Cryptoassets The Innovative Investor's Guide To Bitcoin And Beyond 2017


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Praise for Cryptoassets and Chris Burniske and Jack Tatar
Anyone with a practical or theoretical interest in nancial markets should
know about cryptoassets. Burniske and Tatar do an excellent job explaining
this brave new world to us.
HARRY MAX MARKOWITZ, winner of the Nobel Prize
in Economics and founder of Modern Portfolio eory
Cryptoassets is an outstanding overview of the state of digital currencies and
assets. Highly recommended for those who want to understand where nance
is going.
and board partner at Andreessen Horowitz
Burniske and Tatar have delivered a seminal guide to what may be the big-
gest investment opportunity since the Internet. Informative and actionable,
Cryptoassets is a must-read for crypto-enthusiasts and capital market investors
ARTHUR B. LAFFER, chairman of Laer Associates,
member of President Reagans Economic Policy Advisory Board,
and creator of the Laer Curve
As we hurtle into a new, decentralized economy, Burniske and Tatar have laid
down something of immense importance: a coherent logic, a new science
even, for investing in the assets that will dene that coming world.
MICHAEL J. CASEY, senior advisor to the Digital Currency
Initiative at MIT Media Lab and coauthor of e Age of
In this sweeping and lucid work, Burniske and Tatar make a compelling case
that cryptoassets are foundational to the second generation of the Internet
and represent a once-in-a-generation opportunity for the innovative inves-
tor. Required reading for anyone wanting to understand the future of nance,
business, and more.
ALEX TAPSCOTT, CEO of NextBlock Global
and coauthor of Blockchain Revolution
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Poised to be one of the most profound inventions in history, blockchain technol-
ogy may change everything—just as the wheel and the Internet did. Chris and
Jack will help you understand blockchains and the cryptoassets within them. If
youre a nancial advisor, this book will help you serve your clients better.
RIC EDELMAN, three-time #1 Independent Financial Advisor
(Barron’s) and New York Times bestselling author of
e Truth About Your Future
Investors are always seeking new assets to diversify their portfolios, and the
emergence of cryptoassets provides such an opportunity. Burniske and Tatar
oer the rst detailed analysis of cryptoassets from the perspective of a port-
folio investment.
CAMPBELL R. HARVEY, former president of the American
Finance Association and professor of nance at the Fuqua School
of Business at Duke University
Cryptoassets is the denitive guide that comes just in time to introduce you
to a radically new era of innovative investment. is book tells you all you
need to know to invest in this supreme opportunity of our time: replacing
the porous top-down “winner-take-all” Internet with a safe and cornucopian
cadastre of trust and opportunity that makes us all potential winners.
GEORGE GILDER, cofounder of the Discovery Institute
and author of e Scandal of Money
e growth and importance of cryptocurrency and cryptocomputing rivals
the early growth of the commercial Internet and web, and the technical and
economic revolution that will result is perhaps even more signicant than the
rst phase of the Internet. Cryptoassets is an excellent introduction to this
breakthrough in technology and nance, and a tremendous resource for those
eager to get their heads around what can be a daunting and complex subject.
JEREMY ALLAIRE, CEO and founder of Circle
is is an extremely well-researched and timely “state of the nation” treatise on
cryptoassets. I’m excited that the knowledge base of our industry is continuing
to expand with such high-quality thought leadership and insights.
VINNY LINGHAM, cofounder and CEO of,
Shark on Shark Tank South Africa, and board member
of the Bitcoin Foundation
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Since Bitcoins creation, people have been wondering why it and other crypto-
assets have any value. Chris Burniske and Jack Tatar give the most compelling
case for why, with sharp, detailed analysis that reects their deep understand-
ing of the technology and their strong nance background. Beginners as well
as more seasoned crypto investors will nd new insights and sensible tips in
this practical guide.
LAURA SHIN, senior editor at Forbes and host of Unchained
Cryptoassets is a fascinating introduction to this new space of the digital econ-
omy. e authors surface many historical examples to remind us that in times
of excitement, it is even more important to pay attention to the teams and tal-
ent behind each project.
CHRISTIAN CATALINI, eodore T. Miller Career
Development Professor at MIT and assistant professor of
technological innovation, entrepreneurship, and strategic
management at the Sloan School of Management at MIT
Cryptoassets is a must-read for all nancial services executives and investors
who want to understand the fundamentals and future directions of this bur-
geoning new asset class. Delivered by two of the foremost authorities in the
nascent, multibillion-dollar space, this is the most extensive guide on crypto-
assets currently available.
SANDRA RO, former head of digitization at CME Group
As renowned industry thought leaders, its no surprise that Chris and Jack
have delivered what is likely the most thoughtful and in-depth framework for
evaluating cryptoassets. Within this book, they’ve rolled up their sleeves to
provide helpful historical context and a valuation framework that readers will
nd intellectually stimulating and illuminating for understanding this rapidly
emerging world of cryptoassets.
SPENCER BOGART, managing director
and head of research at Blockchain Capital
Chris is at the forefront of the important work to better understand and ana-
lyze this emerging class of assets. In this book, he and Jack have encapsulated
years of their thinking in an easy-to-digest manner.
DAVID KINITSKY, VP of research and innovation
at Fidelity Labs
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For the uninitiated, the world of cryptocurrencies is fraught with risks and pit-
falls. No one should venture into this world without preparation. Cryptoassets
explains, in simple to understand terms, the full paradigm of Bitcoin and its
successor currencies, and it provides everything needed to explore this excit-
ing world.
JOHN MCAFEE, founder of McAfee Associates
A thorough, balanced, and easy read. I would recommend this to anyone who
considers building a portfolio of cryptoassets.
RYAN SELKIS, former director of investments at Digital
Currency Group and managing director of CoinDesk
Serious investment professionals should read Cryptoassets if they want to
understand and value the rst new asset class of the twenty-rst century. Chris
and Jack explain this new-age investment opportunity comprehensively, art-
fully, and masterfully.
of ARK Investment Management
A rare combination of quantitative analysis and rst principles-based think-
ing—this is insightful, original content.
ADAM WHITE, vice president of Coinbase
and general manager of GDAX
In an increasingly digital world, it is only a matter of time until enormous
amounts of value are transmitted and secured via blockchains, including the
value of music and creative works. Cryptoassets makes blockchains accessible
to the nontechnical by exploring their varied origin stories, use cases, and fun-
damental value. If you’re looking for a grounded, rst-principles approach to
the next wave of Internet innovation, then this is a great book to read.
JESSE WALDEN, founder of Mediachain Labs
and blockchain lead at Spotify
Chris and Jack show us the future of cryptoassets today. eir outlook is
pointed and perceptive. A must-read to understand the next era in wealth and
value creation.
WILLIAM MOUGAYAR, general partner at Virtual Capital
Ventures and author of e Business Blockchain
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Young, Stanford-trained blockchain analyst and investor Chris Burniske has
teamed up with nancial planning expert and author Jack Tatar to provide
the rst comprehensive guide to understanding the fastest growing, most
exciting asset class under the sun. While many investors are still waking up
to the opportunity, these assets have already provided outsized returns, as the
overall market is now hovering around $100 billion, which is 10x from a year
ago and 100x from four years ago. Collectively referring to these investments
as “crypto assets,” Burniske and Tatar provide a solid background on how the
technology arose, what problems it solves, and how, like the Internet itself, its
going to have a dramatic impact on not only the venture capital process but
on investing itself. Don’t think of rebalancing your portfolio without reading
this book.
MICHAEL TERPIN, founder of Transform Group,
organizer of CoinAgenda, and cofounder of BitAngels
While the cryptoasset space has witnessed exponential growth, to achieve its
full potential, it has to be broadly integrated into the real world. With consis-
tent objectivity and clarity, Chris and Jacks book details cryptoassets as an
asset class, and will prove inuential in driving institutional investor adoption
of this groundbreaking opportunity.
JENNIFER ZHU SCOTT, founding partner of Radian Partners
and member of the Future of Blockchain Council of the World
Economic Forum
Cryptoassets provides a great introduction to and overview of the young yet
rapidly growing universe of all things blockchain. is industry, asset class,
and overall idea will make you ponder why abstract concepts like money,
identity, and business function like they do in the world today, and how the
innovation were seeing will completely reshape the economy of tomorrow.
From setting the stage to diving into specic protocols and projects to sharing
practical knowledge on how to invest in these emerging assets, Chris and Jacks
combination of expertise and familiarity with the complex topics at hand are
testament to why I have considered them some of the best resources through-
out my journey of falling deeper and deeper down the crypto rabbit hole.
ALEX SUNNARBORG, research analyst at CoinDesk
and cofounder of
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From inception to the latest phase, Cryptoassets explores the past, present, and
future of this new asset class. It’s not a hard read yet delves into much of the
detail needed for a complete understanding of the benets, and risks, of bit-
coin, blockchain, and more. Chris and Jack have written a book I highly rec-
ommend to investors in this burgeoning eld!
PAT BOLLAND, former business editor at CNBC, CBC, BNN
Cryptoassets is the bible for all things crypto. Whether youre a beginner or
expert, you will walk away with a deeper understanding of the entire eco system
aer reading this book.
GREG ROSEN, principal at BoxGroup
Chris and Jack provide a holistic view of the origin, evolution, and analysis of
cryptoassets. It goes through their very short but intense history, talks about
methods for analyzing their value, and identies the ones with potential. I’d
recommend it to anyone who wants to dive into investing and understanding
how cryptoassets will shape the future of society and the creation of value.
LUIS CUENDE, cofounder of Aragon and Stampery
ose of us who work in the blockchain industry have long realized that the
rise of cryptocurrencies as a legitimate asset class was inevitable. But most
traditional investors have been slow on the uptick. Chris was the rst buy-
side analyst to focus exclusively on this emerging asset class, and Jack was one
of the earliest nancial journalists to stress its importance. For years, Chris
has been working hard to bring Wall Streets rigorous analytical methodolo-
gies to cryptocurrencies, while Jack has been busy explaining the benets of
cryptocurrencies to audiences around the world. Now, with Cryptoassets, they
describe, as nobody has before, why every investor should incorporate bitcoin,
ether, and new blockchain-based assets into their portfolios, and how to ana-
lyze these tokens in order to make the right investments.
TRAVIS SCHER, investment associate at Digital Currency Group
Chris and Jack have written our generations A Random Walk Down Wall
Street. is book is required reading for anyone looking to get involved with
and prot from the cryptoassets boom.
PATRICK ARCHAMBEAU, VP of engineering at CoinDesk
and cofounder of
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Chris and Jack have been fellow travelers in the blockchain space since way
before it was a polite cocktail party topic. Over the years, weve laughed and
marveled together at how the space has evolved. is book could not be more
timely in describing an emerging $100+ billion nancial market and all of the
chaos and promise it brings. e authors capture not only the technical and
market analysis you need to know to invest in these projects but also the ethos
and excitement of the people pushing the envelope. Savor this book. Its a time-
capsule view of the birth of an amazing technology.
PETER KIRBY, cofounder and CEO of Factom, Inc.
Burniske and Tatar thread the needle between an approachable guide for new-
comers and thought-provoking insights for seasoned investors. I will surely be
assigning it to my graduate students as we cover cryptoassets.
STEPHEN MCKEON, associate professor of nance at the
Lundquist College of Business at the University of Oregon
Token-based fund-raising is here to stay, and this book oers the best way
to value cryptoassets that Ive seen. e book provides background and the
potential impacts of ICOs, oering insightful knowledge to both those enter-
ing the space and experienced investors like myself. I would recommend this
book for any crypto reading arsenal!
PAUL VERADITTAKIT, partner at Pantera Capital
Burniske and Tatar have now given me an easy response when people ask how
to get started with cryptoassets—this book!
ARI PAUL, CIO of BlockTower Capital
is is a seminal work in the evolution of the cryptosphere as digital money
moves mainstream. e book covers the full potential and array of what this
technology oers in piercing the veil to an Internet of value with all the new
innovations and crossovers from the traditional realm of nance. Chris and
Jack have brought a wealth of knowledge and cross-disciplinary methods to
bear from their respective elds and broken new ground in their analysis of
this exciting new space.
CHARLIE HAYTER, cofounder and CEO of CryptoCompare
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Cryptoassets is a tour de force. Burniske and Tatar are able to leverage their
deep industry experience to condense a complex, continually evolving topic
into a concise and informative guide for investors looking to be on the cutting
edge of a new asset class. Cryptoassets will serve as the entry point to the space
for retail investors for years to come.
PIETER GORSIRA, soware engineer at CoinDesk
and cofounder of
In a world where issuing digital assets becomes as easy as creating a website,
Chris and Jack provide a comprehensive guide that will help you separate the
wheat from the cha.
DEMIAN BRENER, cofounder and CEO of Zeppelin Solutions
As we enter the next great evolution in global nancial markets, Chris Burniske
and Jack Tatar have authored a unique and much-needed volume. It oers
not only a foundational understanding of cryptoassets and digital currencies
but also serves as a reference for evaluating and participating in a cryptoasset
future. A new asset class has emerged, and Cryptoassets is the denitive guide.
RON QUARANTA, chairman of the Wall Street
Blockchain Alliance
is book is very accessible, comprehensive, and easy to read for any size
investor. One of its strengths is its ability to be valuable to the novice and the
experienced professional alike.
JARED HARWAYNEGIDANSKY, founding board member
of the Blockchain Association of Australia
Chris and Jack have created a book that not only explains the world of crypto-
assets but provides a framework for how to invest in it and become part of
what may be the greatest investment opportunity since the Internet.
NED SCOTT, founder and CEO of Steemit
Cryptoassets is an intelligent and well-organized introduction to the world of
cryptoassets. e book adapts classic nance pricing models to the challeng-
ing task of valuing cryptoassets, oering the reader a solid head start to invest-
ing in this new exciting asset class.
ALESSIO SARETTO, assistant professor of nance
at the University of Texas at Dallas
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If you want to know how cryptoassets work, get Mastering Bitcoin by Andreas
Antonopoulos, but if you want to know how and why you should be investing
in this new asset class, get yourself a copy of Cryptoassets.
TRON BLACK, investor and principal developer
at Medici Ventures
Newcomers oen try to wiggle their way into the world of accepted nancial
tools. Most fail miserably. But cryptocurrency and its accompanying blockchain
technology have made their mark and will likely have an ongoing impact on
how we all do business. Burniske and Tatar have written an incredibly compre-
hensive book that explains what you need to know about this new asset class.
DOUGLAS GOLDSTEIN, CFP, author of Rich as a King
By explaining the various crypto investments, from coins to tokens to commodi-
ties, and providing the tools to perform investment analysis, Cryptoassets is the
best crypto investment novices, professionals, and business leaders can make.
RON KOCHMAN, former president and CEO of
Volt Information Sciences and cryptoasset angel investor
Cryptoassets provides a one-stop shop for learning about this new asset class.
Youll learn about their colorful histories, how to apply fundamental valuation
techniques, and practical tips to navigate the at-times turbulent markets.
MATTHEW GOETZ, CEO of BlockTower Capital
With investing, people always want to know about the next big thing. For curi-
ous minds who want to know about emerging technologies or even those who
already have an understanding of blockchains, Chris and Jack leave no stone
unturned. From the origins, to an explanation of how it works, to whats next,
the reader will leave excited about the possibilities of investing money and
time in this exciting adventure.
TOM SZAKY, founder and CEO of TerraCycle
is book is a must-read for any nancial advisor who wants to stay on top
of the shiing asset and technological landscape. Advisors would be wise
to familiarize themselves with cryptoassets before their innovative clients
approach them for an intelligent cryptoasset discussion!
FRED PYE, president and CEO of 3iQ Corp.
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What will a technology that validates the order of entries in an electronic led-
ger without a centralized administrator bring? Time will tell. If you cant wait
until then, read Chris and Jacks book. It will give you a great start.
FRANCOIS GADENNE, chairman and executive director
of the Retirement Income Industry Association
e most complete and informational piece of literature on the subject today.
Chris Burniske and Jack Tatar steer the reader through a torrent of unknowns,
illuminating the complicated world of cryptoassets and their underlying tech-
nology, which will more than likely become our generations most important
RYAN LANCELOT, coauthor of What’s the Deal with Bitcoins?
A must-read to appreciate the Bitcoin network eect and the wave of innova-
tion that it launched through the community of people who played critical
roles in creating all the distributed ecosystems that are transforming business
CRISTINA DOLAN, cofounder and COO of InsureX
Crypto trading and the FinTech innovations unlocked by blockchains will do
to Wall Street what personal Internet publishing and blogging did to media
empires. is power shi is inevitable. Capital allocation no longer needs to be
managed by powerful institutions which have proven to be corrupt and reck-
less. Regulation and regulatory capture is putting the U.S. at risk of losing out in
the transition. Chris Burniske and Jack Tatar give you, the individual, the tools
to evaluate these new cryptoassets and take advantage of what I believe will be
the greatest rebalancing of wealth and power that the world has ever seen.
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The Innovative Investor’s Guide
to Bitcoin and Beyond
New York Chicago San Francisco Athens
London Madrid Mexico City Milan
New Delhi Singapore Sydney Toronto
Burniske 00.indd 3 9/11/17 11:29 AM
Copyright © 2018 by Chris Burniske and Jack Tatar. All rights reserved. Except as permitted under
the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed
in any form or by any means, or stored in a database or retrieval system, without the prior written
permission of the publisher.
ISBN: 978-1-26-002668-9
MHID: 1-26-002668-X
The material in this eBook also appears in the print version of this title: ISBN: 978-1-26-002667-2,
MHID: 1-26-002667-1.
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This is a copyrighted work and McGraw-Hill Education and its licensors reserve all rights in and to
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To Dad, who taught me how to write,
and to Mom, who made me believe I could
To Eric and Grace, you are the future
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Authors’ Note xi
Foreword by Brian Kelly xiii
Acknowledgments xvii
Introduction xxi
Chapter 1
Bitcoin and the Financial Crisis of 2008 3
Chapter 2
The Basics of Bitcoin and Blockchain Technology 11
Chapter 3
“Blockchain, Not Bitcoin?” 21
Chapter 4
The Taxonomy of Cryptoassets 31
Chapter 5
Cryptocommodities and Cryptotokens 51
Burniske 00.indd 7 9/11/17 11:29 AM
viii Contents
Chapter 6
The Importance of Portfolio Management and Alternative Assets 69
Chapter 7
The Most Compelling Alternative Asset
of the Twenty-First Century 83
Chapter 8
Dening Cryptoassets as a New Asset Class 107
Chapter 9
The Evolution of Cryptoasset Market Behavior 121
Chapter 10
The Speculation of Crowds and “This Time
Is Different” Thinking 137
Chapter 11
“It’s Just a Ponzi Scheme, Isn’t It?” 155
Chapter 12
Fundamental Analysis and a Valuation Framework
for Cryptoassets 171
Chapter 13
Operating Health of Cryptoasset Networks
and Technical Analysis 185
Chapter 14
Investing Directly in Cryptoassets:
Mining, Exchanges, and Wallets 211
Chapter 15
“Where’s the Bitcoin ETF?” 231
Burniske 00.indd 8 9/11/17 11:29 AM
Contents ix
Chapter 16
The Wild World of ICOs 247
Chapter 17
Preparing Current Portfolios for Blockchain Disruption 263
Chapter 18
The Future of Investing Is Here 279
Chris and Jack’s Go-to Crypto Resources 285
Notes 289
Index 309
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Authors’ Note
When we started writing this book in December 2016, bitcoin was in
the $700s, ether was in the $7s, and the aggregate network value of
cryptoassets was just north of $10 billion. Over the ensuing months
of writing we watched bitcoin push past $4,000, while ether crossed $400, and
the aggregate network value of cryptoassets punched through $100 billion.
Cryptoassets went from being esoteric dark web material to mainstream topics
of conversation and enthusiasm.
When embarking on our literary journey, we recognized the diculty in
documenting arguably the worlds fastest moving markets. ese markets can
change as much in a day—up or down—as the stock market changes in a year.
Nonetheless, we were continually asked the same question: “What should I
read to get the full picture of whats going on in these markets?” e frequency
of this question grew to a clamor as the markets rose through the rst half of
2017, and yet information channels remained stubbornly fragmented among
Reddit, Twitter, Telegram, Slack, Medium, news sites, and more.
While we recognize the diculty in covering the full picture of the ever-
moving cryptoasset markets, we believe that this book provides a comprehen-
sive view of the history, technology, and marketplace dynamics of bitcoin and
beyond. We have craed the book to be as evergreen as possible with regard
to the background and methodologies laid forth, so that even as the markets
change, the book retains its value. We recognize that by the time you read
this, some asset prices may seem like the distant past, and some teams may be
Burniske 00.indd 11 9/11/17 11:29 AM
xii Authors’ note
indignant that we didnt cover their story. We couldn’t possibly have covered
every price change and every story, or we would never have published the
Our hope is to serve as a starting point and means to understanding, so that
we can all study and experience this space together. It is a history that is still in
its earliest stages of being written.
Burniske 00.indd 12 9/11/17 11:29 AM
When I rst learned about bitcoin, I was convinced it would fail. Based
on a few articles and two decades of experience as a skeptical trader,
I loudly—and now regrettably—declared on CNBC’s Fast Money
that bitcoin would not survive. How could it? It was not backed by any entity;
it did not have a central bank; it was not accepted for taxes; and it did not have
an army to enforce its use. Whats more, it was extremely volatile and had a
bad reputation—all of which would contribute surely to its premature demise.
I have never been more incorrect in my entire career.
Somewhere in the CNBC archives exists an awkward video of me railing
against this “magic Internet money.” If youre reading this and have access to
the video, treat it with the respect it deserves and destroy it! Since those unen-
lightened days, I have come to understand that bitcoin—and the blockchain
beneath it—is a technological advancement that has the potential to revolu-
tionize nancial services the same way email did to the post oce.
Once I realized that blockchain technology was a disruptive force, I sought
out people who shared my view. I met Chris Burniske at the very rst Wall
Street Blockchain Alliance holiday party, and we immediately found com-
mon interest in the potential for blockchain-based assets, or cryptoassets, to
become a new asset class for investors. At the time, very few people saw bit-
coins potential, but Chris did, and it was clear to me that he possessed rare
leadership and vision.
Burniske 00.indd 13 9/11/17 11:29 AM
xiv Foreword
Jack Tatar is an expert in retirement planning who has spent over two
decades in the nancial industry and brings a much-needed perspective of
nance and investment knowledge to the cryptoasset world. New technology
can be confusing and intimidating, but through his engaging writing, Jack
possesses the unique ability to distill a complex subject into an easily digestible
serving. As a result of their combined perspectives, Cryptoassets is a book that
will satisfy the most curious minds and engage those approaching the subject
for the rst time.
Readers will benet not only from Chris and Jacks vision but also their
deep knowledge of the topic. As the manager of a hedge fund that invests in
digital assets, I am constantly researching this asset classs investment poten-
tial, and when I get stumped, my rst call is to Chris Burniske. While I am
thrilled that Chris is sharing his unique insights in this book, I am selshly
reluctant to lose my secret go-to resource. Layer on Jacks experience as one of
the rst nancial journalists to write about bitcoin, and you have a powerful
combination. Let them be your resource as well.
e beauty of this book is that it takes the reader on a journey from bitcoins
inception in the ashes of the Great Financial Crisis to its role as a diversier
in a traditional investment portfolio. ose who want to look under the hood
of blockchain technology will be thrilled with the skillful description of the
elegant architecture that powers this technology, and nancial historians, like
myself, will nd the discussion of investment bubbles instructive. Chris and
Jack artfully apply nancial history lessons to the cryptoasset investment world.
