Abstract: In this piece on economics, we look at misconceptions with respect to how banks make loans and the implications this has on the ability of banks to expand the level of credit in the economy.  We analyze the inherent properties of money which ensure that this is the case and the impact this could have on the business cycle.

Dynamics of Credit Expansion

The core characteristic of the traditional banking system and modern economies, is the ability of the large deposit taking institutions (banks) to expand the level of credit (debt) in the economy, without necessarily needing to finance this expansion with reserves.

An often poorly understood point in finance, is the belief that banks require reserves, liquidity or “cash”, in order to make new loans. After-all where do banks get the money from? It is true that smaller banks and some financial institutions do need to find sources of finance to make new loans. However, in general, this is not the case for the main deposit taking institutions within an economy.

If a main deposit taking institution, makes a new loan to one of their customers, in a sense this automatically creates a new deposit, such that no financing is required.  This is because the customer, or whoever sold the item the loan customer purchased with the loan, puts the money back on deposit at the bank.  Therefore the bank never needed any money at all. Indeed there is nothing else people can do, the deposits are “trapped” inside the banking system, unless they are withdrawn in the form of physical notes and coins, which rarely happens nowadays.

Please consider the following simplified example:

1. A large bank, JP Morgan, provides a mortgage loan to a customer, who is buying their first home, for $500,000
2. JP Morgan writes a check to the mortgage customer for $500,000
3. The mortgage customer deposits the check into his deposit account, at JP Morgan
4. The mortgage customer writes a new check, for $500,000 and he hands it over to the seller of the property
5. The seller is also banking client of JP Morgan and as soon as she receives the check, she deposits it into her JP Morgan bank account

Illustrative diagram of a new home mortgage with one dominant bank in the economy

As one can see, the above process had no impact on the bank’s liquidity or reserves, the bank never had to spend any “cash” at any point in the above example. Of course, the seller of the property does not necessarily have to have an account with the same bank as the one which provided the loan.  However large deposit taking institutions, such as JP Morgan, HSBC or Bank of America, have large market shares in the deposit taking business, in their local markets.  Therefore, on average, these large banks expect more than their fair share of new loans to end up on deposit at their own bank. Actually, on average, new loans in the economy actually increases the liquidity for these large banks, rather than decreasing it.

The accounting treatment of this mortgage, for the bank, is as follows:

• Debit: Loan (asset): $500,000
• Credit: Deposit (liability): $500,000

The bank has therefore increased its assets and liabilities, resulting in balance sheet expansion.  Although from the point of view of the home seller, she has $500,000 of cash.  The above transaction has increased the amount of loans and deposits in the economy. From the customer’s point of view, these deposits are seen as “cash”. In a sense, new money has been created from nothing, apart from perhaps the asset, which in this case is the property.  In the above scenario, M0 or base money, the total value of physical notes and coins in the economy, as well as money on deposit at the central bank, remains unchanged.  M1, which includes both M0 and money on deposit in bank accounts, has increased by $500,000.  Although the precise definition of M1 varies by region.

Cash reserves from the point of view of a bank are physical notes and coins, as well as money on deposit at the central bank.  The ratio between the level of deposits a bank can have and its reserves, is called the “reserve requirement”.  This form of regulation, managing the reserve requirement, leads to the term “fractional reserve banking”, with banks owing more money to deposit customers than they have in reserves. However, contrary to conventional wisdom, in most significant western economies, there is no regulation directly limiting the bank’s ability to make these loans, with respect to its cash reserves.  The reserve requirement ratio typically either does not exist, or it is so low that it has no significant impact.  There is however a regulatory regime in place that does limit the expansionary process, these are called “capital ratios”. The capital ratio, is a ratio between the equity of the bank and the total assets (or more precisely risk weighted assets). The bank can therefore only create these new loans (new assets) and therefore new deposits (liabilities), if it has sufficient equity.  Equity is the capital investment into the bank, as well as accumulated retained earnings.  For example if a bank has $10 of equity, it may only be allowed $100 of assets, a capital ratio of 10%.

The credit cycle

To some extent, the dynamic described above allows banks to create new loans and expand the level of credit in the economy, almost at will, causing inflation. This credit cycle is often considered to be a core driver of modern economies and a key reason for financial regulation. Although the extent to which the credit cycle impacts the business cycle is hotly debated by economists.  These dynamics are often said to result in expansionary credit bubbles and economic collapses. Or as Satoshi Nakamoto described it:

Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve

Ray Dalio, the founder of Bridgewater Associates (a leading investment firm), appears to agree that the credit cycle is a major driver of swings in economic growth, at least in the short term, as his video below explains:

The view that the credit cycle, caused by fractional reserve banking, is the dominant driver  of modern economies, including the boom and bust cycle, is likely to be popular in the Bitcoin community.  This theory is sometimes called Austrian business cycle theory, although many economists outside the Austrian school also appreciate the importance of the credit cycle.

