BK2Cents

SEEING THROUGH THE HYPE AND GIMMICKS

Brian Kelly, Portfolio Manager

Blockchain Money Grabs Recall The 90s Internet Bubble: “Déjà Vu All Over Again”

After the recent “Money 2020” payments conference in Amsterdam, a CNBC colleague, Arjun Kharpal, wrote that he overheard one conference delegate telling another, “Let's just call it a blockchain1 anyway, we'll get funding.” That same day, Forbes published a piece re-visiting “blockchain” stocks, pointing out that even if calling something blockchain might bump a company’s stock price for a few weeks, it seldom lasts if the initiative is just a fig leaf.

For those of us who cut our teeth during the technology bubble of the 1990s, this sounds awfully familiar. In those days, simply launching a website could boost a company’s stock, even if the website didn’t do anything. Today, that notion sounds quaint. But back then, launching a website sounded like a big deal because hardly anybody knew what a website was, or what it was supposed to do.

We know better today, and there are two ideas I’d suggest that people remember when trying to sort the hype, gimmicks, and money grabs from the real opportunities in crypto2 and blockchain:

First is that most crypto-blockchain initiatives will likely fail. I’ve said it before publicly: in my view, 90% of initial coin offerings (ICOs) will probably go to zero. That shouldn’t be surprising, given that 90% of venture start-ups don’t pan out. It’s just a handful of companies, out of hundreds, or even thousands, that go on to become the next Amazon, Facebook, or Netflix.

Failure rates are likely to be high because many of today’s crypto-blockchain ideas are just too early, or they lack an addressable market, or the technology isn’t ready, or management doesn’t have the execution chops to build a viable business.

But that brings us to idea number two: Just because it’s too early now, or the tech isn’t ready now, that doesn’t mean it never will be. People love to joke about the now-deceased Pets.com as emblematic of the speculative tech bubble of the 1990s.

Consider that Chwey.com (a company with the same business model, product line up, and strategy) just pulled in a $1 billion private equity investment for just 20% of the company. That’s a $5 billion valuation for a business model that would have gone bankrupt (and did) back in 2000.

U.S. Tempting The Currency Fates?

Put this news in a similar category of “too early but not out of the question”: the Chief Executive Officer of Lazard, Ken Jacobs, made some eyebrow-raising comments a couple of weeks ago that America’s new unilateralism is “tempting the world” to find an alternative to the U.S. dollar as a reserve currency. He said that it’s unlikely in the near term, and I would agree, but he specifically mentioned cryptocurrencies as a reserve currency alternative.

While it’s not practical today, with a little imagination, as Jacobs suggests, one can see the possibilities for a digital reserve currency, as well as the macroeconomic shifts that could get us there.

The U.S. is currently running twin deficits – budget and trade deficits. Today, they are working together to support our status as the world’s reserve currency. Countries that accumulate dollars through trade invest those dollars back into U.S. government debt. But if tariffs and other measures crimp global trade, then our trading partners will have fewer dollars to buy our debt. This could happen just at a time that the U.S. needs to issue mountains of debt to finance an exploding budget deficit. At that point, trade and budget deficits may no longer work together. Those particular dynamics—falling investment combined with growing debt—are the recipe for the kind of acute crises we have seen unfold many times, especially in the developing world.

Moreover, for the first time the world now has an alternative to gold: Bitcoin. Using a supranational currency standard offers a technology solution to nations fleeing a reserve currency vulnerable to unreliable trade policies, disinvestment, and growing debt problems.

WHAT DOES MY 2CENTS ADD UP TO?

This post could have a different title: “What a difference a few decades can make.”

With emerging technologies, a big part of the recipe for success is: Right place. Right time. Right tech. Don’t forget that Bitcoin is not the world’s first digital currency. We had HashCash, Nick Szabo’s Bitgold and other iterations before Bitcoin. The difference with Bitcoin is that I believe it solves the problems of digital currency better; the market is ready to embrace and use it; and technology has advanced far enough to support it.

So how does one tell what’s viable now—in the crypto-blockchain world—instead of what might be viable 20 or 30 years from now?

My approach is to look for companies that: 1) solve a real world problem; 2) solve a problem that could not be solved prior to crypto-blockchain existing; and 3) have the ability execute on the vision, not just the tech vision, but also the business case.

Today, those look like infrastructure plays. That is, any technology offering a platform for others to build on top of. We are looking for foundational protocols that will fuel the next generation of applications across the decentralized web. If I were to make an analogy to the early days of the Internet: I’d be looking for the Ciscos of the world, not the Facebooks. People could not get online to use something like Facebook until we had enough routers to support that kind of traffic.

Today, in my view, the most viable crypto-blockchain opportunities are in the backbone technologies. Just remember that naming something “blockchain” or “crypto” doesn’t automatically make it a viable business, and even if it’s a good idea in principle, a viable market and business model might still be decades away.

This blog is intended for information purposes only and does not constitute investment advice. This blog contains the opinions of Brian Kelly. Blockchain technology and cryptocurrencies are subject to several risks which should be considered when evaluating an investment that provides exposure to this sector. The Rex BKCM ETF is not suitable for all investors. The Fund should only be utilized by investors who are willing to assume a high degree of risk and intend to actively monitor and manage their investments in the Fund. Please see important risk disclosures at the bottom of the page.​

1 Blockchain is a decentralized, digitally disseminated ledger of data. The basis of a successful blockchain system is once a new group of information, or “block”, is added, the information automatically disseminates and is downloaded to each computer on the network. This assures that a single computer could not change information on a block: it would be overruled by a consensus of all the other computers on the network. This process renders all information on a completed block decentralized and theoretically permanent.