Spoiler alert: even though blockchain technology is disrupting traditional
nancial market structures, fear and greed remain uniquely human traits that
can and will nd a place in cryptoassets. ankfully, Chris and Jack give readers
the tools and knowledge to know what to look out for when bubbles do occur.
Armed with this knowledge, the reader can then use the valuation frame-
work laid out in Chapters 12 and 13 to nd the most promising cryptoassets.
Valuing cryptoassets is done unlike traditional investments; they typically
do not have revenue or cash ows and thus present a conundrum for those
evaluating their merits. Here, Chris and Jack present groundbreaking work
on how to properly value an asset based on the network eect and teams of
decentralized developers. Everyone who is even thinking about investing in
cryptoassets needs to read these chapters.
One of the most fascinating outcomes of the blockchain revolution is how
cryptoassets are disrupting the disruptors. As Chris and Jack explain, the ven-
ture capital business model is being turned on its head by crowdfunding eorts
Burniske 00.indd 14 9/11/17 11:29 AM
Foreword xv
that include initial cryptoasset oerings, or ICOs. Cryptoassets are made of
code, and because they easily track and convey ownership, they can be used
as fund-raising tools for startups. In the last two years, there has been a wave
of entrepreneurs that bypassed venture capitalists and instead chose to raise
startup capital via these methods.
As with any new model, there are questions about legality and sustainabil-
ity, but the Silicon Valley ethos of “break things rst, then ask for forgiveness
has found its way to Wall Street. Professionals who are involved in all aspects
of fund-raising—from venture capital to capital markets—will nd the dis-
cussion of these new methods of raising capital riveting, maybe even a little
e nal chapter of my book e Bitcoin Big Bang was titled “Everything
You Know About Business Is Wrong,” and it previews what Chris and Jack
have identied as a game-changing development in the way capital is raised
and distributed. Self-funded, decentralized organizations are a new species in
the global economy that are changing everything we know about business. A
cryptoasset as the fuel for a decentralized organization not only changes the
organizational chart, it also rearranges incentive structures.
ese new organizations are altering the way soware is developed.
Cryptoassets have inverted the value creation structure that worked so well
during the development of the Internet. ese so-called fat protocols are self-
funding development platforms that create and gain value as applications are
built on top. is is an entirely new paradigm for open-source projects that
incentivizes developers to build socially useful projects.
When I started working on Wall Street, the Internet was something on a
computer at the end of the trading desk. Amazon, eBay, and Google did not
exist—but within ve years, these companies had changed the world. As a
greenhorn trader, I was too young and inexperienced to recognize that the
Internet was a once-in-a-generation investment opportunity. I was convinced
that I would not see another exponential investment opportunity for the rest
of my career—until I discovered blockchain technology. Blockchain technol-
ogy is one of the most important innovations in the history of nance. It is
changing the way we transact, distribute capital, and organize our companies.
If youre like me and missed investing in the Internet, read this book so you
can take advantage of the biggest investment opportunity since the Internet.
BRIAN KELLY, CNBC Contributor and
Manager of the BKCM Digital Asset Fund
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Thanks rst and foremost to the best literary partner one could have—
the great Karen Lacey. is truly was a three-person production, and we
thank you for helping us dene, rene, and execute on our vision. Not
only did you hone our thinking, but you dove deep down the cryptoasset rab-
bit hole too! Anyone looking to work with a gied and patient literary partner
can nd Karen at
anks to our wonderful editor at McGraw-Hill, Casey Ebro, and our liter-
ary agent, Marilyn Allen.
Special thanks to all of those in the cryptoasset and nancial community
who provided ideas, advice, and commentary, especially the awesome trio of
Alex Sunnarborg, Patrick Archambeau, and Pieter Gorsira, as well as Charles
Bovaird, Balaji Srinivasan, Arthur Laer, Michael Casey, Alex Tapscott, Ric
Edelman, Campbell Harvey, George Gilder, Jeremy Allaire, Vinny Lingham,
Laura Shin, Christian Catalini, Sandra Ro, Spencer Bogart, David Kinitsky,
John McAfee, Ryan Selkis, Adam White, Jesse Walden, William Mougayer,
Michael Terpin, Jennifer Zhu Scott, Pat Bolland, Greg Rosen, Luis Cuende,
Travis Scher, Peter Kirby, Stephen McKeon, Paul Veradittakit, Ari Paul, Charlie
Hayter, Demian Brener, Ron Quaranta, Jared Harwayne-Gidansky, Ned Scott,
Alessio Saretto, Tron Black, Douglas Goldstein, Matthew Goetz, Tom Szaky,
Fred Pye, Ryan Lancelot, Cristina Dolan, Ryan Strauss, Jack Hough, and of
course to Brian Kelly for his support, friendship, and assistance. We appreci-
ate the support of the worldwide cryptoasset community and if we forgot to
Burniske 00.indd 17 9/11/17 11:29 AM
xviii ACknowledgments
list anyone who was there for us during this journey, please forgive us—it’s
because of the crypto-community that this book exists!
—CB and JT
anks to Dad, who was a writer himself, and from a young age had me jour-
naling, writing summer book reports, and submitting essays to justify the pur-
chase of gadgets. He taught me the importance of never having a TV in the
house, that all creativity comes at the cost of maintenance, and that excellence
should never be compromised.
anks to Mom, who has been a fountain of belief and support through the
good and the bad. While she may not know much about blockchains (yet), she
loves them because I love them. She is the most positive person I know and the
one who has taught me how to nd silver linings in the clouds. anks to my
brother, Justin, who resisted the urge to strangle me when Mom was away, and
taught me that power doesnt always have to corrupt.
ank you to Cathie Wood, who plucked me from a shmongership and
taught me that not all nance is bad. In a few years, Cathie taught me more
about economics, the markets, and how the world works than I learned in my
time at Stanford. In a world where mentors are increasingly rare, Cathies guid-
ance has been pivotal in my life. ank you to Rob Wood, the friendly giant
who introduced us.
anks to Brett Winton, who has taught me how to approach the most com-
plex of problems and that maybe I’m not as dense as I fear. To Joel Monegro,
who has been my thematic torchbearer in the world of crypto, thank you.
eres no one I look forward to brainstorming with more than you. anks to
James Wang, who taught me to love Twitter, and that valuation matters.
Last but not least, thanks to Jack, who has been the driving force behind this
book. If not for a fateful lunch at Consensus and Jacks relentless enthusiasm,
this book never would have happened.
anks to the great Harry Markowitz for his advice and insight. One of the
wonderful results of this book has been my ability to gain the friendship of this
wonderful man. anks, Harry! I’m humbled by your assistance.
Special thanks to my bubbie, Stu Sharo, for taking the dive into this wacky
world, his advice on the cover, and for being a brother to me for so many years.
Burniske 00.indd 18 9/11/17 11:29 AM
ACknowledgments xix
anks to Stu Rosenberg for also taking the dive and providing such great sup-
port and friendship over the years.
Special thanks for my angel investing partner and dear friend, Ron
Kochman, for his honest insight into the book and for making this journey so
much more entertaining. Also to Steve Katz, who we miss every day.
anks to the great John Gioia for his advice and insight throughout the
entire process of creating this book. anks to Irene Cibas for just being her-
self and putting up with John and me for so many years. anks also to Bill
Bonomo, John Barbera, and David Fink for their help and support during the
years when I needed it. Of course, thanks to the legendary Sam Kirk for his
assistance throughout this process.
To my Mom and Dad, who may not be here physically, but inspire and
direct me each and every day.
Most of all, thanks to my family, who put up with me during this process.
I couldnt have done any of it without you. To my children, Eric and Grace, I
could never fully articulate how important and valuable your advice and sup-
port has been to me. Youre my inspiration for everything.
Finally, to the reason for my being and the love of my life, my Maudee Ann.
No one knows better than you what crazy schemes and ideas I’ve had in my
life, and youve endured them and supported me throughout. I thank God for
allowing me the opportunity to live my life with you, and I thank you for, well,
everything. I love you more than words can tell . . . always!
And of course, to my terric coauthor, Chris, who brings intellect, humor,
compassion, and honesty to everything he does. e best part of this book was
making your friendship.
Burniske 00.indd 19 9/11/17 11:29 AM
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Books, TV shows, and movies have been making futuristic predictions
for decades, many of which were originally considered absurd. Star
Trek featured several that proved to be not so outlandish: the indis-
pensable handheld communicators have become today’s smartphones, the
personal access display device is now our tablet, and a universal translator
exists, of which there are several apps to choose. Edward Bellamy’s enigmati-
cally titled 1887 book Looking Backward predicted debit and credit cards, and
2001: A Space Odyssey imagined forms of social media, though nothing on the
scale that we currently have. Alvin Toers Future Shock gripped readers in the
1970s as it predicted the exponential change destined to shake our society, and
issued a warning: “In the three short decades between now and the twenty-
rst century, millions of ordinary, psychologically normal people will face an
abrupt collision with the future.” is future would create “the shattering stress
and disorientation that we induce in individuals by subjecting them to too
much change in too short a time.
Exponential change has now become a buzzword, but the power of an expo-
nential curve is rarely considered. Each year will entail greater change than the
year before. Such a concept diers drastically from a linear rate of change,
where the future will change just as quickly as the past did (see Figure I.1.) e
two may appear similar in the early days of change, but when the exponential
curve starts to inect it quickly, and at times violently, it distinguishes itself.
Burniske 00.indd 21 9/11/17 11:29 AM
xxii IntroduCtIon
56 7
Exponential (2x)Linear (2x)
Figure I.1 n Exponential versus linear rates of change
While year 1 exhibits the exact same value for linear and exponential change
in Figure I.1, as does year 2, by year 7 an exponential rate has progressed nearly
tenfold more than the corresponding seventh period of linear change. We oen
operate with the rough assumption that the rate of change over the next year or
two will be roughly equal to that over the prior years, which is a linear world
view. at works for the early stage of change, but not when the exponential
curve starts to bend like a hockey stick. Unfortunately, most investment portfo-
lios are being managed with a linear world view, with indices that are pegged to
the past guiding our future investments. Nothing could be more shortsighted
or potentially dangerous in a time of exponential change.
e Internet has irrevocably changed the world, and it continues to do so as
developers build on the platform of connection it creates. us far, the World
Wide Web has been the greatest meta-application to leverage the underlying
ber of the Internet. e indexed web contains at least 4.73 billion pages, near-
ing the point where there will be one page for every human.1
e beginning of the Internet is commonly associated with the 1990s,
with Tim Berners-Lee stumbling upon the idea of the World Wide Web
while trying to create an information management system for CERN, and
Marc Andreessen developing the rst widely used web browser, which ulti-
mately became Netscape. Although the accomplishments of Berners-Lee and
Andreessen were linchpins to mainstream adoption, the web and the ability
to browse it were the rst killer apps built on top of the Internet, not to be
conated with the creation of the Internet itself. We are likely still in the early
Burniske 00.indd 22 9/11/17 11:29 AM
IntroduCtIon xxiii
stages of leveraging the potential of the Internet and building meta-applica-
tions atop it.
e Internet was rst conceptualized in the early 1960s to create resilient
communication systems that would survive a nuclear attack on the United States.
According to one of the Internets progenitors, Paul Baran, the key to accom-
plishing such resilience was decentralization.2 J. C. R. Licklider proselytized the
concept of an “Intergalactic Computer Network,” convincing his colleagues at
DARPA—which is responsible for investigating and developing new technolo-
gies for the U.S. military—of its importance.3 Leonard Kleinrock, an MIT pro-
fessor, was doing work on packet switching—the technology underpinning the
Internet—that would lead to the rst book on the subject: Communication Nets.
Ironically, though they were all working on a means to connecting the world,
many of the early researchers in this period were unaware of one another.
But their dream has been realized. Every day more than 3.5 billion Google
search queries are made,4 18.7 billion text messages are sent (that doesnt even
include WhatsApp and Facebook Messenger, which combine for more than 60
billion messages per day),5 and 269 billion emails are sent.6 Interestingly, how-
ever, the Internet has become increasingly centralized over time, potentially
endangering its original conception as a “highly survivable system.
Human ingenuity oen surfaces when its most needed, and now, a new
technology is emerging that returns to the decentralized ethos of the original
Internet with the potential to revolutionize our computational and transac-
tional infrastructure: blockchain technology. Every second, millions of pack-
ets of information are transacted between humans and machines using the
Internet, and blockchain technology is forcing us to rethink the costs, security,
and ownership of these transactions.
Blockchain technology came from Bitcoin. In other words, Bitcoin is the
mother of blockchain technology. Bitcoin, with a capital B, is a platform that
carries upon it programmable money, known as bitcoin with a lowercase
b. e technological foundation to this platform is a distributed and digital
ledger referred to as a blockchain. In January 2009, when Bitcoin was rst
released, it embodied the rst working implementation of a blockchain the
world had seen.
Since then, people have downloaded the open-source soware that is
Bitcoin, studied its blockchain, and released dierent blockchains that go far
beyond Bitcoin. Blockchain technology can now be thought of as a general
purpose technology, on par with that of the steam engine, electricity, and
machine learning.
Burniske 00.indd 23 9/11/17 11:29 AM
xxiv IntroduCtIon
To quote a May 2016 article in Harvard Business Review by Don and Alex
Tapscott: “e technology most likely to change the next decade of business is
not the social web, big data, the cloud, robotics, or even articial intelligence.
It’s the blockchain, the technology behind digital currencies like bitcoin.7
Incumbents are sensing the inherent creative destruction, especially within
the nancial services sector, understanding that winners will grow new mar-
kets and feast o the disintermediated. Many startups are eyeing these middle-
men with the o-ickering thought that has been credited to Amazons Je
Bezos: “Your fat margins are my opportunity.8
If nancial incumbents dont embrace the technology themselves, Bitcoin
and blockchain technology could do to banks what cell phones did to tele-
phone poles. Nearly every global bank, exchange, custodian, and nan-
cial services provider is part of some blockchain consortium, investing in
the potential disruptors or internally building its own team. ese players
include JP Morgan, Goldman Sachs, Citibank, the New York Stock Exchange,
NASDAQ, Banco Santander, Barclays, UBS, South African Reserve Bank,
Bank of Tokyo Mitsubishi, Mizuho, China Merchants Bank, Australian Stock
Exchange, and more.
Financial incumbents are aware blockchain technology puts on the horizon
a world without cash—no need for loose bills, brick-and-mortar banks, or,
potentially, centralized monetary policies. Instead, value is handled virtually,
through a system that has no central authority gure and is governed in a
decentralized and democratic manner. Mathematics force order in the opera-
tions. Our life savings, and that of our heirs, could be entirely intangible, oat-
ing in a soup of secure 1s and 0s, the entire system accessed through comput-
ers and smartphones.
Technology providers smell the disruption as well, with Microso and IBM
most vocally leading the charge. Microso provides Blockchain as a Service
(BaaS) for developers within its Azure cloud platform. Marley Gray, its direc-
tor of technology strategy, has said, “We want, and frankly our customers want,
access to every blockchain. It could be two guys in a garage that forked bitcoin
and had this genius idea and people want to try that out. We dont want to have
any barriers. Were open to all. We help even the smallest players onboard.9
Just as the Internet and World Wide Web changed how we live our lives and
interact with others, it also made millionaires out of the innovators who began
companies based on these technologies—and the investors who invested in
them. ose with the foresight to have bought Google during its “Initial Public
Burniske 00.indd 24 9/11/17 11:29 AM
IntroduCtIon xxv
Oering” (IPO) would have seen a 1,800 percent appreciation by August 2016,
and those who bought Amazons IPO would have seen a 1,827 percent appre-
Blockchain architectures and their native assets are well on their way to
becoming the next great meta-application to leverage Internet infrastructure.
ey already provide services that include global currencies, world computers,
and decentralized social networks, among hundreds of others.
e native assets historically have been called cryptocurrencies or altcoins,
but we prefer the term cryptoassets, which is the term we will use through-
out the book. e terms cryptocurrencies and altcoins convey only a fraction of
the innovation that is occurring in the cryptoasset economy. Not all of the 800
existing cryptoassets are currencies. We are not just witnessing the decentral-
ized creation of currencies but also of commodities and polished digital goods
and services, as blockchains meld technology and the markets to build Web 3.0.
It’s early enough in the life of blockchain technology that no books yet have
focused solely on public blockchains and their native cryptoassets from the
investing perspective. We are changing that because investors need to be aware
of the opportunity and armed both to take advantage and protect themselves
in the fray.
Inevitably, innovations of such magnitude, fueled by the mania of mak-
ing money, can lead to overly optimistic investors. Investors who early on saw
potential in Internet stocks encountered the devastating dot-com bubble. Stock
in Books-A-Million saw its price soar by over 1,000 percent in one week simply
by announcing it had an updated website. Subsequently, the price crashed and
the company has since delisted and gone private. Other Internet-based high y-
ers that ended up crashing include, Worldcom, and WebVan.11 Today,
none of those stocks exist.
Whether specic cryptoassets will survive or go the way of Books-A-Million
remains to be seen. Whats clear, however, is that some will be big winners.
Altogether, between the assets native to blockchains and the companies that
stand to capitalize on this creative destruction, there needs to be a game plan
that investors use to analyze and ultimately prot from this new investment
theme of cryptoassets. e goal of this book is not to predict the future—it’s
changing too fast for all but the lucky to be right—but rather to prepare inves-
tors for a variety of futures.
Bitcoin, the most widely known cryptoasset, has been riding a roller coaster.
If one had invested $100 in bitcoin in October 2009—the rst time an exchange
Burniske 00.indd 25 9/11/17 11:29 AM
xxvi IntroduCtIon
rate was established for the nascent digital currency—one would now have
over $100 million. In November 2013, if one had invested that same $100 in
bitcoin, one would have endured an 86 percent drop by January 2015. ere
are nearly 800 other stories to tell, considering there are over 800 crypto assets
oating on globally connected and ever-on markets. At the end of 2016, a list
of the top 50 included:12
Bitcoin, Ethereum, Ripple, Litecoin, Monero, Ethereum
Classic, Dash, MaidSafeCoin, NEM, Augur, Steem, Iconomi,
Dogecoin, Factom, Waves, Stellar Lumens, DigixDAO, Zcash,
Lisk, Xenixcoin, E-Dinar Coin, Swiscoin, GameCredits, Ardor,
BitShares, LoMoCoin, Bytecoin, Emercoin, AntShares, Gulden,
Golem, Tether, ShadowCash, Xaurum, Storjcoin, Stratis,
Nxt, Peercoin, I/O Coin, Rubycoin, Bitcrystals, SingularDTV,
Counterparty, Agoras Tokens, Siacoin, YbCoin, BitcoinDark,
SysCoin, PotCoin, and Global Currency Reserve.
is book will be the rst of its kind to dive deep into a number of these.
While many have slipped under the mainstream radar, the opportunities they
present may be just as great as bitcoin.
We hope to transform today’s intelligent investor into an innovative inves-
tor by providing a guide that explains what cryptoassets are, why they should
be considered, and how to invest in them. Written by Benjamin Graham, e
Intelligent Investor is a seminal work on value investing that Warren Buet
crowned as “the best book about investing ever written.13 While we can only
hope to achieve a fraction of the success Graham had in educating investors,
our goals are very similar. We have chosen to focus on an asset class that didn’t
exist in Grahams day, and one that serves as a nice hedge against the exponen-
tial change that increasingly will disrupt existing portfolios over time.
One of the keys to Grahams book was always reminding the investor to
focus on the inherent value of an investment without getting caught in the
irrational behavior of the markets. Just as he aimed to arm the intelligent
investor with the tools to make an investment decision based on fundamental
analysis, we hope to do the same for the innovative investor who is considering
adding cryptoassets to his or her portfolio.
is is not a get-rich-quick book with the latest hot tips. Rather its a book
that grounds this new asset class in the context of its own history, common
investment strategies, the history of nancial speculation, and more. Investors
Burniske 00.indd 26 9/11/17 11:29 AM
IntroduCtIon xxvii
who follow through on their interest in cryptoassets and examine them in the
context of their overall nancial goals and portfolio strategies will become
innovative investors.
We’ve written this book for the novice and the expert. Weve divided it into
three parts: What, Why, and How. e What lays the foundation for this new
asset class, providing a concise explanation of the technology and history of
cryptoassets. e Why dives into why portfolio management matters, as well
as why we think this is a whole new asset class that oers great opportunity—
as well as great risk. e How details how to approach adding a crypto asset to
a portfolio, including a framework for investigating the merits of a new asset,
and the logistical grit of acquisition, storage, taxes, and regulation. Each chap-
ter eectively can stand alone.
e world of cryptoassets may at times feel like science ction; we imagine
that when the Internet was rst explained and discussed, people felt the same
way. For many, change sparks fear. We understand that. But it also kindles
opportunity, and we hope to prepare the reader to recognize, understand, and
act on the opportunities available in the world of cryptoassets.
Tomorrow inevitably becomes today. Exponential change isnt going away.
is book will help the innovative investor not only survive but thrive. Lets
dive in.
Burniske 00.indd 27 9/11/17 11:29 AM
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Part I
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Bitcoin and the
Financial Crisis of 2008
Chapter 1
In 2008, Bitcoin rose like a phoenix from the ashes of near Wall Street col-
lapse. In the four months of August to October 2008, an unprecedented
series of changes occurred: was registered, Lehman Brothers
led for the largest bankruptcy in American history, Bank of America bought
Merrill Lynch for $50 billion, the U.S. government established the $700 billion
Troubled Asset Relief Program (TARP), and Satoshi Nakamoto published a
paper that founded Bitcoin and the basis of blockchain technology.1
e entwinement of the nancial collapse on the one hand and the rise
of Bitcoin on the other is hard to ignore. e nancial crisis cost the global
economy trillions of dollars and burned bridges of trust between nancial
titans and the public.2 Meanwhile, Bitcoin provided a system of decentralized
trust for value transfer, relying not on the ethics of humankind but on the cold
calculation of computers and laying the foundation potentially to obviate the
need for much of Wall Street.
