May 2019 Commentary

June 7, 2020

In the month of May 2019, IC fund returned 36.82% to the partners in the fund. The biggest invention in crypto markets is bitcoin, as sound money, it will have far reaching consequences on humanity than internet. This rabbit hole is deep with bitcoin and takes a while for people to understand the full impact of it. Another of our portfolio companies is Chainlink (LINK token), which I have described when it was trading around $0.4 in the month of February. Chainlink provides real-world data to smart contracts in a blockchain-agnostic fashion. This month, Google has announced an integration (not partnership) with Chainlink in providing real-world data to smart contracts running on Google cloud. Chainlink is also working on integrating with SWIFT, VISA and Microsoft. This recent announcement with Google has pushed its price to $1.82 (as of today), but I believe we have barely even scratched the surface with its full impact.

               We have added a new position, called LEO token, which was issued by iFinex, which is the parent company to Bitfinex. We started purchasing around $1.25. Bitfinex is one of the largest fiat-to-crypto exchanges in the world, which started its operations in 2012. It is smaller when compared to Binance, but Bitfinex is in a different category as a fiat-to-crypto on-ramp. iFinex is the holding company for ethfinex, Bitfinex, Nectar, Crypto derivative exchange, EOSfinex, Tokinex ( fund-raising platform), Dazaar (distributed marketplace), Betfinex(online betting), and μFinex. It is difficult to cover all the details of Bitfinex’s history here, but can be checked on its Wikipedia page. This diverse ecosystem of companies assures us of steady revenues.

What prompted Bitfinex to issue LEO? Bitfinex was using a payment processor company known as Crypto Capital. Crypto Capital had bank accounts in Poland and few other countries, where the bank accounts were frozen to the tune of $850 million. Crypto Capital was the custodian of the assets of the stable coin, Tether (USDT) which is issued by Bitfinex. Currently $3.4 billion dollars’ worth of Tether are circulating in the market. Bitfinex claims that all the Tethers used are 100% backed by dollars in the bank. In April of 2019, NY Attorney General Letitia James filed a suit accusing Bitfinex of misrepresenting the degree to which Tether is backed. NYAG claims that Tether is not 100% backed by dollars in the bank, but only 73%. Many people expected the Tether price to collapse after the NYAG lawsuit. But the market completely ignored the lawsuit and now Tether is trading at a premium.

In view of the pending lawsuit, we need to ask is Bitfinex really trustworthy? Bitfinex suffered a hack in 2016, to the tune of 119,756 BTC ($72 M at that time). Most exchanges suffering such huge losses would have gone bankrupt. But Bitfinex, stopped the withdrawals on the exchange and uniformly distributed the losses to all the account holders.  At that time, it minted a new token called BFX. At a conversion price of $1 for each BFX token, it deposited the BFX tokens to all the account holders. Most of the account holders suffered losses close to 36%, but received BFX tokens in return. Bitfinex later redeemed 100% of the BFX tokens for $1. As a result, in dollar terms all account holders recovered their losses. Bitfinex covered the hack from its own profits. It shows the ethics of the company. Bitfinex remained antifragile and came back stronger when faced with adversity.

This time, Bitfinex did not actually lose the money to hackers but, due to a government injunction, funds are frozen in a bank account. Bitfinex did not immediately reach Wall Street to raise money. It managed to raise $1 billion dollars from its customers in 10 days. It received $1 billion dollars from customers and issued them 1 billion tokens of LEO in exchange, in a private sale. The fact that it was able to raise $1 billion from its customers show how much confidence Bitfinex’s customers have on the company to sustain itself. We believe this is a good model for the industry. It shows that the crypto industry can thrive without needing help from venture capitalists, investment bankers and even stock exchanges. According to Bitfinex CTO, Paolo Ardoino, the amount was raised by a “legion of inside and outside users” who invested over $1 million each, as well as several industry giants and private companies that invested more than $100 million each. It was also reported that more than 80% of this $1 billion was raised from 15 people around the world. So, most of the investors are really quite wealthy and most of the supply is held in strong hands. Bitfinex has remained a very profitable business, with $570 million in revenue, generating a gross profit of $418 million, with just 90 employees. This table was presented from their white paper.

Next question, we need to ask is why would these rich investors give them $1 billion for these 1 billion LEO tokens? iFinex is the main holding company with numerous lines of businesses, with Bitfinex being one of them. iFinex want to use LEO token as a fuel on all its operations. It is used to pay for Maker fees, taker fees, margin lending fees, withdrawal fees, used as collateral for margin loans, used as collateral for derivatives, deposit fees and many others as described in the whitepaper. Bitfinex will also take a minimum of 27% of their revenues (not profit) every day and use it to buy them in the market and burn the tokens out of circulation till all the tokens are burnt. Bitfinex does not care about the price of LEO token in the market. It does not care if its price is $1.75 (current market price) or $10,000. It simply takes 27% of previous day’s revenues, buys the tokens in the market and burns them via a SmartContract, which is publicly verifiable. There are 3 more additional values:

  1. 95% of any funds recovered from Crypto Capital will be used to buy and burn LEO tokens. This could increase the burn by $850 million
  1. At least 80% of the funds recovered from 2016 hack of 119,756 BTC will be used to buy and burn
  1. iFinex may also burn LEO tokens that were used to pay trading fees on any of its other platforms, which also have potential for huge revenue growth