2 A cryptocurrency (crypto) is a digital currency typically utilizing a Blockchain system for transaction records and cryptography for security. The major differentiator from physical currency is it isn’t issued by a central authority and thus theoretically acts independently of traditional banking and government influence. A crypto-asset would be holding a certain amount of cryptocurrency, or a derivative for which value is driven by the price of an underlying cryptocurrency.

Sources that inspired this entry:

https://www.cnbc.com/2018/06/06/blockchain-is-so-hyped-right-now-and-many-companies-will-get-burned.html

https://www.forbes.com/sites/petertchir/2018/06/06/re-visiting-the-blockchain-stocks/#20bc4a1c543f

https://www.bloomberg.com/news/articles/2018-06-07/u-s-tempts-dollar-s-fate-by-going-it-alone-lazard-ceo-says

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GOVERNMENTS QUICKLY CHANGING THEIR TUNE ON BLOCKCHAIN

Brian Kelly, Portfolio Manager

All Over The World, Governments Are Seeing Enormous Potential In Enterprise Blockchain Applications

Go back five years or so and you’d be hard-pressed to find any government endorsing blockchain1 technology, and many were (and still look to be) openly hostile to cryptocurrencies. That posture is now shifting—quickly.

An hour-long TV special aired in China last week, extolling the virtues of blockchain and claiming that its value is “ten times more than that of the Internet.” To me, that does not sound like a country intent in keeping up its ban on cryptocurrencies2. And contrary to what many Westerners believe about China’s crypto-hostility, I’ve talked to a number of investors in China, Singapore, and Hong Kong who all have said that crypto/blockchain is alive and thriving in China. In my view, China is likely to re-emerge very soon as a big player in this space.

Moreover, proposed government blockchain initiatives now run the gamut, with objectives as diverse as preventing corruption in public sector finance (Italy), streamlining land registries (Netherlands) and managing customs controls (South Korea).

Where governments used to openly dismiss blockchain, they are now seeing potential benefits in its traceability. They have come to understand that it is not necessarily the anonymous, shady underworld they thought it was. The more they explore its potential, the more use cases they are finding, particularly for blockchain enterprise applications.

And now that they’ve stuck their toe in the water, I don’t believe it will take long for them to see the potential benefits of blockchain-based currency systems—i.e., “cryptocurrencies.” There is hardly any large-scale adopter that’s larger than a government. So this slow coming-about of the ship of state is potentially a huge development for blockchain technology applications, manufacturers, and implementers.

Rewards Programs Joining the Crypto Ecosystem?

Two of the themes I’ve been covering in this blog are “interoperability” and diversification within the cryptocurrency ecosystem. This week we see another small step forward on both fronts, both in the arena of consumer loyalty programs.

Right now, you can use your American Airlines miles to book a hotel room, so why shouldn’t you be able to use them to buy a burger? Or a pair of sunglasses? Every year, American Express publishes a rewards catalogue where you can exchange your points for everything from electronics, to kitchen gadgets, to apparel.

These rewards programs are, in many ways, already a kind of “permissioned” currency—useable within a closed ecosystem built by each company. But now those ecosystems may be getting larger, potentially even approaching the utility of cash.

American Express has built a blockchain application that lets its merchants develop bespoke Amex rewards points programs. Just as you might get airline points for booking a rental car (or vice versa), now you might be able to get Amex points for buying a cup of coffee, or a sale item that a retailer wants to move off the shelf. More important, once you earn them, you may be able to spend them any way you like.

Meanwhile, Mastercard has patented a system that puts coupons on the blockchain. EZ Rent-A-Car is piloting a program to let rewards members exchange their points for bitcoin. Rakuten, the Japanese e-commerce giant, has about $9 billion in rewards outstanding and is talking about converting those to a loyalty “coin” that is convertible to fiat currency.

Fungible rewards points offer greater flexibility to consumers, attracting them to the issuer’s rewards ecosystem. That attracts more merchants, and accrues more fees to the program operator. And finally, the larger the program, the more data (troves of it) the operator will have on consumer purchasing habits and trends.

There are two key take-aways here:

First, the more that rewards points can act like cash (and that’s where it looks like they are headed), the more potential value in the issuing enterprise, whether it’s an airline, retailer, or credit card company.

Second, I have said before that the cryptocurrency ecosystem is not winner-take-all: it has room for a diverse array of digital tokens, with “interoperability” (i.e., convertibility) driving growth of the ecosystem. New developments on the rewards front demonstrate both points: growing diversity, with issuers fueling adoption by making digital tokens as convertible as possible.

WHAT DOES MY 2CENTS ADD UP TO?

We are seeing some every encouraging signs in the direction of crypto-blockchain adoption, across a diverse set of players. But this is truly emerging technology. Many of these initiatives will fail, and because there is so much attention on this space right now, many of those failures will be very public.

On the path to crypto-blockchain adoption, it’s important to remember the old adage of: crawl, walk, run. As one emerges from the crawling stage, there can be a lot of bumps, bruises, falling down, and the occasional nasty head bang.

In my view, investors should neither be surprised, nor frightened away, by recent data out of China that most blockchain initiatives are abandoned after 15 months. (That small data point has been getting too much press.) After all, 95% percent of all venture capital start-ups fail to deliver the projected return on investment. An article in Fortune a few years back quoted a 90% failure rate for corporate “innovation” projects. An estimated 75% of corporate “change initiatives” will fail. The failure rate for IT projects varies between 50% and 70%, depending on whom you ask.

On the whole, I see very positive signs around enterprise blockchain adoption and cryptocurrency diversification. But high failure rates in tech innovation are normal. So, avoid falling in love, and don’t be too disheartened if favored opportunities don’t pan out.

I’d suggest that one needs to have an active approach to managing opportunities in this space: rigorously vetting opportunities to find those that may have the best chance at success and longevity. Think of it like putting bumper-guards on the coffee table and plug-covers over the power outlets.