Referring to Satoshi as “he” is simply a matter of convenience because to this
day no one knows exactly who or even what Satoshi is. He, she, they, or it
remains totally anonymous. On a prole page Satoshi created for the P2P
Foundation—which he used to communicate with others as he spun up
Bitcoin—he wrote that he was a 37-year-old male living in Japan.3
Burniske 01.indd 3 9/9/17 1:12 PM
Yet outside of Japan, fact digging has led people to believe Satoshi resided
in the United Kingdom, North America, Central America, South America, or
even the Caribbean. People point to his impeccable written English or occa-
sionally British phrases as proof of U.K. residence,4 while others cite his post-
ing patterns as being indicative of living in geographies in Eastern or Central
time zones.5 A number of phony Satoshis have appeared, too, as the media
is all too eager to present a solution to such a juicy puzzle. An Australian,
Craig Wright, claimed to be Satoshi in May 2016 and momentarily grabbed
the attention of publications such as e Economist6 and Wired7 before being
Claims of Satoshis origin now cover ve continents, leading us back to the
possibility that maybe Satoshi isn’t even a single person but rather a group
of people. e mastery Satoshi showcased across a wide scope of topics—
including cryptography, computer science, economics, and psychology—and
the ability to communicate it all uidly seems to support the hypothesis that
Satoshi is more than one person. But who would they be? While the mystery
may never be solved, Satoshi most certainly was aware of Wall Streets growing
For nancial titans, 2008 proved a slowly unfolding nightmare. In March of
that year, the rst major Wall Street institution—Bear Stearns—acquiesced to
its demons. Aer weathering every type of market for 85 years, Bear Stearns
was nally dragged under by a slumping housing market. On March 16,
JPMorgan Chase & Co. bought it for $2 a share, about 1 percent of the value
of its $170 per share price from a year prior.9 To catalyze the deal, the Federal
Reserve agreed to facilitate the purchase of $29 billion in distressed assets
from Bear Stearns.10 Yet disturbingly, a month aer the buyout, John Mack and
Lloyd Blankfein, CEOs of Morgan Stanley and Goldman Sachs Group Inc.,
respectively, told shareholders the housing market crisis was going to be short-
lived and nearing a close.11
Much of this crisis was born of irresponsible lending, known as subprime
loans, to Americans who couldnt repay their debts. Historically, when a bank
issued a loan, the bank was on the hook for ensuring that the borrower repaid
the funds. However, in the case of many subprime loans, once these loans were
issued to borrowers, they were then packaged, or securitized, into complex
instruments known as collateralized mortgage obligations (CMOs). ese
Burniske 01.indd 4 9/9/17 1:12 PM
BiTCOin And ThE FinAnCiAl CRiSiS OF 2008 5
CMOs were then sold to other investors, eectively passing on the risk like a
hot potato through the nancial markets, with purchasers lured by the prom-
ise of high returns combined with low risk, due to purported diversication.
What people didn’t realize, including Wall Street executives, was how deep
and interrelated the risks CMOs posed were. Part of the problem was that
CMOs were complex nancial instruments supported by outdated nancial
architecture that blended analog and digital systems. e lack of seamless digi-
tal documentation made quantifying the risk and understanding exactly what
CMOs were composed of dicult, if not impossible. Furthermore, as these
CMOs were spread around the world, global investors were suddenly inter-
connected in a web of American mortgages.12 In the summer of 2008, despite
the lack of nancial transparency but emboldened by access to funds from
the Federal Reserve in case of further distress, Richard Fuld Jr., the CEO of
Lehman Brothers, eerily claimed, “We cant fail now.13
As a storm brewed around unknowing Wall Street executives, Satoshi
Nakamoto was busy eshing out the concept of Bitcoin. On August 18, 2008,, the home website for information on Bitcoin, was registered.14
Whether as an individual or an entity, whats now clear is that Satoshi was
designing a technology that if existent would have likely ameliorated the toxic
opacity of CMOs. Due to the distributed transparency and immutable audit
log of a blockchain, each loan issued and packaged into dierent CMOs could
have been documented on a single blockchain. is would have allowed any
purchaser to view a coherent record of CMO ownership and the status of each
mortgage within. Unfortunately, in 2008 multiple disparate systems—which
were expensive and therefore poorly reconciled—held the system together by
digital strings.
On the morning of Wednesday, September 10, 2008, Fuld and other senior
management faced a dierent reality from Fulds condent summer procla-
mation. Management struggled to explain to a group of critical analysts $5.3
billion worth of write-downs on “toxic assets” and a quarterly loss of $3.9 bil-
lion.15 e call ended abruptly, and analysts signed o unconvinced of the
measures Lehman was taking. e markets had already punished Lehman the
day before, dropping its stock price 45 percent, and on Wednesday it dropped
another 7 percent.16
Two days later, on Friday aernoon, the CEOs of Merrill Lynch, Morgan
Stanley, and Goldman Sachs met at the New York Federal Reserve, along with
the Federal Reserve Chairman, the U.S. Treasury Secretary, and the president
of the New York Federal Reserve. e aernoons topic was what to do about
Burniske 01.indd 5 9/9/17 1:12 PM
Lehman Brothers. It was clear the situation had become critical. Initially it
appeared either Barclays or Bank of America would come to the rescue of
Lehman Brothers, but that likelihood quickly evaporated.
On Saturday, as the same group met again at the New York Fed, John
ain, Merrill Lynchs CEO, had an unsettling thought. During the brieng on
Lehmans situation, he realized his company might only be a few steps from the
same catastrophe. “is could be me sitting here next Friday,17 he said. ain
quickly moved to nd suitors for Merrill, the most promising option being
Bank of America, which had already been in talks to buy Lehman. With talks
secretly progressing between Merrill Lynch and Bank of America, Lehman
Brothers held Barclays as its only suitor hope.
By Sunday, September 14, Barclays was ready to approve a deal to buy
Lehman Brothers. Lehman only needed the U.S. or British government to back
its trading balances for a couple of days, enough time for Barclays to conduct
a shareholder vote for nal approval. Neither government was willing to step
in, and the likelihood of a deal began to melt. With only a few hours le until
Asian markets opened for trading, the U.S. government questioned Lehman
on its only remaining option: bankruptcy.
Harvey Miller, a well-regarded bankruptcy lawyer at Weil, Gotshal &
Manges, had been working quietly since ursday night to lay the groundwork
for this worst-case bankruptcy scenario. When asked by a senior Fed ocial if
Mr. Miller felt Lehman was ready to le for bankruptcy, he responded: “is
will cause nancial Armageddon.
If Lehman led for bankruptcy, nancial rms that did business with
Lehman would also lose billions, potentially triggering a domino eect of
Later that evening, Bank of America inked a deal to buy Merrill Lynch for
$50 billion, and a couple of hours later, in the early hours of Monday morning,
Lehman Brothers led for Chapter 11 bankruptcy protection, making it the
biggest bankruptcy in U.S. history. So came to an end a 164-year-old rm born
from a dry-goods store that had evolved into the fourth largest U.S. investment
bank. It signaled the end of an era.18
Lehmans bankruptcy and Merrill’s buyout proved to be only the beginning.
On Tuesday, the Federal Reserve Bank of New York was authorized to lend up
to $85 billion to the American International Group (AIG), the biggest insurer
in America, as the behemoth organization began to teeter.19 It was mid-
September and darker clouds loomed on the horizon for Wall Street and global
nancial markets.
Burniske 01.indd 6 9/9/17 1:12 PM
BiTCOin And ThE FinAnCiAl CRiSiS OF 2008 7
Six and a half weeks later, on October 31, 2008, Satoshi released the Bitcoin
white paper, which serves as the genesis for every single blockchain imple-
mentation deployed today and forevermore. In the concluding paragraph of
his foundational paper, Satoshi wrote: “We have proposed a system for elec-
tronic transactions without relying on trust.20
By the time he released the paper, he had already coded the entire system.
In his own words, “I had to write all the code before I could convince myself
that I could solve every problem, then I wrote the paper.21 Based on historical
estimates, Satoshi likely started formalizing the Bitcoin concept sometime in
late 2006 and started coding it around May 2007. In this same time span, many
regulators began to believe that the U.S. housing market was overextended and
likely in for a rough ride.22 It’s hard to believe someone with such breadth of
knowledge as Satoshi would be working in isolation from what he was wit-
nessing in global nancial markets.
e day aer publishing his white paper, Satoshi sent an email to “e
Cryptography Mailing List” with a link to his paper.23 e list was composed
of subscribers focused on cryptography and its potential applications. Satoshi’s
email sparked a chain of responses.
On Friday, November 7, 2008, in reply to his increasingly passionate group
of followers, he wrote: “You will not nd a solution to political problems in
cryptography . . . but we can win a major battle in the arms race and gain a new
territory of freedom for several years. Governments are good at cutting o the
heads of centrally controlled networks like Napster, but pure P2P networks
like Gnutella and Tor seem to be holding their own.24 It’s clear from this quote
that Satoshi was not creating Bitcoin to slip seamlessly into the existing gov-
ernmental and nancial system, but instead to be an alternative system free of
top-down control, governed by the decentralized masses. Such decentralized
autonomy was foundational to the early days of the Internet as well, where
each node on the network was an autonomous agent that corresponded with
other agents through shared protocols.
On November 9, the Bitcoin project was registered on,
a website geared toward facilitating open-source soware development. In
response to a growing number of inquiries and interest on e Cryptography
Mailing List, Satoshi wrote on November 17: “I’ll try and hurry up and release
the source code as soon as possible to serve as a reference to help clear up all
these implementation questions.25
Burniske 01.indd 7 9/9/17 1:12 PM
en Satoshi went quiet for a couple months as Wall Street continued to
crumble. e Emergency Economic Stabilization Act of 2008 had done little
to ameliorate the meltdown that ensued aer Lehmans bankruptcy. Passed by
Congress and signed by President George W. Bush on October 3, the emer-
gency act had established the $700 billion TARP. As a result of TARP, the U.S.
government acquired preferred stock in hundreds of banks as well as massive
companies such as AIG, General Motors, and Chrysler. e stock didn’t come
for free, though. It took $550 billion in investments to stabilize those teetering
In the opening moments of Bitcoins life as a public network, Satoshi made
clear he was attuned to the failings of the global nancial system. In the rst
instance of recording information on Bitcoins blockchain, Satoshi inscribed:
e Times 03/Jan/2009 Chancellor on brink of second bailout of banks,27 in
reference to an article that appeared in the British publication e Times on
the U.K.s likely need to assist more banks in staying aoat.28 Many years later
people would realize that one of the most powerful use cases of blockchain
technology was to inscribe immutable and transparent information that could
never be wiped from the face of digital history and that was free for all to see.
Satoshis choice rst to employ this functionality by inscribing a note about
bank bailouts made it clear he was keen on never letting us forget the failings
of the 2008 nancial crisis.
Nine days aer this poignant inscription, the rst ever transaction using bit-
coin took place between Satoshi Nakamoto and Hal Finney, an early advocate
and Bitcoin developer. Nine months later the rst exchange rate would be set
for bitcoin, valuing it at eight one-hundredths of a cent per coin, or 1,309 bit-
coin to the dollar.29 A dollar invested then would be worth over $1 million by
the start of 2017, underscoring the viral growth that the innovation was poised
to enjoy.
Diving deeper into Satoshis writings around the time, it becomes more
apparent that he was xated on providing an alternative nancial system, if
not a replacement entirely. Aer the network had been up and running for
over a month, Satoshi wrote of Bitcoin, “It’s completely decentralized, with no
central server or trusted parties, because everything is based on crypto proof
instead of trust . . . I think this is the rst time were trying a decentralized,
non-trust-based system.30
Burniske 01.indd 8 9/9/17 1:12 PM
BiTCOin And ThE FinAnCiAl CRiSiS OF 2008 9
On December 5, 2010, Satoshi showed an unnervingly human side, plead-
ing that WikiLeaks not accept bitcoin as a means of payment aer major credit
card networks had blocked users from supporting the site. Satoshi wrote, “No,
dont ‘bring it on. e project needs to grow gradually so the soware can be
strengthened along the way. I make this appeal to WikiLeaks not to try to use
Bitcoin. Bitcoin is a small beta community in its infancy. You would not stand
to get more than pocket change, and the heat you would bring would likely
destroy us at this stage.31
Shortly thereaer, Satoshi vanished. Some speculate it was for the good of
Bitcoin. Aer all, being the creator of a technology that has the potential to
replace much of the current nancial system is bound eventually to invoke
the wrath of powerful government and private sector forces. By disappearing
into the ether, Satoshi removed the head of Bitcoin, and with it a single point
of failure. In his wake stands a network with thousands of access points and
millions of users.
Wall Street, on the other hand, suered from many points of failure. When
the dust settled, the U.S. government had spent well beyond the $700 billion
initially secured for TARP. In all, $2.5 trillion was injected into the system, not
to mention $12.2 trillion committed to reinstall faith in the delity of nancial
While Wall Street as we knew it was experiencing an expensive death,
Bitcoins birth cost the world nothing. It was born as an open-source technol-
ogy and quickly abandoned like a motherless babe in the world. Perhaps, if
the global nancial system had been healthier, there would have been less of
a community to support Bitcoin, which ultimately allowed it to grow into the
robust and cantankerous toddler that it currently is.
Since Satoshi disappeared, Bitcoin has unleashed a tidal wave of disruption
and rethinking of global nancial and technological systems. Countless deri-
vations of Bitcoin have been created—systems such as Ethereum, Litecoin,
Monero, and Zcash—all of which rely on blockchain technology, Satoshis gi
to the world. At the same time, many nancial and technological incumbents
have moved to embrace the technology, creating confusion around all the
innovation unfolding and what is most relevant to the innovative investor. e
next chapter will involve solidifying understanding of blockchain technology,
Bitcoin, bitcoin, cryptoassets, and where the investment opportunities await.
Burniske 01.indd 9 9/9/17 1:12 PM
Burniske 01.indd 10 9/9/17 1:12 PM
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The Basics of Bitcoin and
Blockchain Technology
Chapter 2
Its time to crystallize the dierence between Bitcoin, Bitcoins blockchain,
bitcoin with a lowercase b, blockchain technology, and other related but
distinct concepts. At rst blush, this space appears jargon heavy, deterring
many from even attempting to understand it. In reality, there are only a few for-
eign concepts, encapsulated in recently invented words, which unfortunately
keep people out. Since these words are used frequently when people talk about
dierent applications of Bitcoin or blockchain technology, the space appears
impenetrable—but it’s not. All thats required is a concerted eort to nail down
the key concepts, which then become the mental scaolding that will support
understanding of the many applications of blockchain technology.
Bitcoin with an uppercase B refers to the soware that facilitates the trans-
fer and custody of bitcoin the currency, which starts with a lowercase b.
Bitcoin equals soware.
bitcoin equals currency.
Much of this book will use Bitcoin (with a capital B) as the starting point.
Bitcoin is the genesis of the blockchain movement. It is common to compare
newly created blockchains with Bitcoins because Bitcoins blockchain is the
longest standing point of reference. erefore, understanding the basics of
Bitcoin is critical.
However, to truly understand Bitcoin, one has to move beyond think-
ing of it as some digital Ponzi scheme or shadowy system used by criminals.
Burniske 01.indd 11 9/9/17 1:12 PM
ose are stale stories that continue to tumble through the media mill. In
July 2016, researchers from the London School of Economics and Political
Science, Deutsche Bundesbank (Germany’s central bank), and the University
of Wisconsin at Madison released the paper “e Evolution of the Bitcoin
Economy.” ree reputable institutions would not waste their time, nor jeop-
ardize their reputations, on a nefarious currency with no growth potential.
In that paper, the researchers describe an extensive analysis they performed
on Bitcoins blockchain and the transactions therein. Below is a summary of
what they found:
In this paper, we gather together the minimum units of Bitcoin
identity (the individual addresses), and group them into approxi-
mations of business entities, what we call “super clusters.”
While these clusters can remain largely anonymous, we are able
to ascribe many of them to particular business categories by ana-
lyzing some of their specic transaction patterns, as observed
during the period from 2009–2015. We are then able to extract
and create a map of the network of payment relationships among
them, and analyze transaction behavior found in each business
category. We conclude by identifying three marked regimes that
have evolved as the Bitcoin economy has grown and matured:
from an early prototype stage; to a second growth stage popu-
lated in large part with “sin” enterprise (i.e., gambling, black
markets); to a third stage marked by a sharp progression away
from “sin” and toward legitimate enterprises.1
Certainly, some of the earliest adopters of Bitcoin were criminals. But the same
goes for most revolutionary technologies, as new technologies are oen useful
tools for those looking to outwit the law. Well get into the specic risks associated
with cryptoassets, including Bitcoin, in a later chapter, but it’s clear that the story
of bitcoin as a currency has evolved beyond being solely a means of payment for
illegal goods and services. Over 100 media articles have jumped at the opportu-
nity to declare bitcoin dead,2 and each time they have been proven wrong.
When one considers Bitcoin neutrally in the context of a broader theme
of technological evolution, it sits in the sweet spot of key technology trends.
For example, the world is increasingly real-time, with people connecting in
peer-to-peer manners, empowering and connecting individuals regardless of
geographic or socioeconomic birth. Bitcoin ts these thematic molds. It allows
Burniske 01.indd 12 9/9/17 1:12 PM
ThE BASiCS OF BiTCOin And BlOCkChAin TEChnOlOgY 13
a global transaction to be settled in an hour as opposed to a couple of days. It
operates in a peer-to-peer manner, the same movement that has driven Uber,
Airbnb, and LendingClub to be multibillion-dollar companies in their own
realms. Bitcoin lets anyone be their own bank, putting control in the hands of
a grassroots movement and empowering the globally unbanked.
However, Bitcoin has done something arguably more impressive than Uber,
Airbnb, and LendingClub. ose companies decentralized services that were
easily understandable and had precedent for being peer-to-peer. Everyone has
had a friend drive them to the airport, or stayed with a relative in another
country, or borrowed money from their parents. Decentralizing a currency,
without a top-down authority, requires coordinated global acceptance of a
shared means of payment and store of value.
Currency originally came about to facilitate trade, allowing society to move
past barter and the double coincidence of wants. It has evolved over time to be
more convenient, resulting in its present paper state. Inherently, that paper
has little value other than the fact that everyone else thinks it has value and
the government requires it be accepted to fulll nancial obligations. In that
sense, it is a usefully shared representation of value. e libertarians in the
room would say it’s a usefully shared illusion of value, going back to the idea the
paper itself is worth little. Bitcoin is a similarly shared representation of value,
except it has no physical manifestation and no top-down authority to protect
it. Despite these hurdles, the elegance of the mathematics that allow it to func-
tion has also allowed it to grow and store billions in value.
Part of the Bitcoin soware involves the building of Bitcoins blockchain,
which can be thought of as a digital ledger that keeps track of user balances via
debits and credits. In this sense, Bitcoins blockchain is a database that records
the ow of its native currency, bitcoin. What makes this digital ledger special?
Bitcoins blockchain is a distributed, cryptographic, and immutable data-
base that uses proof-of-work to keep the ecosystem in sync. Technobabble?
Sure. But impenetrable technobabble? No.
Distributed refers to the way in which computers access and maintain Bitcoins
blockchain. Unlike most databases that rigidly control who can access the
Burniske 01.indd 13 9/9/17 1:12 PM
information within, any computer in the world can access Bitcoins block-
chain. is feature of Bitcoins blockchain is integral to bitcoin as a global
currency. Since anyone anywhere can tap into Bitcoins blockchain to see the
record of debits and credits between dierent accounts, it creates a system of
global trust. Everything is transparent, so everyone is on a level playing eld.
Initially a scary word, cryptography is the science of secure communication.
It involves taking information and scrambling it in such a way that only the
intended recipient can understand and use that information for its intended
purpose. The process of scrambling the message is encryption, and unscram-
bling it is decryption, performed through complex mathematical techniques.
Cryptography is the battleeld on which those trying to transmit information
securely combat those attempting to decrypt or manipulate the information.
More recently, cryptography has evolved to include applications like proving
the ownership of information to a broader set of actors—such as public key
cryptography—which is a large part of how cryptography is used within Bitcoin.
Encryption techniques have been employed for centuries. Julius Caesar
used a simple method of encryption during times of war to inform his gener-
als of his plans. He would send messages using letters that were three letters
after the letter they were supposed to represent. For instance, instead of using
the letters ABC in his message, he would write them as DEF and his generals
would decrypt them to understand his intended message. Understandably,
this form of encryption did not remain secure for long.3
A more recent example that was the subject of the movie The Imitation
Game was the effort during World War II of a group of English cryptographers
to decode the messages of Nazi Germany, which were encrypted by a coding
device called the Enigma machine. Alan Turing, a luminary in machine learn-
ing and articial intelligence, was a major player on the team whose efforts to
break the Enigma code ultimately had a debilitating impact on German war
strategies and helped to end the war.
Cryptography has become a vital part of our lives. Every time we type in a
password, pay with a credit card, or use WhatsApp, we are enjoying the ben-
ets of cryptography. Without cryptography, it would be easy for bad actors to
steal sensitive information and use it against us. Cryptography makes sure the
information can only be used by those for whom it is intended.
Burniske 01.indd 14 9/9/17 1:12 PM
ThE BASiCS OF BiTCOin And BlOCkChAin TEChnOlOgY 15
Every transaction recorded in Bitcoins blockchain must be cryptographically
veried to ensure that people trying to send bitcoin actually own the bitcoin
they’re trying to send. Cryptography also applies to how groups of transac-
tions are added to Bitcoins blockchain. Transactions are not added one at a
time, but instead in “blocks” that are “chained” together, hence the term block-
chain. We will go deeper into the specics of the process in the proof-of-work
section that follows, but for now heres the takeaway: cryptography allows the
computers building Bitcoins blockchain to collaborate in an automated system
of mathematical trust. ere is no subjectivity as to whether a transaction is
conrmed in Bitcoins blockchain: it’s just math. For a deep dive on cryptogra-
phy, we highly recommend e Code Book: e Science of Secrecy from Ancient
Egypt to Quantum Cryptography by Simon Singh.
e combination of globally distributed computers that can cryptographically
verify transactions and the building of Bitcoins blockchain leads to an immu-
table database, meaning the computers building Bitcoins blockchain can only
do so in an append only fashion. Append only means that information can
only be added to Bitcoins blockchain over time but cannot be deleted—an
audit trail etched in digital granite. Once information is conrmed in Bitcoins
blockchain, it’s permanent and cannot be erased. Immutability is a rare feature
in a digital world where things can easily be erased, and it will likely become
an increasingly valuable attribute for Bitcoin over time.
While the previous three attributes are valuable, none of them is inherently new.
Proof-of-work (PoW) ties together the concepts of a distributed, cryptographic,
and immutable database, and is how the distributed computers agree on which
group of transactions will be appended to Bitcoins blockchain next. Put another
way, PoW specically deals with how transactions are grouped in blocks, and
how those blocks are chained together, to make Bitcoins blockchain.
e computers—or miners as they’re called—use PoW to compete with one
another to get the privilege to add blocks of transactions to Bitcoins block-
chain, which is how transactions are conrmed. Each time miners add a block,
Burniske 01.indd 15 9/9/17 1:12 PM
they get paid in bitcoin for doing so, which is why they choose to compete in
the rst place.
Competition for a nancial reward is also what keeps Bitcoins blockchain
secure. If any ill-motivated actors wanted to change Bitcoins blockchain, they
would need to compete with all the other miners distributed globally who have
in total invested hundreds of millions of dollars into the machinery necessary
to perform PoW. e miners compete by searching for the solution to a cryp-
tographic puzzle that will allow them to add a block of transactions to Bitcoins
e solution to this cryptographic puzzle involves combining four vari-
ables: the time, a summary of the proposed transactions, the identity of the
previous block, and a variable called the nonce.
e nonce is a random number that when combined with the other three
variables via what is called a cryptographic hash function results in an output
that ts a dicult criteria. e diculty of meeting this criteria is dened by
a parameter that is adjusted dynamically so that one miner nds a solution
to this mathematical puzzle roughly every 10 minutes. If all of this seems like
drinking water out of a re hose, that’s okay—its that way for everyone at the
outset. We’ll cover this process in greater detail in Chapter 4, and then go even
deeper in Chapter 14.
e most important part of the PoW process is that one of the four variables
is the identity of the previous block, which includes when that block was cre-
ated, its set of transactions, the identity of the block before that, and the blocks
nonce. If innovative investors keep following this logic, they will realize that
this links every single block in Bitcoins blockchain together. As a result, no
information in any past block, even if it was created years ago, can be changed
without changing all of the blocks aer it. Such a change would be rejected by
the distributed set of miners, and this property is what makes Bitcoins block-
chain and the transactions therein immutable.