However, there are alternative views.  For example another successful investment firm, Marathon Asset Management, identifies the “capital cycle” as the main driver of the business cycle, rather the credit cycle.  In their view a cycle emerges with respect to investment in production, as the below diagram illustrates.

The capital cycle

Source: Capital Account

The fundamental cause of the credit expansionary dynamic

The above dynamic of credit expansion and fractional reserve banking, is not understood by many. However, with the advent of the internet, often people on the far left politics, the far right of politics or conspiracy theorists, are becoming partially aware of this dynamic, perhaps in an incomplete way. With the “banks create money from nothing” or “fractional reserve banking” narratives gaining some traction. The question that arises, is why does the financial system work this way?  This underlying reasons for this, are poorly understood, in our view.

Individuals with these fringe political and economic views, may think this is some kind of grand conspiracy by powerful elite bankers, to ensure their control over the economy. For example, perhaps the Rothschild family, JP Morgan, Goldman Sachs, the Bilderberg Group, the Federal Reserve or some other powerful secretive entity deliberately structured the financial system this way, so that they could gain some nefarious unfair advantage or influence? Actually, this is not at all the case.

The ability of deposit taking institutions to expand credit, without requiring reserves, is the result of inherent characteristics of the money we use and the fundamental nature of money. This is because people and businesses psychologically and for very logical practical reasons, treat bank deposits in the same way as “cash”, when they could alternatively be considered as loans to the bank. This enables banks to then expand the amount of deposits, knowing they are safe, as customers will never withdraw it, since they already think of it as cash.

Bank deposits are treated this way for perfectly reasonable and logical reasons, in fact bank deposits have some significant advantages over physical cash. Bank deposits are simply much better than physical cash.  It is these inherent and genuine advantages that cause fractional reserve banking, not a malicious conspiracy, as some might think.

Advantages of bank deposits compared to physical notes and coins

Abstract: In this piece we look at why Bitcoin might have some unique combinations of characteristics, compared to traditional forms of money.  We examine the implications this could have on the ability of banks to engage in credit expansion.

The main features of the different types of money

Despite the strong advantages of bank deposits mentioned in part 1 of this piece, namely the ability to use it electronically, physical notes and coins do have some significant benefits over electronic money.  The following table aims to summarize the main features of the different types of money, bank deposits, physical cash and Electronic Cash (Bitcoin).

Features of electronic bank deposits, physical notes & coins and electronic cash

Feature	Bank deposit	Physical cash	Electronic Cash
Advantages of physical cash
Funds are fully protected in the event the bank becomes insolvent or inaccessible*
It is difficult for the authorities to confiscate funds
Funds can be effectively hidden from the authorities
Transactions cannot easily be blocked
Transfers can be highly anonymous
Transfers can be irrevocable
Transfers can occur instantly	?		?
Payments can occur 24×7	?
Transaction fees are zero	?
Payments work during power outages or when communication networks are down
Money can be used without purchasing or owning a device
Anyone can use the system, without seeking permission
Advantages of electronic systems
Payments can be made over the internet
Change does not need to be calculated
Payments can easily be recorded
Funds can easily be secured to prevent theft			?

Note: * Physical cash still has a potential problem with respect to the solvency, related to the policy of the central bank which issues the currency

Due to the strengths mentioned in the above table, physical cash will always have its niche use cases. However, on balance, banking deposits are superior to physical cash, for the majority of users.  The ability to use bank deposits electronically is particularly compelling, especially in the digital age.  As we explained in part one of this piece, it is this ability to use the money electronically that ensures there is always high demand for bank deposits, giving banks the ability to freely expand the level of credit.

The unique properties of Bitcoin

Bitcoin shares many of the advantages of physical cash over electronic bank deposits.  Although Bitcoin does not have the full set of advantages, as the table above demonstrates.  However the key unique feature of Bitcoin, is that it has both some of the advantages of physical cash and the ability to be used electronically.

Bitcoin aims to replicate some of the properties of physical cash, but in an electronic form, an “electronic cash system”.  Before Bitcoin, people had to make a binary choice, between physical cash or using a bank deposit.