This blog is intended for information purposes only and does not constitute investment advice. Blockchain technology and cryptocurrencies are subject to several risks which should be considered when evaluating an investment that provides exposure to this sector. Please see important risk disclosures at the bottom of the page.

1 Blockchain is a decentralized, digitally disseminated ledger of data. The basis of a successful blockchain system is once a new group of information, or “block”, is added, the information automatically disseminates and is downloaded to each computer on the network. This assures that a single computer could not change information on a block: it would be overruled by a consensus of all the other computers on the network. This process renders all information on a completed block decentralized and theoretically permanent.

2 A cryptocurrency (crypto) is a digital currency typically utilizing a Blockchain system for transaction records and cryptography for security. The major differentiator from physical currency is it isn’t issued by a central authority and thus theoretically acts independently of traditional banking and government influence. A crypto-asset would be holding a certain amount of cryptocurrency, or a derivative for which value is driven by the price of an underlying cryptocurrency.

Sources that inspired this entry:

https://www.forbes.com/sites/billybambrough/2018/06/01/italy-just-took-a-step-closer-to-mass-blockchain-adoption/#393c7e2846c5

https://cointelegraph.com/news/netherlands-land-registry-to-test-blockchain-solution-for-real-estate

https://cointelegraph.com/news/korean-customs-service-to-develop-full-scale-blockchain-customs-platform

https://www.americanbanker.com/news/has-amex-found-a-data-gold-mine-with-its-rewards-blockchain

https://www.ccn.com/mastercard-wins-patent-for-blockchain-based-coupon-authentication-system/

https://www.bloomberg.com/news/articles/2018-05-30/forget-airline-miles-crypto-coins-are-coming-to-reward-programs

https://www.inc.com/john-mcdermott/report-3-out-of-4-venture-backed-start-ups-fail.html

http://fortune.com/2014/10/07/innovation-failure/

http://www.connerpartners.com/how-challenging-is-the-change/the-dirty-little-secret-behind-the-70-failure-rate-of-change-projects

https://www.cio.com/article/3068502/project-management/more-than-half-of-it-projects-still-failing.html

http://www.information-age.com/projects-continue-fail-alarming-rate-123470803/

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SINGAPORE PUTS PEDAL TO THE METAL IN BLOCKCHAIN

Brian Kelly, Portfolio Manager

Asian Nations Vying For Global Leadership

In last week’s post, after Blockchain1 Week, we addressed the issue of adoption versus development: Asia is working overtime on adoption, while the U.S. is still working on development.

This week we see that theme continuing to play out—with interesting news, this time out of Singapore. A recent article in Forbes listed all the ways Singapore is vying to lead the blockchain race, proposing a new regulatory regime for decentralized exchanges, as well as new clearing and settlement systems, and even floating the idea of putting the national currency on the blockchain.

We also saw supportive news out of South Korea, where the National Assembly started pushing regulators to lift their ban on Initial Coin Offerings. The elections coming up on June 12 have become somewhat of a referendum on crypto2 policy, with crypto-friendly candidates favored. South Korea is one of the world’s biggest cryptocurrency hubs: on some days accounting for upwards of 40% of global bitcoin trading. Bringing Korean demand back on line, and fresh cash into the ecosystem, could be hugely supportive of crypto prices.

Meanwhile, back in the U.S., the state of Wyoming’s efforts to be the blockchain-friendliest state in the union appear to be paying off. Wyoming has attracted a raft of new crypto and blockchain start-ups. But as CNBC pointed out, it’s still very early days: “So far, only a small fraction of them exist as more than electronic paperwork.” Despite the fanfare, nothing on Wyoming’s horizon is as “shovel ready” as the myriad projects getting underway all across Asia.

The take-away here is that Asia is working on adoption more than any other region of the world. Asia, as first-mover, is successfully modeling what a crypto-blockchain-driven future could look like. And every new initiative potentially stokes global demand for this new asset class.

Good News: Cypto Price Manipulation The Subject U.S. Criminal Probe

The U.S. Department of Justice, working with the Commodities Futures Trading Commission, is looking into crypto price manipulation. They are going after traders who spoof, wash trade and otherwise manipulate the market.

In my view, this is good news, and potentially wildly bullish for crypto assets in the long term. It’s true that, in the short term, sentiment could take a hit until the probe is finished. It could push back new money entering the market, at least from the U.S. But the longer-term agenda of regulators is to “clean up” these markets, potentially making them safe enough for institutional participation—a critical development in terms of market growth.

The correct frame for understanding this news, in my view, is that crypto-blockchain is an emerging asset class. Eventually, institutions will be hard-pressed to stay on the sidelines. But they cannot enter the market until there is a viable spot3 market, as free as possible from manipulation—a market safe enough to receive the blessing of regulators in terms of approving ETFs, mutual funds, and other regulated investment vehicles.

That’s why this investigation is good news. It’s a prelude to a more transparent market, accessible through regulated vehicles, and safe enough for institutional assets—which, by the way, total anywhere from $100T to $300T globally.

WHAT DOES MY 2CENTS ADD UP TO?

What we’re seeing here—in the rapid adoption across Asia, and the cleanup of markets in the U.S.—is a maturation of an emerging asset class. I have no doubt that there will be bumps. This process is very unlikely to proceed in a straight line. But the asset class is moving, in fits and starts, toward maturity.

In the end, what could that look like? For starters, take cryptocurrencies as an investible asset class, compared to the size of the world’s institutional asset pool. At the low end, we’re talking about perhaps $100 trillion in institutional assets. By contrast, the current market cap of all crypto assets is about $400 billion globally.

Taking just the lowest estimate of global institutional assets: if half a percent were allocated to cryptocurrencies, that would double crypto’s global market cap, independent of any market-related gains or losses; a one percent allocation could triple crypto’s global market cap.4 That’s without taking into account any multiplier effect.