Miners are economically rewarded for creating a new block with a transac-
tion that grants them newly minted bitcoin, called a coinbase transaction, as
well as fees for each transaction. e coinbase transaction is also what slowly
releases new bitcoin into the money supply, but more on that later.
To tie everything together using an analogy that will prepare us for a discus-
sion of the applications of blockchain technology in Chapter 3 (see Figure 2.1).
Burniske 01.indd 16 9/9/17 1:12 PM
ThE BASiCS OF BiTCOin And BlOCkChAin TEChnOlOgY 17
It’s helpful to think of the concepts as a stack of hardware, soware, applica-
tions, and users in relation to a personal computer.
e miners that build Bitcoins blockchain with the PoW process are the
hardware, just as a MacBook Pro provides the hardware for a personal com-
puter. at hardware runs an operating system (OS); in the case of Bitcoin,
the operating system is the open-source soware that facilitates everything
described earlier. is soware is developed by a volunteer group of developers,
just as Linux, the operating system that underlies much of the cloud, is main-
tained by a volunteer group of developers. On top of this hardware and operat-
ing system combination are applications, just as Safari is an application that
runs on an Apple operating system. e applications interface with the Bitcoin
operating system, which pushes and pulls information to and from Bitcoins
blockchain as needed. Lastly, there are the end users that interface with the
applications, and someday may have no concept of the hardware or soware
underneath because all they need to know is how to navigate the applications.
Broadly, there are two types of entities that can own the hardware support-
ing blockchains: public and private. e dierence between public and private
blockchains is similar to that between the Internet and intranets. e Internet
is a public resource. Anyone can tap into it; theres no gatekeeper. Intranets,
on the other hand, are walled gardens used by companies or consortiums to
transmit private information. Public blockchains are analogous to the Internet,
whereas private blockchains are like intranets. While both are useful today,
theres little debate that the Internet has created orders of magnitude more
value than intranets. is is despite vociferous proclamations by incumbents
Miners = Hardware
End Users
Bitcoin Software = Operating System
Figure 2.1 n Bitcoin as a stack of hardware, OS, applications, and end users
Burniske 01.indd 17 9/9/17 1:12 PM
in the 1980s and 1990s that the public Internet could never be trusted. History
is on the side of public networks, and while history doesn’t repeat, it does oen
e important distinction boils down to how the entities get access to the
network. Remember, a blockchain is created by a distributed system of com-
puters that uses cryptography and a consensus process to keep the members of
the community in sync. A blockchain is useless in isolation; one might as well
use a centralized database. e community of computers building a block-
chain can either be public or private, commonly referred to as permissionless
or permissioned.
Public systems are ones like Bitcoin, where anyone with the right hardware
and soware can connect to the network and access the information therein.
ere is no bouncer checking IDs at the door. Rather, participation in the net-
work forms an economic equilibrium in which entities will buy more hard-
ware to take part in building Bitcoins blockchain if they feel they can make
money doing so. Other examples of public blockchains include Ethereum,
Litecoin, Monero, Zcash, and so on, which will be discussed in more detail in
Chapters 4 and 5.
Private systems, on the other hand, employ a bouncer at the door. Only enti-
ties that have the proper permissions can become part of the network. ese
private systems came about aer Bitcoin did, when enterprises and businesses
realized they liked the utility of Bitcoins blockchain, but weren’t comfortable
or legally allowed to be as open with the information propagated among public
ese private blockchains have thus far been most widely embraced by the
nancial services as a means to update IT architecture that hasnt had a major
faceli since preparation for the Y2K bug. Within nancial services, these pri-
vate blockchains are largely solutions by incumbents in a ght to remain incum-
bents. While there is merit to many of these solutions, some claim the greatest
revolution has been getting large and secretive entities to work together, sharing
information and best practices, which will ultimately lower the cost of services
to the end consumer.5 We believe that over time the implementation of private
blockchains will erode the position held by centralized powerhouses because of
the tendency toward open networks. In other words, its a foot in the door for
further decentralization and the use of public blockchains.
e potential applications of private blockchains extend far beyond the
nancial services industry. Banks and other monetary intermediaries have
most quickly moved to adopt the technology because the use cases are most
Burniske 01.indd 18 9/9/17 1:12 PM
ThE BASiCS OF BiTCOin And BlOCkChAin TEChnOlOgY 19
obvious for a system that specializes in securing transactions. Beyond the
nancial services industry, others that are exploring the applications of block-
chain technology include the music industry, real estate, insurance, healthcare,
networking, polling, supply chains, charities, gun tracking, law enforcement,
governments, and more.6
roughout this book, we will focus on public blockchains and their native
assets, or what we will dene as cryptoassets, because we believe this is where
the greatest opportunity awaits the innovative investor. Sometimes, crypto-
assets have the exact same name as their parent blockchain but with dier-
ent capitalization. Other times theres a slightly dierent name for the asset.
For example, the native asset of Bitcoins blockchain is bitcoin, the native asset
of Ethereums blockchain is ether, the native asset of Litecoins blockchain is
litecoin, etc.
Many public blockchains are markedly dierent from one another. Some
members of the early Bitcoin community feel the denition of what makes
something a blockchain should be very specic, in particular, that any block-
chain must use proof-of-work as the means of consensus. We disagree with
that exclusive worldview, as there are many other interesting consensus mech-
anisms being developed, such as proof-of-stake, proof-of-existence, proof-
of-elapsed-time, and so on. Just as machine learning is not just one thing,
but composed of the Symbolists, Connectionists, Evolutionaries, Bayesians,
and Analogizers, so too can blockchain technology have many avors. In
e Master Algorithm,7 Pedro Domingos hypothesizes that all these camps
of machine learning—which at times have been bitter rivals—will one day
coalesce. e same will likely be true of blockchain technology. If these dis-
tributed databases of value are to be truly transformational, they will have to
interoperate and value one another.
Despite increased interest in blockchain technology, confusion remains as
to what it specically means due to imprecision in the use of the term. For
example, “a blockchain,” “the blockchain,” “blockchain,” and “blockchain
technology” can all refer to different things.
Typically, when people say the blockchain, they are referring to the origi-
nal, or Bitcoin’s blockchain. At the risk of redundancy but in pursuit of clarity,
we will always use “Bitcoin’s blockchain” instead of “the blockchain.”
Burniske 01.indd 19 9/9/17 1:12 PM
On the other hand, terms such as a blockchain and blockchain technology
typically refer to derivatives of the original that now may have nothing to do
with Bitcoin. Meanwhile, blockchain is normally used to refer to the concept
itself, with no particular implementation in mind. It is the most amorphous,
so our least favored of the terms.
Burniske 01.indd 20 9/9/17 1:12 PM
“Blockchain, Not Bitcoin?”
Chapter 3
In drawing a line between public and private blockchains, we have entered
contentious territory that the innovative investor should understand. e
dierence between these two types of blockchains and the groups that sup-
port them is full of tension, because the two camps have dierent goals for the
technology. At the risk of overgeneralizing, private blockchains are backed by
incumbents in their respective industries, while public blockchains are backed
by the disruptors.
To round out the context within which the innovative investor approaches
cryptoassets, its important to understand how the world evolved beyond a
single blockchain—Bitcoins blockchain—to include public and private block-
chains. Otherwise, investors may be confused when they hear someone claim
that Bitcoin is no longer relevant or that its been displaced. Neither of these
claims is true, but its nonetheless helpful to understand the motivations and
rationale behind those that say they are.
We le Bitcoin in Chapter 1 with Satoshi pleading on December 5, 2010, for
WikiLeaks not to accept bitcoin for donations to its site, because bitcoin was
still too young and vulnerable to attack. is was about two years aer the
birth of Bitcoins blockchain, during which it had lived a mostly quiet and
nerdy life. at was all about to change.
Burniske 01.indd 21 9/9/17 1:12 PM
A few months aer Satoshis plea, a soware application was released that
would make Bitcoin famous. Launched in February 2011, the Silk Road pro-
vided a rules-free decentralized marketplace for any product one could imag-
ine, and it used bitcoin as the means of payment. You name it, the Silk Road
had it. Gawker put it succinctly in a June 2011 article, “e Underground
Website Where You Can Buy Any Drug Imaginable.1 Clearly, this was one way
that Bitcoin developed its dark reputation, though its important to know that
this was not endorsed by Bitcoin and its development team. e Silk Road was
simply making use of this new digital and decentralized currency by building
an application atop its platform.
e Gawker article led to the rst Google search spike in Bitcoins life, as
shown in Figure 3.1, and would drive the price of bitcoin from about $10 to
$30 in the span of a week.2 However, the Gawker article jump paled in com-
parison to the global Google search volume in March to April 2013, which
corresponded with a nearly eightfold increase in price, from roughly $30 to
$230 in about a month. e drivers behind this bitcoin demand were more
opaque than the Gawker spike, though many point to the bailout of Cyprus
and the associated losses that citizens took on their bank account balances
as the core driver. Bitcoin received ample interest for being outside of gov-
ernment control, making its holders immune to such events. Bloomberg ran
a story on March 25, 2013, with the eye-catching title, “Bitcoin May Be the
Global Economy’s Last Safe Haven.3
While the spring of 2013 was notable, it was a preview for bitcoins grand
opening to global attention. is came six months later, in November 2013,
1 Feb 2009 1 Aug 2013
Gawker Article about
the Silk Road, Bitcoin
Rises from ~$10 to $30,
3-Fold in a Week
Bitcoin Rises from
~$30 to $230, 8-Fold
in a Month
Bitcoin Crosses $1,000
for First Time, 5-Fold
in a Month
Figure 3.1 n Google search spikes for the term “bitcoin”
Source: Annotation of Google Search screenshot
Burniske 01.indd 22 9/9/17 1:12 PM
“BlOCkChAin, nOT BiTCOin?” 23
when increased demand for bitcoin in China along with interest from the U.S.
Senate on the innovation led to a stratospheric ascent through $1,000 that
grabbed international headlines.4
Google search trends are a useful indicator of what is grabbing mainstream
attention. The innovative investor can go to and
explore the patterns of how people are searching for different topics. Google
even provides the option to explore search trends by geographical location,
giving charts of where interest is spiking, as well as showing what related top-
ics are on the rise. For example, after typing in “bitcoin,” investors can look
at Google search trends for the last year, or ve years, or a custom range, and
investigate how Nigeria differs from India. We recommend orienting with this
tool even beyond cryptoassets, as it’s a fascinating window into the global
mesh of minds.
At this point, bitcoins spike captured the attention of the Peoples Bank of
China, which promptly implemented restrictions on bitcoins use, declaring it
was “not a currency in the real meaning of the word.5 e China ruling, com-
bined with the FBIs capture of the creator of the Silk Road, Ross Ulbricht,6 and
soon thereaer the collapse of the biggest exchange at the time, Mt. Gox,7 put
many bitcoin investors on edge as to its long-term viability in the face of gov-
ernment and law enforcement crackdowns.8 Bitcoins subsequent price descent
through all of 2014, bottoming in January 2015, was volatile, prolonged, and
dispiriting for many early adopters who had been drawn to the new concept.
While bitcoins price was declining, its developers plowed forward with
improving the protocol and building applications atop it. During that time,
conversations about the underlying technology gained momentum, as early
Bitcoiners9 emphasized that Bitcoin was important not only because of the
decentralized currency aspect but also because of the architecture that sup-
ported it. is emphasis on the technology supporting Bitcoin came about just
as a slew of developers and enterprises began to investigate Bitcoin because of
the headlines that had grabbed their attention. Clearly, something was going
on, and newcomers to the technology were trying to gure out what.
e trifecta of current Bitcoiners defending and explaining the disruptive
potential of Bitcoins technology, bitcoins price descending dramatically, and
Burniske 01.indd 23 9/9/17 1:12 PM
newcomers investigating the technology led to a seismic shi in the Bitcoin
narrative. Newcomers didnt necessarily see the need for bitcoin in the ways
in which they wanted to use blockchain technology, and they felt rearmed
in their belief by the continued descent of bitcoins price through 2014. But to
Bitcoiners it had always been “bitcoin and blockchain.” e asset, bitcoin, was
what incentivized an ecosystem of players—miners, developers, companies,
and users—to secure and build upon Bitcoins blockchain, delivering means of
exchange and store of value services to the world.
Out of this examination of the technology underlying Bitcoin, two move-
ments exploded in the blockchain technology space. One was the proliferation
of new cryptoassets that supported new public blockchains, like Ethereum.
ese new public blockchains oered utility outside the realm of Bitcoin. For
example, Ethereums goal was to serve as a decentralized world computer,
whereas Bitcoin aimed to be a decentralized world currency. is diversity has
led to tension among players as some of these cryptoassets compete, but this is
nothing like the tension that exists between Bitcoin and the second movement.
e second movement that exploded on the scene questioned whether
bitcoin, or any cryptoasset, was necessary to get the value out of blockchain
technology. It is this second movement that we will investigate further in this
chapter, as its important for the innovative investor to understand why some
people will claim bitcoin and other cryptoassets aren’t needed to keep their
implementations secure and functioning: welcome to the world of private
The word blockchain was not mentioned once in Satoshi’s 2008 white paper.
It was early Bitcoin companies that popularized the word within what was
then a niche community. For example,, a popular Bitcoin
wallet service,10 was launched in August 2011. Satoshi, on the other hand,
frequently referred to the system as a “proof-of-work chain.” The closest he
came to saying blockchain was with phrases such as “blocks are chained” or
a “chain of blocks.” Since Satoshi only places “proof-of-work” directly before
“chain,” many early Bitcoiners are adamant that the term blockchain should
only be used if it is proof-of-work based. Remember that proof-of-work is a
mechanism whereby all the computers building Bitcoin’s blockchain remain
in sync on how to construct it.
Burniske 01.indd 24 9/9/17 1:12 PM
“BlOCkChAin, nOT BiTCOin?” 25
Articles like one from the Bank of England in the third quarter of 2014 argued,
e key innovation of digital currencies is the ‘distributed ledger,’ which
allows a payment system to operate in an entirely decentralized way, without
intermediaries such as banks.11 In emphasizing the technology and not the
native asset, the Bank of England le an open question whether the native
asset was needed.
At the Inside Bitcoins conference in April 2015,12 many longtime Bitcoiners
commented on how many Wall Street suits were in attendance. While Bitcoin
was still king, there were growing whispers of “blockchain not bitcoin,” which
was heresy to Bitcoiners.
e term blockchain, independent of Bitcoin, began to be used more widely
in North America in the fall of 2015 when two prominent nancial magazines
catalyzed awareness of the concept. First, Bloomberg Markets published an
article titled “Blythe Masters Tells Banks the Blockchain Changes Everything:
e banker who helped give the world credit-default swaps wants to upend
nance again—this time with the code that powers bitcoin.13 In emphasizing
the code that powers bitcoin,” this article quietly questioned the need for the
native asset, instead emphasizing the underlying technology. Masters was a
well-known and respected gure in nancial services, one that people associ-
ated with nancial innovation. Her choice to join a little-known rm at the
time called Digital Asset Holdings, aer having been the head of global com-
modities at JPMorgan Chase, was reason to believe that blockchain technology
was no longer on the fringe of the business world. In the article, a quote from
Masters brought everyone to attention: “You should be taking this technology
as seriously as you should have been taking the development of the Internet in
the early 1990s. Its analogous to email for money.
e October 31, 2015, issue of the Economist featured “e Trust Machine
on its front cover, and while the article tipped its hat to Bitcoin, its focus was
the more broadly applicable “technology behind bitcoin” and used the term
blockchain throughout.14
e combination of Masters, Bloomberg, and the Economist led to a spike
in interest in blockchain technology that set o a sustained climb in global
Google search volumes for “blockchain” that is still in an upward trend. In the
two weeks between October 18 and November 1, 2015, just aer Bloomberg
and the Economist published their articles, global Google search volumes for
“blockchain” grew 70 percent (see Figure 3.2).
Burniske 01.indd 25 9/9/17 1:12 PM
Figure 3.2 n The rise in Google Search trends for the term “blockchain”
Data sourced from Google Search Trends
Masterss focus for blockchain technology in nancial services is on private
blockchains, which are very dierent from Bitcoins blockchain. Pivotal to the
current conversation, private blockchains dont need native assets. Since access
to the network is tightly controlled—largely maintaining security through
exclusivity—the role of computers supporting the blockchain is dierent.15
Since these computers dont have to worry about attack from the outside—
they are operating behind a rewall and collaborating with known entities—it
removes the need for a native asset that incentivizes the build-out of a robust
network of miners.
A private blockchain is typically used to expedite and make existing pro-
cesses more ecient, thereby rewarding the entities that have craed the so-
ware and maintain the computers. In other words, the value creation is in the
cost savings, and the entities that own the computers enjoy these savings. e
entities dont need to get paid in a native asset as reward for their work, as is
the case with public blockchains.
On the other hand, for Bitcoin to incentivize a self-selecting group of global
volunteers, known as miners, to deploy capital into the mining machines
that validate and secure bitcoin transactions, there needs to be a native asset
that can be paid out to the miners for their work. e native asset builds out
support for the service from the bottom up in a truly decentralized manner.
Public blockchains are not so much databases as they are system architectures
Burniske 01.indd 26 9/9/17 1:12 PM
“BlOCkChAin, nOT BiTCOin?” 27
spawned from the bottom up to orchestrate the creation of globally decentral-
ized digital services. Over time, miner compensation will shi from the issu-
ance of new bitcoin to transaction fees, and if global adoption is great enough,
then transaction fees will be sucient to sustain miners.
e kernel of belief held by many avid proponents of private blockchains
is that the native assets themselves (such as bitcoin) are irrelevant; they can
be removed from the architecture and the best parts of the technology can
remain intact. For the use cases these people are pursuing, thats true. For pub-
lic blockchains, however, its not true. Enterprises that have come to explore
blockchain technology from the perspective of how they can use it to update
their current technology stacks, very much in the form of a database, most
oen fall into the private blockchain bucket. Many nancial services compa-
nies are the earliest adopters of this mindset.
Beyond questioning the need for native cryptoassets—which would natu-
rally infuriate communities that very much value their cryptoassets—tensions
also exist because public blockchain advocates believe the private blockchain
movement bastardizes the ethos of blockchain technology. For example, instead
of aiming to decentralize and democratize aspects of the existing nancial ser-
vices, Masterss Digital Asset Holdings aims to assist existing nancial services
companies in adopting this new technology, thereby helping the incumbents
ght back the rebels who seek to disrupt the status quo.
While we have our beliefs about the most exciting applications of blockchain tech-
nology, we dont ascribe to an exclusive world view. Instead, we believe Bitcoins
blockchain is one of the most important blockchains in existence, and that it has
given birth to a new general purpose technology that goes beyond Bitcoin.
General purpose technologies are pervasive, eventually aecting all con-
sumers and companies. ey improve over time in line with the deation-
ary progression of technology, and most important, they are a platform upon
which future innovations are built. Some of the more famous examples include
steam, electricity, internal combustion engines, and information technology.16
We would add blockchain technology to this list. While such a claim may
appear grand to some, that is the scale of the innovation before us.
As a general purpose technology, blockchain technology includes private
blockchains that are going to have a profound impact on many industries
and public blockchains beyond Bitcoin that are growing like gangbusters.
Burniske 01.indd 27 9/9/17 1:12 PM
e realm of public blockchains and their native assets is most relevant to the
innovative investor, as private blockchains have not yielded an entirely new
asset class that is investable to the public.
By now it will be clear to the innovative investor that the blockchain technol-
ogy space is still working itself out and will continue to do so for years to come.
Captivating technologies have a gravitational pull that brings in new minds
with varied perspectives and that will push the boundaries of the technology.
e progression of a new technology, and the way it evolves as it gains men-
tal mindshare, is at the core of Gartner’s Hype Cycle for Emerging Technologies
(Gartner is a leading technology research and advisory rm),17 which displays
ve common stages of technology.18
Innovation Trigger
Peak of Inated Expectations
Trough of Disillusionment
Slope of Enlightenment
Plateau of Productivity
First is the Innovation Trigger that brings the technology into the world. While
not very visible, just as Bitcoin wasn’t visible in the early years of its life, word
spreads and expectations grow. Over time the murmurs gain momentum,
building into a crescendo that is Gartner’s second stage, the Peak of Inated
Expectations. e peak represents the height of confusion around the deni-
tion of the original technology, because people oen apply it optimistically to
everything they see. No technology is a panacea.
As companies sprout to life and attempt to transition ideas into reality,
shiing from proof-of-concepts to at-scale implementations, it frequently
turns out that implementing a new disruptive technology in the wild is much
harder than anticipated. e new technology must integrate with many other
systems, oen requiring a wide-reaching redesign. It also requires retraining
of employees and consumers. ese diculties slowly push the technology
into the Trough of Disillusionment, as people lament that this technology will
never work or is too dicult to deal with.
When enough people have given up, but the loyal keep working in dedica-
tion, the technology begins to rise again, this time not with the irrational exu-
Burniske 01.indd 28 9/9/17 1:12 PM
“BlOCkChAin, nOT BiTCOin?” 29
berance of its early years, but instead with a sustained release of improvements
and productivity. Over time the technology matures, ultimately becoming a
steady platform in the Plateau of Productivity that provides a base on which to
build other technologies.
While its hard to predict where blockchain technology currently falls on
Gartner’s Hype Cycle (these things are always easier in retrospect), we would
posit that Bitcoin is emerging from the Trough of Disillusionment. At the same
time, blockchain technology stripped of native assets (private blockchain) is
descending from the Peak of Inated Expectations, which it reached in the
summer of 2016 just before e DAO hack occurred (which we will discuss in
detail in Chapter 5).
Cryptoassets beyond bitcoin are at dierent points between the Innovation
Trigger and the Trough of Disillusionment. ese dier because they came
to life at dierent points aer bitcoin and many are still emerging. Suce it
to say, the promise is great, the tensions are high, and opportunity awaits the
innovative investor. Let’s now take a tour of the various cryptoassets that cur-
rently exist.
Burniske 01.indd 29 9/9/17 1:12 PM
Burniske 01.indd 30 9/9/17 1:12 PM
This page intentionally left blank
The Taxonomy of Cryptoassets
Chapter 4
As we’ve seen, bitcoin ignited the cryptoasset revolution, and its success
has led to the birth of numerous other permissionless (public) block-
chains with their own native cryptoassets. We also refer to these as bit-
coins digital siblings. As of March 2017, there were over 800 cryptoassets with
a fascinating family tree, accruing to a total network value1 of over $24 billion.2
At the time, bitcoin was the largest and most widely transacted of these assets
by a wide margin, with a network value of $17 billion, accounting for nearly 70
percent of the total network value of cryptoassets. e next largest cryptoasset
by network value was Ethereums ether at over $4 billion. Yes, the numbers
have changed a lot since. Crypto moves fast.
