State of DeFi & Current Primitives

Advantages of Decentralized Finance:

• Permissionless: Anyone is able to access decentralized financial networks through an internet connection. No individual can be denied service based on who they are, where they were born, or how much money they have
• Programmable: Developers can create and intertwine financial services at a very low cost. Plug and play architecture helps compound the power of these services
• Transparent: Public blockchains are transparent and auditable. They retain best of both worlds: informationon financial exchanges are available while privacy can be preserved
• Trustless: Users don’t have to trust a central party to ensure that transactions are valid
• Censorship Resistant: No central party is able to reverse the order of transactions and deem a validated transaction invalid at some later point in time. Similarly, a central party can’t turn off the service and anyone with access can use the network

Popular DeFi use cases:

• Lending – Borrowing/Lending on a public blockchain with much less friction vs. traditional platforms.
• Derivatives/Assets – Synthetic assets which are derivatives of other assets allows exposure without having the actual asset.
• Decentralized Exchanges – Traders can trade on platforms that do not hold their funds custody
• Payment solutions – Traditionally centralized payment solutions can be decentralized to be as effective while staying censorship-free

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The DeFi Stack

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Risk is not removed, but shifted from counterparties to smart contracts

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The DeFi Stack: Stablecoins

Stablecoin implementations:

1. Traditional Collateral-backed
2. Crypto Collateral-backed
3. Hybrid / Algorithmic

Traditional Collateral stablecoins include Tether (88% of the total stablecoin market share) and USDC (4.4%)

MakerDAO’s Dai is the most prominent crypto collateralized stablecoin, with a market cap of ~$86M

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The DeFi Stack: Lending Protocols

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The DeFi Stack: Oracles

Oracles provide smart contracts with data from the outside world (i.e. the price of ETH to trigger a liquidation if collateralization drops below requirements)

Current approaches to ensure validity of oracles include:

• Multiple data sources – Safer, but more expensive
• Multiple oracles – Reduces probability of collusion
• Financial incentives / penalties – Earn rewards for performing honest work, but penalize if they misbehave

There is no one-size-fits-all solution as dApps require different guarantees based on their specific use cases, with the trade-off being safety vs. cost.

The DeFi Stack: DEX

Decentralized exchanges operate without a central authority or middlemen, allowing users to transact peer-to-peer with little risk of censorship

While DEXs historically suffer from price discrepancies across exchanges, the increasing popularity of DEX aggregating tools has tightened the spread across these exchanges

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• Protocol for automated token swapping on Ethereum
• ETH and ERC20 tokens are pooled in reserves, and the ratio of these assets determines the exchange rate

• Decentralized ERC20 exchange with token for staking
• Similar to centralized alternatives, but trades are settled on-chain

• Protocol for peer-to-peer asset exchange on Ethereum
• Native ZRX token used for governance and fees
• Offers tools for other DEXs to implement

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The DeFi Stack: Payments

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Challenges Beyond DeFi: Cross-Fi

What’s holding #DeFi from mass adoption today?

• Availability of fiat on / off ramps
• Lack of financial privacy
• Scalability / high gas costs
• Smart contract / technical risk (and lack of insurance)
• Lack of identity / credit scores leading to over-collateralization requirements
• Friction around UX / UI

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Scalability / high gas costs

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Lack of identity / credit scores leading to over-collateralization requirements

Differing approaches based on the applicant’s credit profile:

1. Unbanked or “thin-file” (no significant credit history or identity)

• Alternative credit scoring (Tala, CELO) – Rental, phone, TV payments, Bank account information (deposits/withdrawals), Social media / mobile phone data, Public address credit history (Graychain)
• P2P / social vouching (VouchForMe)

2. Existing credit, but no blockchain identity / credit score

• Integration of traditional credit scoring data (Bloom, Colendi)
• Privacy preserving solutions (Enigma and Spring Labs)
• Decentralized identity solutions (uPort)
• Wyre’s ERC-721 compliance / identity token

A proof-of-stake smart contract platform that allows people to send value to each other with only a phone number

Reputation is attached to phone numbers and measured through the use of EigenTrust, a P2P reputation management algorithm based on mobile phone data and attestations

Celo allows for multiple stable-value currencies where each coin is pegged to a measurable value such as the Dollar, Euro, the price of a barrel of oil, etc.

cGLD, the native digital asset of Celo, is an ERC-20 compliant token and will be partially used to fund the reserve

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Smart contract / technical risk (and lack of insurance)

MakerDAO has established a security roadmap for the upcoming Multi-Collateral Dai launch, showcasing best practices:

Emergent solutions like NexusMutual provide “smart contract cover” to secure risk and potential bugs in code (i.e. DAO hack or Parity multi-sig freeze)

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Availability of fiat on / off ramps

Increasing competition should lead to fee compression

Centralized

Non-custodial

• Peer-to-peer trading platform to facilitate the sale/purchase of crypto for fiat
• Uses smart contracts to lock up crypto assets and wire transfers for payments
• Only available with European banks, where Open Banking Laws allow oracles to verify transactions and notify smart contracts to unlock assets
• Fees are up to 3% of the transaction
• Currently only supporting ETH and DAI

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Friction around UX / UI

“Over 90% of users who try to use a dApp will give up when told they need to download Metamask”

1. Wallet SDKs enable a Web2 login experience with a username and password, removing the requirement to download a separate extension in order to use the app
2. Smart Contract Wallets can be programmed to have the same security guarantees as a traditional bank (account recovery, fraud protection, and withdrawal limits). Implemented via Smart Contract Wallets, Meta transactions allow users to use dApps immediately via sponsored gas fees, removing the need for users to pre-purchase crypto or install a browser extension

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Lack of Financial Privacy & Auditability

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• proof of solvency, capacity-specific keys
• supersonics, bulletproof, zether, authenticated data structures
• privacy vs. regulatory compliance

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Harmony’s contribution to DeFi & Cross-Fi

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• Fiat Integrations & dApp Payments via Carbon
• Developer tools to port EVM compatible dApps
• Bridges from ERC20 / BEP2 to native ONE token
• Lower gas fees w/o sacrificing decentralization
• Unbiasable randomness
• Decentralized exchange functionality

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Gateway: dApp Payment & Fiat Integrations

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• 30-second fiat on-ramp to ONE
• Harmony-native stablecoins
• 5-line code to integrate

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Decentralized market makers via Hummingbot

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• Open finance, open source
• 102 decentralized market makers constituting 8% of ONE volume
• for arbitrage, dex, algo trading

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Developer Tooling

• Harmony Protocol
• API’s
• SDK
• Testnet
• Smart Contracts

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Harmony cross-chain bridge

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• Gateway to swap $ONE BEP2 tokens to ERC20, and in the future, ERC20 to native mainnet $ONE tokens
• Providing better liquidity for the $ONE ecosystem
• Enabling cross-chain interoperability

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Randomness vs. Fairness

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• States/moves stored on chain
• Unbiasable dice for random puzzles as fair tournaments
• Built-in staking & betting

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Current challenges within cross-border payments

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Remittance cost drivers:

1. Inefficient correspondent banking systems
2. Lack of market competition in certain corridors
3. Regulation and compliance costs
4. Agent network infrastructure

Estimated $32 billion in remittances aren’t sent due to high transactional costs associated with cross-border money transfers

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Cross-Fi: DeFi meets Cross-Border Payments

Current challenges:

Slow

Multi-hop money movements between correspondent currency pairs can take between 1-5 days to fully settle

Limited accessibility

Cash dependent transactions rely heavily on local distribution, which is scarce, especially in rural areas

Limited trust

Last mile transfers rely on fragmented P2P networks with centralized counterparties

Friction across geographies / markets

Current digital payment solutions can be limited in coverage (i.e. Grab cannot be used in China)

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Harmony offering:

Finality

Harmony provides instant finality, reducing settlement time to seconds vs. days

Digital wallets

1.7 billion adults remain unbanked, yet two-thirds of them own a mobile phone1

Trust layer

Cryptography, combined with Harmony’s immutable ledger, provides trust without the need for intermediaries or centralized 3rd parties

Borderless

Fully compliant regional solutions combined with low cost fiat on and off ramps reduce geographical frictions

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Harmony’s Cross-Fi Solutions Roadmap

Research

Cross-Fi:

• Transaction value proposition (settlement, peg, rates, identity)
• Financial products with China / India / Vietnamese currency pairs
• Remittance, billing, payroll in Europe

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Privacy

Ring Signature Implementation on Harmony, enabling obfuscation of transactions behind a group of similar transactions

Audible privacy financial transactions with Findora collaboration

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Tooling

Cross-border payment stack (lending, identity, stablecoins)

Simplified on-boarding experience to enable mass adoption

Development of fiat on / off ramps and exchange venues

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Adoption

Decentralized credit facility platform, where users can use ONE as collateral to mint various fiat-pegged stablecoins