It’s tough to find any asset class with a potential upside of this magnitude—and that’s purely on the cryptocurrency side. It does not include blockchain opportunities for hardware makers, software/app designers, and legacy businesses with flare for innovation.

I believe that understanding the secular opportunity in crypto-blockchain requires keeping an eye on broad themes—like adoption across Asia and potential institutional entry in the U.S. It’s early in the maturation process for this emerging asset class, but supportive developments like these may indicate possible tectonic shifts in value and opportunity.

This blog is intended for information purposes only and does not constitute investment advice. The blog contains the opinions of Brian Kelly. Blockchain technology and cryptocurrencies are subject to several risks which should be considered when evaluating an investment that provides exposure to this sector. Investing involves risk, please see important risk disclosures at the bottom of the page.

1 Blockchain is a decentralized, digitally disseminated ledger of data. The basis of a successful blockchain system is once a new group of information, or “block”, is added, the information automatically disseminates and is downloaded to each computer on the network. This assures that a single computer could not change information on a block: it would be overruled by a consensus of all the other computers on the network. This process renders all information on a completed block decentralized and theoretically permanent.

2 A cryptocurrency (crypto) is a digital currency typically utilizing a Blockchain system for transaction records and cryptography for security. The major differentiator from physical currency is it isn’t issued by a central authority and thus theoretically acts independently of traditional banking and government influence. A crypto-asset would be holding a certain amount of cryptocurrency, or a derivative for which value is driven by the price of an underlying cryptocurrency.

3 Spot market means the current price of an asset or index.

4 Neither REX Shares nor Brian Kelly are endorsing this specific price target or methodology for valuing cryptocurrencies, instead these are discussion topics brought up by others. The BKC fund does not directly invest in Bitcoin at this time, however it may be subject to some of the risks associated with price movements of cryptocurrencies. Please review the prospectus for further disclosures of risk.

Sources that inspired this entry:

https://www.forbes.com/sites/chynes/2018/05/25/how-singapores-academics-are-helping-it-win-the-blockchain-race/#5e2515b92c89

https://www.coindesk.com/us-department-of-justice-cftc-probe-crypto-market-manipulation-report/?utm_content=buffere74dd&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer

https://www.fundstrat.com/

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Blockchain Adoption Ramping Up in Asia

Brian Kelly, Portfolio Manager

U.S. Works on Blockchain Development, While Others Prioritize Adoption

The week of May 14, 2018 was blockchain1 week in NYC and if you haven’t been paying attention, you could no longer ignore this potentially revolutionary technology. More than 8,500 people attended the Consensus Conference up from 700 just a few years ago. Beyond the juicy headlines – things like Snoop Dogg playing a private concert for Ripple2 supporters – there is a trend taking shape, which many U.S.-based investors may not have seen.

My biggest takeaway from Blockchain Week is that massive amounts of cryptocurrency3 and blockchain adoption are happening in Asia. I noticed this trend when I travelled to Hong Kong in March. While the U.S. was fretting over regulatory clarity, Asia had taken the crypto-ball and run with it. The side conversations I had during Blockchain Week confirmed my observation from earlier this year. Asia is the leading market for cryptocurrency use and adoption.

Did you know that China has quietly taken first place in blockchain and cryptocurrency patents? That’s right, China, the country that has banned cryptocurrencies too many times to count. China holds three times as many applications as the second-place U.S., according to Forbes. The number of Chinese blockchain and crypto patent applications has nearly quintupled since 2016.

In India, conglomerate Infosys is launching a blockchain-based trade network called India Trade Connect. Infosys is partnering with seven Indian banks to help “digitize trade finance business processes, including validation of ownership, document certification and payments,” according to a company press release.

On May 14, HSBC announced first-ever trade finance transaction using blockchain platform: a letter of credit issued to U.S. agriculture giant, Cargill. And there was a smattering of blockchain adoption announced in Israel (blockchain-based securities lending), Russia (a blockchain-based bond purchase), Spain (blockchain-based proxy voting). Even JPMorgan recently appointed a head of crypto development—based in the UK, rather than at headquarters in New York.

The bottom line: don’t judge blockchain momentum (and by extension crypto) by what’s happening in the U.S.

China Launches New Crypto Index – Ranks Ethereum4 #1

China, which has proven to be a wet blanket on cryptocurrencies so far, recently launched a new crypto index. The ostensible reason is a “lack of objective analysis” in the crypto space, according to the government agency managing the index. Color this weathered investor skeptical of their rationale.

Ask yourself why would a country that bans crypto trading launch a government-sponsored crypto index—and one that explicitly ranks the usefulness of crypto currencies? If cryptocurrencies are truly to remain banned in China, there would be no need for this index.

Not only is the initiative is surprising, but so are its results: ranking Ethereum number one and Bitcoin number 13. (More on that in a future post.)

My view is that China realizes the immutable audit trail of crypto could be helpful to the government. As discussed last week, I don’t believe China will cede the crypto space to regional leaders Japan and South Korea. And China’s recent moves don’t look like the actions of a country bent on shutting down cryptocurrencies forever. They look like delaying tactics. I believe China is likely to "un-ban" crypto, with the blessing of the central bank, once they have figured out how to craft a system of state control.

Bottom Line: pay attention to what the big players are doing, not what they are saying. As the saying goes, paying attention is the cheapest thing you can do.

WHAT DOES MY 2CENTS ADD UP TO?

If one steps back to look at what the biggest players in the crypto-blockchain space are doing, what you see is accelerating adoption outside the U.S., particularly in Asia.

Crypto is thriving in China, even as the government works out its regulatory scheme. Japan now recognizes cryptocurrencies as valid means of payment (as long as they are registered with the government). Blockchain is finding new applications in financial markets in Japan and India. South Korea has done a u-turn and is trying to figure out how to regulate and tax its booming crypto markets.