As the investment landscape for cryptoassets continues to grow beyond
bitcoin, it’s vital for the innovative investor to understand the historical con-
text, categorization, and applicability of these digital siblings, so that potential
investment opportunities can be identied. To this end, we aim to provide
a historical grounding of who and what led to the creation of many notable
cryptoassets. rough this process, we will also introduce more detailed con-
cepts that will go into the innovative investors toolset when investigating
future cryptoassets.
Burniske 01.indd 31 9/9/17 1:12 PM
Historically, cryptoassets have most commonly been referred to as crypto-
currencies, which we think confuses new users and constrains the conver-
sation on the future of these assets. We would not classify the majority of
cryptoassets as currencies, but rather most are either digital commodities
(crypto commodities), provisioning raw digital resources, or digital tokens
(cryptotokens), provisioning nished digital goods and services.
A currency fullls three well-dened purposes: to serve as a means of
exchange, store of value, and unit of account. However, the form of currency
itself oen has little inherent value. For example, the paper bills in peoples
wallets have about as little value as the paper in their printer. Instead, they have
the illusion of value, which if shared widely enough by society and endorsed
by the government, allows these monetary bills to be used to buy goods and
services, to store value for later purchases, and to serve as a metric to price the
value of other things.
Meanwhile, commodities are wide-ranging and most commonly thought
of as raw material building blocks that serve as inputs into nished products.
For example, oil, wheat, and copper are all common commodities. However, to
assume that a commodity must be physical ignores the overarching “oine to
online” transition occurring in every sector of the economy. In an increasingly
digital world, it only makes sense that we have digital commodities, such as
compute power, storage capacity, and network bandwidth.
While compute, storage, and bandwidth are not yet widely referred to as
commodities, they are building blocks that are arguably just as important as
our physical commodities, and when provisioned via a blockchain network,
they are most clearly dened as cryptocommodities.
Beyond cryptocurrencies and cryptocommodities—and also provisioned
via blockchain networks—are “nished-product” digital goods and services
like media, social networks, games, and more, which are orchestrated by crypto-
tokens. Just as in the physical world, where currencies and commodities fuel an
economy to create nished goods and services, so too in the digital world the
infrastructures provided by cryptocurrencies and cryptocommodities are com-
ing together to support the aforementioned nished-product digital goods and
services. Cryptotokens are in the earliest stage of development, and will likely
be the last to gain traction as they require a robust cryptocurrency and crypto-
commodity infrastructure to be built before they can reliably function.
Burniske 01.indd 32 9/9/17 1:12 PM
In summation, we believe that a clearer view of this brave new world of
blockchain architecture includes cryptocurrencies, cryptocommodities, and
cryptotokens, just as we have had currencies, commodities, and nished goods
and services in the preceding centuries. Be it a currency, commodity, or ser-
vice, blockchain architectures help provision these digital resources in a dis-
tributed and market-based manner.
In this chapter, we focus on the most important cryptocurrencies today,
including bitcoin, litecoin, ripple, monero, dash, and zcash. e next chapter
covers the world of cryptocommodities and cryptotokens, the development of
which has been accelerated by the launch of Ethereum and its value proposi-
tion as a decentralized world computer. Besides its status as the number two
cryptoasset by network value, Ethereum has also spawned many other crypto-
assets that creatively utilize its network.
While we cannot possibly cover all the cryptoassets, we will focus on those
we believe will help the innovative investor gain the broadest perspective. To
those entrepreneurs and developers who’ve created assets that were unable to
cover here, we apologize. Many amazing projects were created in the process
of writing the book, and if we tried to incorporate them all the book would
never have been nished. To that end, weve included a listing in the resources
section to enable access to information on other cryptoassets.
Sometimes the word crypto makes people shudder, perhaps because they
associate it with illicit activity, but that’s a mental bias that is important to
overcome. Crypto is simply a tip of the hat to and a shortening of the key
technology underlying these systems: cryptography. As discussed in Chapter
2, cryptography is the science of securely transmitting data so that only
intended recipients can make use of it. Cryptography is used to ensure that
cryptoassets are transferred to the intended recipients securely. Given our
digital world and the increasing prevalence of hacks, the secure transmission
of resources is paramount, and cryptoassets have such security in spades.
e pursuit of a decentralized, private, and digital currency predates bitcoin
by decades. Bitcoin and its digital siblings are just part of a broader evolu-
tion of currencies that has taken place over centuries. At their inception,
Burniske 01.indd 33 9/9/17 1:12 PM
currencies were a solution to ease the impreciseness of barter trade, and for
centuries metal coins with material value served as the currencies of choice.
Fiat currency was an innovation beyond metal coins, as it was much easier to
transport, but the entirety of its value relied upon the governments stamp of
approval and mandate of legal tender. We believe that currency void of any
physical representation is the next phase of the evolution, and in our Internet-
tethered world an inevitable one.
As innovations underlying the Internet gained steam, so too did the real-
ization that we would need a secure form of digital payment. One of Bitcoins
most famous ancestors was pioneered by a company called DigiCash, led by
David Chaum, who remains one of the most famous cryptographers in crypto-
asset history. In 1993, prior to Marc Andressen founding Netscape, Chaum
invented the digital payment system called ecash. is allowed secure and
anonymous payments across the Internet, no matter the amount.3
Clearly, Chaums timing could not have been better given the tech boom
that followed through the mid- to late-1990s, and his company, DigiCash, had
several opportunities for growth, any of which might have made it a household
name. However, while Chaum was widely regarded as a technical genius, as
a businessperson he le much to be desired. Bill Gates approached Chaum
about integrating ecash into Windows 95, which would have immediately
given it global distribution, but Chaum refused what was rumored to be a
$100 million oer. Similarly, Netscape made initial inquiries about a relation-
ship, but management was quickly turned o by Chaums attitude. In 1996,
Visa wanted to invest $40 million into the company but were dissuaded when
Chaum demanded $75 million (if these reports are correct, it’s clear that the
potential price for Chaums creation was dropping).4
If all had gone well, DigiCashs ecash would have been integrated into all
our web browsers at the ground oor, serving as the global Internet payment
mechanism and potentially removing the need for credit cards in online pay-
ments. Sadly, mismanagement ultimately ran DigiCash into the ground, and
in 1998 it declared bankruptcy. While DigiCash failed to become a household
name, some players will resurface in our story, such as Nick Szabo, the father
of “smart contracts,” and Zooko Wilcox, the founder of Zcash, both of whom
worked at DigiCash for a time.5
Other attempts were made at digital currencies, payment systems, or stores
of value aer ecash, like e-gold and Karma. e former ran into trouble with
the FBI for serving a criminal element,6 while the latter never gained main-
Burniske 01.indd 34 9/9/17 1:12 PM
stream adoption.7 e pursuit of a new form of Internet money drew the atten-
tion of present day tech-titans such as Peter iel and Elon Musk, both of
whom had a hand in founding PayPal. Except for Karma, the problem with all
these attempts at digital money was that they werent purely decentralized—
one way or another they relied on a centralized entity, and that presented the
opportunity for corruption and weak points for attack.
One of the most miraculous aspects of bitcoin is how it bootstrapped support
in a decentralized manner. e importance, and diculty, of being the rst
currency to do so cannot be emphasized enough. Until people understand how
bitcoin works, they oen argue that it has no value as currency because, unlike
what they’re used to, you can’t see it, touch it, or smell it.
Paper currency has value because it is mutually agreed upon by members
of society that it has value. Its much easier for society to agree to this with
a government involved. Getting a global society to agree that something has
value and can be used as a currency without government support and without
a physical form is one of the most signicant accomplishments in monetary
When bitcoin was launched, it had zero value in the sense that it could be
used to purchase nothing. e earliest adopters and supporters subjectively
valued bitcoin because it was a fascinating computer science and game theory
experiment. As the utility of Bitcoins blockchain proved itself a reliable facili-
tator of Money-over-Internet-Protocol (MoIP),8 use cases began to be built
using bitcoin, some of which now include facilitating e-commerce, remit-
tances, and international business-to-business payments.
Concurrent with the early development of use cases, investors started to
speculate on what future use cases would look like and how much bitcoin
those use cases would require. Together, the combination of current use cases
and investors buying bitcoin based on the expectation for even greater future
use cases creates market demand for bitcoin. How much is a buyer willing to
pay for something (the bid), and how much is a seller willing to receive to part
with that item (the ask)? As with any market, where the bid and ask meet is
where the price is set.
Burniske 01.indd 35 9/9/17 1:12 PM
Mathematically Metered Supply
One of the keys to supporting bitcoins value was its issuance model. Recall
from Chapter 2 that miners—the people running the computers building
Bitcoins blockchain—are paid each time they append a block of transactions.
ey are paid in new bitcoin created by a coinbase transaction that is included
in each block.9 For the rst four years of Bitcoins life, a coinbase transaction
would issue 50 bitcoin to the lucky miner. e diculty of this proof-of-work
process was recalibrated automatically every two weeks with the goal of keep-
ing the amount of time between blocks at an average of 10 minutes.10 In other
words, 50 new bitcoin were released every 10 minutes, and the degree of dif-
culty was increased or decreased by the Bitcoin soware to keep that output
time frame intact.
In the rst year of bitcoin running, 300 bitcoin were released per hour (60
minutes, 10 minutes per block, 50 bitcoin released per block), 7,200 bitcoin
per day, and 2.6 million bitcoin per year.
Based on our evolutionary past, a key driver for humans to recognize some-
thing as valuable is its scarcity. Satoshi knew that he couldn’t issue bitcoin at a
rate of 2.6 million per year forever, because it would end up with no scarcity
value. erefore, he decided that every 210,000 blocks—which at one block
per 10 minutes takes four years—his program would cut in half the amount
of bitcoin issued in coinbase transactions.11 is event is known as a “block
reward halving” or “halving” for short.
On November 28, 2012, the rst halving of the block reward from 50 bitcoin
to 25 bitcoin happened, and the second halving from 25 bitcoin to 12.5 bitcoin
occurred on July 9, 2016. e third will happen four years from that date, in
July 2020.12us far, this has made bitcoins supply schedule look somewhat
linear, as shown in Figure 4.1.
However, when we step back and take a longer-term perspective, bitcoins
supply trajectory looks anything but linear (see Figure 4.2). In fact, by the
end of the 2020s it will approach a horizontal asymptote, with annual sup-
ply ination less than 0.5 percent. In other words, Satoshi rewarded early
adopters with the most new bitcoin to get sucient support, and in so doing
created a big enough base of monetary liquidity for the network to use. He
understood that if bitcoin was a success over time its dollar value would
increase, and therefore he could decrease the rate of issuance while still
rewarding its supporters.
Burniske 01.indd 36 9/9/17 1:12 PM
Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
Figure 4.1 n Bitcoin’s supply schedule (short-term view)
Data sourced from
Number of Bitcoin Outstanding
Figure 4.2 n Bitcoin’s supply schedule (long-term view)
Long term, the thinking is that bitcoin will become so entrenched within
the global economy that new bitcoin will not need to be issued to continue
to gain support. At that point, miners will be compensated for processing
transactions and securing the network through fees on high transaction
It’s common to hear that bitcoin supply will max out at 21 million units by
2140. is is a function of continuing to divide the units of supply released by
a factor of two every four years. As of January 1, 2017, already 76.6 percent of
bitcoins supply had been brought into existence,13 and by the time the next
Burniske 01.indd 37 9/9/17 1:12 PM
block reward halving happens in 2020, 87.5 percent of the bitcoin ever to be
minted will be in existence. A few years aer 2100, we will reach a supply of
20,999,999 bitcoin, which is eectively 21 million. It is bitcoins scarce supply
schedule that makes many think of it as digital gold.14
Within a couple years of launching, it had become clear that bitcoin was the
rst fully decentralized cryptocurrency to gain signicant adoption, but there
were some aspects with which people were not fully satised. For example,
bitcoins 10-minute block time meant that, depending on when a consumer hit
send, it could take up to 10 minutes, sometimes more, for the transaction to be
appended to Bitcoins blockchain.
Oen this delay was more of an issue for the merchant than the consumer,
as the merchants needed to know they were getting paid before they could
release a good or service. Others worried about bitcoins hash function in the
proof-of-work process, because hardware was being created that specialized
in this hash function and would lead to increased centralization of the min-
ing network. For a decentralized currency, increased centralization of the
machines that processed its transactions was concerning. Fortunately, Bitcoins
protocol is open-source soware, which meant developers could download
the entirety of its source code and tweak the aspects they felt most needed
xing. When the updated soware was ready, the developers released it in a
manner similar to how Bitcoin was originally released. e new soware oper-
ated similarly to Bitcoin, but required its own set of developers to maintain it,
miners to provide the hardware, and a separate blockchain to keep track of the
debits and credits of the new native asset.
rough this combination of open-source soware and ingenious program-
mers, many other cryptocurrencies have been brought into existence. ose
that are only slight modications of Bitcoin are oen referred to as altcoins.
Namecoin15 was the rst signicant fork away from Bitcoin. Interestingly, it
was less about creating a new currency and more about utilizing the immu-
table nature of the blockchain, a use case we’ll address more in the next
chapter. A website created with Namecoin comes with the .bit domain (as
Burniske 01.indd 38 9/9/17 1:12 PM
opposed to the .com domain) and provides security and censorship resistance
to those sites registered with it.16
Namecoin grew out of an idea on the Bitcointalk forum in 2010 that
focused on BitDNS (DNS stands for domain naming service, which handles
all web addresses).17 In 2013, a service called NameID was released that
uses the Namecoin blockchain to enable the creation of and access to web-
sites that have a Namecoin identity.
Namecoin acts as its own DNS service, and provides users with more
control and privacy. As opposed to the typical way in which websites are reg-
istered through a government controlled service such as ICANN, a Namecoin
site is registered through a service that exists on each computer on the
Namecoin network. This improves security, privacy, and speed. To gain a .bit
site, one must have namecoin to do so, thus the need for the native asset.
While a handful of altcoins were released through 2011, Litecoin was the
rst that would retain signicant value to this day. e cryptocurrency was
developed by Charlie Lee, an MIT graduate who was a soware engineer at
Google. When Lee learned of Bitcoin he quickly understood its power, leading
him to mine bitcoin before trying to create his own variants. Aer the unsuc-
cessful launch of Fairbrix in September 2011, Lee tried again with Litecoin in
Litecoin aimed to improve upon Bitcoin in two ways. For one, Litecoins
block times were 2.5 minutes, four times faster than Bitcoins, which would be
important for merchants needing faster conrmation of consumer’s payments.
Second, Litecoin used a dierent hash function in the proof-of-work pro-
cess—also known as a block hashing algorithm—which tried to make the
mining process more accessible to hobbyists. To put it into perspective, in the
early years of Bitcoin mining, people used central processing units (CPUs),
which are the core chips in personal computers, eectively forcing the com-
puters to be used solely for mining purposes. In 2010, people aer greater
eciency began using the graphic card (GPU) of an existing computer for the
mining process.
Many, including Lee, anticipated a shi to yet more dedicated and special-
ized mining devices called ASICs (application-specic integrated circuits).
ASICs required custom manufacturing and specically designed computers.
Burniske 01.indd 39 9/9/17 1:12 PM
As a result, Lee correctly foresaw that bitcoin mining would ramp beyond the
reach of hobbyist miners and their homegrown PCs.
Lee wanted a coin that retained its peer-to-peer roots and allowed users
to be miners without the need for specialized and expensive mining units.
Litecoin accomplished this by using a block hashing algorithm called scrypt,
which is memory intensive and harder for specialized chips like ASICs to gain
a signicant edge upon.
Other than these two tweaks, much of Litecoin remained similar to Bitcoin.
e innovative investor will have realized, however, that if blocks are issued
four times as fast as bitcoin, then the total amount of litecoin released will be
four times greater than that of bitcoin. is is exactly the case, as litecoin will
converge upon a xed 84 million units, whereas bitcoin will converge upon a
quarter of that, at 21 million units.19 Lee tweaked the halving characteristics,
too, so that a halving occurs at 840,000 blocks, as opposed to bitcoins 210,000.
As Figure 4.3 shows, this puts litecoin on a similar yet larger supply trajectory
than bitcoin. Notably, the annual rates of supply ination are exactly the same
for the number of years the cryptocurrency is from launch.
It’s important to realize that if bitcoin and litecoin are both being used in
similar size markets and therefore have the same size network values, a unit
of litecoin will be one-fourth as valuable as a unit of bitcoin because there are
four times as many units outstanding. is is an important lesson, because all
cryptocurrencies dier in their supply schedules, and thus the direct price of
each cryptoasset should not be compared if trying to ascertain the apprecia-
tion potential of the asset.
Number of Coins Outstanding
Years from Launch
Litecoin Bitcoin
Figure 4.3 n The comparative supply schedules of Litecoin and Bitcoin
Burniske 01.indd 40 9/9/17 1:12 PM
Litecoins network is oen used as a testing ground for Bitcoin soware
updates, given that Litecoin is nimbler than Bitcoin because it stores a fraction
of the monetary value. It has also been used as the basis for other cryptoassets.
At the start of 2017, litecoin was the fourth largest cryptoasset in terms of
network value.20
Ripple is a cryptocurrency created in 2004 by Ryan Fugger, a web developer
from Vancouver, British Columbia. Work on the project actually began before
Satoshi and Bitcoin,21 when Fugger was searching for a way to allow commu-
nities to create a system of money out of chains of trust. For example, if Alice
trusts Bob, and Bob trusts Candace, and Candace trusts Dave, then Alice can
send money to Dave (whom she doesnt know) by rst transferring value to
Bob, who transfers that same value to Candace, who takes that value and depos-
its it in Daves account. Using this concept, payments can “ripple” through the
network via these chains of trust. Fugger called this concept
While Fugger’s RipplePay did grow to 4,000 users,22 it did not catch re the
way bitcoin did. In August 2012, Fugger was approached by the notable nan-
cial innovators Chris Larsen and Jed McCaleb. Larsen had founded E-Loan—
one of the rst companies to provide access to mortgage loans online—and
Prosper, a leader in the peer-to-peer lending space.23 McCaleb was the founder
of Mt. Gox, the biggest bitcoin and cryptocurrency exchange in the world at
that time.
Fugger announced the partnership: “I believe if anyone can develop the
Ripple concept on a global scale, they can. eir system is based on a Bitcoin-
style blockchain, much as we have discussed here over the last few years as an
interesting possibility, but with a novel miner-less consensus mechanism that
allows transactions to be conrmed near instantaneously.
Interestingly, in November 2012, this statement from Fugger appeared on
Bitcoins dedicated communication channel, a Reddit-style site called bitcoin-
talk, under the heading, “Is Ripple a Bitcoin Killer or Complementer? Founder
of Mt. Gox will launch Ripple.24 is would not be the last time someone
asked if a new upstart would be a Bitcoin-killer.
Not long aer, in the spring of 2013, it was announced that Larsen and
McCalebs company that developed the Ripple protocol, then called OpenCoin,
had secured funding from prestigious venture capitalists, including Andreessen
Horowitz.25 is was a notable development—a sign of approval of the viability
Burniske 01.indd 41 9/9/17 1:12 PM
of cryptocurrency from one of the most revered venture capital rms in the
world. OpenCoin would later rebrand as Ripple Labs.
Ripples technology did several new things. It didnt have miners. Instead
it utilized a consensus algorithm that relied on trusted subnetworks to keep a
broader decentralized network of validators in sync. ats enough to confuse
any innovative investor. What’s important to recognize is that Ripples con-
sensus algorithm relied on trust of some sort, which was vastly dierent from
Bitcoins proof-of-work design that assumed anyone could be a bad actor.
Ripple also used trusted gateways as endpoints for users, and these gate-
ways could take deposits and redeem debts in all kinds of asset pairs, including
traditional at currency. is built o Fugger’s original chains of trust but on
a global multi-asset scale. Routing a transaction through Ripples network was
like sending a packet of information through the Internet, pinging amid con-
nected servers.
If users didn’t want to rely on these gateways, Ripple also had its own native
cryptocurrency, called ripples, and commonly referred to as XRP. XRP could
be used to connect two endpoints in the Ripple network that didn’t have a
connection of trust.
But this is where the Ripple team ran into contentious territory, even if the
concept was born of good intentions. Since there was no mining process, there
was no means to distribute XRP. Instead, 100 billion units of XRP were created
and initially held by Ripple Labs (at that time, OpenCoin). While there was,
and still is, intent to distribute all this XRP to seed use, as of writing the major-
ity of XRP is still under the control of Ripple Labs.
is has led to mistrust of the Ripple protocol from much of the cryptocur-
rency community. Vitalik Buterin, who would later go on to create Ethereum,
wrote in February 2013 for Bitcoin Magazine: “Because of the monetary distri-
bution, OpenCoin may well face an uphill battle convincing the community
that they can be trusted.26
Pricing services like CoinCap don’t list XRP’s total available supply as the
100 billion that Ripple lists27 but only include the ripple that has thus far been
distributed to the public, which is just north of 37 billion units.28 A word to the
wise for the innovative investor: with a new cryptocurrency, its always impor-
tant to understand how it’s being distributed and to whom (well discuss this
further in Chapter 12). If the core community feels the distribution is unfair,
that may forever plague the growth of the cryptocurrency.
Ripple has since pivoted away from being a transaction mechanism for the
common person and instead now “enables banks to send real-time interna-
Burniske 01.indd 42 9/9/17 1:12 PM
tional payments across networks.29 is focus plays to Ripples strengths, as it
aims to be a speedy payment system that rethinks correspondent banking but
still requires some trust, for which banks are well suited.
A somewhat comic cryptocurrency addition arrived on December 8, 2013
(less than two weeks aer bitcoin hit a notable high of $1,242) in the form of
dogecoin.30 Dogecoin was launched as a ri o Doge the dog, which Wired
magazine had pegged as 2013’s meme31 of the year.32 Doge was a Shiba Inu dog
whose image with captions of an internal monologue went viral.
Dogecoin was initially oated as a joke. Jackson Palmer, who worked in
the marketing department of Adobes Sydney oces and was a cryptocur-
rency enthusiast, sent the tweet: “Investing in Dogecoin, pretty sure it’s the
next big thing.33 Aer a positive reception to what was intended as a joke, he
bought the domain, Jacksons activity caught the attention of
Billy Markus, a Portland, Oregon-based developer who aspired to launch a
new cryptoasset. In Markuss own words: “e rst thing I said was, ‘is is so
funny.’ en I said, ‘I should just make this coin.34
Markus used Litecoins code to derive Dogecoin, thereby making it one
more degree of separation removed from Bitcoin. If Litecoin was a child of
Bitcoin, then Dogecoin was a grandchild of Bitcoin. A notable variation was
that Dogecoin planned to issue a much larger amount of dogecoin than bitcoin
or even litecoin. e plan was to have 100 billion dogecoin in circulation aer
1.5 years.35 at would equal nearly 5,000 times more coins than bitcoin when
it reaches its maximum supply.
