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Canaccord Genuity is the global capital markets group of Canaccord Genuity Group Inc. (CF : TSX)The recommendations and opinions expressed in this research report accurately reflect the research analyst's personal, independent and objective views about any and allthe companies and securities that are the subject of this report discussed herein.
US Equity Research
14 November 2017
Source: CoinMarketCap, CoinSchedule, Canaccord Genuity
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BitcoinYTDperformance
Michael Graham, CFA
| Analyst | Canaccord Genuity Inc. (US) | MGraham@canaccordgenuity.com | 212.849.3924
Austin Moldow
| Associate | Canaccord Genuity Inc. (US) | AMoldow@canaccordgenuity.com | 212.849.3931
Scott Suh
| Associate | Canaccord Genuity Inc. (US) | SSuh@canaccordgenuity.com | 212.389.8360
Industry Update
Crypto Quarterly – Q4/17
In this inaugural edition of our Crypto Quarterly, we explore the major developmentssince publishing our revised white paper on blockchain and cryptocurrencies in earlyOctober. Key updates within include:
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Thinking through the ICO boomlet –
The topic of whether the world needs a fewdigital currencies to enable a more friction-free remittance process for certain types of transactions is somewhat controversial, but nowhere near as contentious as the ICOboomlet which has created over 1,000 crypto coins that range from "utility tokens" toequity proxies. We provide historical perspective and examine the key issues surroundthe ICO market.
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Update of recent events –
As cryptocurrencies have drawn in an increasing numberof enthusiasts and institutional investors alike, governments around the world haveramped up their efforts to regulate the still-nascent industry in recent months.Following in China's footsteps, South Korea announced its ban on initial coin offeringsin late September, while Russia declared its intent to block access to cryptocurrencyexchanges. Meanwhile, the much-anticipated Segwit2x bitcoin fork was called off on11/8, sending shockwaves within the blockchain community and causing the price of Bitcoin Cash to skyrocket in the days following the announcement.
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Update on key developments –
We highlight several notable thematic developmentsover the last several months, including the cancellation of the Segwit2x Bitcoin fork,Japan's rise as the predominant leader by bitcoin transaction volume, and hedgefunds' increased participation in ICO pre-sales.
•
Update on major cryptocurrencies –
Bitcoin is up ~580% YTD, while altcoins such asEthereum (up ~3,870%) and Ripple (up ~3,060%) have amassed even more outsizedgains so far this year. While there are now over 1,200 cryptocurrencies in existencewith a total market cap of ~$210B, Bitcoin has gained market share in 2017, andcurrently commands 53% of the entire market.
•
Update on ICO market –
Through October, companies have raised ~$3.3B via initialcoin offerings YTD. After a record ~$800M was raised in August, the ICO market cooledsomewhat in October to ~$375M.
•
Cryptocurrency valuation framework –
Our revised valuation framework accountsfor Bitcoin Cash's recent market share gains owing to the cancellation of the Segwit2xBitcoin fork and for the higher prices of all six cryptocurrencies that we assess.Notably, our framework now utilizes slightly lower discount rates relative to ourprevious iteration published in early October, in a nod to the apparent increasing acceptance of cryptocurrencies as a new asset class by retail and institutionalinvestors.
For important information, please see the Important Disclosures beginning on page 23 of this document.
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Thinking through the ICO boomlet
At Money2020 (the fintech mecca) in Las Vegas in 2016, there was a lot of talk about Bitcoin, but not in a good way. Bitcoin had recently depreciated from ~$750 to ~$500
and many talked about how it was “over” and that we were lucky to have “that whole thing” behind us. Fast forward a
year to October 2017, and one Bitcoin was commanding nearly $5,000 USD. The crypto crowd was cool again, and the most packed sessions were the ones focused on the new digital currencies.