I cut my teeth as a trader during the telecom and Internet boom of the 1990’s and the spirit of adoption across the Pacific reminds me of what I heard from telecom analyst in the 1990s about Latin America. While analysts were busy assessing the potential expansion of landline systems by traditional telcos, Latin American consumers were busy leapfrogging legacy technologies in favor of mobile phones.

The U.S. has a highly efficient legacy banking and payments system. So I don’t see it as a mystery why crypto-blockchain adoption has been slower here. At the same time, it also should not be surprising that savvy Asian consumers are ahead of the curve on adoption, particularly in areas where it enables them to leapfrog outmoded legacy systems.

The key message here: global adoption is accelerating, but if you’re only looking at the U.S., you’re going to miss that story.

Looking at the entire global picture, the story is one of growth—in the overall ecosystem, the diversity of applications that reside there, and the value they may create for consumers, businesses and investors.

This blog is intended for information purposes only and does not constitute investment advice. The blog contains the opinions of Brian Kelly.

1 A cryptocurrency (crypto) is a digital currency typically utilizing a Blockchain system for transaction records and cryptography for security. The major differentiator from physical currency is it isn’t issued by a central authority and thus theoretically acts independently of traditional banking and government influence. A crypto-asset would be holding a certain amount of cryptocurrency, or a derivative for which value is driven by the price of an underlying cryptocurrency.

3 Blockchain is a decentralized, digitally disseminated ledger of data. The basis of a successful blockchain system is once a new group of information, or “block”, is added, the information automatically disseminates and is downloaded to each computer on the network. This assures that a single computer could not change information on a block: it would be overruled by a consensus of all the other computers on the network. This process renders all information on a completed block decentralized and theoretically permanent.

2,4 Ripple and Ethereum are two individual cryptocurrency networks.

Ripple.com: Ripple provides one frictionless experience to send money globally using the power of blockchain. By joining Ripple’s growing, global network, financial institutions can process their customers’ payments anywhere in the world instantly, reliably and cost-effectively. Banks and payment providers can use the digital asset XRP to further reduce their costs and access new markets.

Ethereum.org: Ethereum is a decentralized platform that runs smart contracts: applications that run exactly as programmed without likely downtime, censorship, fraud, or third-party interference. These apps run on a custom built blockchain, a shared global infrastructure that can move value around and represent the ownership of property.

Sources that inspired this entry:

https://www.forbes.com/sites/ralphjennings/2018/05/17/how-china-pulled-ahead-of-the-u-s-in-patent-applications-for-new-technology/#55d070c26048

https://www.infosys.com/newsroom/press-releases/Pages/pioneers-blockchain-based-trade-network.aspx

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A New Kind Of Trans-Pacific Partnership?

Brian Kelly, Portfolio Manager

South Korea and China Warming To Crypto-Blockchain

Asian market could be huge drivers of crypto1-blockchain2 adoption in the coming years, if recent events are any indication.

First, take South Korea, a burgeoning hub of activity: about 30% of salaried workers are crypto investors; the country accounted for one-third of ether-based transactions3 just last summer; and by the fall it had surpassed China in overall crypto trading. Then regulators cracked down: banning securities firms from handling bitcoin futures, imposing new capital controls on crypto-exchanges, and banning anonymous accounts. Rumors even swirled about banning initial coin offerings4 (ICOs). Crypto market tumbled on the news.

But an enormous popular backlash forced the government into a u-turn. Now it seeks to “normalize” cryptocurrencies and is even proposing a taxation scheme to begin in 2019. Two of South Korea’s largest commercial banks have each launched partnerships aimed at building crypto-based payments systems.

Second, consider China, where top mining pools control more than half the global hashrate5 for bitcoin. Despite its crackdown on crypto markets, the government recently announced its backing for a $1.6 billion blockchain development fund. Chinese tech giants Tencent, Alibaba, and Baidu are battling to lead in the blockchain space. And while central bank governor Yi Gang remains skeptical about cryptocurrencies, he is “exploring a better way for digital currency to play a more active role in service to the real economy.” And just this month the bank affirmed that cryptocurrency R&D was a “top priority.”

It’s hard to imagine China, given its competitive nature, ceding crypto markets to regional leaders Korea and Japan. A more likely scenario is that China finds some sort of regulatory scheme that enables crypto-adoption, but with strict government control.

Macro Factors Supportive for Crypto Growth

Negative Sentiment Potentially Creates Opportunity For Investors

The trends taking shape across Asia point to the early stages of a mass adoption trend—among billions of potential users around the world.

What does that mean for valuations? JPMorgan seems to think it’s a bad thing, telling investors they should be worried, for example, that 20% of chipmaker AMD’s revenue could be driven by crypto markets. (Cryptocurrency “miners” rely almost exclusively on graphics cards made by AMD and its key competitors.)

Since when does leading an enormous potential growth market translate into a negative? When the market believes that the growth is unsustainable. That’s JPMorgan’s view, and that pessimism may be weighing on AMD’s stock price.

Yet, mass adoption trends are only looking stronger as time goes on. The danger here is that investors betting against crypto-driven earnings growth could get caught wrong-footed when sentiment reverses, as I believe it will once mass adoption gains even more steam.

Here is a back-of-the envelope calculation of what mass adoption could look like for cryptocurrencies. Back in April, Tim Draper forecast a bitcoin price of $250,000, and while that may sound outrageous, consider6:

  • From a macro viewpoint, a currency’s market cap generally grows to whatever size is required to support the underlying economy.
  • The most compelling use case for cryptocurrencies is that they become the de-facto monetary standard for the rapidly developing Internet of Things (IoT).
  • How big, potentially, is the IoT? John Chambers estimated that the market could be as large as $19 trillion. Roughly the same size as the entire U.S. economy.
  • If we look at the monetary base supporting America’s current GDP of $18.6 trillion, it’s about $3 trillion.
  • Using that as a baseline market cap for bitcoin, one could back into a figure in the mid-$200,000s6.