Cross-border payment applications leveraging Harmony’s scalability, fast finality, decentralization and low transaction costs

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Help us build the future of Cross-Fi

Meet our team in Silicon Valley or in our upcoming partnership roadshows:

Harmony India Roadshow

• Delhi: Nov 7-9th
• Bangalore: Nov 7-9th
• Get in touch: harmony.one/india-event

China

• Beijing Office Q4 2019
• Shanghai Dec 2019 – Jan 2020

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Links:

• Binance Launchpad, Mainnet Milestones
• Ambitions on Sleeve & TGI Community
• Bring Research & Privacy to Production
• Coinbase Shortlist, Acquisition w/ Animoca

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Appendix

Premier Investment Hub is a diversified asset manager built to bridge the gap between institutional capital and the digital asset markets

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Index

• Select 20 Index + Digital Fund in Q1 2019 and BTC Income & Growth Digital Fund in Q2 2019 launched
• Roadmap contains 14 other digital security issuances within the next 24 months

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Fund

• Early-stage crypto hedge fund started by the Founder of Premier Investment Hubmaker Partners
• Invests in both equity and tokens of early stage companies and cryptocurrencies

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Harmony: Solving the Quadrilemma

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Decentralization: Origin of 1,000+ Nodes

• 80% nodes by community
• 56% first-time operators
• 56% first-time operators

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Quadratic Voting vs Capped Median

• Cap #stakers to network seats
• Median decides effective stake
• 15% cap on top stakers from overtake, bottom from apathy

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O(1) Secure Resharding

• O(n2) view change, blocks in 1.3s
• O(n2) view change, blocks in 1.3s
• Verifiable Delay Function from scratch

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The DeFi Stack: Lending Counterparties

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Speculating / hedging

Gaining additional exposure to a digital asset with leverage, shorting when you believe one may be overvalued

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Trading / arbitrage

Taking advantage of arbitrage opportunities across exchanges

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Tax deferment / working capital

Selling a coin for fiat may trigger a tax bill, whilst selling a borrowed coin may not

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Not all protocols are created equal: degrees of centralization within DeFi

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The DeFi Stack: DEX

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DeFi Liquidity Models

Video Game Addressable Market

• The global games industry is $138Bn by revenue
• The industry has grown $67Bn in the last five years, driven by the explosion of mobile gaming
• ~$5Bn in total transactions1 were processed on the Ethereum, EOS and TRON blockchains in 2018
• Hence, today blockchain-based games are a small but growing piece of the global gaming industry

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Blockchain-Based Gaming Rationale

Smart Contracts for Fair Gameplay

• Today most gaming software (the graphics, the gameplay and the currency) is all proprietary
• Everything is controlled by operators, which puts players at the whim of changes by game developers and publishers
• With blockchain-based games, developers can program open-source smart contracts to determine payout functions, ensuring fairness in gameplay

Fungible Tokens as Currency

• Blockchain-based games can use cryptocurrencies (fungible tokens) as a cross-platform payment mechanism
• Many existing games have their own in-game currency. Unless they are cryptocurrencies, their value is not transferable to other games
• Cryptocurrencies as a payment mechanism are the only way that smart contracts can process and issue digital assets

Non-Fungible Tokens for Digital Assets

• A non-fungible token (NFT) can be used to uniquely identify an asset in a game (i.e. a rare sword won from a particular boss or a gamer’s reputation)
• If many different games use the same NFT standard for in-game assets, creations will have resale value outside of their game and be traded in marketplaces

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Blockchain and Video Gaming Have an Interconnected History

It’s arguable that digital assets in video games led to the emergence of cryptocurrency

World of Warcraft Gold

• World of Warcraft has an in-game currency (which was uncommon at the time) called World of Warcraft Gold
• The process was simple: purchase the gold with fiat currency and then use it to buy things in the game. Certain items that could be stolen from some of the toughest bosses became extremely valuable
• Given the popularity of WoW, this marked the emergence of digital assets with real value at scale

Digital Asset Farmers

• Gamers who recognized the emergence of digital assets with real value began “farming” these rare items and selling them for a premium at a later date
• This is seen by many as the predecessor to crypto mining
• Brock Pierce, Jonathan Yantis and Steve Bannon (then of Goldman Sachs) joined forces at Internet Gaming Entertainment (IGE), entered around this concept

WoW Gold vs. Crypto

• WoW gamers became comfortable with these online transactions, digital markets, & converting their digital money back into fiat
• The difference between WoW Gold and Bitcoin is that the Gold is centrally owned and possessed by developers, while Bitcoin is owned/possessed by players in their digital wallets
• The central ownership of Gold allowed developers to halt transactions and ban users from “misbehaving”

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The Blockchain Gaming Stack

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Two Types of Blockchain Games Today

Roleplay or Collectibles

• Most blockchain-based games in the market today are either roleplay games or digital collectible games
• Roleplaying games are essentially dynamic digital collectible games, where items in the storylines develop tradeable value

Gambling

• Blockchain gambling dApps have become the easiest onramp to gambling for users, as most blockchain gambling sites are not licensed
• Cryptocurrency, decentralization, and smart contract integration helps to bring transparency to payout models in online gambling and solves many of the industry’s fundamental pitfalls

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Digital Collectibles Have Proven, Real-World Value

How much would a fan pay to own an original character of Fornite legend Ninja after he retires?

• If blockchain can prove players truly own certain assets, the gaming community is passionate enough that they would pay substantial amounts for certain items
• The limited number of games that have integrated blockchain have proven this to be true

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How to Access Blockchain-Based Video Games

For now, all blockchain-based video games are PC and mobile based. Players are connected through hot wallets

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Blockchain Game Analytics

DappRadar is the main analytics platform and ranking engine for blockchain dApps that tracks number of users, number of transactions and transaction volume per game

• dApps with the highest usage are games, despite the hype around decentralizing all types of applications

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Top 5 Blockchain Games on DappRadar Today

Rankings as of 6/18/19, ranked by number of users. Unclear today how much usage is real vs. artificially created by bots.

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Leading investors for blockchain gaming

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Challenges for Blockchain-Based Gaming

1. Onboarding:

• Getting gamers to join the blockchain is a pain
• Can developers make the blockchain invisible?

2. Item-first gaming is expensive:

• You need to buy items to play
• Can we make games F2P? i.e. Cryptage Origins

3. Transactions are expensive:

• Writing data on the blockchain costs time & gas
• Can we make Tx fast & free? I.e. Loom, Efinity, Tenfold (layer 2 solution examples)

4. Immature & inaccurate data analytics:

• How much volume is real vs. generated by bots?

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What is a Non-Fungible Token?

Non-Fungible Tokens (NFTs) are unique digital representations of defined digital assets

• In the real world, the majority of luxury assets – those that are considered to have scarcity value – are non-fungible (real estate, cars, boats, art, vintage baseball cards, even people)
• Identity & reputation is another important NFT use case for gaming

Benefits of NFTs

• Transferability: because NFTs are held by the user instead of the game developer, the user has the ability to trade the NFT on third-party marketplaces without permission from the game developer
• Authenticity: the token standard helps prove ownership of the asset

Token Standards

• An NFT token standard (i.e. ERC721) is a free, open standard that defines a minimum interface a smart contract must implement to allow unique tokens (NFTs) to be managed, owned, and tradeda

Standards for Digital Asset Ownership

Today, there are three defined levels to standards for digital ownership:

Digital Assets Level 1:

• A digital asset is digital text or media, whose ownership you control inside of a game or application

Digital Assets Level 2:

• ….whose ownership can be verified on a blockchain

Digital Assets Level 3:

• …and whose controls adhere to a broadly accepted protocol so that the digital objects can be sent to third party markets

We are currently at the third level with token standards such as ERC721, dGoods and Simple Assets, which allow smart-contracts to hold an ownership database of unique items

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Non-Fungible Token Ecosystem

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Over 7.5M NFT Transactions in 2018

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Player-Owned Economies

• Because digital creations in a game now can have real value outside of the game, developers can monetize a substantial portion of the assets they create. As a result, “player-owned” game economies are evolving
• Game developers can define what player-owned economies mean in their respective games. For example, developers can a) sell game assets (e.g. race cars) to players or content creators at wholesale, b) provide cookie-cutter tools for players to make custom modifications, and c) players can resell those new unique assets back into the game through a marketplace
• If players can create their own assets (and are motivated to do so because they can make money), this would reduce today’s 100% creation burden on developers

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Case Study: Loom Network – Scaling Solution for Blockchain-Based Games

