The future of Cryptocurrencies (Part 2)

(Reading time 6 minutes)

Let’s continue where we’ve stopped. In the first part you have read some historical facts about the birth of the money, and the birth of the cryptocurrencies. Then we’ve looked at the 2 biggest contenders in the crypto world Bitcoin and Ethereum – their shared characteristics and differences. In the second part of the post the students turned to the advantages and disadvantages that Bitcoin and Ethereum have,  so they can make their final analysis, and see if Bitcoin and Ethereum are a good investment for the future. Again this is just analysis, and it is not a financial advice. If you are trying to invest in Bitcoin or Ethereum, always look for a professional advice, and invest the amount of money that you can afford to lose. Let’s see what the researches have come up with:

Out with the old, In with the new

To form a strong forward-looking analysis, the researches decided to interview several blockchain experts as well as cryptocurency traders. Each of the experts were asked on the probability of various macro events occurring which might affect the demand for each cryptocurrency, and also to rate the level of impact each event might have on the two cryptocurrencies using a 5 point scale, beginning from Very Low, Low, Medium, High and Very High. They’ve agreed that the macro events and the probable level of impact that each event might have on them was LOW for Bitcoin and MEDIUM for Ethereum.

Emerging market uptake

Interesting thing that they found out, was that the cryptocurrencyes can be more leveraged in countries with less developed financial infrastructure, but high smartphone usage. For example, in Kenya over half of the national GDP is operated by digital currency. Other countries that have experienced significant devaluation of their national currency could also take advantage of the efficiencies that are offered by cryptocurrencies, in terms of moving money into and out of the country. Overall, the potential impact of emerging market uptake is likely to be more relevant with Bitcoin, which represents the most widely adopted cryptocurrency.

Financial Institution Uptake

A lot of financial institutions have shown a willingness to experiment with blockchain technology. Also there has been an unwillingness by large financial institutions to adopt the specific currencies of either Bitcoin or Ether. While blochchain technology is likely to be adopted by financial institutions during the five-year timeline, it is unlikely that either Bitcoin or Ether currencies will be widely adopted by major financial institutions.

Major Regulation/Deregulation

Bitcoin has benefited from largely permissive regulation in the western countries, but has been subject to more restrictions in Asia. The ban of Bitcoin in China has led to a significant depression in Bitcoin prices worldwide. Conversely, it has been inferred by numerous sources that in order to achieve widespread adoption among financial institutions, regulation must be in place to ensure safe and secure transactions. Global deregulation would impact both Bitcoin and Ether to varying degrees. Bitcoin being traded as a currency, would see significant value growth, allowing access into numerous market and ease of transactions across the borders, while Ether would likely see greater value as a result of widespread adoption and reduction of limitations with the smart contract application. The intrinsic value of a unit of Ehter would not necessarily grow, but the widespread adoption of the Ethereum Network would likely grow, leading to greated demand for smart contracts and Ethereum.

Major Network Compromise

In an ecosystem that promotes highly complex and anonymous exchanges of data, the possibility for major network compromises seems high. The recent example of the DAO (Decentralized Autonomous Organization), attack that caused 3.6 million Ether to be transferred illegally in to an alternate DAO indicates the possibility and potential severity of such hacks. There is a possibility of 51% attack on the value of Bitcoin and that is mostly by the stakeholders, but the possibility of a major hack is unlikely to happen, thanks to the rigid framework of Bitcoin. The only exception is a failure of a Bitcoin Exchange like in the case of Mt. Gox. Conversely, Ether has already experienced a significant hack, leading to the fork between the Ethereum and Ethereum Classic. In the Ethereum network the risk of a major hack is much higher due to more freedom in the network. And also there is always a risk of major hacks on the exchanges where both Bitcoin and Ethereum are traded.

Global Economic Events

Bitcoin has utility strictly as a digital currency. Therefore Bitcoin can be expected to have an opposite relationship to the state of global economy. Places or countries who have poor financial infrastructure or highly inflated currencies are more likely to identify Bitcoin  as an alternative measure for transacting. Ether should also carry an opposite relationship to the global economy due to the same factors and plus the more innovative nature of the Ethereum Network. Bitcoin values is more likely to act in the same manner as commodities, Ether value should relate more closely to widespread adoption of the network and smart contracts.

E-commerce Uptake

There is potential for e-commerce to positively impact the value of Bitcoin and Ether. However Bitcoin is better positioned to be used in these transactions. The current payment systems are set up such that there are multiple tоuch points which leads to costly transactions and long processing times. The cryptocurrenceis eliminate the need for these verification procedures and reduce the transaction time. Bitcoin appears specifically useful to minimize these costs.

Financial Technology Uptake

The Blockchain applications for Financial Technology are more favourable for the Ethereum platform, as it is more flexible platform for these institutions to carry out their operations. The benefit that is achieved is a secure transaction as well as a single ledger.

Quantitive analysis

To compile a quantitative analysis, several simplifying assumptions were made to assist with the creation of a 5-year predictive model for the price of each cryptocurrency. They used a Monte Carlo simulation or probability (a technique used to understand the impact of risk and uncertainty in financial, project management, cost and other forecasting models). They run over 100 simulations to compile an expected return on each cryptocurrency after 5 years. The results were that Bitcoin is outperforming Ethereum with 16%. Bitcoin 58%, Ethereum 42%.

Investment strategy

After taking into account the various analysis that they’ve performed, the researches gave weight to each analysis. The results of the regression analysis were quite positive, but they have heavily discounted its results in the overall portfolio decision criteria due to its limitation, and gave only 5% weight. Due to the forward looking nature of the Monte Carlo analysis and its ability to incorporate a multitude factors that could potentially play out over the next five years, they have allocated the remaining weight to the results of this analysis. And also they have added a three different sub criteria for the results of the analysis. Here is the table that shows the impact of each of the weightings on the portfolio

Conclusion

As you can see from the results of the analysis, Bitcoin is consistently the better performer however, Ether has proven that it should also warrant of the portfolio. All things considered, with this analysis you should invest 69% into BTC and 31% into ETH in order to maximize your return over the next 5 years. With this analysis and all the factors that were taken into consideration it has been concluded that Bitcoin is likely to experience more growth in the 5 years horizon.

Thank you for reading

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