WHAT DOES MY 2 CENTS ADD UP TO?

If you are an investor, you generally fall into one of two categories. You invest in things that don’t change, or you invest in things that do. (Sometimes both.)

Famed value investor Warren Buffett recently called cryptocurrencies “rat poison.” But consider his frame of reference. To quote Buffett himself: “[My] approach is very much profiting from lack of change rather than from change.” He buys established companies with slow, steady growth that may compound over the long term, things like: Wrigley’s Chewing Gum, GEICO insurance, Seas Candies, Southwest Airlines, etc.

That’s why he hates crypto-assets.

By contrast, I’m a macro investor who invests in things that do change. And I have found that, when those things are misunderstood, that’s where investors may find the highest potential returns. Don’t forget that just a year ago Buffett admitted he “blew it” by not investing in Google and Amazon during their early days.

So in conclusion, let’s consider another Buffett quote: “Games are won by players who focus on the playing field –- not by those whose eyes are glued to the scoreboard.”

My view is that Mr. Buffett is obsessed with the scoreboard of speculation—i.e., what the hot money is doing in the crypto-blockchain space. That’s not what I’m focused on at all.

I’m focused on the playing field: a nascent digital IoT marketplace, potentially worth $19 trillion or more, which is in the midst of creating a new type of monetary standard. This diverse, digital ecosystem is showing signs of rapid growth. And many different types of coins may have a place in this ecosystem, with overall cryptocurrency growth supported by interoperability among all of them.

It is not a winner-take-all scenario, in my view. Bitcoin probably won’t be the only winner. There could be plenty of winners as this new world unfolds—among cryptocurrencies, hardware makers, and businesses that learn to capitalize on the blockchain.

It’s only “rat poison” if your investment philosophy is based on optimizing the status quo. For those of us who invest in change, it’s called “opportunity.”

This blog is intended for information purposes only and does not constitute investment advice. The blog contains the opinions of Brian Kelly.

Sources that inspired this entry:

https://qz.com/1166103/a-third-of-south-korean-workers-have-invested-in-cryptocurrencies-like-bitcoin/

https://www.forbes.com/sites/elaineramirez/2018/02/28/facts-and-myths-surrounding-crypto-in-south-korea-death-taxes-and-bans/#10e9f6ec57e4

https://cointelegraph.com/explained/south-korea-and-crypto-regulations-explained

https://www.csmonitor.com/Business/2013/0830/Warren-Buffett-10-pieces-of-investment-advice-from-America-s-greatest-investor/It-s-far-better-to-buy-a-wonderful-company-at-a-fair-price-than-a-fair-company-at-a-wonderful-price

https://www.goodreads.com/quotes/1140603-games-are-won-by-players-who-focus-on-the-playing

1 A cryptocurrency (crypto) is a digital currency typically utilizing a Blockchain system for transaction records and cryptography for security. The major differentiator from physical currency is it isn’t issued by a central authority and thus theoretically acts independently of traditional banking and government influence. A crypto-asset would be holding a certain amount of cryptocurrency, or a derivative for which value is driven by the price of an underlying cryptocurrency.

2 Blockchain is a decentralized, digitally disseminated ledger of data. The basis of a successful blockchain system is once a new group of information, or “block”, is added, the information automatically disseminates and is downloaded to each computer on the network. This assures that a single computer could not change information on a block: it would be overruled by a consensus of all the other computers on the network. This process renders all information on a completed block decentralized and theoretically permanent.

3 Ether-based transactions are transfers of the ‘Ether’ cryptocurrency on the Ethereum network. The Ethereum network is a decentralized platform built on blockchain technology. For more information visit: www.ethereum.org.

4 An Initial Coin Offering (or ICO) is similar to an Initial Public Offering of a stock, where a specific cryptocurrency is offered to the public for the first time.

5 Hashrate refers to the total computing power thrown at a particular cryptocurrency network. For example, the more computing power dedicated to mining for Bitcoin, the higher the Bitcoin network’s hashrate.

6 Neither REX Shares nor Brian Kelly are endorsing this specific price target or methodology for valuing cryptocurrencies, instead these are discussion topics brought up by others. The BKC fund does not directly invest in Bitcoin at this time, however it may be subject to some of the risks associated with price movements of cryptocurrencies. Please review the prospectus for further disclosures of risk.

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BIG AUTO THROWS DOWN THE GAUNTLET

Brian Kelly, Portfolio Manager

In a potential tectonic shift, industry heavyweights form a blockchain alliance

Last week, four of the world’s largest automakers (Ford, GM, BMW and Renault) launched a blockchain1 alliance that could represent a tectonic shift, not just in the adoption of blockchain tech, but also in the race to lead the next iteration of the “automobile” industry.

The short version is that the new working group—called the Mobility Open Blockchain Initiative (MOBI)—is aiming to put blockchain tech into your car, for use cases as diverse as vehicle identity and ownership, ridesharing, payments, navigation, insurance, and many others. But while the group was founded by four automakers, it’s also open to energy companies, infrastructure providers, and public transportation providers, potentially expanding the connectivity of automobile-based blockchains to a much larger transit network.

Another important development is that MOBI is looking to create standards for data to have property rights. Legacy tech players like Apple and Google are vying to get the data you produce in your car so that they can aggregate and monetize it—never mind their efforts to actually design and build the next generation of cars. MOBI potentially represents an end-run around the programs of legacy tech leaders, making customers’ data self-sovereign and giving consumers control over data property rights associated with transportation.

Why is this potentially a tectonic shift? Because it has the potential to disrupt the growth plans of legacy tech into the auto sector.

A New Cornerstone Laid in Fin-Serv?