• The user experience for blockchain-based gaming is contingent on transactions having low-latency
• Rather than clogging mainchains like Ethereum or EOS, Loom Network has built an SDK that allows developers to create an unlimited number of sidechains to scale their dApps as needed
• These sidechains are connected to the mainchain through Loom’s central hub called PlasmaChain. This way, sidechains can process transactions without having to touch the Ethereum blockchain
• Loom first integrated its PlasmaChain with Ethereum in 2018, meaning PlasmaChain’s smart contract functionality is compatible with the ERC20 and ERC721 token standards
• On June 6, 2019, Loom completed its integration of PlasmaChain with the TRON blockchain
• Loom’s sidechains (i.e. GameChain) are now being used by multiple games and dApps in production

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Case Study: Enjin & ERC1155 Token Standard

• Founded in Singapore in 2009, Enjin allows gamers to build their own social profiles that connect to game servers. Over 250,000 gaming communities and twenty million gamers are registered on Enjin’s platform
• Enjin is building a facilitation layer on top of Ethereum (wallets, cryptocurrency and NFT, and virtual item management apps) to make asset interoperability possible
• Enjin’s differentiator is its work on a new token standard and smart contract platform, ERC1155
• Unlike ERC721, in which a new smart contract must be deployed for each new instance of an NFT, a single ERC1155 smart contract can govern an infinite number of NFTs

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Case Study: Decentraland – Merging VR and Digital Collectibles

• Decentraland is a virtual world owned by its users built on the Ethereum blockchain, defined by cartesian coordinates (x,y). The world is divided into ~90,000 parcels of LAND (NFTs). The entire city (Genesis City) is roughly the size of Washington DC
• Each parcel of LAND is ten square meters and can be bought and sold using Decentraland’s cryptocurrency MANA. Users can create, experience, and monetize content and applications on LAND using Decentraland’s SDKs
• The parcels are NFTs whose ownership is recorded on the Ethereum blockchain using the ERC721 standard
• Once VR technology becomes interchangeable with reality, colonization of new worlds will become the focus. MANA NFTs make colonization possible

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Legality of Online Gambling Today

Online gambling operations are predominantly banned in Eastern Europe and the US, legal in Africa and South America, regulated in Europe and have mixed regulations throughout Southeast Asia

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The Rise of Online Gambling

Online gambling is a burgeoning industry that’s becoming mobile and consolidating. Yet as it grows, its trust and authenticity issues are becoming more onerous

Explosive Growth

• According to a report published by British consulting company Juniper Research, the growing demand for digital products will drive the online gambling market to $1 trillion by 2022, with the total number of online gamblers exceeding 684 million

Mobile

• H2 Gambling Capital believes that by 2023, over 50% of gross online gambling revenues will come from mobile devices. As of September 2018, 68% of mobile revenue comes from betting

Consolidation

• According to data provided by Global Betting & Gaming Consultants, in the past few years the global gaming market has been characterized by a consolidation of assets by such companies as Paddy Power, Betfair, Ladbrokes, Coral, Bwin, and GVC Holdings

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Future Growth Driven by Sports Betting

United States – the fastest growing sports betting market

• May 2018: Supreme Court strikes down law banning sports betting outside Nevada
• June 2018 to November 2018: 7 states (Delaware, Mississippi, New Jersey, New Mexico, Pennsylvania, Rhode Island, West Virginia) legalized full scale sports betting
• Seven additional states have passed a bill, but full legalization is pending

United Kingdom / Europe: The longest-standing sports betting market

• Online betting has been largely regulated in the UK and Europe for the past two decades
• The UK is the largest regulated online market in the world, generating ~£5.6 billion ($7.0 billion) in gross revenue each year

Asian-Pacific Region (APAC): the largest sports betting market by market share

• Residents falling in the APAC region are responsible for 47% of the world’s sports wagers
• Even so, APAC is projected to witness major growth in the upcoming years because of the improving economic conditions throughout the region (increasing disposable income for population base of more than 4 billion people)

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Hottest Sports Betting Market is eSports

eSports is the fastest growing sector in the expanding sports betting market, a indication of the rise in popularity of virtual competition

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The Flaws in Online Gambling

1. Users cannot be certain whether the gambling website is working against them by tweaking the odds in favor of the house
2. Platforms themselves have to bear the risk that their clients might cheat

• Because countries restrict online gambling, the operator has the ability to block a user from withdrawing of funds after winning a jackpot
• Unlike banks, players’ deposits are not insured if an operator is shut down, becomes insolvent, is seized, or goes offline

3. Bad actors can register multiple accounts by using remote server connections to give the appearance of operating in a different jurisdiction, making it easier for them to move money undetected
4. If a hacker steals money from the website, both operators and users suffer

As the online gambling market continue to advance and proliferate, it is imperative these flaws be addressed in conjunction

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The Solution: Blockchain-Based Online Gambling

1. The implementation of blockchain technology will make the operations of gambling websites more transparent, allowing each party to verify that the gambling process is fair. We believe it will also solve the issue of security
2. Transaction costs can be reduced dramatically, and money withdrawals will be much faster. While payout withdrawals presently take between three to five days, cryptocurrency transactions are almost instantaneous
3. The use of cryptocurrency will attract new clients to the market – those who cannot use centralized gambling sites due to a lack of access to banks or residency in a country where financial institutions do not allow gambling transactions

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Degree of Cryptocurrency’s Impact on Online Gambling

There are degrees to how cryptocurrency can impact online gambling / sports betting

• Using cryptocurrency to gamble on non-digital assets
  Example: using Bitcoin to wager on real world professional sports
• Using cryptocurrency to gamble on digital assets
  Example: using Bitcoin to wager on eSports or online poker
• Future: using cryptocurrency to gamble on NFTs
  Example: using Bitcoin to bet on a digital horse participating in the Virtual Kentucky Derby

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Ethereum versus EOS and Tron

• Driven by a) throughput advantages and as compared to Ethereum and b) zero transaction fees to users, Tron and EOS have become the preferred mainchains for blockchain gambling dApps
• Cost and scalability will ultimately determine which networks see the majority of interactive games built on them

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Case Study: Virtupoker

Virtupoker has built an end-to-end protocol using digital wallets and Ethereum smart contracts to bring transparency to online poker

• By registering, players are issued a wallet and can send either ETH or VPP (native ERC20 cryptocurrency) to their wallet address
• A poker table on Virtupoker uses an Ethereum smart contract which includes the custom parameters of the game (# of players, game type, buy-in amount, etc). Players join a table by sending the buy-in amount to the table address and waiting for the transaction to confirm
• When a player leaves a table or when a tournament is over, the table contract auto-executes and pays out each player balance owed directly back to their wallet

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Distribution of the presentation is strictly prohibited. Nothing in this presentation should be construed as an investment offer. This presentation is intended for information purposes only. Premier Investment Hub is the brand name for Premier Investment Hub Group. Subsidiaries include Premier Investment Hub LLC a registered investment adviser CRD # 292343. More information can be found at www.adviserinfo.sec.gov.

Premier Investment Hub is not a broker-dealer, and will not engage in any activities requiring registration as such. Premier Investment Hub is not licensed to provide tax, legal or accounting advice and will not do so. Premier Investment Hub will use its commercially reasonable efforts to reach the client objectives, but there is no warranty or guarantee that such can be achieved. Services requiring advisory registration are provided by Premier Investment Hub LLC.

TL:DR Crypto lending today is primarily driven by speculation. Brokerage margin lending is the closest real-world comparison, justifying current crypto rates of 8–10%. As more potential lenders get comfortable with the technical risks, the supply of lenders will start to outweigh the demand of borrowers and margins will eventually compress. While speculation is the primary use case for crypto lending, I am optimistic there will be additional use cases for crypto lending as the technology and ecosystem matures (credit scoring, insurance, etc.)

Crypto lending has grown significantly over the past 18 months and has gained even more attention as of late given attractive interest rates relative to typical savings accounts that earn roughly 2% APR.

Looking at a P2P crypto lending platform like Dharma, lenders can currently earn 8% by lending their USDC, a USD stablecoin formed as a partnership between Circle and Coinbase and 11% for Dai, MakerDAO’s stablecoin that is also designed to be pegged to $1 USD.

On the surface, these rates may sound too good to be true. But, for every lender, there must be a borrower. So who is borrowing at double digit rates?

Crypto Lenders

Because cryptocurrencies are so volatile, almost all crypto loans are over-collateralized. In general, they require collateral ratios of 150%+ to secure a loan, which provides some safe guards for lenders to manage counterparty risk. So a potential borrower would need to put up at least $15,000 worth of crypto (BTC, ETH, etc) as collateral to get a $10,000 loan.

There are two major types of players in the crypto lending market, Custodial and Non-Custodial lenders. The main trade-off between custodial and non-custodial lenders is around Counterparty Risk (trusting a company) vs. Technical Risk (trusting code).

With custodial lending, I am trusting that the entity will safely custody my crypto assets and limit counterparty risk from potential borrowers, ensuring my loan gets paid back in full and on time.