Although technically physical cash is a kind of a bank deposit, a deposit at the central bank, physical cash still has unique bearer type properties which could not be replicated in an electronic form.  For the first time ever, in 2009, Bitcoin provided the ability to use a bearer type asset, electronically.  The the simple table below illustrates this key unique feature of Bitcoin and blockchain based tokens.

The binary choice in legacy finance & the new option Bitcoin provides

	Bearer type instrument	Electronic type instrument
Physical Cash (Notes & Coins)
Electronic money (Bank Deposit)
Electronic Cash (Bitcoin)

Therefore Bitcoin can be thought of as a new hybrid form of money, with some of the advantages of physical cash, but also some of the advantages of bank deposits.

Bitcoin’s limitations

Although Bitcoin has inherited some of the strengths of both traditional electronic money systems and physical cash.  Typically Bitcoin does not have all the advantages of either electronic money or physical cash, however it is uniquely positioned to be able to have subset of the features of each.  This provides a new middle ground option.

For example, Bitcoin may never have the throughput of traditional electronic payment systems or the ability to use without electricity such as with physical cash.  Although as technology improves, Bitcoin may slowly develop more strengths and gradually improve its capabilities, to narrow the gap.

The implications of these characteristics on credit expansion

Understanding the dynamics of these characteristics, can be useful in evaluating the potential economic significance of Bitcoin, should the ecosystem grow. Bitcoin has at least six properties which provide some level of natural resilience against credit expansion, which traditional money does not have. This is because the advantages of keeping money on deposit at a bank are not always as pronounced in Bitcoin, compared to the alternatives.  However, Bitcoin is certainly not immune to the same credit expansionary forces which exist in traditional systems, indeed people can keep Bitcoin on deposit at financial institutions just like they can with physical cash.  Bitcoin may merely have greater resistance to the same credit expansionary forces.

At the core of our reasoning, is looking the advantages of bank deposits compared to physical cash, which are the characteristics that enable large banks to freely expand credit and evaluating to what extent they apply in Bitcoin.  As the table below shows, the advantages of keeping money on deposit at a bank are less significant in the Bitcoin world, therefore we think Bitcoin does have some unique resilience against the forces of credit expansion.

Physical cash vs bank deposits compared to Bitcoin vs Bitcoin deposits

The economic consequences of less credit expansion

The consequences of the lower level of credit expansion this analysis implies, does not really say much about whether this potentially new economic model will be more beneficial to society, nor does it say much about whether Bitcoin will be successful or not. The former is something that has been heavily debated by economists for decades and the latter is a separate topic, in our view.  Although, despite decades of economic debate, perhaps Bitcoin is sufficiently different to the money which came before it, such that the debate is required again, with new very different information.  For example inflation  or deflation, caused by cycles of credit expansion, may have very different consequences in a Bitcoin based financial system, than on one based on bank deposits and debt.  A key problem with deflation in a debt based money system, is that it increases the real value of debt, resulting in a downwards economic spiral.  For non debt based money systems like Bitcoin, it is less clear what the implications of deflation are.

Although Bitcoin may not necessarily result in a superior economic model, we think this analysis may suggest that Bitcoin may have some properties that make the economic model somewhat unique or perhaps interesting, compared to the possible models that came before it.  Therefore it does look like an area worth examining.

To many, the ultimate objective of Bitcoin is to become sufficiently dominant, such that there is a significant decrease in credit expansionary forces, which can neutralize the credit cycle and therefore the business cycle.  Although, this should be considered as an extremely ambitious objective, which we consider as extremely unlikely.  And even in the remarkable circumstance that Bitcoin grows to this scale, other  unforeseen economic problems, particular to Bitcoin, may emerge.

Abstract: The upcoming SegWit2x hardfork lacks replay protection.  In this piece we look at what you can do to protect yourself, by analyzing various ways you could split your coins.

Overview

SegWit2x (B2X) is a proposal to double Bitcoin’s capacity limit. This is an increase in the maximum block weight to 8MB from 4MB.

The upgrade is an incompatible with Bitcoin’s current consensus rules (known as a hardfork), which means it is likely to result in a new coin, such that Bitcoin holders prior to the fork will receive both original Bitcoin (BTC) and SegWit2x coin (B2X) after the fork. In many ways this is similar to the recent Bitcoin Cash hardfork (also an increase in the blocksize limit to 8MB). A key difference is that unlike Bitcoin Cash, B2X does not include strong transaction replay protection. Therefore many users could lose funds, on the other hand, those that do successfully protect their funds could make positive investment returns.

The hardfork is expected to occur on around Saturday 18th November 2017. (Block number 494,784)

Why bother splitting?