Crypto-Custody Solutions on the Horizon for Institutions

The New York Times reported last week that Intercontinental Exchange (ICE), parent company of the New York Stock Exchange, is planning to open a digital currency exchange where institutional investors can buy, trade and hold bitcoins. Included in the plan would be one-day swaps2 contracts that “end with the customer owning Bitcoin the next day — with the backing and security of the exchange.”

Why is this another potential tectonic shift in the crypto-blockchain space? Because any program that enables institutions to hold digital tokens has to include a custody solution, a challenge that has until now eluded the industry.

One of the key roadblocks to institutional participation in trading and owning crypto3-assets has been the lack of custody solutions—which, for institutional fiduciaries, would run afoul of all kinds of investment, risk management and compliance mandates. Putting a viable custody solution in place would bring institutions one giant step closer to being able to trade crypto-assets in client accounts.

Where will the next shoe drop? Well, investors should be keeping an eye on the biggest players in the custody business—BNY Mellon, State Street and JPMorgan being the mightiest of them all. (It was revealed last week that, despite Jamie Dimon’s public disdain for Bitcoin, JPMorgan filed a patent for a blockchain-based settlement technology. Could his resistance to crypto be wavering?)

If one of the big custody players were to announce a comprehensive custody solution for crypto-assets, that would be another tectonic shift. Stay tuned.

WHAT DOES MY 2 CENTS ADD UP TO?

One has to think about the adoption of these new technologies in geologic terms. As the tectonic plates of a new continent begin to form, cool, and shift into place, there will be moments when things potentially change in a big way, very fast. That’s how I look at the MOBI and ICE developments.

Resistance, however, is still firm among many legacy players. Last week, the well-known research company Gartner Group published the results of a Chief Information Officer (CIO) survey, showing that only 22% of CIOs plan on using blockchain technology. Gartner concluded that the technology is “massively hyped.”

For investors this is potentially good news, as it may actually support today’s crypto-blockchain investment thesis. One of the biggest mistakes an investor can make is to wait for a change in sentiment, and for the skeptical herd to suddenly pile into a new market. That’s when investors are most at risk of buying at the top.

It makes me think of a quote from the President of Michigan Savings Bank when asked about investing in Ford Motor Corp. in 1903: "The horse is here to stay, but the automobile is only a novelty, a fad." Blockchain and crypto skeptics are ignoring a technology potentially even more revolutionary than the automobile was in 1903.

And yet, that skepticism is predictable. When you ask legacy providers about bleeding-edge new tech, you get a legacy point of view, defending a legacy business model. The most telling quote of the Gartner press release says: “[Blockchain] therefore implies that traditional lines of business and organization silos can no longer operate under their historical structures.”

Exactly. That’s the opportunity MOBI and ICE are pursuing. That is the evolving world just now taking shape. And who knows what kinds of vibrant ecosystems will be built atop these new continents?

Currently, the skeptical herd is still looking back over its shoulder—believing that “historical structures” will last forever. I believe that forward-thinking investors would be wise not to make that same mistake.

This blog is intended for information purposes only and does not constitute investment advice.

1 Blockchain is a decentralized, digitally disseminated ledger of data. The basis of a successful blockchain system is once a new group of information, or “block”, is added, the information automatically disseminates and is downloaded to each computer on the network. This assures that a single computer could not change information on a block: it would be overruled by a consensus of all the other computers on the network. This process renders all information on a completed block decentralized and theoretically permanent.

2 A swap contract is an agreement between two parties to exchange financial instruments at specified periods of time. Most swaps involve cash flows based on a notional principal amount based on a benchmark rate or index price. For example one party may swap cash for an asset with promise to swap back at a later time at a specified price or a floating price based on an index.

3 A cryptocurrency is a digital currency typically utilizing a Blockchain system for transaction records and cryptography for security. The major differentiator from physical currency is it isn’t issued by a central authority and thus theoretically acts independently of traditional banking and government influence. A crypto-asset would be holding a certain amount of cryptocurrency, or a derivative for which value is driven by the price of an underlying cryptocurrency.

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BLOCKCHAIN COMES TO BENTONVILLE

Brian Kelly, Portfolio Manager

Skeptics miss the big story: Adoption of blockchain technology is happening faster and more broadly than most people realize

A few weeks ago, a Walmart executive in charge of food safety told an MIT conference that he’d had a “religious conversion” on blockchain technology. It was a watershed moment—or should have been—for people who still believe that blockchain is something to worry about for the future. The thinking goes: “Gee isn’t it neat that people will be able to use this someday to do great things.”

Well, blockchain is not some future tech we have to wait for. It’s happening right now, even in Middle America. Companies are using it to reshape their businesses: Walmart is pushing food suppliers to get on the blockchain train, to “help reduce waste, better manage contamination cases, and improve transparency,” according to Bloomberg.

At the same time, some companies are making moves toward blockchain but missing the point of it—accidentally, or maybe on purpose. Sony filed a patent application for cloud-based locker technology, looking to solve its digital rights management challenges. Problem is, Sony’s approach was not borne of the open-source mantra underpinning the technology. The whole point of blockchain is that users don’t need a centralized third party to run things.

Sony’s new approach may be a way to defend their brand and revenue model—and still reap the lion’s share of money generated by creative content. But it still represents the old way of doing things. A truly decentralized platform would allow artists to post new work to a global network, while independently tracking their rights and revenue all the way through the system. In a truly blockchain-driven world, artists wouldn’t need Sony any more. (They might not even need copyrights, but that’s a topic for a future post.)

Laggards and skeptics beware: Blockchain is coming. It’s happening fast. Infrastructure plays and applications (like Walmart’s) may offer the most promise for businesses and investors. On the other hand, if you’re using blockchain to defend your position as a middleman in a fracturing world, it likely won’t work very long, if at all.