Markuss team later chose to issue roughly 5 billion coins each year, and this
created a vastly dierent supply schedule from those of the deationary bitcoin
and litecoin. Dogecoin mostly gained traction amongst Internet tippers. e
supply schedule has kept the value of a single dogecoin to a fraction of a cent,
which is suited to its intended use case. As Palmer stated in an early interview:
It’s not taking itself as seriously, it’s not being used by people
worrying about whether they’ll become rich . . . It’s something to
share for thanks or kudos.36
Palmers marketing expertise was another feature that dierentiated
Dogecoin from other cryptocurrencies at the time. e Dogecoin commu-
Burniske 01.indd 43 9/9/17 1:12 PM
nity raised $50,000 via Dogecoin to send the Jamaican bobsled team to the
Olympics; raised another $55,000 via Dogecoin to sponsor a NASCAR driver
who raced with the Dogecoin logo at the Talladega Speedway; and raised
money to support clean water projects in Kenya via Doge4Water, making the
donation via a Twitter-based tip service.37
While Dogecoin may have been launched as a joke, its association with a
wildly popular Internet meme, its lighthearted origins, and its savvy focus on
slick marketing led to a quick rise, and its network value grew to $70 million
only seven weeks aer launch.38 But that did not last long. As of March 2017,
its network value had dipped to slightly above $20 million.
is bizarre merger of a cryptoasset and pop culture is not surprising con-
sidering 2013 was the year that the price of bitcoin ranged from $13 in January
to over $1,000 in early December.39 e power and enthusiasm of Dogecoins
user community shouldnt be dismissed, even if we encourage the innovative
investor to do ample due diligence on it as an investment. While Dogecoin had
its aws, it continues to exist and has taught the cryptocurrency space valuable
lessons about gathering community support in an Internet era.
Much like the anonymous Satoshi, Auroracoin’s creator also had a cti-
tious name: Baldur Friggjar Óðinsson. Baldur created Auroracoin based on
Litecoin’s code and decided to “air-drop” the cryptocurrency to Icelanders
with the intent of providing 50 percent of all auroracoin in existence to resi-
dents. The hope was that such a distribution would jump-start national use
of the cryptocurrency.
A key to Baldur’s plan was his access to the government’s national identi-
cation system, which led speculators to believe mistakenly that Auroracoin
was sponsored by the Icelandic government. In anticipation of the airdrop,
speculators bid Auroracoin’s network value over $1 billion.40
By the time the airdrop began on March 25, 2014, speculators had sobered
somewhat, and Auroracoin was hovering just over a $100 million network
value. By the end of the month, it would be below $20 million, as citizens
receiving Auroracoin moved to sell it on exchanges to turn a prot.41 Along
with the drop in price was a loss of condence and enthusiasm for the new
cryptocurrency. Few, if any, retailers were willing to accept auroracoin, and
it was soon considered a “failed experiment.”42 Some also saw it as a scam
Burniske 01.indd 44 9/9/17 1:12 PM
perpetrated by its creator. To this day, auroracoin takes the cake as the crypto-
currency with the grandest plan for widespread usage throughout one country.
It continues to exist, with a handful of Icelandic developers working to
revive the concept and the technology. In 2016, ads began to appear through-
out Iceland’s capital city of Reykjavik heralding the return of Auroracoin. As a
result, beers in Iceland were being purchased for auroracoin,43 and many other
retail establishments began to utilize the cryptocurrency. Then a scandal hit
and the prime minister was forced to resign because of his involvement with
the Panama Papers.44 This led to the growth in popularity of a political party
known as the Pirate Party, which had a favorable view on cryptocurrencies.45
Suddenly there was speculation46 that Iceland could revisit the potential for
Auroracoin and its role as a national cryptocurrency.47 As acceptance grows
and politics change, it will be interesting to watch what happens next for the
Icelandic cryptocurrency.
Auroracoin is a cautionary tale for both investors and developers. What
began as a seemingly powerful and compelling use case for a cryptoasset suf-
fered from its inability to provide value to the audience it sought to impact.
Icelanders were given a cryptocurrency with little education and means to
use it. Unsurprisingly, the value of the asset collapsed and most considered
it dead. Nevertheless, cryptocurrencies rarely die entirely, and Auroracoin
may have interesting times ahead if its developer team can gure out a way
While Litecoin, Ripple, and Dogecoin all added elements to the mix of what it
meant to be a cryptocurrency, they did not provide the privacy that many early
Bitcoin advocates yearned for. It is a common misconception, even for Bitcoin,
that it is an anonymous payment network. Bitcoin transactions are pseudony-
mous, and since every transaction can be seen by any third party, there is a
wealth of information for anyone who would like to pinpoint who the partici-
pants are. Inarguably, someone who wants to use a currency for illegal activity
is better o using cash than bitcoin. With every transaction, bitcoin leaves an
indelible digital mark in Bitcoins blockchain.
Currently, three notable cryptocurrencies put privacy and anonymity rst.
In order of launch, they are Dash, Monero, and Zcash. All three pursue this
value proposition dierently. Monero is likely the most relevant to the inno-
Burniske 01.indd 45 9/9/17 1:12 PM
vative investor, with a sustained record of operations, solid cryptography,
and a sound issuance model. While Dash has merits, it has contested origins.
Meanwhile, Zcash uses some of the most bleeding-edge cryptography in the
world, but it is one of the youngest cryptoassets in the book and suitable only
for the most experienced cryptoasset investors.
Monero and Its Predecessor, Bytecoin
Monero is a descendent of a lesser-known cryptocurrency called Bytecoin.
Bytecoin was craed quite dierently from Bitcoin, using technology known
as CryptoNote. Similar to Litecoins scrypt, CryptoNotes block hashing algo-
rithm aims to avoid the specialization and therefore centralization of the min-
ers supporting the network by requiring an order of operations that favors
general purpose chips like the CPUs found in PCs.48 Beyond a focus on more
egalitarian proof-of-work, CryptoNote provided untraceable payments,
unlinkable transactions, and blockchain analysis resistance.49 Adam Back is
considered the inspiration for Satoshis proof-of-work algorithm and is pres-
ident of Blockstream, one of the most important companies in the Bitcoin
space. In March 2014, he tweeted about CryptoNote, saying it was one of the
few ideas in the cryptocurrency space outside of Bitcoin that held a “defensible
rationale for existence.50
Some may ask why Monero stole the show from Bytecoin. Bytecoins block-
chain and the issuance of its currency, bytecoin, started on July 4, 2012, but it
did not become widely known until almost two years later when an announce-
ment for it appeared on on March 12, 2014.51 People were
intrigued but confused about why the Bytecoin team had taken two years
to make it public. Some argued that it was because the developers wanted to
make sure the technology was soundly running before drawing more atten-
tion. Others argued that something more insidious was at play, called a
premine (pronounced “pre-mine”).
Bytecoin planned to issue 184.46 billion bytecoin via the mining process,
but by the time it was made publicly known, 150 billion bytecoin were already
in existence, more than 80 percent of the total supply.52 A classic premine,
Bytecoin had quietly released a large amount of the coins in a manner that
disadvantaged the broader community. Bitcoin and the permissionless block-
chain movement was founded on principles of egalitarian transparency, so
premines are widely frowned upon. While they still occur, many are scams
that the innovative investor should be wary of. A key dierentiator between
Burniske 01.indd 46 9/9/17 1:12 PM
a scam and good intent is the communication and rationale of the developer
team behind the issuance model.
On April 8, 2014, the user named “eizh,” who would later
become a Monero developer, made the comment, “Im surprised someone
hasnt started a clone for a fairer distribution and active development.53 On
April 9, 2014, only a month aer the public announcement of Bytecoin, an
involved user known as “thankful_for_today,” made a post to
titled “Bitmonero—a new coin based on CryptoNote technology—launched,
with the intent to launch mining in nine days.54 BitMonero was quickly
renamed Monero and oen referred to as XMR.
e most dening feature of Monero is its use of ring signatures, a crypto-
graphic technology that had been evolving since 1991.55 Moneros ring signa-
tures are best explained in the context of Bitcoin. In Bitcoin, to create a trans-
action, a known individual signs o on the balance of bitcoin he or she is
trying to send. In Monero, a group of individuals signs o on a transaction
creating a ring signature, but only one in the group owns that monero. e
CryptoNote website puts it succinctly:
In the case of ring signatures, we have a group of individuals,
each with their own secret and public key. The statement proved
by ring signatures is that the signer of a given message is a mem-
ber of the group. The main distinction with the ordinary digital
signature schemes is that the signer needs a single secret key,
but a verier cannot establish the exact identity of the signer.
Therefore, if you encounter a ring signature with the public keys
of Alice, Bob and Carol, you can only claim that one of these
individuals was the signer but you will not be able to pinpoint
him or her.56
While many are suspicious of such privacy, it should be noted that it has
tremendous benets for fungibility. Fungibility refers to the fact that any unit
of currency is as valuable as another unit of equal denomination. A danger for
bitcoin, especially for balances known to have been used for illegal activity, is
that if an exchange or other service blacklists that balance, then that balance
becomes illiquid and arguably less valuable than other balances of bitcoin.
While subtle, losing fungibility could be the demise of a digital and distributed
currency, hurting the value of all units, not just the ones used for illegal activ-
ity. Fortunately, this is one problem that Monero does not have to deal with.
Burniske 01.indd 47 9/9/17 1:12 PM
Moneros supply schedule is a hybrid of Litecoin and Dogecoin. For monero,
a new block is appended to its blockchain every 2 minutes, similar to Litecoins
2.5 minutes. Like Dogecoin, however, it will have a small degree of ination for
its entire life beginning in May 2022, when 0.3 monero will be released every
minute, totaling 157,680 monero every year. At that time, there will be 18.1
million units of monero outstanding, so ination in that rst year will be only
0.87 percent.57 As we head further into the future, that ination decreases as
the base of monero outstanding increases. Interestingly, in 2040 there will be
nearly equivalent units of bitcoin and monero outstanding, and in the period
of 2019 to 2027, Moneros rate of supply ination will be lower than Bitcoins,
but in all other periods the opposite is true.58
Expectedly, Moneros ability to create privacy in transactions was a techno-
logical breakthrough that was recognized within the cryptoasset community
and the markets. By the end of 2016, Monero had the h largest network
value of any cryptocurrency and was the top performing digital currency in
2016, with a price increase over the year of 2,760 percent. is clearly demon-
strates the level of interest in privacy protecting cryptocurrency. Some of that
interest, no doubt, comes from less than savory sources.
Another cryptocurrency targeting privacy and fungibility is Dash. It launched
its blockchain a few months before Monero, on January 19, 2014. Its lead
developer, Evan Dueld, created Dash by forking the Bitcoin protocol and
implementing a coin focused on privacy and speedy settlement of transac-
tions. e Dash white paper that Dueld coauthored outlined his intent:
A crypto-currency based on Bitcoin, the work of Satoshi
Nakamoto, with various improvements such as a two-tier incen-
tivized network, known as the Masternode network. Included are
other improvements such as Darksend, for increasing fungibility
and InstantX which allows instant transaction conrmation with-
out a centralized authority.59
Dash, however, got o to a rocky start. Instead of a premine, it had what is
called an instamine, where 1.9 million coins were created in the rst 24 hours.
Considering that three years later, in January 2017, there were just north of 7
million coins, this was a signicant error that drastically beneted the com-
Burniske 01.indd 48 9/9/17 1:12 PM
puters that supported the Dash network in the rst 24 hours, notably Dueld
Dueld reasonably pleaded best intentions, arguing that, “I was working a
very challenging day job while working on Dash in the rst couple weeks. So I
was putting out res every night, keeping tabs on Dash during the day (while
getting yelled at by my boss when he caught me a couple times).60
From our perspective, if there is a major disruption or error in the launch
of a cryptocurrency that signicantly skews its distribution, then that crypto-
currency should be relaunched. In fact, Dueld easily could have relaunched
Dash, especially considering the network was only days old when the insta-
mine began to be widely talked about, but he chose not to. It wouldnt have
been unusual to relaunch, given that other cryptocurrencies have done so via
the forking of original code. e creators of Monero, for example, specically
chose not to continue building o Bytecoin because the premine distribution
had been perceived as unfair.
e most interest in a cryptocurrency in 2016 was generated by a new crypto-
asset called Zcash. e Bitcoin and blockchain community has always been
excited by new developments in anonymity and privacy, but Zcash took that
excitement to a new level, which upon issuance drove the price through the
roof. Like bitcoins, zcashs issuance model was ethical. However, when bitcoin
launched from zero units outstanding, next to no one knew about it. When
zcash launched from zero units outstanding, it seemed like the entire crypto-
universe knew about it, and everyone wanted some.
e scarcity in initial supply combined with the hype pushed the price of
zcash to astronomical levels. It quickly reached $1,000 per coin, which at the
time was even higher than the price of bitcoin. At one point on Poloniex, a
popular cryptoasset exchange, the price reached 1 zcash for 3,299 bitcoin, or
almost $2 million at the time.61 However, by the end of 2016, the hysteria had
dissipated and zcash was trading in a stable range of $45 to $50.
e Zcash team is led by Zooko Wilcox, whom we have mentioned prior as
an early employee at David Chaums DigiCash. rough his time at DigiCash
and longstanding involvement in cryptography and cryptoassets, Zooko has
become one of the most respected members in the community. A key inno-
vation of Zcash is the use of a type of zero-knowledge proof, referred to as
zk-SNARKs, which allow transactions to be sent between parties without any
Burniske 01.indd 49 9/9/17 1:12 PM
information being revealed other than the validity of the transaction. While it
is still early days for Zcash, we are of the belief that the ethics and technology
chops of Zooko and his team are top-tier, implying that good things lie in wait
for this budding cryptocurrency.
• • •
By the end of 2016, the price of bitcoin had reached a level just below $1,000
(which it broke in January 2017), and there were over 800 cryptoassets in a
market that totaled over $17 billion. At that time, the top assets in order of
network value were: Bitcoin, Ethereum, Ripple, Litecoin, Monero, Ethereum
Classic, and Dash.
e innovative investor may note from this list that Ethereum follows
Bitcoin. Its story is one that includes brilliant developers, a wider denition of
blockchain technology, and one of the largest hacks on a cryptoasset ecosys-
tem to date. In the next chapter, well look at the creation of Ethereum and the
signicant impact it has and will have on the future of cryptoassets.
Burniske 01.indd 50 9/9/17 1:12 PM
and Cryptotokens
Chapter 5
Cryptocurrencies are a powerful vertical of cryptoassets, but as we laid
out in the start of the last chapter, only one of three. e other two,
cryptocommodities and cryptotokens, are a rapidly growing segment
of this budding new asset class. First, lets look at cryptocommodities.
In some ways, cryptocommodities are more tangible in value than crypto-
currencies. For example, the largest cryptocommodity, Ethereum, is a decen-
tralized world computer upon which globally accessible and uncensored
applications can be built. It’s easy to appreciate the value of using such a com-
puter, and therefore Ethereum provides a digitally tangible resource. Paying
to use Ethereums world computer—also known as the Ethereum Virtual
Machine (EVM)—is reminiscent of when schools and libraries had shared
computers that students could use. One person could sit down and use a com-
puter for a while before moving on, and then another person would come and
use it.
e Ethereum Virtual Machine operates somewhat similarly to a shared
computer, except it is global in scale and more than one user can operate it
at a time. Just as everyone can see Bitcoin transactions from anywhere in the
world, anyone can see Ethereums programs running from anywhere in the
world. While this chapter will dive deep into Ethereum as a cryptocommodity,
there are many other budding cryptocommodities, provisioning decentralized
Burniske 01.indd 51 9/9/17 1:12 PM
resources like cloud storage, bandwidth, transcoding, proxy re-encryption,
and so on.
e founding team of Ethereum and its native asset, ether, weren’t the rst
to dream of globally distributed computer programs, or what are commonly
referred to as smart contracts. For example, Nick Szabo, who was also one
of Chaums disciples at DigiCash (Chapter 4), had been talking about smart
contracts and digital property since the early 1990s. In 1996, he published an
article in the magazine Extropy on the topic entitled “Smart Contracts.1
Smart contracts are critical to understand but have a misleading name. e
rst thing people think of when they hear smart contracts is legal documents
that think for themselves, which misses the mark by a wide margin. We believe
smart contracts are better thought of as conditional transactions because they
refer to logic written in code that has “IF this, THEN that” conditions. For
example, it can easily be programmed in a smart contract that “IF Jack misses
his ight and IF it was the airlines fault, THEN the airline pays him the cost of
the ight.” A vending machine is another commonly used example of a smart
contract: “IF the user puts in enough money and IF the user types in the right
code, THEN the user gets Doritos.” ese conditions can become much more
complex, creating conditional waterfalls depending on the process being pro-
grammed and the variables that need to be met.
While Szabo had the early vision for smart contracts, the Ethereum team
would be the rst to create a mainstream and attention-grabbing platform to
execute smart contracts in a decentralized manner. At the core of the team is
Vitalik Buterin, who many regard as Ethereums Satoshi.
Buterin was born in Russia but grew up in Canada. He had the good for-
tune of a freethinking father,2 who in February 2011 introduced 17-year-old
Buterin to Satoshis work and Bitcoin.3 Bitcoin had only been functioning for
two years at that point, and no major alternative was in existence. It would not
be until October of that year that Charlie Lee would release Litecoin.
It wasn’t long before Buterin fell down the Bitcoin rabbit hole. He quickly
became one of the rst well-known journalists pioneering the world of crypto-
assets, even cofounding Bitcoin Magazine, which remains one of the best deep
dive sites for technical analysis of blockchain architectures. While writing arti-
cles that merged sophisticated technical information with an enthusiastic and
optimistic style, he used his mathematical prowess to consider how to improve
Burniske 01.indd 52 9/9/17 1:12 PM
on the technology. He was, aer all, a Bronze medal winner at the International
Olympiad in Informatics4 at the age of 18 and could reportedly add three-digit
numbers in his head at twice the speed of the average human being.5
To that end, Buterin tinkered with a number of Bitcoin projects that would
inform his future work on Ethereum. In a blog post titled “Ethereum: Now
Going Public,” he started with a tip of the hat to Bitcoin:
I rst wrote the initial draft of the Ethereum whitepaper on a
cold day in San Francisco in November, as a culmination of
months of thought and often frustrating work into an area that
we have come to call “cryptocurrency 2.0”—in short, using the
Bitcoin blockchain for more than just money. In the months
leading up to the development of Ethereum, I had the privilege
to work closely with several projects attempting to implement
colored coins, smart property, and various types of decentralized
e projects Buterin references in the last sentence approached the transac-
tion of bitcoin using Bitcoins blockchain more abstractly. As we have already
learned, transacting bitcoin involves the transmission of information that
results in a debit or credit of a balance of bitcoin in a user’s address.
In his blog post, Buterin mentions colored coins. ese involve the marking
of an address in Bitcoin with information beyond just the balance of bitcoin in
that address. Further identiers could also be appended to the address, such
as information that represented ownership of a house. In transferring that bit-
coin in that address to another address, so too went the marker of information
about house ownership.
In this sense, by sending bitcoin, the transaction also signied the transac-
tion of property rights to a house. ere are several regulatory authorities that
need to recognize that transfer for this example to become an everyday reality,
but the point is to show how all kinds of value can be transmitted through
Bitcoins blockchain.
Counterparty is a cryptocommodity that runs atop Bitcoin, and was launched
in January 2014 with a similar intent as Ethereum. It has a xed supply of
Burniske 01.indd 53 9/9/17 1:12 PM
2.6 million units of its native asset, XCP, which were all created upon launch.
As described on Counterparty’s website, “Counterparty enables anyone to
write specic digital agreements, or programs known as Smart Contracts,
and execute them on the Bitcoin blockchain.”7 Since Bitcoin allows for small
amounts of data to be transmitted in transactions and stored on Bitcoin’s
blockchain, it becomes the system of record for Counterparty’s more exible
functionality. Since Counterparty relies upon Bitcoin, it does not have its own
mining ecosystem.
The reason Bitcoin developers haven’t added extra functionality and ex-
ibility directly into its software is that they have prioritized security over com-
plexity. The more complex transactions become, the more vectors there are
to exploit and attack these transactions, which can affect the network as a
whole. With a focus on being a decentralized global currency, Bitcoin devel-
opers have decided bitcoin transactions don’t need all the bells and whistles.
Instead, other developers can either nd ways to build atop Bitcoin’s limited
functionality, turning to Bitcoin’s blockchain as a system of record and means
of security (e.g., Counterparty), or build an entirely different blockchain
system (e.g., Ethereum).
Many were working on building this decentralized future on top of
Bitcoin, but it wasnt easy. e exibility in adding identiers to addresses
and creating dierent kinds of transactions was purposefully restricted in
Bitcoin for the sake of scalability and security. Bitcoin, aer all, was still an
experiment. A decentralized currency was enough of a holy grail for Satoshi,
and he didn’t have to swallow the whole world in one bite. But Buterin
wasnt satised with Bitcoin as it was and had wide-ranging aspirations for
improvements. He wanted a system that was more exible and that behaved
more like a computer and less like a calculator for debits and credits of bit-
coin balances.
Although he invented Ethereum in 2013, Buterin formally announced it in
January 2014 at the North American Bitcoin Conference,8 where he was sur-
rounded by eager reporters, many of whom had been his colleagues in months
past. By that time, he had already garnered the support of over 15 developers
and dozens in the community outreach team.9
In Ethereums white paper that initially described its inner workings,
Buterins team made no qualms about their aspirations:
Burniske 01.indd 54 9/9/17 1:12 PM
What is more interesting about Ethereum, however, is that the
Ethereum protocol moves far beyond just currency. Protocols
around decentralized le storage, decentralized computation
and decentralized prediction markets, among dozens of other
such concepts, have the potential to substantially increase the
efciency of the computational industry, and provide a massive
boost to other peer-to-peer protocols by adding for the rst time
an economic layer.10
Importantly, Buterin did not intend for Ethereum and its native asset, ether, to
be a minor variation on Bitcoins codebase. is distinguished Ethereum from
many of the altcoins that came before it.
By having no aliation with “coin” in its name, Ethereum was mov-
ing beyond the idea of currency into the realm of cryptocommodities. While
Bitcoin is mostly used to send monetary value between people, Ethereum
could be used to send information between programs. It would do so by
building a decentralized world computer with a Turing complete programming
language.11 Developers could write programs, or applications, that would run
on top of this decentralized world computer. Just as Apple builds the hard-
ware and operating system that allows developers to build applications on top,
Ethereum was promising to do the same in a distributed and global system.
Ether, the native unit, would come into play as follows:
Ether is a necessary element—a fuel—for operating the distrib-
uted application platform Ethereum. It is a form of payment
made by the clients of the platform to the machines executing the
requested operations. To put it another way, ether is the incen-
tive ensuring that developers write quality applications (wasteful
code costs more), and that the network remains healthy (people
are compensated for their contributed resources).12
Miners of Ethereum would be processing transactions that could transfer not
just ether but also information among programs. Just as Bitcoin miners were
compensated for supporting the network by earning bitcoin, so too would
Ethereum miners by earning ether, and the process would be supported by a
similar proof-of-work consensus mechanism.
Burniske 01.indd 55 9/9/17 1:12 PM
Buterin understood that building a system from the ground up required a sig-
nicant amount of work, and his announcement in January 2014 involved the
collaboration of a community of more than 15 developers and dozens of com-
munity members that had already bought into the idea. Satoshis announce-
ment of Bitcoin, in contrast, had involved a quiet mailing of the white paper
to a relatively unknown mailing list composed mainly of academics and hard-
core cryptographers. e ensuing development of the Bitcoin soware before
launch mostly involved just two people, Satoshi and Hal Finney.13
Buterin also knew that while Ethereum could run on ether, the people who
designed it couldnt, and Ethereum was still over a year away from being ready
for release. So he found funding through the prestigious iel Fellowship.