The SegWit2x split will result in two coins, the existing Bitcoin (BTC) and a new “spin-off” coin SegWit2x (B2X). This is likely to lead to significant price volatility, which may present investment opportunities. Due to the lack of replay protection, whatever your view on the situation or your investment strategy, it is sensible to split your coins as soon as possible, to ensure as much flexibility as possible and also to protect your coins.  Many users are likely to intend to send only one of the two coins in a transaction, but accidentally send both, which may result in an irrecoverable loss of funds.  If you do not split, you could be one of these users incurring losses.

Unfortunately the lack of strong replay protection may also present an opportunity for scammers/attackers. For example scammers could repeatedly deposit and withdraw from exchanges, hoping to find any weaknesses. If any exchange has not implemented replay protection, attackers are likely to exploit this quickly, which could make the exchange insolvent. In addition to this, individual users could be targeted by scammers. Scammers could sell the victim Bitcoin, knowing their wallet is following the wrong chain or scammers could acquire Bitcoin from a victim who is expected to replay coins on both chains to the buyer.

These kind of losses and attacks could damage the reputation of the ecosystem, therefore a contentious hardfork without strong replay protection is a high risk event with potentially significant negative consequences. However, there are actions you can take to protect yourself.

Splitting your coins

When the hardfork occurs, your Bitcoin will exist separately on both chains BTC & B2X, in the same output. Since the B2X hardfork does not contain transaction replay protection enabled by default, when spending your coins, in either chain, the transaction could be replayed on the other chain.  Therefore the prudent thing to do is split your coins, so that your BTC and B2X exist on different outputs on each chain, which means that your transactions can no longer be replayed.

Unfortunately this is not a simple process and many people are unlikely to be able to achieve this. You cannot split your coins prior to the hardfork, however a prudent strategy may be to prepare how you plan to split beforehand, for example moving your coins to a different wallet before the split occurs. For many users this is not likely to be easy, however if you act fast, there could be investment rewards, if you are able to sell the spin-off coin before others have a chance to do so.

Which wallets to use

In order to split your coins, you would either need to manually construct your own transactions or use two wallets, one for BTC and one for B2X, since most wallets will not allow you to broadcast two conflicting transactions. You will then need two separate wallets, to receive the coins on each side of the split.

Unfortunately two full node wallets are likely to be necessary to protect your coins, for example Bitcoin Core for BTC and BTC1 for B2X. A full node wallet means it verifies all the consensus rules on the entire blockchain. Two fully verifying nodes may be needed because:

• On the BTC side you may need a wallet that enforces the 4 million unit weight limit (which B2X plans to breach), and;
• On the B2X side you need a wallet that enforces the coin wipeout protection rule, which requires non witness data in the first B2X block to be greater than 1MB.

You need to ensure each respective wallet enforces each of these rules, to make sure your wallets does not follow a different chain to the one on which your coins are located on.  Otherwise your coins could disappear from your wallet.

In order to prudently prepare for the hardfork, it might be a good idea to run full nodes of each client on a separate computer. The syncing process can take several days, therefore perhaps you could start to run the nodes before the fork, as you may want to be ready to split your coins and spend them as soon as possible.

The splitting methods

Method 1: The trial and error approach

The most basic way of splitting is to run a BTC client and a B2X client, import your private keys, and then try to send your coins to yourself, to two different outputs on each chain. Either both transactions confirm, in which case you succeeded, or the same transaction occurs on both chains, and you simply try again.

The trouble with this method is that it could be expensive, in terms of both time and money. Many people may try this approach and therefore network congestion could be high, and the more failed attempts occur the more one needs to pay in fees. In addition to this, at least one of the two chains is guaranteed have minority hashpower, which could increase the block interval in the short term, resulting in more transaction congestion and you would need to wait for your transaction to confirm on both sides of the split to ensure you are protected.

Unfortunately, the trouble with B2X, is not only did this fork not implement strong replay protection, so that BTC transactions are valid on B2X and vica versa, but B2X also uses the same network magic as BTC. Therefore, by default your B2X wallet will broadcast its transactions to the BTC network, making transaction replay likely.

Method 2: Locktime

Locktime is a transaction field, which ensures a transaction is only valid after a certain block height. By default some wallets, including Bitcoin Core, add the current block height to the locktime field for their transactions. There are several motivations for this transaction type, one of which is to reduce the incentive for miners to orphan the current leading block, in order to get more fee income, by scooping up the fees from transactions already confirmed in the last block and the transactions in the memory pool. This is expected to be a potential problem in the future when the block reward is low.