EARLY INNINGS IN THE LIFE OF BITCOIN

Volume is Growing as Adoption Ramps Up

Within about 12 months from now, 20% of the financial services clients on Thompson Reuters’ data and trading platforms will likely have implemented crypto trading programs—according to a company survey. That’s just a small example of the growing appetite for cryptocurrencies from established fin-serv players.

As another example, take Goldman Sachs, a leader and innovator in many investment markets. Goldman is ramping up its crypto capabilities by hiring a dedicated trader. It’s a move that, in my view, will spark interest, and activity, among many big players on “The Street.” Why? Two years ago Goldman backed the crypto-exchange start-up Circle Financial when very few big firms would consider touching it. Then suddenly, after Goldman moved, everybody wanted in. This new move puts establishment types on notice that not only is crypto here to stay, it’s an opportunity to be taken seriously.

There’s also evidence of crypto’s momentum in the explosion of activity on crypto exchanges big and small. Bitcoin futures quintupled in volume over the course of April. Seattle-based Bittrex, one of the world’s largest alt-coin exchanges, reopened in April 2018 after being shut to new investors for about four months due to high demand—except that upon reopening, demand was so high it had to hit pause again, after less than 24 hours!

A new app—Robinhood—a stock investing app for millennials, launched crypto-investing capabilities with great fanfare and built a waitlist of 1 million potential customers, within 4 days! If big players in the advisory/trading/custody business (think: Schwab, E-Trade, Merrill) are not looking at this technology, they may be losing out on engaging and attracting the next generation of investors.

WHAT DOES MY 2 CENTS ADD UP TO?

Skeptics continue to bash blockchain, and especially digital currencies, as a “bubble already popping.” But in truth, both represent brand new technologies that solve a lot of problems: they are finding new applications every day; they continue to expand their reach, justify their economic value, and find new customers.

Now, one thing they certainly don’t do is eliminate human fear and greed, which can play a big role in market behavior.

Just as with any new market, these technologies may go through booms and busts as they gain their footing and create new economic niches. (As of this writing, Bitcoin is on the march again, breaking through a technical resistance point of $9,000 at the end of April.1 And when prices rallied, short sellers got crushed.) In the end, I believe these technologies have the potential to serve as global hub for all kinds of financial activity, and we have not even scratched the surface of their potential.

It’s far too early to call this game.

1 Bitcoin performance does not represent the Fund. The Fund does not invest directly in Bitcoin. The Fund may invest in Bitcoin indirectly by investing in the Bitcoin Investment Trust ("GBTC").

This blog is intended for information purposes only and does not constitute investment advice.

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© REX Shares LLC 2018

  REX SHARES  

Exchange Traded Concepts, LLC serves as the investment advisor and Vident Investment Advisory & BKCM Funds, LLC serve as sub advisors to the fund. The Funds are distributed by Foreside Fund Services, LLC., which is not affiliated with Exchange Traded Concepts, LLC or any of its affiliates.

Shares are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. REX NAVs are calculated using prices as of 4:00 PM Eastern Time. The closing price is the Mid-Point between the Bid and Ask price as of the close of exchange. In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. In emerging markets, these risks are heightened, and lower trading volumes may occur. Investments in smaller companies typically exhibit higher volatility.

Carefully consider the Funds' investment objectives, risk factors, charges and expenses before investing. This and additional information can be found in the Funds' summary and full prospectuses, which may be obtained by calling 1-844-REX-1414. Read the prospectus carefully before investing.

There is little regulation of cryptocurrency and blockchain technology other than the intrinsic public nature of the blockchain system. Any future regulatory developments could affect the viability and expansion of the use of cryptocurrency and blockchain technology. Cryptocurrency and blockchain technology systems may operate across many national boundaries and regulatory jurisdictions; therefore, cryptocurrency and blockchain technology may be subject to widespread and inconsistent regulation.

Currently, there are few public companies where blockchain technology represents an attributable and significant revenue stream. Blockchain technology may never develop optimized transactional processes that lead to increased realized economic returns to any company in which the fund invests.

Generally, cryptocurrency and blockchain technology is not a product or service that provides identifiable revenue for companies that implement or otherwise use it. Therefore, the values of the stocks in which the fund will invest may not be a reflection of their connection to cryptocurrency and blockchain technology, but may be based on other business operations.

Cryptocurrency Risk. By virtue of the Fund’s investment in stocks that derive revenue from cryptocurrency-related activities, shareholders may be exposed indirectly to the risks of cryptocurrencies. Cryptocurrencies are extremely new and nontraditional assets and a potential shareholder’s ability to evaluate the performance of cryptocurrencies be limited. Digital assets, represented on a decentralized public transaction ledger that is maintained by an open source protocol, are substantively different from traditional assets and investments. Because if the complex nature of cryptocurrency, an investor in the Fund may face numerous material risks that may not be present in other investments. Current IRS guidance indicates that digital assets such as cryptocurrencies should be treated and taxed as property, and that transactions involving the payment of cryptocurrency for goods and services should be treated as barter transactions. This treatment may create a potential tax reporting requirement in any circumstance where the ownership of a cryptocurrency passes from one person to another.

Blockchain Technology Risk. The stocks in which the Fund will invest will be subject to the risks associated with blockchain technology, which is a new and relatively untested technology. The risks associated with blockchain technology may not emerge until the technology is widely used. Blockchain systems could be vulnerable to fraud, particularly if a significant minority of participants colluded to defraud the rest. Access to a given blockchain requires an individualized key, which, if compromised, could result in loss due to theft, destruction or inaccessibility.

An investment in the Fund in is subject to risks including loss of principal. There can be no assurance the Fund will achieve it's investment objectives. The Fund can be more volatile than broad market averages. Additional risks for the Fund include: emerging markets risk, foreign securities risk, geographic risk, geopolitical risk, liquidity risk, non-diversification risk, technology risk, and valuation risk. For a complete description of these risk please read the prospectus carefully.