               Next question, we need to ask is why would these rich investors give them $1 billion for these 1 billion LEO tokens? iFinex is the main holding company with numerous lines of businesses, with Bitfinex being one of them. iFinex want to use LEO token as a fuel on all its operations. It is used to pay for Maker fees, taker fees, margin lending fees, withdrawal fees, used as collateral for margin loans, used as collateral for derivatives, deposit fees and many others as described in the whitepaper. Bitfinex will also take a minimum of 27% of their revenues (not profit) every day and use it to buy them in the market and burn the tokens out of circulation till all the tokens are burnt. Bitfinex does not care about the price of LEO token in the market. It does not care if its price is $1.75 (current market price) or $10,000. It simply takes 27% of previous day’s revenues, buys the tokens in the market and burns them via a SmartContract, which is publicly verifiable. There are 3 more additional values:

  1. 95% of any funds recovered from Crypto Capital will be used to buy and burn LEO tokens. This could increase the burn by $850 million
  1. At least 80% of the funds recovered from 2016 hack of 119,756 BTC will be used to buy and burn
  1. iFinex may also burn LEO tokens that were used to pay trading fees on any of its other platforms, which also have potential for huge revenue growth

 Scarcity and utility drive value. The market cap of LEO today is $1.25 billion, which is the multiplication of market price of $1.25 with the supply of 1 billion tokens. The market cap of LEO can stay the same but still the price can go higher. Bitfinex has been highly transparent about their burn mechanism and have established a website, where it shows the number of tokens that are being bought and burnt at https://leo.bitfinex.com/. The supply already started shrinking down to 999,698,921 from the burning that happened so far in the month of June. Here is another site, that shows real-time statistics pulled independently from blockchain: https://leoburn.org/. We projected the burn rate into the future to predict the potential investment returns.

 Scarcity and utility drive value. The market cap of LEO today is $1.25 billion, which is the multiplication of market price of $1.25 with the supply of 1 billion tokens. The market cap of LEO can stay the same but still the price can go higher. Bitfinex has been highly transparent about their burn mechanism and have established a website, where it shows the number of tokens that are being bought and burnt at https://leo.bitfinex.com/. The supply already started shrinking down to 999,698,921 from the burning that happened so far in the month of June. Here is another site, that shows real-time statistics pulled independently from blockchain: https://leoburn.org/. We projected the burn rate into the future to predict the potential investment returns.

We have half-jokingly included the last column, to make a point. That indicates that token supply will reduce to a negative number, which is absurd. Based on this projection, somewhere between 6/2026 and 6/2027 all the tokens will be burned from circulation. We estimated the Bitfinex revenues based on its current trading volume of $300 million per day and calculated the fees. We made two very conservative assumptions, in this projection to show the potential for the price appreciation.

  1. Bitfinex revenues will grow at a rate of 10% every year.
  1. As Bitfinex purchases tokens in the market, it will not increase its market cap.

Assumption #1: Based on the past history, Bitfinex revenues have grown faster than 10%. crypto market is still very small portion of the world at close to 1% of the world’s population. As bitcoin grows higher and proves itself as a global currency it can be used by 50% of the world in the coming decades. Since it collects its fees in crypto assets like BTC, ETH any increase in the price of bitcoin or Ethereum in dollars will drive up its revenues very high, when measured in dollars. iFinex is planning to launch a derivative platform similar to Bitmex, which can grow revenues. Bitmex currently trades a notional value of $123.37 billion per month or $1 trillion on an annualized basis. Bitfinex received $1 billion of new capital from its customers to continue expanding into new lines of business.

Assumption #2: Scarcity drives the prices up. If the current market cap is $1.25 billion, if Bitfinex purchases say 10 million tokens and burns them, it has to push the price up. This is due to the fact that if the demand stays the same but supply decreases, price must increase. This assumption is the reason why the token supply projection is negative by 6/2026 and reality will prove that this assumption is wrong. However, to be on the conservative side, we are simply dividing the market cap by the number of circulating tokens to arrive at the future price. In reality, Bitfinex will be able to buy fewer tokens, as the price will keep going up with each purchase.

With the bull case in mind, we can explore events that could potentially have negative effects on LEO token price. If Bitfinex is shut down by regulators, it will not be able to buy back these tokens. Some people can attempt to front-run the LEO buyback by buying before Bitfinex buys and then quickly sell after the price increase. However, Bitfinex has decided to randomize the time every hour so that people cannot predict at what exact time of the hour, they buy the tokens back.

Economic incentives drive people’s actions. If we understand the incentives of all the participants in an economic transaction, we can predict the outcomes with reasonable probability. All the original investors in this token have deep pockets. They will be able to hold out longer than most small investors. Why do they need to sell their tokens, if they already know that Bitfinex is going to buy them?  The most patient investor who will never sell at any price will reap the benefit from the impatient investors. In a centralized system like stock market, minority shareholders are forced to redeem their shares, even if they don’t like. Not so, on a decentralized blockchain. In fact, an investor who has even 1000 tokens could be the last person on the planet to sell to test how high it can go. What will be token price when only 1 million tokens are left? If the market cap at 1 million tokens is say, 10 billion dollars (which is only 5 times the current marketcap) each token should be valued at $10,000. Even if the price of each token is $10,000 an investor could simply wait and decide to sell when the supply reaches say 500,000 tokens to get a better price. A rational investor will always hold, knowing that there is an automated, predictable buyer (whose revenues are growing every day) to buy his assets.

LEO token is a store of value. Bitfinex provides the picks and shovels to the crypto gold-rush. Bitfinex is the digital casino for crypto assets which is open 24 hours a day, 365 days in a year, and makes money both in bull and bear markets. Holding LEO token is akin to buying the royalty to the stream of revenue from this digital casino in perpetuity. It is scarcity on steroids. Bitfinex will be snatching out tokens from one impatient investor at a time, one by one, relentlessly, every hour of the day in perpetuity. This grand experiment will only stop when all of them are taken out. Bitfinex creates demand for the token every day with its services, while continuously reducing its supply. It is interesting to see how the game theory plays out between investors, traders and Bitfinex on a global scale.

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