One could try to use this feature to split BTC and B2X coins. For example, if the BTC chain has a 5 block lead over the B2X chain, you could send a BTC transaction with the current block height as the locktime, therefore this transaction will be invalid on B2X for the next 5 blocks. If the transaction confirms on BTC, you could then send another different transaction spending the same output on the B2X network, before the 5 block period is over. This could also work the other way around if B2X has the block height lead.

This method sounds complicated, and involves monitoring both chains. However, using the Bitcoin Core wallet this may happen by default and can be combined with the trial and error method described above. In theory, all you need to do is see which chain is in the lead, with respect to block height, and then send your transaction on that chain first.

Method 3: The “official” opt in replay protection

The B2X chain is considering adding opt in replay protection. This essentially means B2X client defines a subset of existing valid transactions and then prohibits these transactions on the B2X chain. Therefore you could send a transaction in this format on the BTC network and it would be invalid on B2X, resulting in a successful split.

However, this could be technically challenging to do, as it is not clear if any BTC wallets will support this feature and there may not be enough time for wallets to implement this for ordinary users. In addition to this, it is not known what type of opt in replay protection B2X will use or if this feature will be enabled at all. The official B2X client appears to have gone through the following iterations:

• Initially there was no opt in transaction replay protection
• A method of replay protection using OP_Return was merged into the codebase
• A new replay protection method, banning transactions with an output to a particular P2SH address was merged
• Problems were found with the latest method, which could apparently result in the loss of funds. Therefore a few days ago this opt in replay protection was removed from the B2X client

Therefore it is not clear what the opt in replay protection for B2X will be and it’s possible there could be no option here at all.

Method 4: Taint the coins with already split coins

Somebody else may have successfully been able to split their coins. They could then send you an output from their split coins. You could then use this output as an input for your new transaction. Since this input only exists on one chain, your transaction would be invalid on the other chain. Ideally this could be the coinbase reward from a block mined after the split, that way you can be sure your transaction can only occur on one side of the split, regardless of any potential re-orgs.

This process seems easier than the above methods, although you must ensure you get your coin control in your wallet arranged correctly to ensure you spend the desired transaction input. This method requires waiting for somebody else, therefore it could be slow, which may be a problem if you want to split as soon as possible.

Method 5: Let an exchange do it

You could send your coins to an exchange which supports both BTC and B2X, the exchange could then handle the split for you. You need to check if the policy of the exchange is to split your coins before the split or to also split coins sent to them after the split.

A disadvantage of this policy is that your need to take counterparty risk, which you may not want to do with your long term savings.  Taking such a risk could be particularly problematic during a high risk, high volume period such as a chain split without strong replay protection, which may present operational challenges for the exchanges. This method also goes against a common narrative or mantra in the Bitcoin community, which is you should always control your private keys, especially during a hardfork.

Although an advantage of sending your coins to the exchange before the fork, is that you may be able to trade the two coins very quickly, perhaps even faster than those doing the above split methods. This could provide you better investment opportunities.

Conclusion

Perhaps the best strategy is to combine the above methods. After reviewing the policy of the exchanges, you could send some of your coins to an exchange of your choice before the fork and then attempt to split the remainder of your coins using method 2 explained above.

However, despite all this advice, it’s probably likely that the overwhelming majority of Bitcoin holders will take no preparatory action for the split. Therefore if you do any above, you are probably well ahead of the majority, which could hopefully lead to some financial rewards or at least help you avoid losses.

Abstract: The upcoming SegWit2x hardfork is likely to lead to price volatility.  In this piece we look at some potential investment strategies which could allow you to capitalize on the event.

Strategy 1: Do nothing

The most popular investment strategy following the split is likely to be to take no action and remain a holder of both BTC and B2X. This is probably the most prudent approach, as your assets may be protected whichever coin becomes more valuable. Most people may pursue this strategy out of laziness rather than choice.  However, even if this is your preferred investment strategy, it may still be sensible to try and split your coins anyway; to increase the flexibility of your investment strategy and protect your funds in case you need to make a transaction.

Strategy 2: Invest in your favored coin

Many investors may support either the BTC or B2X coin for ideological reasons or because they feel their chosen coin has the best characteristics.

• Supporters of BTC typically prefer the consensus rules to be robust, as they feel this results in superior or more unique monetary characteristics. Also they typically value the cautious and meticulous approach of the current development team. BTC supporters may want flexibility and innovation to come from other layers in the system above the consensus rule layer.
• In contrast to this B2X supporters may value a more flexible consensus ruleset to ensure the system is dynamic and able to cater to user requirements more quickly. B2X supporters typically value the user experience over the monetary characteristics of the system. Typically they draw less distinction between changes in the consensus layer and other types of changes to the system.