Billionaire Peter iel, who cofounded PayPal and was Facebooks rst outside
investor, created the iel Fellowship to reward talented individuals who leave
the traditional path of college and pursue immediate ways to make an impact
in the world. Winners might conduct scientic research, create a startup, or
nd other ways to improve society and the world. iel Fellowships care-
fully chosen visionaries receive $100,000 over the course of two years, and the
award has been considered more competitive than gaining acceptance to the
worlds best universities. In June 2014, Buterin received the iel Fellowship14
as a 20-year-old dropping out of the University of Waterloo to pursue his inter-
est in Ethereum on a full-time basis.
While Buterin may go down as one of iels greatest investments, iel
wasnt alone in recognizing the potential of Ethereum. In 2014, Buterin was
given the World Technology Award in Information Technology Soware,15
alongside inuential names such as Elon Musk in the Energy category and
Walter Isaacson in Media & Journalism.
While the iel Fellowship was an indication of what was to come for
Buterin, $100,000 wasnt enough to sustain his team. To that end, from July 23,
2014, to September 2, 2014, they staged a 42-day presale of ether, the crypto-
commodity underlying the Ethereum network.16
Ether was sold at a range of 1,337 to 2,000 ether per bitcoin, with 2,000
ether per bitcoin on oer for the rst two weeks of the presale and then declin-
ing linearly toward 1,337 ether per bitcoin in the latter half of the sale, creating
momentum by incentivizing people to buy in at the beginning. Overseeing the
legal and nancial nuances around this sale was the newly created Ethereum
Foundation headquartered in Zug, Switzerland.17
Burniske 01.indd 56 9/9/17 1:12 PM
Ethereums fund-raising eort was not only innovative and timely, it was
also record-breaking. e public invested 31,591 bitcoin, worth $18,439,086,
for a total of 60,102,216 ether—an implied rate of $0.31 per ether. At the time,
it was the largest single crowdfunding eort.18 Some thought it outrageous that
the team supporting a blockchain architecture could raise $18 million without
a functioning product, as this was clearly dierent from Bitcoins process.
Venture capital investors (VCs) oen invest in ideas and development
teams, having faith they will work their way toward success. Ethereum democ-
ratized that process beyond VCs. For perspective on the price of ether in this
crowdsale, consider that at the start of April 2017, ether was worth $50 per
unit, implying returns over 160x in under three years.19 Just over 9,000 peo-
ple bought ether during the presale, placing the average initial investment at
$2,000, which has since grown to over $320,000.20
According to the Ethereum white paper, the prots from this sale would
be “used entirely to pay salaries and bounties to developers, and invested
into various for-prot and non-prot projects in the Ethereum and crypto-
currency ecosystem.” In addition to the 60 million ether sold to the public,
roughly 6 million was created to compensate early contributors to Ethereum,
and another 6 million for long-term reserves of the Ethereum Foundation.
e extra allocation of 12 million ether for the early contributors and
Ethereum Foundation has proved problematic for Ethereum over time, as
some feel it represented double dipping. In our view, with 15 talented develop-
ers involved prior to the public sale, 6 million ether translated to just north
of $100,000 per developer at the presale rate, which is reasonable given the
market rate of such soware developers.
at said, the allocation of capital into founders’ pockets is an important
aspect of crowdsales. Called a “founder’s reward,” the key distinction between
understandable and a red ag is that the founders should be focused on build-
ing and growing the network, not fattening their pockets at the expense of
investors. In our opinion, the Ethereum developers were not fattening their
pockets, they were putting food on the table. eir modest allocation is a far
cry from the antics that some cryptoasset creators have attempted since.
Following the presale, it was a year of development before the Ethereum
network went live. During this time, the Ethereum team stayed in close touch
with its burgeoning community, releasing proof-of-concepts for the commu-
nity to evaluate, organizing conferences, funding projects based on Ethereum,
and writing frequent blog updates.21 Perhaps taking note from Dogecoin, the
Ethereum team understood the importance of the community in bootstrap-
Burniske 01.indd 57 9/9/17 1:12 PM
ping support for its decentralized system. Although blockchain architectures
are cold code, they are warm social networks.
With the money they raised, the Ethereum team was also able to test the
network before launch in a way that Satoshi and his small group of support-
ers were not able to. Starting at the end of 2014 and for the rst half of 2015,
the Ethereum Foundation encouraged battle testing of its network, both in a
grassroots bug bounty program and in formal security audits that involved
professional third-party soware security rms.22 e innovative investor
should take note of this battle-testing practice, which we also saw with Zcash,
as it is an indicator of how seriously core developers take security in their
decentralized architectures.
Ethereums network with its underlying blockchain went live on July 30, 2015.
While much development energy had gone into creating the Ethereum so-
ware, this was the rst time that miners could get involved because there was
nally a blockchain for them to support. Prior to this launch, Ethereum was
quite literally suspended in the ether. Now, Ethereums decentralization plat-
form was open for business, serving as the hardware and soware base for
decentralized applications (dApps). ese dApps can be thought of as complex
smart contracts, and could be created by developers independent of the core
Ethereum team, providing leverage to the reach of the technology.
To explain how a dApp works, we’ll use an example from the company
Etherisc, which created a dApp for ight insurance to a well-known Ethereum
conference. is ight insurance was purchased by 31 of the attendees.23
Figure 5.1 shows a simplied diagram. Using Ethereum, developers can mimic
insurance pools with strings of conditional transactions. Open sourcing this
process and running it on top of Ethereums world computer allows everyday
investors to put their capital in an insurance pool to earn returns from the
purchasers of insurance premiums that are looking for coverage from certain
events. Everyone trusts the system because it runs in the open and is auto-
mated by code.
Since the launch of Ethereum, a near endless stream of dApps have been
released to run on it, many of which have their own native unit. We refer to
Burniske 01.indd 58 9/9/17 1:12 PM
many of these dApp native units as cryptotokens, while others refer to them as
appcoins. A dApp with its own native cryptotoken will use ether as a crypto-
commodity to pay the Ethereum network to process certain dApp transac-
tions. While many dApps use a cryptotoken, the native units of some dApps
should be classied as a cryptocommodity layered on top of Ethereum, like
Golem, which aims to be a supercomputer for compute intensive problems.
e dierence boils down to whether a raw digital resource is being provi-
sioned (cryptocommodity) or if the dApp is providing a consumer-facing n-
ished digital good or service (cryptotoken).
Most cryptotokens are not supported by their own blockchain. Oen
these cryptotokens operate within applications that are built on a cryptocom-
modity’s blockchain, such as Ethereum. To continue with the Apple analogy:
applications in Apples App Store don’t have to build their own operating sys-
tems, they run on Apples operating system. Due to Ethereums wild success,
other decentralized world computers have popped up, such as Dnity, Lisk,
Rootstock, Tezos, Waves, and more that can support their own dApps. Just as
many altcoins tried to improve upon Bitcoin, these platforms are cryptocom-
modities that aim to improve upon Ethereums design, thereby attracting their
own dApps and associated cryptotokens.
A full list of Ethereum dApps can be seen and explored here: http://dapps e code of many can be investigated in full here: https://live
Fault of
Fault of
Figure 5.1 n Hypothetical dApp-based ight insurance
Burniske 01.indd 59 9/9/17 1:12 PM
60 CRYPTOASSETS We will look at the most (in)famous of the dApps thus
far, as it will inform the innovative investor on all future dApps and poten-
tial cryptotoken investments. We should note that dApp development and the
associated native units has been one of the fastest moving areas in the crypto-
asset space, as we watched new ones come out each week during the writing
of this book. us, the curious reader should take time aer this chapter to
further explore them as we are only scratching the tip of the iceberg in this
Standing for decentralized autonomous organization, e DAO was a com-
plex dApp that programmed a decentralized venture capital fund to run on
Ethereum. Holders of e DAO would be able to vote on what projects they
wanted to support, and if developers raised enough funding from e DAO
holders, they would receive the funds necessary to build their projects. Over
time, investors in these projects would be rewarded through dividends or
appreciation of the service provided.
e vision of a decentralized autonomous organization like e DAO is
somewhat like autonomous vehicles—whereas humans used to have to drive
cars, the cars increasingly can drive themselves. Similarly, whereas humans
used to be needed for all aspects of business processes, oen in manual paper
pushing, approval, orchestration, and so on, a decentralized autonomous orga-
nization can codify much of those processes so that the company better drives
itself. As exciting as the concept was, e DAO was nearly Ethereums undoing.
e creators of e DAO implemented a crowdfunding eort. eirs sur-
passed the amount raised by Ethereum by nearly an order of magnitude, set-
ting the record for the largest amount ever raised in this manner: over $168
million.24 e crowdfunding required that investments be made with ether,
and because of this, by the end of the crowdfunding period e DAO team
held 11.5 million ether, or 15 percent of all the ether created to that point.
While enthusiasm and interest in e DAO was clear, some developers were
concerned it was not ready for prime time. A paper published by a group of
computer scientists who examined the workings of e DAO expressed con-
cern that there were major security vulnerabilities that threatened its pend-
ing release on Ethereums network. “e current implementation can enable
attacks with severe consequences,” explained Dino Mark, Vlad Zamr, and
Emin Gün Sirer.25
Burniske 01.indd 60 9/9/17 1:12 PM
Subsequently, there was a call for a moratorium on activity around e
DAO until the issues were satisfactorily addressed.26 However, the call went
unheeded and on May 28, 2016, the day aer the crowdsale was completed,
tokens in e DAO (DAOs)—which were received in exchange for the ether
invested at the crowdfunding—began trading on exchanges.
Less than three weeks later, on June 17, 2016, a major hack on e DAO was
conducted that gained control of 3.6 million ether, one-third of the amount
that had been committed to the project. e hack had nothing to do with
an exchange, as had been the case with Mt. Gox and other widely publicized
Bitcoin-related hacks. Instead, the aw existed in the soware of e DAO.
is soware was hosted on Ethereums blockchain, for all eyes to see, and it
needed to be awless.27 However, as critics had pointed out, the code was far
from perfect. Given the scale of assets e DAO had raised, there was signi-
cant incentive for a hacker to break in. As a result, the worlds largest crowd-
funding eort and a major showcase for the capabilities of Ethereum became
a bust.
Buterin and those involved with e DAO and Ethereum immediately
began to address the hack. e situation was problematic, however, because
Ethereum was a decentralized world computer that provided the platform for
dApps to run on. However, it did not promise to audit and endorse each appli-
cation. Similarly, while Apple may screen the apps that go into its App Store, it
doesn’t claim responsibility for their inner workings. Core Ethereum develop-
ers were helping e DAO team. is was analogous to Apple engineers help-
ing to x a ailing app.
None of the options to correct the situation were particularly palatable.
e primary solution was to release a soware update to Ethereum that would
remove the funds from the hackers account within e DAO, returning them
to the rightful shareholders. Known as a “hard fork,” Ethereums blockchain
would be slightly modied to allow for the investors in the project to have their
funds returned. Stephen Tual, founder and COO of, the main com-
pany behind e DAO, explained the x as follows, “In summary, a hard fork
will retrieve all stolen funds from the attacker. If you have purchased DAO
tokens, you will be transferred to a smart contract where you can only retrieve
funds. Since no money in e DAO was ever spent, nothing was lost.28
However, a hard fork would run counter to what many in the Bitcoin and
Ethereum communities felt was the power of a decentralized ledger. Forcefully
removing funds from an account violated the concept of immutability. is
was exacerbated by the fact that a centralized set of players was making the
Burniske 01.indd 61 9/9/17 1:12 PM
decision. Many complained of moral hazard, and that this would set a prec-
edent for the U.S. government or other powerful entities to come in someday
and demand the same of Ethereum for their own interests. It was a tough deci-
sion for all involved, including Buterin, who while not directly on e DAO
developer team, was an administrator.
With an understanding of both sides of the debate, Buterin supported the
decision to hard fork because of his view that Ethereum was still in a devel-
opment stage and that a lesson such as this would help shape the technology
going forward. “I dont think the way things are done right now are precedent-
setting,” he said.29 In the end, Buterin and much of the Ethereum team used
their own technical skills to aggressively correct the situation that e DAO
had created.30
A hard fork doesn’t come without risks, and unfortunately, Ethereum would
pay a dear price for its decision to help e DAO. While hard forks are oen
used to upgrade a blockchain architecture, they are typically employed in situ-
ations where the community agrees entirely on the benecial updates to the
architecture. Ethereums situation was dierent, as many in the community
opposed a hard fork. Contentious hard forks are dangerous, because when
new soware updates are released for a blockchain in the form of a hard fork,
there are then two dierent operating systems. While the two operating sys-
tems share a common ancestor, and therein a common record of transactions,
once the hard fork occurs, the two operating systems split, and so too do their
blockchains, each with separate native units. While some people think, “Great,
I’ve just doubled my money,” a hard fork can oen crash the value of the native
units on the two separate blockchains, as people worry about an ongoing
schism within a divided community (see Figure 5.2). With two separate block-
chains, miners, developers, and companies building applications, users must
decide which blockchain and its inherent operating system to support. While
many initially claimed the hard fork a success for Ethereum, a few big traders
started to buy up as much of the native asset on the lesser supported chain as
On July 23, 2016, cryptoasset exchange Poloniex listed this newly branded
network, called Ethereum Classic, with its own native ether classic (ETC).31
Once a widely used exchange like Poloniex listed ETC, an open market was
created for the asset, and people quickly started to speculate on its value. is
drew more miners to support Ethereum Classics blockchain, which continues
to exist to this day and as of writing tends to stick near 5 percent the network
value of Ethereum.32
Burniske 01.indd 62 9/9/17 1:12 PM
Ethereum Classic
Last block
before hard
Figure 5.2 n The forking of Ethereum as a result of The DAO’s bug
e site for Ethereum Classic denes the cryptoasset as “a continuation of
the original Ethereum blockchain—the classic version preserving untampered
history; free from external interference and subjective tampering of transac-
tions.” 33
While e DAO may have been a disaster, the concept of a decentralized
autonomous organization is generalizable past this single instance. e inno-
vative investor should expect to see similar concepts coming to market over
the years with their own cryptotokens and should know that not all DAOs or
dApps with cryptotokens are similarly shaky.
For example, a fully functional decentralized insurance company, Airbnb,
or Uber all hold great promise, and developer teams are working on similar
use cases. One can think of an Airbnb or Uber as a middleman, connecting the
consumer and provider of a service, and then taking a 20 to 30 percent fee for
doing so. While many merchants understandably complain about credit card
fees of 2 to 3 percent, the “platform fees” of Airbnb, Uber, and similar platform
services are borderline egregious. Many of the cryptotoken systems that are
imitating such platforms plan to take a fee that is an order of magnitude less,
using underlying blockchain architectures to facilitate the decentralized trans-
fer of value and services. Many of these systems have their own cryptotokens
and will run on Ethereum or a similar platform. However, some will be much
better constructed than others, and it is unlikely that Ethereum, or platforms
like it, will help dApps in future debacles.
Burniske 01.indd 63 9/9/17 1:12 PM
One of the more interesting dApps in development uses Ethereums blockchain
to facilitate prediction markets. e company Augur seeks to provide a plat-
form that allows users to wager on the results of any event, creating a market
for people to test their predictions.34 Hence the term “prediction market.” For
instance, if someone had sought to predict whether Donald Trump or Hillary
Clinton would win the 2016 U.S. presidential election, he or she could have used
Augur to create a prediction market and wager against others on the outcome (if
the service had been up and running at the time).
Augur uses a cryptotoken, which it calls Reputation (REP), to incentivize
people to report on the outcomes of events truthfully. ese reporters are dif-
ferent from the people wagering on the outcome of events. e problem with a
decentralized prediction market is that theres no centralized authority on the
outcome of events. Augur uses REP to reward people who report truthfully
and penalize those who lie. Augur explains it as follows:
Those who hold Reputation are expected to report accurately on
the outcome of randomly selected events within Augur every few
weeks. If holders fail to report accurately on the outcome of an
event, or attempt to be dishonest—the Augur system redistrib-
utes the bad reporter’s Reputation to those who have reported
accurately during the same reporting cycle.35
Augur conducted its own crowdfunding eort in 2015, selling 80 percent of
a xed supply of 11 million REP. In so doing, it raised over $5 million to fund
the creation of the platform. Brian Armstrong, CEO of Coinbase, which is one
of the largest companies in the cryptoasset sector, has called it an “awesome
project with huge potential.36 Even Vitalik Buterin acknowledged its potential
when he called it an “Uber for knowledge.37
Augur is one of the clearest uses of cryptotokens, and its potential suc-
cess could set the stage for even more implementations of crypotokens in the
future. A similar prediction market system, Gnosis, held a crowdsale in April
2017 raising money at an implied valuation north of $300 million.
While Ethereum has a robust community building on it, several similar
platforms have taken note of its success. e aforementioned Dnity, Lisk,
Burniske 01.indd 64 9/9/17 1:12 PM
Rootstock, Tezos, and Waves as of writing all are at dierent stages of develop-
ment, between pre-crowdsale to already operating in the wild, and oer their
own variations of a decentralized world computer.
Rootstock, similar to Counterparty, intends to run on Bitcoin. Rootstock is
led by Sergio Lerner, who specialized in IT security for much of his life, and
when he rst came to Bitcoin audited many aspects of the code. He now leads
a team that is basically building Ethereum on Bitcoin, and the system will be
compatible with all dApps that run on Ethereum. Just as Ethereum has ether,
Rootstock will have its own native currency called RSK.
While some posit that Rootstock will be a signicant competitor to
Ethereum,38 we think the two will coexist and provide healthy redundancy.
Having two or more widely recognized decentralized world computers to run
on will make dApps more resilient to disruptions. If one network is experienc-
ing severe trouble, then a dApp can replicate its state on another similar plat-
form, and from then on process all transactions through that platform. While
the transition would likely induce harrowing market volatility, such optional-
ity means that dApps are not beholden to the platforms they build upon.
Lastly, at the risk of confusing the innovative investor, we should add that
a dApp may use many cryptocommodities simultaneously, but for dierent
infrastructural purposes. For example, a dApp may use a decentralized cloud
storage system like Filecoin to store large amounts of data, and another crypto-
commodity for anonymized bandwidth, in addition to using Ethereum to pro-
cess certain operations.
For such bleeding-edge platforms, it is most important for the innovative
investor to keep track of developer mindshare and miner support. Both are
vital to the long-term growth and survival of these platforms. Developers
will quickly iterate and x bugs, while miners will provide the hardware and
resources necessary to computationally secure the platform. Since these are
decentralized systems operating in the wild, they need to move fast and be
properly secured. Only then will other developers build dApps on them.
Now that the innovative investor has an understanding of what these assets
are, we want to move into why that investor should consider placing them in
his or her investment portfolio. Although cryptoassets are creating a rapidly
evolving and somewhat complex future, investment tenets that have stood the
test of time still apply. Returning to the fundamentals of investment theory
will allow innovative investors to properly position their overarching portfolio
to take advantage of the growth of cryptoassets responsibly.
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Part II
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The Importance of Portfolio
Management and Alternative Assets
Chapter 6
(Jack) was a columnist at in August 2013, when I made
the logical leap to add bitcoin to my portfolio. While initially born of curi-
osity, my interest in bitcoin had grown more mature and serious with each
passing month. As a writer focused on retirement, I decided that I could only
recommend the asset to others if I had the courage to put it in my own retire-
ment portfolio.
Not only did I decide to invest in bitcoin, I decided to place the entirety
of that year’s allocation for my Simplied Employee Pension (SEP) plan into
bitcoin. When I announced what I had done in my article “Do Bitcoins Belong
in your Retirement Portfolio?,1 it created a stir online and in the nancial
planning community. My writing over the years had consistently discussed the
need to remain prudent when making investment decisions, rationally build-
ing portfolios that balanced risks and returns.
A balanced approach to investing grew from my experience as a nancial
consultant. I come from a background of not only working within companies
in the nancial community, but also from nearly a decade of working directly
with regular investors who are trying to accomplish their nancial goals and
objectives. I have sat around hundreds of kitchen tables with my clients and
near-clients, explaining my belief that their personal dreams of retirement or
sending their children to college could be accomplished by following a disci-
pline of saving and proper asset allocation. I believe in the power of building
a prudent portfolio based upon the needs and risks of each individual client.
Burniske 02.indd 69 9/9/17 1:46 PM
To some, my decision to invest in bitcoin ew in the face of my own advice.
I may have managed portfolios in a prudent manner for myself and others,
but my interest in new technologies in the past made me no stranger to criti-
cism. During the dot-com days, I made (and lost) a sizeable amount of money
investing in companies that ew high in terms of valuation only to crash on
the shores of reality as they were little more than business facades. Was I chas-
ing a similar crash-and-burn scenario with bitcoin? Even my technologically
and investment savvy son, Eric, initially criticized me about bitcoin. “ey
have these things called dollar bills, Dad. Stick to using those.2
However, I saw real potential in the virtual currency. Over the months I
spent evaluating it, I analyzed bitcoin the same way I analyzed every other
asset I added to my own or a clients portfolio, just as I had done over the last
30 years. I carefully considered and quantied bitcoins market behavior (using
the tools that follow), so I knew what beast I was dealing with. I ruminated on
the percentage of my portfolio I could responsibly allocate to it, with the over-
arching goal of sensible asset allocation among stocks, bonds, and alternative
assets. en, I investigated the mechanics of putting bitcoin into a retirement
account. e overall process of analyzing an asset was the same; Id done it
countless times before. e only dierence this time was that it was bitcoin.
When evaluating any investment decision, the starting point is always an
individuals nancial goals, time horizon, and risk tolerance. Goals are what
the funds will be used for, and the time horizon reveals when they will be
used. Risk tolerance takes a bit more analysis. Each investor has a unique
tolerance for the ongoing gyrations of the value of his or her portfolio. For
example, do people lose sleep when their portfolio uctuates, or do they
slumber through ups and downs, dreaming of long-term gains? Once goals,
time horizon, and risk tolerance are determined, one can proceed to develop-
ing an investment portfolio that maximizes returns while staying within the
bounds of these parameters.
Nobel Prize winner Harry Max Markowitz dened an approach to con-
structing portfolios in 1952 that has been the model that most advisors and
investors have followed since. His Nobel Prize winning eort created modern
portfolio theory (MPT), which provides for the construction of investment
portfolios that maximize expected returns based upon a targeted level of risk.
Burniske 02.indd 70 9/9/17 1:46 PM
His eorts showed that higher returns are achieved by taking on higher risk,
while also recognizing what he called an ecient frontier, which denes the
maximum possible expected return for a given level of risk.
e key for any investor employing MPT is to explicitly consider risk.
While risk is not a palatable thought for retail investors—many of whom pre-
fer to dream of risk-free million-dollar returns—there can be no reward with-
out risk. e Securities and Exchange Commission, which regulates securities
markets in the United States, has this advice about risk for investors:
When it comes to investing, risk and reward are inextricably
entwined. You’ve probably heard the phrase “no pain, no gain.”
Those words come close to summing up the relationship between
risk and reward. Don’t let anyone tell you otherwise. All invest-
ments involve some degree of risk. If you intend to purchase
securities—such as stocks, bonds, or mutual funds—it’s impor-
tant that you understand before you invest that you could lose
some or all of your money. The reward for taking on risk is the
potential for a greater investment return.3
Well tackle the specics of quantifying risk shortly, mainly through a dis-
cussion of volatility. Similarly, we will dive into how to approach absolute
returns and the returns per unit of volatility, or risk-reward ratio.