With non-custodial lending, I trust that the smart contract code will run as designed and does not have any bugs that will result in lost funds / hacks.

Centralized, custodial lenders include companies like Genesis Capital, BlockFi, Nexo and Celsius as well as centralized exchanges like Bitfinex, Liquid and BitMEX and centralized OTC desks like Galaxy, OSL and Cumberland.

Decentralized, non-custodial credit protocols include Compound(decentralized money market protocol), Dharma (P2P lending protocol), MakerDAO (decentralized credit facility) and Uniswap (decentralized exchange that enables lenders to provide liquidity).

While there is certainly nuance between all of the above examples, these decentralized protocols are slowly emerging as competitors to centralized, custodial credit providers and differ mainly on lending rates & custody management.

However, centralized providers are still the largest crypto lenders today, with Genesis Capital, originating over $1.5B in annualized volume alone:

Crypto Borrowers

Genesis Capital outlines 3 main use cases for borrowing cryptocurrencies from their clientele:

1. Speculating / Hedging

2. Trading / Arbitraging

3. Operating Working Capital

A majority of crypto-backed loans seem to be speculative in nature, such as gaining additional exposure to a digital asset with leverage, shorting a digital asset you believe may be overvalued or taking advantage of arbitrage opportunities across exchanges.

The crypto community has embraced a cultish culture of “hodling” instead of selling during periods of volatility, so a portion of hodlers are likely using their crypto as collateral for working capital / loans. This can be especially advantageous for US investors as they can avoid tax liabilities by borrowing as opposed to selling their crypto and triggering a taxable event. (disclaimer: this is not tax advice and you should consult an accountant).

Lastly, crypto-native organizations who need operating working capital can take out loans with their balance sheets as collateral. Indeed we saw this happen more frequently in the bear market:

So out of these three potential borrower bases, we can see roughly 2/3rds of the lending volume in Q3 was driven by speculators / trading activity, rather than accessing working capital. As we emerge from the bear market, I’d speculate that the “working capital” borrowers will become a smaller % of total lending volume as market conditions continue to turn bullish.

Intuitively this makes sense for non-custodial lending activity as well and I’d argue even more of non-custodial crypto lending activity today is driven by speculators.

Looking specifically at activity by users of MakerDAO’s Dai, we can see a majority of transfers were sent to decentralized exchanges such as OasisDEX (recently rebranded to eth2dai) and centralized exchanges like HitBTC, presumably to purchase cryptocurrencies as ETH is the only trading pair on OasisDEX/eth2dai and HitBTC is a crypto-only exchange (ETH/DAI is by far the most liquid Dai pair on HitBTC with $2.3M in 24h volume compared to $30k for USDT/DAI as of 5/29/2019).

The selling of DAI on exchanges for other cryptocurrencies recently caused Dai to de-peg, as holders immediately sell their Dai for other assets (over 45% of Dai is first spent within an hour). Without anything to offset this natural selling pressure, the price of Dai fell under $1.00 in Q1 2019, although it has since rebounded after a series of stability fee increases.

                                                                                                        Historical DAI / USDC price on Coinbase

Looking at the operating working capital use case, there has been some anecdotal evidence that crypto projects have been taking loans out via MakerDAO using their ETH treasury holdings as collateral (Aragon’s $1M CDP).

And maybe a portion of DAI-hards are willing to stomach double-digit borrow rates instead of selling their precious ETH…

Yes, there are probably a minority of early adopters who want to avoid a large tax bill…

But the strict over-collateralization requirements of these loans likely means that a retail consumer is likely not the typical borrower. On the aggregate, if a potential borrower needs to take out a loan for working capital (to pay off a bill, mortgage, etc.), wouldn’t they just sell a portion of their 150%+ crypto collateral or use a centralized loan provider at a lower rate before taking on a burdensome 15%+ APR loan?

In such a volatile asset class, where Bitcoin can move 20% within an hour, I’d wager speculators are likely the most willing to borrow at these high costs to either gain leverage or short an asset as the profits may outweigh the costs. Crypto is a casino, after-all:

So if we accept the assumption that the majority of crypto lending today is driven by speculators, rather than access to working capital, the closest comparison for crypto lending rates are brokerage margin loan rates. Under that lens, crypto rates start to make a little more sense.

Brokerage margin lending is profitable and relatively low risk given the collateral requirements. However, there is currently no way for the average user to supply capital and earn a profit (unless you are the broker).

The unique innovation in crypto lending is that for the first time, lending platforms are able to open up the supply side via smart contracts. While some custodial lenders like Genesis and BlockFi supply capital and capture the lending margin themselves, other custodial providers like Celsius and Nexo, in addition to non-custodial lenders like dYdX, Dharma and Compound have opted to democratize the supply side.

The big implication being that, for the first time, any one in the world can now supply liquidity to potential borrowers and earn 8–10%+ APR, in a completely permissionless manner. Pretty powerful.

It’s important to note that Ethereum smart contracts are still nascent, and therefore hold a high degree of technical risk (see: Parity multi-sig hack, DAO, etc). While there is currently over $500M+ of ETH locked up in smart contracts across non-custodial lending platforms (a pretty big bug bounty), formal verification tools and the emergence of insurance solutions will slowly lower technical risks, in addition to time.

A few interesting examples of crypto native smart contract insurance providers are defisurance, which leverages Augur prediction markets to insure deposits and Nexus Mutual, a digital cooperative/mutual that covers members against smart contract failure.

While we are still far away from traditional insurance providers securing smart contracts as they have just starting to explore insuring custodians, any centralized / decentralized insurance solution will significantly drive adoption and start to level the playing field vs. centralized lending providers.

After taking into account the technical risks associated with crypto lending, higher APR’s for stablecoins relative to brokerage margin rates start to make sense and are still relatively underpriced given the current state of smart contracts and lack of insurance. Most recently, Zeppelin identified a minor bug in MakerDAO’s governance contractduring Coinbase Custody’s audit process. While this bug had minimal impact and wasn’t related to the main set of lending smart contracts, it’s important to be realistic about how nascent this technology is.

The Future of Crypto Lending

To answer the question of how sustainable the current crypto lending markets are, it helps to take a step back and look at the aggregate supply and demand. If we indeed assume that the majority of crypto lending borrowers today are speculators, I imagine the “demand side” will continue to grow as crypto continues gaining adoption and remains a volatile asset class.

However, it’s far more likely that as potential lenders eventually get comfortable with the risk/reward trade-off and realize they too can earn 8%+, the supply side will eventually outpace the current demand from speculators.

The most likely scenario is that crypto lending rates will continue to increase in periods of significant volatility, but decrease on the aggregate as more individuals/entities begin to supply liquidity and enter the space.

What remains to be seen is if crypto lending can start to address new use cases beyond speculation and further grow the demand side. I’m particularly excited to see the emergence of decentralized credit scoring solutions enter the crypto lending space, as they will lower the restrictive 150%+ collateral requirements and open up the supply of potential borrowers.

By combining the powerful innovation of opening up the lending supply side, introducing decentralized credit & insurance solutions, and lowering the cost to serve via smart contracts, I’m optimistic we’ll start to see crypto lending solutions address emerging markets that traditional financial institutions have historically ignored.

Please reach out if you are working on any part of the decentralized lending stack: roy@premierinvestmenthub.com.

DISCLAIMER:

This informational piece is intended to inform Premier Investment Hub’s audience of the current status of the crypto industry. Nothing in this material should be interpreted as an offer or recommendation to buy, sell or hold any security or other financial product. Premier Investment Hub LLC is a registered investment adviser, registered with the state of California. Registration with the SEC or state authority does not imply a certain level of skill or training. Additional information including important disclosures about Premier Investment Hub LLC also is available on the SEC’s website at www.adviserinfo.sec.gov. Or, learn more information about Premier Investment Hub at www.premierinvestmenthub.com.

Roy Learner is an Associate at Premier Investment Hub. The views expressed in this report reflect Roy Learner’s personal views about the subject companies, platforms, issuers, security and non-security investments (“investments”) and not those of Premier Investment Hub. Roy Learner’s comments are not intended to be construed as recommendations or an offer to buy, sell or hold any investment. Roy Learner’s compensation is not directly or indirectly related to the specific recommendations or views contained in the research report. The ecosystem landscape included in this post is intended to provide generalized guidance; nothing in this analysis is intended as investment advice, a recommendation or an introduction to particular funding or capital resource.

This is what navigating the ecosystem financing landscape feels like

Ecosystem financing has become an increasingly important subject these days. Why?

1. Both the number of crypto funds and total Assets Under Management (“AUM”) have rapidly declined with cryptoasset prices
2. As the need for treasury management has become increasingly clear, so has the importance of finding the most effective ways to deploy capital.
3. Maybe most importantly, a new generation of layer 1 smart contract platforms are launching and competition for high-quality developers and their applications is heating up

Ecosystem financing is strategic in nature and thus offers an important complement to purely financial investments made by venture capital funds. Grants and investments are a big part of a protocol’s limited toolkit to attract developer talent and build a dedicated and energized user base.