If you agree with one of these visions more than the other, it might be a good idea to invest in the coin that matches your vision, this may not only help you obtain larger returns if your vision is correct, but may also help ensure your favoured token is the “winner”, as it may contribute to the value of the coin.

Alternatively you may not care which vision “wins”, but want to back the winner. In this case it’s important not just to gage opinion, but also the level of conviction those on each side of the debate have. Somebody slightly favouring one of the visions but also wanting to hedge their bets may have less of an impact than a die hard supporter of one of the visions, who is willing to sell all their coins on one side of the split no matter what. This factor could favor the BTC side, since many die hard “large blockers” may have already sold some BTC to invest in Bitcoin Cash.

The most common investment strategy after the fork may be to do nothing. However, of the tiny minority of people that do act, many of those people may be sellers of B2X. This is because the section of the minority that took action in favor of the large block chain in August, will not be allocated either BTC or B2X for the coins they sold for Bitcoin Cash. In contrast, the minority that quickly sold Bitcoin Cash in August, will be allocated BTC and B2X this November. Although, obviously this is highly speculative and nobody really knows what will happen.

Strategy 3: Invest in whichever coin is the cheapest/the “bad” coin – The Joel Greenblatt strategy

The top investment tip in one of our favorite books on investing, Joel Greenblatt’s “You can be a stock market genius” (bad title but a great read), appears to be that if a stock split occurs, one should buy the less favored company, the spin-off.  In this case B2X is the spin-off token.

Joel Greenblatt’s Gotham Capital achieved annualized investment returns of 50% from 1985 to 1994. One of the core strategies of the fund in this period was to invest in “bad” spin-off companies. As Greenblatt explains:

There are plenty of reasons why a company might choose to unload or otherwise separate itself from the fortunes of the business to be spun off. There is really only one reason to pay attention when they do: you can make a hole of money investing in spin-offs. The facts are overwhelming. Stock of spin-off companies, and even shares of the parent companies that do then spinning off, significantly and consistently outperform the market averages. One study completed at Penn State, covering a twenty five year period ending 1988, found that stocks of spin-off companies outperformed their industry peers and the S&P 500 by about 10% per year in their first three years of independence.

Greenblatt mentions that spin-offs tend to be driven by a “desire to separate out a bad business so that an unfettered good business can show through to investors”. The bad company or spin-off company is typically sold by investors, with the negative narrative around the bad company dominant at the time of the split, causing negative sentiment. As Greenblatt explains:

The spin-off process itself is a fundamentally inefficient method of distributing stock to the wrong people. Generally, the new spin-off stock isn’t sold, its given to shareholders who, for the most part, were investing in the parent company’s business. Therefore, once the spin-off’s shares are distributed to the parent company’s shareholders, they are typically sold immediately without regard to the price of fundamental value. The initial excess supply has a predictable effect on the spin-off stock’s price: it is usually depressed. Supposedly shrewd institutional investors also join in the selling. Most of the time spin-off companies are much smaller than the parent company. A spin-off may be only 10 or 20 percent the size of the parent. Even if a pension or mutual fund took the time the analyze the spin-off’s business, often the size of these companies is too small for an institutional portfolio.

Greenblatt goes on to cite four spin off case studies, Host Marriott/Marriott International, Strategic Security/Briggs & Stratton, American Express/Lehman Brothers and Sears/Dean Witter, where this thesis applied.

In many ways there are some analogies between the opportunities which may arise from Bitcoin spin-offs such as B2X and stock spin-offs. Perhaps B2X is being distributed to the “wrong people”. Bitcoin investors typically value robust rules and the resulting highly resilient monetary properties. Perhaps, some of the Bitcoin investors who value other characteristics such as flexibility and user experience may have already divested into Ethereum or Bitcoin Cash, therefore the remaining investors may “dump” B2X. The risk for B2X proponents is they allocate their new coin to the “wrong people” and the price becomes “depressed”.  However, this could provide contrarian investors an opportunity.

The price of B2X could fall to cheap levels and there could be significant amounts of negative sentiment with some people writing the coin off. This could then be a good time for contrarians to invest in B2X. This investment philosophy seems to go against a common narrative in the Bitcoin space that “network effect is king” or “the most work chain wins”, meaning a minority chain has limited prospects. However, there may be little investment basis for this view.