While its vital to understand the individual attributes of each asset in a
portfolio, MPT goes beyond single assets to emphasize a holistic approach to
the risks and returns of the overall portfolio. e same can be said of how a
coach approaches any team. Understanding the strengths and weaknesses of
each team member is important, but it’s more important to understand how
the team members play together. Great teams can be composed of average
players, while a disjointed combination of great players can make average
Markowitzs ecient frontier, which maximizes returns for a given level of
risk, is reached by smartly combining assets in a portfolio. A savvy combina-
tion of assets can actually decrease the risk of the portfolio to a lower level
than any single asset in the portfolio (other than risk-free issues), which is one
of the areas in which cryptoassets become particularly noteworthy. We will
return to how an investor can cra such a portfolio aer we outline the three
core characteristics of individual assets.
Burniske 02.indd 71 9/9/17 1:46 PM
Standard Deviation
Standard deviation of returns, or the range that an assets price will vary from its
mean value, is one of the most common measures of risk. While Markowitzs
approach makes clear the need for risk in a portfolio, most investors are risk-
averse to one degree or another, and so they must be compelled by the poten-
tial for increased reward if they are to increase their risk. To help with the anxi-
ety of risk, MPT denes it quantitatively, removing much of the uncertainty.
Typically, simply being well informed lets investors sleep better at night.
e standard deviation of returns draws from the statistics of normal bell
curves. If the average value, or mean, of a bell curve is 10 and its standard
deviation is 5, then 68 percent of the time a randomly chosen entity from
the sample will fall between 5 and 15. Five is one standard deviation to the
le of 10, and 15 is one standard deviation to the right of 10. Due to the way
normal curves work, 95 percent of the time a random sample will fall within 2
standard deviations of the mean, so between 0 and 20 for our example. is is
illustrated in Figure 6.1.
99.7% of the Data Are Within
3 Standard Deviations of the Mean
μ – 3σμ – 2σμσμ + σμ + 2σμ + 3σ
95% Within
2 Standard Deviations
68% Within
1 Standard Deviation
Figure 6.1 n A standard deviation bell curve
Burniske 02.indd 72 9/9/17 1:46 PM
For example, take a stock that has an expected return (mean) of 7 percent and
a 5 percent standard deviation of expected returns. ere is a 68 percent prob-
ability that this stock will yield returns between 2 and 12 percent in the upcom-
ing year. With a less aggressive asset, say a bond that has an expected return of
4 percent and standard deviation of 1 percent, then 68 percent of the time it can
be expected to yield between 3 and 5 percent in the coming year. ere is less
potential for both upside and downside with the bond, whereas the stock has
much more potential for some great years, but also the potential risk of seriously
dreary years. Hence, the standard deviation of expected returns informs inves-
tors of the amount of risk they’re taking if they were to hold only that asset.
For a more holistic view, compare a portfolio with a standard deviation of
returns of 4 percent to one that has a standard deviation of 8 percent. If both
portfolios have the same expected return of 7 percent, it wouldnt be a prudent
decision to invest in the portfolio with more volatility, as they both have the
same expected return. Taking on a higher level of risk has no benet in this
light, and if a portfolio is unwisely constructed, investors can end up taking on
more risk than they’re compensated for.
Sharpe Ratio
Similar to the concepts behind MPT, the Sharpe ratio was also created by a
Nobel Prize winner, William F. Sharpe. e Sharpe ratio diers from the stan-
dard deviation of returns in that it calibrates returns per the unit of risk taken.
e ratio divides the average expected return of an asset (minus the risk-free
rate) by its standard deviation of returns. For example, if the expected return
is 8 percent, and the standard deviation of returns is 5 percent, then its Sharpe
ratio is 1.6. e higher the Sharpe ratio, the better an asset is compensating an
investor for the associated risk. An asset with a negative Sharpe ratio is punish-
ing the investor with negative returns and volatility.
Importantly, absolute returns are only half the story for the Sharpe ratio.
An asset with lower absolute returns can have a higher Sharpe ratio than a
high-ying asset that experiences extreme volatility. For example, consider an
equity asset that has an expected return of 12 percent with a volatility of 10
percent, versus a bond with an expected return of 5 percent but volatility of 3
percent. e former has a Sharpe ratio of 1.2 while the latter of 1.67 (assum-
ing a risk-free rate of 0 percent). e ratio provides a mathematical method to
compare how dierent assets compensate the investor for the risk taken, mak-
ing bonds and equities, or apples and oranges, more comparable.
Burniske 02.indd 73 9/9/17 1:46 PM
Correlation of Returns and the Efcient Frontier
One of the key breakthroughs of modern portfolio theory was to show that a
riskier asset can be added to a portfolio, and if its behavior diers signicantly
from the preexisting assets in that portfolio, it can actually decrease the overall
risk of the portfolio. How can a risky asset make a portfolio less risky? e key
is correlation of returns.
Correlation simply measures how assets move in relation to one another.
e measurement ranges from a value of +1 to −1. If assets are perfectly
positively correlated, then they move in tandem: if one is up 10 percent, the
other is up 10 percent as well, for a score of +1. Similarly, if they are perfectly
negatively correlated at −1, then when one is up 10 percent the other will be
down 10 percent. If there is zero correlation, then the assets are completely
independent, and how one asset is behaving in the market has no bearing on
the other.
Stocks and bonds are oen the major tools advisors and investors use to
reduce risk as they try to build portfolios made up of assets with low correla-
tions. Historically, stocks and bonds have moved dierently from each other.
When the economy is strong and stocks are generally rising, money ows out
of bonds as investors fear they’re missing out, causing bond prices to slump
and stocks to go higher. Investors are alive and well, with risk-on attitudes.
When stock prices falter, investors become concerned by the potential losses,
and money ows from stocks into the relative safety of bonds, known as a
ight to safety. Such risk-o markets depress the price of stocks and oat the
price of bonds.
e two assets move in dierent directions based on the same news. ey
act almost like two people on a seesaw. is historical balancing of risk between
stocks and bonds should be done as precisely as possible, otherwise wild mar-
ket swings one way or the other will have a painful impact on the innovative
investor’s portfolio.
Combining assets that have a variety of correlations makes it possible to
create a portfolio that can perform in both bull and bear markets. Just because
a few players are feeling sick doesnt mean the whole team has to fail. One of
the crown jewels of Markowitz’s MPT was his concept of the ecient frontier,
which indicates where a portfolio can provide the best expectation of return
for its level of risk (see Figure 6.2). e use of this concept is valuable for build-
ing portfolios because it helps to visualize how some groups of assets won’t
provide enough return for the risk taken.
Burniske 02.indd 74 9/9/17 1:46 PM
Possible CAL
Expected Return
Standard Deviation
Figure 6.2 n The efcient frontier of modern portfolio theory
Within the nancial services industry, people talk about risk in two ways:
systematic and unsystematic. Systematic risk is the risk inherent to investing
in assets subject to the eects of macroeconomic events—like global gross
domestic product (GDP) growth, trade relations, warfare, and so on. It is also
known as undiversiable risk because all assets are aected by it. Unsystematic
risk, on the other hand, is the risk specic to each individual investment, such
as market sector, management, product expansion, geographic exposure,
and so on. It is also known as rm-specic risk and can be neutralized with a
smartly constructed portfolio.
Unsystematic risk can be mitigated by constructing a portfolio of assets that
neutralizes dierent rm-specic risks that could impact a portfolio. Ideally,
the portfolio is craed so that when one investment is negatively hurt by a
specic event, another asset potentially could benet by that very same event.
For example, if a carbon tax is put on industry in the United States, then com-
panies that are purely involved in oil and coal procurement may be adversely
hit, while solar companies may jump. is carbon tax is not a systematic risk
if it doesnt aect the market as a whole. Instead, it is an unsystematic risk that
inuences specic companies within the markets. In this case, the stocks of the
oil company and the solar company would be examples of assets that experi-
ence negative correlation of returns to this event.
Burniske 02.indd 75 9/9/17 1:46 PM
What holds true for specic assets within the same asset class also holds
true between the asset classes themselves. If unsystematic risk is fully neutral-
ized by constructing a portfolio of assets and asset classes that have low to
negative correlation of returns, then that portfolio will be exposed only to sys-
tematic risk. Modern portfolio theory takes it a step further by saying over the
long term, investors are rewarded only for the systematic risk they take on and
will be adversely aected over the long run if they leave themselves exposed to
unsystematic risk.
With the tools of MPT its possible to construct a portfolio that stays within
an investors risk prole while still generating returns sucient to meet long-
term nancial goals and objectives. e innovative investor recognizes that
the overall risk of his or her portfolio can be reduced by including assets that
are uncorrelated to the traditional capital markets, such as bitcoin and its
digital siblings.
For many years, traditional asset allocation models strictly focused on den-
ing percentages of a portfolio in either stocks or bonds. For instance, the
American Association of Individual Investors provides simplied models for
three types of investors:4
Aggressive investors: 90 percent diversied stock and 10 percent xed
Moderate investors: 70 percent diversied stock and 30 percent xed
Conservative investors: 50 percent diversied stock and 50 percent
xed income
ese three simple models can be used by people of dierent ages who have
dierent investment time horizons. A whole host of equities can be included
within “diversied stock,” and even more so for the variety of bonds that can be
used for “xed income.” For example, equities can be considered based on the
size of the company, the growth characteristics, the valuation, the sector type,
geographic exposure, and so on. Similarly, bonds can include government or
corporate issues, with varying durations, credit ratings, and tax advantages.
is traditional approach to asset allocation ran aground in 2008, when
the nancial markets collapsed and investors found that even if they had both
Burniske 02.indd 76 9/9/17 1:46 PM
stocks and bonds in their portfolio, they all fell together.5 e average investor
felt betrayed by the tried and trusted model of stocks and bonds moving in
a noncorrelated fashion. e crash of 2008 shook these investors from their
economic lullaby.6 In an increasingly globalized world where capital mar-
ket assets are more closely intertwined, it was becoming clear that twentieth-
century diversication models wouldnt cut it for twenty-rst-century
While the crash of 2008 was felt by most everyone, it soon surfaced that
some people had not only weathered the storm but made signicant money by
leveraging the strong winds of fortune.7 Hedge fund managers who had been
operating in relative secrecy were now being named as the new “masters of the
universe” for their ability to avoid much of the damage of the crash and, for
some, to prot greatly from it.
e nancial crisis of 2008 caused many nancial advisors and wealth man-
agers to evaluate dierent approaches to portfolio construction other than
solely stocks and bonds. e returns seen by hedge funds during the crisis
were identied as examples where nontraditional and alternative investment
vehicles had provided positive (in some cases, drastically so) performance
John Paulson became the face of hedge fund billionaires who beneted
from the crisis when it was revealed that he had personally earned over $1 bil-
lion from his fund management, including the Paulson Advantage Plus Fund
(an event-driven fund). is fund alone ranked number one over the period
of 2006 to 2008 with an annualized return of nearly 63 percent. Equally suc-
cessful was James Simonss Renaissance Technologies Medallion Fund with a
return of 80 percent in 2008. Becoming a hedge fund manager became all the
rage for business-minded students when it was revealed that the top 25 hedge
fund managers had earned a total of $22.3 billion in 2007 and $11.6 billion
in 2008.8
With numbers like these, the world of hedge funds caught the attention of
the media. Investors questioned if these managers had something to do with
the crash.9 ey also wanted to know what they were doing dierently and
whether it was something they could do as well.
Burniske 02.indd 77 9/9/17 1:46 PM
First, lets understand what we mean by a hedge fund and how they dier
among themselves. It’s dicult to lump hedge funds together in one group, as
they oen have dierent investment objectives and approaches. Historically,
one of the easiest ways to spot hedge funds has been their high fee structure.
For example, many hedge funds operate under a 2 and 20 model, or some-
times 3 and 30, where they charge a 2 percent annual management fee and take
20 percent of the prots from a year. Other common characteristics include
their exclusivity and general secrecy.
Prior to the 2008 nancial crisis, investors who took advantage of hedge
fund performance and the alternative investments they utilized were typi-
cally of ultra-high net worth with sizeable investable assets, given that oen
the minimum investment was $1 million or more to gain entry. Additionally,
investors had to tie up their funds for lengthy periods as part of the agreement
with the hedge fund manager.
While mutual funds provide a prospectus that outlines exactly the approach
and asset classes to be used, hedge funds are oen veiled in secrecy. ey might
publicly advertise a broad investment strategy, but specics are oen withheld
to preserve the secret sauce of the hedge fund. Hedge fund managers demand
a high amount of exibility and tolerance from their clients.
For example, hedge fund managers could buy real estate or take owner-
ship in what they believe to be an undervalued company (either publicly or
privately held). If they believe upcoming political changes may favor oil, they
could lease oil tankers or make a sizeable investment in a foreign oil part-
nership. ey can also utilize assets such as timber, short positions in stocks
(meaning they’re betting on the price falling), commodity derivatives, and yes,
germane to this book, bitcoin and other cryptoassets.
Even with this lack of transparency and liquidity, auent investors rushed
to hedge funds to chase the performance of managers like Paulson, Simons,
and others. An underlying assumption for hedge fund investors was that they
needed to be auent enough to handle the high risk and volatile nature asso-
ciated with a hedge fund manager’s approach and fund assets. For the typical
investor, the high asset commitments, illiquidity, and lack of transparency kept
hedge funds beyond their reach. Fortunately, the underlying ability to utilize
alternative investments in any portfolio is not as elusive as many are made
to think.
Burniske 02.indd 78 9/9/17 1:46 PM
Alternative Investments Dened
So how does one dene an “alternative investment”?
A search online and in dictionaries will present a reader with the percep-
tion that accurately dening the term is quite complicated due to the wide
range of investments included, ranging from hedge funds to private equity to
direct investments in natural resources like gold and timber.10
e reality is that classifying alternative investments can be a moving tar-
get as investment options and trends change over time. Many investors may
already have alternative investment vehicles in their portfolio without speci-
cally referring to them as such. An investment such as an exchange traded
fund (ETF) that specializes in arbitrage strategies or futures contracts may
look like any other ETF in a portfolio, but it could be considered an alterna-
tive investment.11 Physical holdings in gold, silver, real estate, art collections,
or personally-owned businesses are all part of someones net worth and could
also be considered as alternative investments.
A more current and concise way to describe an alternative investment is
that it’s an asset with its own unique economic and value-based characteristics
that are separate from those of the primary investments of stocks and bonds.
For an investor, the main concern is to have assets that perform in a noncor-
related fashion to stocks and bonds—which have historically made up most
investors’ portfolio models—and many alternative assets t that bill.
If done properly, when the overall market has a severe meltdown as hap-
pened in 2008, specic alternative investments within portfolios may not
decrease. Equally, in market upturns those same assets may or may not also
increase in value; they may lose value, but such is the cost of overall risk reduc-
tion. As a small portion of the innovative investor’s overall portfolio, alterna-
tives are an eective way to balance risk and provide a cushion in the case of a
stock or bond meltdown.
Today’s innovative investor can build an investment portfolio and asset alloca-
tion strategy with a clear understanding of risk and reward, and the inclusion
of alternative investments can help. is has not been lost on wealth manage-
Burniske 02.indd 79 9/9/17 1:46 PM
ment rms that are now looking more aggressively into how alternative invest-
ments can be used to improve client returns.
For example, Morgan Stanley has outlined asset allocation models for its
high net worth investors with under $25 million in investable assets; those
models recommend 56 percent stocks, 19 percent bonds, 3 percent cash, and
22 percent alternatives. For those clients with over $25 million in investable
assets, the recommendation is for 50 percent stocks, 19 percent bonds, 3 per-
cent cash, and 28 percent in alternatives.12 Merrill Lynch has recommended
allocation models for its typical client that include alternatives near or above
20 percent of a portfolio.13
Clearly, the inclusion of alternative investments should not be limited to
only high net worth investors. Historically, one of the biggest reasons alterna-
tive investments have not been incorporated into retail portfolios is because
of their illiquid characteristics. Many retail investors cant guarantee that they
won’t need to access their funds for 10 years, making many alternatives out of
reach. at, however, is changing.
Over the last decade, to address the need for alternative investment options
as a way to provide diversication and noncorrelation from the traditional cap-
ital markets, wealth management rms have been creating more investment
options for the typical investor. e proliferation of ETFs has led to the creation
of liquid investments in alternative assets, such as gold, energy resources, and
real estate, as well as ways to play the volatility of the market. Because of the
easy accessibility of these products through the capital markets, these vehicles
and others have found their way into investors’ portfolios and onto the recom-
mended lists of many nancial advisors. e impact of this is seen in a 2015
survey among nancial advisors that found they had placed 73 percent of their
clients in alternative investments, and that nearly three-quarters of advisors
planned to maintain their current alternative investment allocations.14
e survey also showed that in terms of asset allocation, most advisors were
recommending a range of 6 percent to 15 percent of a clients portfolio in alter-
natives. A smaller but not insignicant percentage of advisors recommended
16 percent to 25 percent of their clients’ portfolios in alternatives.
Bitcoin and other cryptoassets are alternative assets that can be safely and
successfully incorporated into well-diversied portfolios to meet these asset
allocation recommendations.15 However, every alternative investment has its
unique set of characteristics, and the innovative investor must understand
Burniske 02.indd 80 9/9/17 1:46 PM
e potential of bitcoin and other cryptoassets is so great that we believe
they should be considered an asset class of their own. We can easily see them
more and more commonly used in many innovative portfolios. We explain
why we think cryptoassets will increasingly be incorporated into mainstream
retail portfolios, rst starting with an exploration of how bitcoins risk, reward,
and risk-reward proles have evolved over the course of its life.
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The Most Compelling Alternative
Asset of the Twenty-First Century
Chapter 7
Bitcoin is the most exciting alternative asset in the twenty-rst century,
and it has paved the way for its digital siblings to enjoy similar suc-
cess. In this chapter, we dive into how bitcoin evolved as an asset in
the context of absolute returns, volatility, and correlations, concluding with
how a small allocation of bitcoin would have aected a portfolio over dierent
holding periods. Because bitcoin can claim the title of being the oldest crypto-
asset—giving us the most data to investigate its maturation—understanding
its longitudinal market behavior will give us a window into how other crypto-
assets may evolve over time.
Let’s go back to the rst time a price was established for bitcoin, October 5,
2009, when it was priced at 1,309 bitcoin to the dollar, or 7/100 of a cent per
bitcoin. A small website called the New Liberty Standard established the rate
based on the amount of money it needed for electricity and rent to maintain
the computer that mined bitcoin versus the amount of bitcoin that had been
reaped from so doing.
If at that time an investor had tracked down one of the few bitcoin miners
in the world and oered $100 for the 130,900 bitcoin implied by that exchange
rate, by now that investor would have amassed over $100 million. A single
Burniske 02.indd 83 9/9/17 1:46 PM
hundred-dollar bill converted into one million hundred-dollar bills: it would
have been one of the best investments of all time.
However, having such impeccable timing is an elusive dream for investors.
When I (Jack) began investigating bitcoin in August 2013,1 bitcoin was trading
at $135; it had already appreciated signicantly from the initial exchange rate
of 1,309 bitcoin to the dollar. Yet I decided it was not too late and ultimately
made the investment.
Similarly, I (Chris) didnt even consider investing in bitcoin when I rst
heard about it in 2012. By the time I began considering bitcoin for my portfo-
lio in late 2014, the price was in the mid $300s, having increased 460,000-fold
from the initial exchange rate. Like Jack, I also didn’t think it was too late and
made the jump. While the innovative investor may interpret the current price
tag on bitcoin as being too high, consider instead what can be done. We believe
its still early days for cryptoassets.
To provide context for bitcoins behavior in the rst eight years of its life,
we will compare it to other popular investments from both traditional and
alternative asset classes. In terms of absolute returns, long-term comparisons
between bitcoin and many other assets make most jaws drop, but its important
to keep endpoint sensitivity in mind. Endpoint sensitivity refers to the starting
and ending dates chosen for comparison, because over time almost all assets
uctuate considerably in value. Choosing a low starting point and a high end-
ing point will yield drastically dierent comparisons than a high starting point
and low ending point.
We have chosen January 3, 2017, as the ending point of analysis for this
chapter, as that was bitcoins eight-year birthday. While designating a xed
endpoint, we have the exibility to choose dierent starting points (including
one of bitcoins most notable peaks in late 2013). By illustrating both high and
low starting points, we are able to show the variety of experiences investors
could have had depending on when they rst bought bitcoin. For those con-
cerned with the cherry-picking of numbers, it should be noted that on January
3, 2017, the price of bitcoin was around $1,000, whereas when this book was
entering its nal stages of editing, bitcoin had risen past $3,000. We nonethe-
less have stuck with the $1,000 price of bitcoin for the following comparison in
pursuit of intellectual honesty.
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To begin with, we examine the longest-term bitcoin prices we have that
come from reliable exchange data. Figure 7.1 provides a comparison of bitcoin
versus three of the most important stock market indices: the S&P 500, the
Dow Jones Industrial Average (DJIA), and the NASDAQ 100, respectively. It
assumes a $100 investment was made on July 19, 2010, a few days aer Mt. Gox
was ocially open for business and providing the rst widely used exchange
services for bitcoin.
ese broad market indices represent how the stock markets performed
on average, with the S&P 500 representing approximately 80 percent coverage
of available U.S. equity market capitalization,2 the DJIA for 30 of the largest
U.S. stocks by market capitalization,3 and the NASDAQ 100 for big domestic
and international companies in sectors that include computer hardware and
soware, telecommunications, and biotechnology.4 Note that the graph uses a
log scale for the y-axis so that the broad market indices can be seen—in other
words, they’d be invisible on a linear scale.
Since July 2010, the three broad indices have done well, with U.S. stocks in
a recovery bull market aer the nancial crisis of 2008. An initial investment
of $100 would have grown to $242, $231, and $291, for the S&P 500, DJIA,
and NASDAQ 100, respectively. Although equity market returns have been
respectable, they have been dwarfed by bitcoin, which has done phenomenally
Value of a $100 Investment Over Time
S&P 500 Dow Jones Industrial Average
NASDAQ 100 Bitcoin
Figure 7.1 n Bitcoin’s performance compared to major
U.S. stock indices since the start of Mt. Gox
Data sourced from Bloomberg and CoinDesk
Burniske 02.indd 85 9/9/17 1:46 PM
in the same period—an initial investment of $100 grew to nearly $1.3 million
by the beginning of January 2017.
Two types of scales are commonly used for representing the change in the
price of assets: linear and logarithmic. Linear price scales show unadjusted
unit changes in the y-axis. For example, if priced in dollars, $10 in value
increase will look the same, whether the asset goes from $10 to $20 or $100
to $110. Logarithmic scales adjust the y-axis—in nance most commonly
by factors of 10—which allows percent price increases to be compared. For
example, on a logarithmic y-axis the price move from $10 to $20 will show
up more clearly than the move from $100 to $110, because the former
represents a 100 percent price increase while the latter is only a 10 percent
price increase. What would look the same on a logarithmic scale, however, is
a move from $10 to $20 and a move from $100 to $200. Logarithmic price
scales are useful in comparing percent price changes over time, as well as
compressing data of widely different values into one chart.
We can also compare these indices to bitcoin by calculating the compound