Despite its importance to the industry, there is currently little to no research available on the ecosystem financing landscape and thus it remains obscure. Like most things in crypto, important information is scattered between hundreds of Medium posts, Github repositories, Twitter feeds, press releases, and foundation/fund websites. Information is often confusing, outdated, and/or contradictory.

This is why I am releasing the Ecosystem Financing Landscape. Now developers and founders will have access to a single source of information that will hopefully help them identify new sources of capital to finance important work.

Why Ecosystem Financing Matters

The Rise and Fall of Crypto Funds

In 2017 and 2018, the industry saw rapid growth in the number of crypto-focused investment funds. However, given the steep decline in prices in 2018, we have already begun to witness a number of funds unwinding. I expect more fund closures in 2019. Many funds posted terrible losses that will make it difficult to ever earn carry and as a result, I believe that their limited partners, dissatisfied with their returns, will begin to redeem capital.

According to Vision Hill Research, as of Q4 2018 there were over 425 known crypto funds with approximately $4.5Bn in AUM (down around 25% from $6Bn in Q2 2018). Vision Hill estimates, that over 53% of that AUM is held with only the top 20 funds, meaning that the remaining 405 funds manage, on average, approximately $5m.*

Ecosystem Financing is a Governance Issue

Ecosystem financing and ongoing protocol funding has been a major theme of the last week as projects determine how to continue incentivizing building. Tom Shaughnessy of Delphi Digital outlines some of the challenges and opportunities in this recent Tweet Storm.

0x’s recent Stake-Based Liquidity Proposal, ZEIP-31, includes a renewed focus on “sustainability” (aka incentivizing the 0x developer community via investments). ZEIP-31 recommends that a portion of 0x trading fees flow back into the 0x community treasury, which will be fully controlled and allocated by $ZRX token holders. The spirit of this proposal is similar to the creation of Moloch Dao, a new kind of organization built to justly deploy grants to Ethereum developers.

Without developer funding, protocols could end up like Grin, in which core developers struggle financially, operating only with the support of donations. This model is unsustainable in the long run, so it is crucial for protocols to determine a governance model that properly incentivizes future core developers.

Two other examples, Decred’s Politeia and Stellar’s Community Fund both place the power of grants in the hands of their communities. While Decred votes for proposals on-chain, Stellar handles these votes off-chain. If you’d like to dive deeper into the difference between the two, check out my colleague Roy Learner’s recent post on voter apathy.

Competition and Adoption

Competition among incumbent smart contract platforms like Ethereum and soon to launch platforms like Polkadot is heating up. #CryptoTwitter is extra salty these days and tribalism seems to be at an all-time high.

As Regan Bozman recently highlighted — adoption at the application layer has failed to materialize. There are a number of reasons behind this. For starters, we all know that existing Web3 infrastructure is insufficient and too costly for high throughput applications. In addition, key developer tools and layer 2 scaling solutions are not ready, though they are on the way.

Superior technology may not be enough to win this smart contract platform “war,” so teams are using every tool at their disposal to win developer attention. This includes deploying capital via foundations and funds. Winning developer mind share will likely have a positive impact on core protocol development into the future.

Perhaps the fat protocol thesis will play out in the long term, but for now the flow of capital that originally poured into layer 1 is moving back up the stack to the application layer, which will be critical to drive users to these platforms.

Ethereum’s Tenuous Lead

According to the Electric Capital’s recent developer report, Ethereum maintains a meaningful lead in developer activity compared to other smart contract platforms (over 2x the monthly CORE developers as the next highest protocol, Bitcoin). Many attribute this to Ethereum’s first-mover advantage and the network effects created by its existing developer community.

However, due to the recent launch of Cosmos, and the coming launch of Polkadot and other platforms, this may change. A minor flare-up that occurred last week within the Ethereum developer community highlights this perfectly. The Aragon team proposed that the ETH Foundation should place money in an Aragon DAO, while they simultaneously explored launching an Aragon parachain on Polkadot.

In addition, many underestimate the impact that ConsenSys had on the growth of the Ethereum community. Remember, ConsenSys deployed hundreds of millions of US dollar equivalent capital to dozens of startup companies and developers over the last two years.

ConsenSys has been challenged lately, cutting 13% of its staff and releasing a number of spokes. These developers are looking for new homes and other smart contract platforms will welcome them with open arms.

That said, Ethereum should not be underestimated. Consensys continues to deploy capital (recently announced their second Taychon cohort) and the ETH Foundation invested over $2 million across 20 teams in Premier Investment Hub IV of its Grant Program last October. There seems to be plenty more where that came from and it is reported that Consensys is raising a fresh $200 million at a minimum $1 billion valuation.

Navigating the Ecosystem Financing Landscape

Developer activity is growing and near all-time highs, but real-world use cases still feel years away with the exception of crypto as a speculative asset class. The long road to adoption will open many opportunities for savvy developers and founders to identify the existing shortfalls of the ecosystem and build solutions.

However, amidst a prolonged bear market, and declining crypto fund AUM, many credible teams still struggle to find financing solutions.

Ecosystem financing options seem to be one viable path forward. There are a number of well-capitalized protocols that are deploying grants and investments to build their ecosystem in a highly competitive environment.

Ecosystem financing typically comes in two forms:

1. Dilutive Capital — this includes venture investment and accelerator programs. Investors take ownership in an entity and invest for profit.
2. Non-dilutive Capital — this includes protocol foundations and grant programs. No ownership is granted and there are no profit expectations, but different incentives for investors.

However, information on these financing programs is scattered and often contradictory, so this is a challenging landscape for entrepreneurs to navigate.

EOS.VC A Case Study in Confusion

One of the largest ecosystem development funds is EOS.VC. Block One created EOS.VC which then announced partnerships with five outside venture capital firms in early 2018 to deploy $725M into EOS-related infrastructure and dApps.

With such deep pockets, EOS has the ability to take market share from Ethereum by offering large investments to companies that build on its protocol. Most recently, EOS partner Galaxy Digital led a $15M investment round into blockchain-based gaming company, Mythical Games.

However, from an entrepreneur’s perspective securing investment from EOS.VC may be confusing and this is true of the ecosystem financing landscape at large. First, it is unclear who is truly in charge of the funds. In July 2018, only a few months after BlockOne announced its five independent partner funds, the company hired Michael Alexander as the CEO of EOS.VC.

Because there are multiple funds and little to no transparency into decision-making, it is difficult for teams to understand what to expect. For example, one of EOS.VC’s partner funds, Galaxy Digital, also makes principal investments off its balance sheet. If an entrepreneur is speaking to Galaxy for investment, does he/she need to build on EOS? It is not 100% clear.

In addition, information is constantly changing. For example, EOS.VC announced a partnership with Tomorrow Blockchain in January 2018, but if you search the EOS.VC website for partners, TomorrowBC is nowhere to be found, while the four other partner funds remain. To date there has been no announcement of a meaningful change in the EOS.VC partner network.

Finally, many in the industry wonder if capital alone is enough. Teams like Block.one also need to entice developers via other community building activities, marketing, hackathons, and ethos. This has been a challenge for EOS as developer activity on the core protocol has declined since launch.

Believe it or not, I do not mean to pick on EOS.VC. In fact, it is one of the most transparent of the ecosystem development funds, which highlights exactly why I decided to consolidate all ecosystem financing information.

Protocol Level-Risk

Another, more cautionary example is that of the RChain Protocol and its ecosystem development fund, Reflective Ventures. The Reflective Ventures website states that the fund deployed $21 million into 21 companies that were interested in building on the RChain network. However, Reflective has since pivoted to become protocol agnostic and rebranded as Counterpointe Ventures.

The website does not specify how Reflective’s investments were structured or the currency it used to make these investments. As The Block announced in December 2018, the RChain Protocol is now “functionally bankrupt”. Development on the protocol has all but ceased and the price of the native token, RHOC, declined over 95% from all time highs. With essentially zero liquidity, it is essentially a zombie protocol.

If Reflective invested RHOC and portfolio companies did not immediately sell, were mandated not to sell (lock up), or were not sent the RHOC all up front (milestone-based financing / earn outs), then those investments, and as a result, those companies might be in trouble.

It’s important to note that ecosystem financing is strategic capital that creates an alignment between the funded team and the native protocol. Receivers of grants and investments take the risk that the underlying protocol might fail.

What Questions Should Developers & Founders Ask?

If you are a developer or founder seeking financing from an ecosystem fund or foundation, it is important to ask the right questions. The below questions are certainly not exhaustive, but may offer a reasonable starting point.