However, whether the Greenblatt spin-off philosophy really applies to Bitcoin spin-offs such as B2X is not clear. Greenblatt still does fundamental analysis on the bad spin-off company, and whether one can take this type of fundamental approach to Bitcoin or its spin-offs, is not obvious. It’s certainly more risky. Although, in my view, after the hardfork, if B2X is trading at c5% or less of the price of Bitcoin and the prevailing narrative is that B2X is dead, then the “bad” coin may be worth a small punt.

Strategy 4: Take advantage of different policies on different exchanges

During the Bitcoin Cash hardfork, different financial platforms had different policies. For example BitMEX essentially ignored Bitcoin Cash, and the futures price just followed Bitcoin. However, Kraken for example, supported Bitcoin Cash, in such a way that those with long margin positions on Bitcoin were also given Bitcoin Cash. Critically on Kraken if you were short Bitcoin at the time of the fork, you were then automatically short Bitcoin Cash. These different policies between exchanges provide asymmetry, which in theory can be used to earn free money.

For example going into the Bitcoin Cash hardfork, an interesting strategy was to open a margin long position of 1 BTC on Kraken and then hedge the position by taking a margin short position of 1 BTC on BitMEX. Thereby after the hardfork, you receive one Bitcoin Cash token on Kraken, essentially for free, since there was no corresponding Bitcoin Cash liability on BitMEX associated with the short.

When it comes to the upcoming fork, there are four relevant potential exchange policies one needs to consider, when trying to engage in this type of arbitrage.

Potential financial platform policies regarding the B2X spin-off token

	Policy A	Policy B	Policy C	Policy D
Split user Bitcoin deposit balances into BTC & B2X
Split user Bitcoin margin long positions into BTC & B2X long positions
Split user Bitcoin margin short positions into BTC & B2X short positions
Bitcoin lenders are due back BTC & B2X
Bitcoin borrowers owe BTC & B2X

Note: It is also possible to have a different policy with respect to Bitcoin lending and Bitcoin margin positions, which is not illustrated in the above chart.

An interesting investment strategy to engage in before the B2X fork could be to open long Bitcoin positions with exchanges with policy C and D, and potentially open short Bitcoin positions on exchanges with policies A, B and C.  In theory, this should allow you to get B2X tokens for free.

One may think that policy C may seem a slightly inappropriate choice, as it results in an asymmetry. However some exchanges did have a policy similar to this with respect to Bitcoin Cash. The rational for this was that the burden on customers who were short Bitcoin, to go out into the market and buy Bitcoin Cash may have been too high, particularly if the liquidity of Bitcoin Cash was low.

As the B2X fork approaches, we may write a piece summarizing the policies of the main exchanges and how one could engage in this type strategy. Although, if you wait for it to be clearly explained, it could be too late and spreads could have already opened up, reflecting the opportunity. On Bitfinex, B2X is already trading at over $1,000, therefore there could be money to be made by engaging in these types of strategies. Perhaps a good idea, if you really like taking risks, may be to review the policies exchanges took with respect to Bitcoin Cash, to get an idea of what their policies might be with respect to B2X and then open your positions before the policies are officially announced.

Abstract: In this week’s piece, we look at the world of ICOs.  We present an interactive visualization, that illustrates the entire ICO landscape and the interconnections between people officially affiliated with each ICO.

Interactive ICO team member network map

Source: BitMEX Research, ICO websites, icoHunt own and provided the raw data (Do not use the data without their permission)

Network map notes

• Blue circles represent ICOs
• Yellow circles represent ICO team members, advisers or backers
• Circle size is weighted by number of links to other ICOs
• Data includes around 500 ICOs &  around 4,900 team members
• We apologies for any errors, omissions or spelling mistakes

ICO network map viewing tips

• Modify the number of nodes to around 1,000
• Alternatively, start with 5 nodes, then gradually press the up arrow to add 10 nodes at a time
• Displaying all 5,388 nodes may use up significant amounts of system resources
• An illustration of the type of visualization which can be produced is provided here

The negative implications of the extent of ICO team member interconnections

The above network visualization illustrates the high degree of interconnections between the ICOs, with a few dominant individuals involved in many projects.  Skeptics may therefore argue that it is not feasible for any one individual to be involved in this many ICOs, and this is an indication of misleading marketing, bad practice or inadequate disclosure.

Comparing ICOs & IPOs

Many of the individuals listed in multiple ICOs are often listed as a backer or adviser, rather than as an individual involved in day to day management.  In some ways they may be more of an ICO “sponsor” than someone actively involved in project development.  For example, as the chart below illustrates, the concentration of individuals involved in multiple ICOs compares reasonably well to financial advisers or book-runners involved in IPOs.

