whole, for that reason many find it difficult to understand. Bitcoin is a decentralised peer-to-peer network, using public key cryptography, with a proof-of-work consensus algorithm rewarding miners with bitcoin to maintain a hash chain of transactions. Bitcoin is also the asset on the blockchain. So is Bitcoin digital gold? a payments network? or more like a commodity? It is all these things. Bitcoin surely is a category creator, and that is why investors and businesses are making bets on this emerging asset class. The market is starting to understand what makes Bitcoin unique.
Most of the financial services being built to trade, invest and lend bitcoin functionally exist in software and not directly on the blockchain, often referred to as being ‘off-chain’. This typically means service providers are closed, custodial and centralised. On Ethereum these same financial services are being built too. But they are being developed programatically directly on-chain using smart contracts and are non-custodial, allowing the user to maintain direct control over their private keys.
What is DeFi and why does it matter?
Ethereum was the first blockchain to support a general-purpose programming language. Smart contracts deployed on Ethereum execute code directly on the blockchain. In 2019, there were a growing number of financial services launched using these contracts. This included borrowing, lending, trading, investing, insurance and derivatives. Given the decentralised, peer-to-peer design of Ethereum’s network, these financial services became known as DeFi. DeFi products are transparent, open source and operate without intermediaries.
This is in contrast to traditional financial services which are closed, complex systems and not as transparent. DeFi shows us that open blockchain networks can provide infrastructure for building new financial services that exhibit the values we actually want to see from existing financial service providers. DeFi has established a market of financial services that are both more efficient, accessible and directly auditable.
Examples of DeFi services. Source: Pantera Capital
One of the first, and arguably the most important DeFi project on Ethereum is MakerDAO. It’s protocol allows users to mint a stablecoin, called DAI, by locking ether as collateral in a contract. DAI maintains a peg to USD, providing price stability for the token, unlike the high volatility of the underlying asset, Ether, hence the name ‘stablecoin’. A user who holds DAI can then earn interest using Compound, which is an interest rate protocol and that allows for lending and borrowing. That same user can then use a service like Zerion to view their crypto assets and liabilities. Stablecoins are allow for a number of different uses as shown above.
All these services are enabled through smart contracts on Ethereum. Since Ethereum is open anyone can build services on top of other services, This allows for fast innovation and building of crypto finance apps. The DeFi community call this ‘money legos’. It represents the composability of Ethereum, where existing protocols can be used as building blocks and used to program higher-level applications. For a developer, it means the ability to build new functionality faster since existing resources can be built on top of easily, at near zero-cost.
The total value of the DeFi market is measured by the Total Value Locked (TVL) in Ethereum, a figure that has just passed $1USbn. As this figure to continue to rise through 2020 so does risk in the system. As a tightly connected set of money protocols, risk in DeFi should not be ignored.
Depositing funds into a DeFi protocol does have risks. There is technical risk. Smart contract code needs to be independently audited. Smart contracts that rely on external information via oracles for functions may not behave as intended depending on the data fed into them. Likewise protocol developers who hold admin key to smart contracts may intentionally or inadvertently introduce risk to protocols as well.
There is also regulatory risk to consider. Given the nascent stage of the development of these services, many regulatory guidelines are unclear. AML and KYC do not exist when using these services. This is what makes them completely accessible, but also why regulatory risk is real.
Risk is being considered by the community though. DeFi Score is an open source framework that helps quantify risk looking at ‘measures of smart contract security, openness of code, collateral, liquidity, and regulatory risk.’ Protocol developers themselves are developing pathways to further decentralise their organisations project control to reduce risk of censorship or code capture. Synthentix is one example with a roadmap for this change.
This all sounds exciting, what do I do next?
Like any new technology, to improve your understanding it’s best to read and then play. There are plenty of resources online for those who want to learn more. The best place to start for beginners is the Bitcoin white paper. Many other pools of resources exist such as the one maintained by Jameson Lopp and the a16z crypto glossary will help you cut through the jargon. There are plenty of digital asset exchanges where you can convert fiat to crypto then start to participate on the Bitcoin and Ethereum networks and even try out DeFi protocols mentioned above.
If you are a business owner or entrepreneur outside of the blockchain world, this is an opportunity. Blockchain startups can raise money using crypto, issue tokens as part of their product, and build communities that cross boundaries with few hurdles. The composability of Ethereum means you can develop products using existing apps and protocols too. Building internal blockchain capability both in product and technical development areas and the search for talent will be a challenge. Establishing partnerships early can position business builders and innovators with the right people and tools to take a lead in this space.
For enterprise, choosing the right platform to build on is key. Public blockchains could become the preferred platforms for the industry over closed, private blockchains. Any application specific private chains will eventually inter-connect with public chains for scaling performance and token transfers. Technology leaders will need to continue to assess the best network solutions for their specific use cases. Risk should be considered, keeping in mind that permissioned networks lack decentralisation and enterprise participants could become beholden to the owners and operators who may empower their own position over participants in the network. This is strategically risky. Utilising and interconnecting with decentralised public blockchains helps mitigates that risk.
2020 will be a year of continued growth and adoption for Bitcoin and Ethereum and their respective ecosystems. In competition new blockchains will emerge to challenge the early mover advantage of these networks. A number of next generation blockchains with alternate consensus algorithms launched in 2019 including Blockstack and Algorand whilst Dfinity plans for 2020. The challenge will be betting against the network effects that Bitcoin and Ethereum maintain, which are well-established, with services, wallets, apps and large developer and user communities already.
Improvements for privacy, scalability and interoperability will come in 2020. Transaction privacy, a core reason for pursuing permission networks, will be addressed on Ethereum with zero-knowledge proofs being deployed through the AZTEC protocol and others. Bitcoin too will become more private with upgrades delivering Schnoor signatures and Taproot. Projects like Cosmos and Polkadot will build out, allowing communication between independent blockchains. ‘One network, many chains’ as Andreas Antonopoulos described it.
Outside of public blockchains, Facebook’s Libra may even launch, as will a number of Central Bank Digital Currencies (CBDC) from nation states, led by China’s Digital Yuan. The BIS has said that 10% of central banks globally are expected to launch CBDCs in the next one to three years, and the WEF even launched a Central Bank Digital Currency Policy‑Maker Toolkit to help.
In 2020, the blockchain sector will surely continue to surprise, innovate and divide. The pipeline of improvements and upgrades for Bitcoin and Ethereum is deep and the applications and protocols being built on-top will grow. Clear business use cases for blockchain are here. Developer tools will mature, networks will improve scalability, investment will continue and user experiences will improve. So buckle up, its going to be another exciting year ahead.