1. Is this an investment (dilutive capital with the expectation of profit) or is this a non-dilutive grant?
2. By taking your investment am I mandated to exclusively develop for your protocol or can I remain protocol agnostic?
3. If the answer to the above is exclusive, am I comfortable taking on the additional platform-level risk?
4. Do I lose my rights to any intellectual property that I develop?
5. Are you investing using your native token, fiat, a stablecoin, ETH, or BTC?
6. Is there a lockup on your investment capital?
7. Do you offer tech support to help us integrate into your protocol?
8. Is the financing milestone based?
9. Do you write follow-on checks?
10. What other value add can you offer (ie: BNB trading support)

Our Findings

Our research identified 28 protocols that offer one or more forms of ecosystem financing. This includes 25 venture funds and accelerators that manage upwards of $1.6 billion and have funded over 100 companies to date. It also includes 20 foundations/grant programs managing over $350 million assets that have funded dozens of developers and companies to date.

This nearly $2bn AUM represents a whopping ~44% of Vision Hill’s estimated Q4 crypto hedge fund AUM, although the $2bn estimate is likely inflated. Many funds launched during late 2017 and early 2018 before the rapid decline in crypto prices. Therefore, it’s more than likely that actual AUM is meaningfully smaller than that listed here, but even so ecosystem financing should not be ignored.

Our landscape includes the following fund and foundation information:

1. Name and Protocol
2. Key Contact
3. Representative Investments / Grants (either specific companies, tools, or services)
4. Investment Thesis (High-level fund goals)
5. Fund Size — as of last announcement
6. Range of Investment / Grant Sizes
7. Date of last publicly announced investment (proxy for a fund’s activity)
8. Website / Application Page
9. Medium & Twitter Accounts

I may have made other mistakes, so if you are part of one of the teams represented in this landscape and identify inaccurate information, please reach out to help me correct it. I hope to keep updating this over time.

If you are part of a team developing a protocol that is interested in launching your own ecosystem financing, or a company seeking ecosystem financing, I’d be happy to connect to further discuss my findings.

*While Vision Hill does not track venture funds, I expect the AUM distribution to be similarly concentrated with a handful of leading funds such as a16z ($300m), Paradigm ($400m) and Pantera ($175m). This means the funding landscape for early-stage projects extremely scattered and hard to navigate.

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DISCLAIMER:

This informational piece is intended to inform Premier Investment Hub’s audience of the current status of the crypto industry. Nothing in this material should be interpreted as an offer or recommendation to buy, sell or hold any security or other financial product. Premier Investment Hub LLC is a registered investment adviser, registered with the state of California. Registration with the SEC or state authority does not imply a certain level of skill or training. Additional information including important disclosures about Premier Investment Hub LLC also is available on the SEC’s website at www.adviserinfo.sec.gov. Or, learn more information about Premier Investment Hub at www.premierinvestmenthub.com.

Mr. Weinstein is a Principal at Premier Investment Hub. The views expressed in this report reflect Mr. Weinstein’s personal views about the subject companies, platforms, issuers, security and non-security investments (“investments”) and not those of Premier Investment Hub. Mr. Weinstein’s comments are not intended to be construed as recommendations or an offer to buy, sell or hold any investment. Mr. Weinstein’s compensation is not directly or indirectly related to the specific recommendations or views contained in the research report. The ecosystem landscape included in this post is intended to provide generalized guidance; nothing in this analysis is intended as investment advice, a recommendation or an introduction to particular funding or capital resource.

Thanks to Roy Learner and Avi Felman.

Blockchains require some form of governance to help the community make adjustments or improvements to the network, like changing certain core parameters like the Block Size or adding new capabilities like SegWit which enable scalability improvements like the Lightning Network.

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Notable examples of off-chain governance include Bitcoin Improvement Proposals (BIP) and Ethereum Improvement Proposals (EIP), which are designed to introduce new features to Bitcoin and Ethereum, respectively.

The typical cadence of off-chain governance is as follows. First, a stakeholder (developer, economic actor, etc.) conducts research and develops a formal proposal. Proposal discussion then occurs across social mediums like #CryptoTwitter, online forums (ETHResear.ch, Reddit), Core Developer meetings, and/or mailing lists. The community, including Core Developers, will review the proposals, provide feedback and decide whether to accept the proposal off-chain. Generally, a significant majority is required to adopt a proposal. Once a proposal is pushed through and widely communicated, node operators will then need to upgrade their software. Proposals are typically batched together for release in a future fork (i.e the Constantinople hard fork included 5 EIPs).

In contrast, on-chain governance activity occurs “on the blockchain”. The major implementations of on-chain governance today feature on-chain voting like Decred’sPoliteia, which allows stakeholders to vote on funding for Decred’s treasury, or Tezos’ multi-step amendment process, in which Tezos token holders can vote on protocol-level changes, such as increasing gas limits as proposed in the recent Athens proposal (more on that later).

While unproven, with many prominent critics noting that on-chain voting can lead to plutocracies and oligopolies, the broader trend of on-chain governance is an important narrative to watch as blockchains continue to evolve.

For those interested in reading more about governance, I highly recommend Fred Ehrsam’s “Blockchain Governance: Programming our Future”.

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Decentralized Voter Turnout

As on-chain governance continues to evolve, there has been momentum with several on-chain votes recently taking place. While the scope of proposals have varying degrees of importance, voter turnout might be extrapolated as a *very general* indicator of community participation within decentralized governance.

The chart below outlines voter turnout represented as a % of circulating token supply for a number of recent proposals. As a rough reference point to the real world, Brexit voter turnout was 72.2%, the average voter turnout for US presidential elections is 50–55% and average U.S. corporate voter turnout historically hovers around 75%.

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These data points are by no means comprehensive and there is significant nuance across projects.

Looking a level deeper, if one were to instead measure voter participation by number of wallet addresses vs. % of circulating supply, it is clear that whales (investors with an outsized proportion of total supply) can significantly swing the numbers.

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As a concrete example, looking at the number of participating wallets for Aragon’s AGP-5, voter participation decreased significantly from 9.3% represented as a % of circulating supply to 0.12% (25 addresses out of >20k). Quick plug to participate in the next Aragon vote taking place on April 25th!

That being said, the clear standouts of this analysis are the Decred Lightning Network at 86%, the Tezos Athens amendment at 72% and Cosmos’ Proposal 1 at 42% (after accounting for voter abstention).

As Cosmos launched just over 2 weeks ago on March 14th, 2019, a more fair comparison may be isolating for online voting power, which significantly improves Cosmos participation to ~73% in Proposal 1 (which officially ends on April 3rd). Additionally, after adjusting for the Tezos Foundation’s public abstention, the Athens amendment vote had a 72% participation rate as the Tezos Foundation’s baking operations manage a 30% of total “Rolls”.

It’s interesting to note that Decred, Tezos and Cosmos have consciously built on-chain governance into their identity as “self-governing” blockchains, and while these are early data points, it seems the communities are buying into the meme. In addition, all 3 protocols provide voters with a direct incentive to participate via Proof of Stake.

Decred’s ticket system allows voters to earn rewards and secure the network by locking up Decred’s native token, DCR, while coupling the ticket with on-chain voting. With over 45% of the total available supply of DCR participating in Proof of Stake mining, DCR stakeholders can earn roughly 12.5% annually by staking.

Likewise, Cosmos yields are hovering around 11% with a solid participation rate at 46.5%, which is notable given that 20% of the Genesis Supply is currently locked up (Interchain Foundation’s 10% is vesting for 6–12 months, ALL IN BITS’ 10% is subject to a 2 year vesting period).

Tezos’ similarly has a high proportion of total available supply mining via Proof of Stake at 81%, although their staking yield is slightly lower at ~7.4% annually. However, simply looking only at staking yield is only half the picture without taking into account annual inflation rates (potentially a future post).

Overall, this added financial incentive via Proof of Staking mining rewards likely contributes to Tezos’, Cosmos’ and Decred’s higher voter turnout.

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Stepping back, the question naturally arises: why is there such a large delta within on-chain voting?

To start, not all proposals are created equal: without picking on 0x, ZEIP-23 may not be as important to 0x as the stability fee is for Maker to support Dai’s peg at $1). Below are general thoughts on a few high level barriers to voter participation.

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Incentives

“Show me the incentive and I will show you the outcome.”

— Charlie Munger

On-chain governance’s underlying assumption is that because token holders and “owners” of a protocol are one and the same, they are economically incentivized to vote in the protocol’s best interest. If tokenholders vote for a proposal that has a negative effect on the protocol, the token’s price will reflect that decision and they will lose money.

While voters are theoretically incentivized to govern given their passive ownership in the underlying network, they may need more “skin in the game” to actively participate. Otherwise voters will remain apathetic if the issue at hand is of a low degree of importance, as shown in practice.

I believe we’ll continue to see future on-chain voting implementations be strongly coupled with direct financial incentives.