Vitalik Buterin is the most prolific person when it comes to ICO involvement.  Our analysis shows he has involvement in at least 13 projects, around 2.5% of the total.  Although if you think of Vitalik’s role as more of a sponsor, then Vitalik has a lower market share than Citibank when it comes to IPOs, which has been the lead bookrunner in 3.7% of the IPOs in the last 12 months.

Market share of advisers (Top 20) – ICO/IPO comparison

Source: BitMEX Research, icoHunt, ICO websites, Bloomberg IPO database
Notes:  The above dataset is from around 520 ICOs and 3,266 IPOs which have occurred in the last 12 months.  The market share is based on the number of offerings, not value of the offerings.

The role of a lead bookrunner in an equity IPO, may be to do the following:

• Underwrite the offering,
• Ensure the offering complies with regulations,
• Ensure price stability and liquidity after the stock lists,
• Prepare marketing materials for the IPO,
• Bring management of the company on a tour to see potential investors in a roadshow,
• Use its investment sales staff to promote the offering to its clients,
• Assist in the allocation of the shares to the offering participants.

In many ways these responsibilities are similar to the roles of some of the most prominent individuals in our ICO analysis above, certainly with respect to marketing and promotion. However, in the world of ICOs the role of the “sponsor” is a lot more murky.  The individual in question is sometimes said to be the person who originated the idea, is involved in management or even the development of the product.  The ICO market therefore lacks clarity with respect to the roles and responsibilities of the individuals involved.

The initial allocation

The initial allocation of shares during an IPO is often an opaque process.  Typically the bookrunner/adviser decides the allocation on a discretionary basis, with the largest institutional and hedge fund clients favored first, rather than a fair random process or auction driven mechanism.  It is somewhat surprising that financial regulators have not clamped down on this practice. Although a counter argument to regulation is that listing companies should have the freedom to decide who their new shareholders are, if their are multiple bidders.  Unfortunately the bookrunner/adviser seems to have a significant influence on the allocation process.

Despite the opportunity to improve on what IPOs do in this area, the initial allocation process when it comes to ICOs does not appear to be much better.  The initial allocation of ICOs is also a murky process, but in some ways even worse than for IPOs, since earlier or better connected investors sometimes get lower prices. The allocation process can be based on who is friends with the people in the team or other industry connections.  Therefore on balance, despite poor practice, IPOs appear to have a somewhat fairer process when it comes to allocation than ICOs.

Although one could cynically say there is a key difference in the offering process between ICOs and IPOs, this time we are the ones in control.

Abstract: Although the reliability of the data is limited, in this piece we look at the investment returns one would have achieved  by investing in ICOs.  We compare the returns against the amount each ICO raised and look at the historic investment performance of the most prolific ICO advisers.

ICO investor returns (log scale)

Source: BitMEX Research, Coinmarketcap, ICO websites, Reddit comments
Notes: A return of 10x means the investor made 10x their money.  Prices up to 25th September 2017

The integrity of the data

• In general the quality of pricing data for ICOs is poor, we are likely to have made significant errors in many cases.  We apologies for any inaccuracies.
• ICOs often have particular circumstances and conditions, for example multiple ICO rounds or offerings in different currencies.  Unfortunately due to a lack of transparency and a high degree of complexity, in some cases, we have not been able to account for all of these particularities in a consistent basis.
• In some circumstances we may have been unable to determine the ICO price and therefore may have used the price on the first day of trading.
• There may be some selection bias in our analysis, for example we may be more likely to have investigated the investment performance of ICOs which subsequently turned out to be successful.
• Unfortunately, in a small number of cases we obtained the ICO price from Reddit comments, due to the lack an alternative source.

ICO investor returns compared to the amount raised in the offering (log scale)

Source: BitMEX Research, Coinmarketcap, ICO websites, Reddit comments, Coindesk
Notes: A return of 10x means the investor made 10x their money

In the above chart we compare the amount raised in the offering with the investment returns of the ICOs.  From looking at the chart, it appears that there is a slight negative correlation, although the correlation is not strong enough to pass rigorous statistical requirements.

ICO investor returns of for the top 20 ICO advisers (log scale)

Source: BitMEX Research, Coinmarketcap, ICO websites, Reddit comments, ICO Hunt
Notes: The numbers in brackets represent the number of ICOs we were able to obtain return data for compared to the total number of ICOs the adviser is involved in

Finally we look at the investment returns of the top 20 most prolific individuals in the ICO space, by number of ICOs.  In many cases, the ICOs occurred very recently and therefore pricing data is not yet available.