Figure 1: Bitcoin 2017 performance, as of 11/13/17
Source: CoinMarketCap, Canaccord Genuity
One session on the burgeoning wave of ICOs (Initial Coin Offerings) stood out in particular. It featured a panel including Ted Livingston, founder of messaging platform Kik (beneficiary of a recent $100m ICO), and Dan Morehead, founder and CIO of Pantera Capital, a money management firm with a $100M fund focused exclusively on ICOs.
Boomlet or Bubble?
As we laid out in our recent whitepaper, we tend to agree with the crypto crowd that
the world will likely benefit from one or a few digital currencies that can find a middle ground between gold and fiat as a medium of exchange, combining the qualities of limited and visible supply with high trust (liquidity), but layering in the convenience of being digital and widely accepted globally. The best example we can offer is a cross-border B2B payment from a company in, say, Sweden to a supplier in Sri Lanka. Making this payment with fiat currencies and the SWIFT system would require time and expense, whereas the same payment in Bitcoin could be free and happen instantly.
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It is less obvious to us that we need all of the over 1,000 crypto coins that have been created to date, raising over $3.3 billion via ICOs so far in 2017 alone. In our opinion, there is clearly a great deal of froth, wishful thinking, and less-than-ethical behavior surrounding many of these coins. That said, however, the great thing about market prices is that they are accurate in the sufficiently short-term 100% of the time. Therefore, we have no quarrel with this estimate; these ICOs have created billions in market value in a very short time, and therefore this definitely qualifies as a boomlet, perhaps on its way to becoming a bo
om. Is it also a bubble? Maybe … but bubbles can
take a long time to pop.
Coin vs Common
The easiest analogy for crypto coins is common stock, although there are significant differences between the two. Some observers have commented that, unlike common stock, the tokens an investor receives from an ICO are worthless because they typically will not confer any right of economic ownership or any portion of the future cash flows of the underlying company. When thinking this through, we should begin by highlighting that not all coins are created equal, and we have seen coins that give the holder a right to receive a portion of a
company’s revenue or net income. Most coins, however, rely on underlying demand for the company’s products or services to, when set ag
ainst a fixed supply of coins, drive the value of these coins higher. More on this later. We also likely should partition our thinking between small and large (activist) shareholders, and between dividend-paying and non-dividend-paying stocks. Large activi
st shareholders can have considerable influence over companies’ governance. It
is not unusual for these shareholders to demand that the value of certain assets within a company be realized through sale or otherwise. Similarly, dividend-paying stocks do provide the holder with steady income (although of course, this is only true
so long as the company’s financial performance makes such a dividend prudent, and
there is almost never a guarantee). In addition, the dividend is typically only part of the reason investors own a stock; usually there is a hope of capital appreciation as well. Excepting these two somewhat special cases, however, the vast majority of ownership
situations for common equity will never fully benefit from a right of ownership. Let’s
consider that share of common stock you might own in, say, GOOGL. We never like to say never, but we deem it HIGHLY unlikely that the management team is going to listen to your views on how to run the company. We deem it HIGHLY unlikely that you could convince the board to exchange your share of stock for 1x10-9 % (your fractional ownershi
p of GOOGL’s 692M shares outstanding) of the company’s office
furniture, intellectual property, cash, accounts receivable, etc. We deem it HIGHLY unlikely that the company is going to pay you a dividend any time soon (although they may buy back stock, which can also more or less happen in coin). If we are correct that all these events are quite unlikely, then what good is that right of ownership? Of course, the share of stock has value
–
going back to our market dynamic, it has value because you could very likely sell it for close to the $1,041 that GOOGL stock commands as we write this. In turn, this price typically depends upon the judgement of the incremental buyer / seller regarding two items: 1) the future operating performance of Alphabet the company (i.e., happy customers, market share, innovative products, revenue, earnings, cash flow, ROIC, ROIC/IC
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essentially how well the company will compete, deploy capital, and serve as a prudent steward of that capital); and 2) what market participants think that operating performance is worth (typically based on some valuation metric like P/E which is a short-cut to considering
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