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Subject Matter Expertise

Tokenholders are not always subject matter experts. For example, a casual holder of MKR may not have the economics background required to vote on the implications of an increase or decrease in Maker’s stability fee. Likewise, a retail hodler likely does not have the technical expertise required to evaluate the merits of implementing ProgPOW on Ethereum. Given the time required to truly understand the ramifications of a proposal vote, voter apathy may be higher for more complex proposals.

Community leaders can help address this with market education (i.e. Jacob Arluck’s piece outlining Tezos Athens) but the average hodler just may not be willing to devote significant time researching the nuances and implications of a specific proposal.

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Voting Infrastructure

While there have been significant strides to improve voting infrastructure, a lack of sophisticated voting tools leads to friction when attempting to vote. Maker actually has one of the better voting user experiences, but the below snapshot showcases the reality of all voting infrastructure today and outlines the various steps required to vote on the most recent stability fee hike.

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First, voters are required to have ETH in their wallets AND need to pay gas so they can connect to Maker’s voting portal, which requires 4 transactions at roughly $1. In addition, linking cold and hot wallets is a requirement — but what if smaller voters don’t have MKR on a cold wallet? Voters may get stuck and give up, as I did.

To play devil’s advocate, Maker may only want more sophisticated investors to participate and requiring a cold wallet may be a natural filter.

However, the broader point still stands that meaningful improvements are needed to reduce voter friction in order for crypto to go mainstream. This rings true not just for voting, but for decentralized applications in general.

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Voting infrastructure will inevitably mature, with Coinbase Custody recently announcing their addition of governance support for Maker as well as intention to add Tezos voting in Q2.

I expect other custodians will follow in Coinbase’s foot steps, which could lead to another potential point of centralization if a majority of voting takes place via 3rd party custodians.

Stakeholder Diversity

Placeholder’s Joel Monegro succinctly outlines the key stakeholders of decentralized networks in his piece, “The Cryptoeconomic Circle”: “The model describes a three-sided market between miners (the supply side), users (the demand side), and investors (the capital side). Miners opt-in to the consensus protocol and coordinate their resources to provide the network’s service in a decentralized manner, users consume the service, and investors facilitate exchange while capitalizing the network.”

Unfortunately in today’s retail-driven market with little actual utility and functionality, tokenholders are mostly investors and speculators. It’s important to have allstakeholder views represented in decentralized networks, especially users.

While the lack of stakeholder diversity is ultimately a byproduct of the ICO bubble, technological improvements will eventually lead to greater utility and a more balanced & diverse group of stakeholders.

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Opportunity Costs

Some on-chain voting implementations require capital to be locked up for the duration of the vote (DFINITY and Polkadot both implement some form of time vote-locking, as further explored in this piece). This is by design, as voters should be held accountable for the repercussions of their vote.

While insignificant today, there are still opportunity costs when locking up tokens as the voter forgoes the ability to sell, or in the near future, earn interest from lending as #DeFi infrastructure continues to mature. Purely speculation, but if many token holders are opportunistic investors as previously hypothesized, then these speculators may value this liquidity significantly more than the future value of the protocol. Tourists vs. Citizens.

However, as we look to future on-chain governance implementations in the next section, these same opportunity costs can be leveraged to incentive behavior in unique on-chain governance designs.

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Novel on-chain governance designs

It’s important to note that “one token, one vote” is merely one simple implementation of on-chain governance that has been experimented with to date. New blockchain projects are on the cusp of implementing novel on-chain governance designs, borrowing concepts like:

• Identity-based “one person, one vote”
• Delegative Democracy
• Technocracy
• Futarchy
• Weighted voting / Quadratic voting

Below are a couple exciting implementations.

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Polkadot

As currently outlined on GitHub, Polkadot’s governance introduces the notion of an on-chain “Council”, comprised of a fixed number of Polkadot stakeholders (envisioned to be 12-24). Each council member is elected through a staggered community Approval Vote (similar to upvoting), with members participating in a representative democracy and continuously rotating as their election term expires (1 member rotates per month).

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The Polkadot Council has the power to propose new “Referenda” (specific proposals)or unanimously veto potentially malicious publicly submitted Referenda as a security backstop. The Council also directly addresses potential scenarios of low voter turnout via Adaptive Quorum Biasing.

The general idea behind Adaptive Quorum Biasing is that if the Council proposes a vote, and there’s low turnout, then the proposal in question requires a lot more No votes over Yes votes to reject the Referenda in question. However, in the same low voter turnout scenario, if a regular token holder proposes a vote, the proposal needs significantly more Yes votes than No votes.

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Adaptive Quorum Biasing provides Polkadot flexibility in low voter scenarios by basing voting majority requirements on turnout, making it easier or more difficult for a proposal to pass if there is no clear majority of voting power for or against it.

In addition to the introduction of a council, Polkadot leverages weighted voting, based on two variables: tokens and time.

tokens: The amount of tokens under ownership by the voter;

time: The amount of time those tokens will remain locked after the referendum has ended, measured in multiples of enactment delay and bounded between one and six.

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The number of tokens are multiplied by the designated time lock to calculate the total number of votes. Weighted voting creates an interesting dynamic whereby passionate voters are able to make their votes count more by increasing their exposure to a decision.

For example, a miner may be willing to take more risk and voluntarily lock their tokens for the maximum amount of time when voting for a Referenda around a change to their bottom line. If the Referenda passes, the miner’s tokens are locked and they face the economic implications of their decision by losing the ability to sell / exit the system until their tokens are unlocked. If the Referenda does not pass, the miner’s tokens are not locked and they can sell or exit the system if they feel strongly enough.

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This is an oversimplification of Polkadot governance process, so I urge the curious to read more on GitHub or watch Ryan Zurrer’s presentation at AraCon 2019.

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DFINITY

DFINITY directly addresses the shortfalls associated with the average user lacking direct subject matter expertise as previously discussed with the design of their Blockchain Nervous System (BNS), a form of Delegative Democracy:

“BNS is an intelligent system that will accept proposals from different stakeholders and then decides on these proposals using votes made by human-controlled neurons. Every, interaction with the neuron is a learning experience for the BNS and it will continuously learn and adapt to make better decisions. Note that the proposals may concern different matters such as Economics, Policy, Protocol Upgrades, Client Upgrades, Fixup or Freeze Resident etc but ultimately the system will follow a democratic voting process and decision making.”

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Neuron’s within the BNS are created via a time-locked security deposit of DFINITY’s native token, DFN. The relative voting power of a Neuron is proportional to the size of total deposits. Similar to Polkadot, if a voter wants to retrieve their deposited DFN, they must “dissolve” their deposit over a significant time period (3 months or longer as outlined in initial BNS designs), creating a strong incentive for Neurons to contribute to net-positive decisions as the value of their locked DFN could fall otherwise.

In addition, DFINITY incentives voter participation by rewarding Neurons with DFN whenever they vote, with rewards being calculated proportional to the size of the Neuron security deposit and the percentage of decisions they participate in.

For example, if the BNS sets voter rewards to 1%, a Neuron that has 100 DFN deposited and participates in all decisions will return 1 DFN, while another 100 DFN sized Neuron that only participations in 50% of the decisions will only return 0.5 DFN.

While there is a clear incentive to participate in every vote, with potentially dangerous repercussions associated with blindly voting, DFINITY allows Neuron’s to follow the votes of other Neurons. By establishing Neuron follower relationships with trusted subject matter experts on relevant proposals, voters are able to delegate their decisions to perceived authorities.

For example, one can program their Neuron to follow a number of Core Developers for protocol-level proposals, or a group of Researchers they align with philosophically. This type of “liquid democracy” allows tokenholders to actively participate in on-chain votes for specific proposals they may not have the expertise to vote on.

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Moving Forward

The amount of experimentation and innovation happening in this space is exciting and provides hope that the barriers associated with low voter turnout will be solved. As a majority of the novel on-chain governance designs are unproven and purely academic at this point in time, it will be fascinating to watch these implementations play out in the wild.

While on-chain governance is a double-edged sword and comes with significant trade-offs, I’m excited to continue closely watching on-chain governance evolve across the coming years. In particular, I hope to see more experimentation around Futarchy and the potential gains in efficiency speculation markets may bring to governance.

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All material presented in this article represents the research analysis and opinions of the author. Nothing in this article should be construed as investment advice.

Market Update

The purpose of this section is to keep you updated on the most important movements in the industry. The crypto markets move at a rapid pace and there is no shortage of news to share. At Premier Investment Hub, we track the markets 24/7 to gain an edge on investing.

Here are some important trends from January and February that we continue to track.

The Smart Money is Pouring In

While crypto prices remain subdued at the start of 2019, there is no doubt that the asset class as a whole continues to gain traction with leading financial and technological institutions.

Only last week, it was reported that Fidelity’s long-awaited digital asset custody solution is already live. The company began onboarding institutional clients in January. In February, JPMorgan announced JPM Coin, a cryptocurrency used for instant settlements of international transactions between corporate clients. This marks a major shift from JPMorgan CEO Jamie Dimon’s previous comments that Bitcoin is a fraud and has led many in the industry to wonder how long this had been in the works.

In addition, Facebook is creating its own cryptocurrency – a stablecoin that will be used to address the $69Bn remittances market in India. Facebook’s stablecoin will be available to WhatsApp users. This likely is only the tip of the iceberg for Facebook’s ambitions in the crypto industry. Recently, Zuck posted an update on the direction he’d like to take Facebook and it read like a crypto canon.

After the Yale Endowment announced that it invested in two leading crypto venture funds, A16Z and Paradigm, it became clear that other institutions would follow suit. Two big announcements in February confirmed this. First, our friend Anthony Pompliano at Morgan Creek announced a $40m digital asset fund anchored by two pension funds from Fairfax County Virginia. Pensions are typically the most risk-averse and slowest moving of all institutional investors, so this is a big deal. Following this news, a leading gatekeeper to major institutional capital, Cambridge Associates, announced that it has begun advising its clients to explore investment options in the crypto industry.

Crypto prices remained relatively unaffected by this Premier Investment Hub of good news, but we remain optimistic that more institutional capital may continue to move into the industry over the coming years. A positive for Premier Investment Hub and the industry at large.

QuadrigaCX & The Case For Non-Custodial Exchanges

In spite of the Premier Investment Hub of new investors entering the space, crypto continues to be plagued by exchange hacks. The most recent hack of leading Canadian exchange, QuadrigaCX, was most unusual. Approximately, $190M in crypto assets are now inaccessible for exchange users. The company’s CEO, Gerald Cotton, died unexpectedly in December taking with him the only knowledge of the exchanges private keys. These keys are needed in order for anyone to access the exchange’s funds.

While this is another huge story tied to an exchange-related issue; we don’t believe that this should be a net negative for the industry at large. It is clear that there is a need for non-custodial exchanges in the crypto industry and as institutions enter, better, more secure custody solutions are coming online.

The ethos behind the crypto market is that of decentralization, so it is not surprising that centralized points of failure, like insecure exchanges, are the main culprits of some of the worst news in crypto today. 

The industry is making progress towards replacing custodial exchanges like QuadrigaCX, with non-custodial “decentralized” exchanges in which the end-users hold their own private keys. This is beneficial because a hacker would need to attack every individual user’s wallet vs. one centralized repository of funds.  Binance, the leading global crypto exchange, recently announced that its non-custodial exchange, Binance DEX, is live for testing on Cosmos, a new interoperability protocol. In addition, this week Bancor, another leading decentralized exchange launched a new wallet to support cross blockchain token trading.

Revived Industry Focus on User Experience Could Drive Adoption

At Premier Investment Hub, we have never subscribed to the Fat Protocol thesis first promoted by Union Square Ventures. In short, this thesis states that it will be the infrastructure of the decentralized internet, not the applications, that will accrue the most value (imagine if HTTP had had a token).

We believe the opposite – value has always accrued and will continue to accrue to the applications that can onboard the most users (whether enterprise or consumer). Companies are rewarded for finding product-market fit and driving adoption.  

That said, we have not yet seen a killer application for crypto (other than as a speculative asset class). This is partly because key technological challenges still need to be solved (scalability, interoperability), but also because very few crypto companies have focused on the user experience (or UX).

This is finally beginning to change. As Taylor Monahan, CEO of MyCrypto (a leading crypto wallet), stated during a recent presentation at Mainframe’s Decentralized Summit, “We need to be building a positive experience that people want to—and can—partake in.”  

This may start with a shift in developer interest from “dApps” (or decentralized applications) to normal centralized applications built on top of decentralized protocols. As Chris Burniske author of CryptoAssets: The Innovative Investor’s Guide and partner at Placeholder VC states in this tweet storm that, “Long term, centralized #crypto apps that build atop decentralized infrastructure will find it the key to what allows them to scale beyond, and outcompete, incumbents that fear public networks & cling to owning their infrastructure.”

Increasingly, leading centralized crypto incumbents like Coinbase and Circle are building using decentralized protocols like 0x and ZeppelinOS and new entrants are following suit. Veil and Dharma Lever are two prime examples of centralized applications that leverage the composability of multiple decentralized protocols. Veil is a prediction market built on top of Augur with a slick user experience. Dharma Lever, is a crypto lending platform built on top of its own decentralized credit protocol, Dharma. Co-founded by Coinbase alum, Nadav Hollander, Dharma is focusing most of its energy on improving the user experience for lending crypto assets. One such improvement is that Dharma Lever pays for the gas (transaction fee) associated with writing the smart contract on their platform to reduce friction.

We’re excited for more companies to leverage the existing crypto infrastructure with a sharpened focus on the end user’s experience. Without ease of use, we’ll never see mass crypto adoption.

More on Scalability: Ethereum Completes Key Upgrade

As we noted in our 2018 year-end LP update, a number of newly scalable blockchains are expected to launch in 2019. If Ethereum wants to keep its first mover advantage, it needs to deliver on a number of protocol upgrades including a move to proof of stake consensus. This long road kicked off with the much anticipated Ethereum upgrade called Constantinople. Constantinople failed to launch on schedule due to the last minute discovery of a bug in the code. However, on February 28th, the Ethereum community announced the implementation of the upgrade which will improve the efficiency of the network by reducing transaction fees and block rewards. Major exchanges like Binance, Huobi, OKex, and Coinbase all announced support for the upgrade.

The race to a scalable blockchain continues, and it remains unclear if Ethereum will be the winner. Ethereum’s main competitive advantage continues to be its strong community of developers (more on that below).

Premier Investment Hub In the News

1. Premier Investment Hub CEO, Dave Siemer, was quoted in a recent report on crypto lending for Tearsheet
2. Premier Investment Hub Principal, Marc Weinstein, was recently quoted in a recent article for Forbes on the growing importance of stablecoins
3. Premier Investment Hub President, Ben Tsai, wrote an op-ed for Block Tribune on the need for digital securities to be driven by demand
4. Premier Investment Hub Principal, Marc Weinstein, wrote an op-ed for Crypto Briefing on the hype surrounding digital securities

Premier Investment Hub Around the Globe

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ETH Denver: February 15-17, 2019

In February, Premier Investment Hub team members Marc Weinstein, Les Borsai, and Tom Lombardi attended the leading US-based developer conference for the Ethereum community, ETHDenver. There were thousands of developers in attendance working on new code and applications for the Ethereum main net. One of the major themes of the conference was a new focus on decentralized or open finance, also known as #DeFi. There were presentations from some of the leading individuals and companies in the crypto industry.

Key takeaway: Ethereum’s competitive advantage lies in the deep pool of developers who continue to build on the protocol.

Oppenheimer Blockchain Summit

Where: New York, NY

When: February 20, 2019

Following the developer conference in Denver, the Premier Investment Hub team attended Oppenheimer’s Blockchain Conference, a 1 day event in New York that highlighting the future of blockchain as an institutional asset class. The conference was well attended by some of New York’s leading financial institutions, hedge funds, and a number of family offices. The quality of the questions showed the improvement in general knowledge surrounding the industry.

Key takeaway: Institutional investors are gearing up to enter the crypto space. The infrastructure that will support their investments and future speculation in the asset class provides an interesting investment opportunity.

Upcoming Conferences

Boston, March 9-10, MIT Blockchain 

Hong Kong, March 12-14, Token 2049

Philadelphia, April 6, Penn Blockchain Conference

Seoul, April 10-11, Deconomy

Long Read: Privacy Coins

In this month’s letter, we share a deep dive from Premier Investment Hub's all star research Associate Jordan Bloch on an important feature to crypto’s success – privacy. Please see attached to this email. 

In a recent letter to Facebook stakeholders, Mark Zuckerberg states,

“As I think about the future of the internet, I believe a privacy-focused communications platform will become even more important than today’s open platforms. Privacy gives people the freedom to be themselves and connect more naturally, which is why we build social networks.”

We couldn’t agree more. In fact, privacy in the crypto markets is a crucial feature that not only improves scalability (speed) of these networks (the less information stakeholders share, the less data needs to be stored in a blockchain), but also (along with stability) might help usher in an age of international crypto payments. Privacy is misunderstood by many outside of the crypto industry as a way for black market participants to obfuscate important transaction data. However, it is much more than that. For example, do you want your coworkers (or anyone for that matter) to be able to track your purchases for the last month? Of course not.

Much progress on this crucial market theme is being made by numerous teams focused on privacy features and coins. In this deep dive, our associate, Jordan Bloch, addresses the two oldest and largest privacy coins by market cap: ZCash and Monero.

In the coming months, we’ll share more research on this subject.