Bitcoin as a productive asset
There’s more to it than meets the eye
According to Greer’s 1997 paper “What is an asset class, anyway,” economic assets can be grouped into three broad categories:
- capital assets, possessing underlying cashflows;
- consumable or transformable assets, which have value in their usage; and
- store of value assets, which can neither be consumed nor have cash flows, but have value anyway.
Bitcoin and most cryptoassets do not have underlying cash flows, so the story goes.
Tokens that premise themselves on granting tokenholders a claim to underlying cash flows might be considered capital assets, but those are also generally considered securities, with troubling implications for issuers and owners. Some assets straddle two categories; gold, for instance, has industrial usage (commodity-like) and is also used as a store of value.
Here I’ll argue that bitcoin is another dual threat: it is clearly used as a store of value, but it also yields cash flows.
This property is largely unique to Bitcoin in the cryptocurrency world, and is another reason why it will be hard to displace.
Wait, what cash flows for Bitcoin?
By cash flows, I’m talking about airdrops and hard forks.
You have probably heard of Bitcoin Cash (BCH) and the upcoming S2X hard fork. You may have heard of Stellar Lumens (XLM). You probably haven’t heard of Byteball (GBYTE) or Clams (CLAM).
Which is a shame, because all of them were freely distributed to every bitcoin holder. In the last twelve months, BCH, XLM, and GBYTE were all disbursed, with bitcoin owners receiving rewards proportional to their stack. Each Bitcoin holder received one Bitcoin Cash, 986 Stellar Lumens, and approximately 2.44 GBYTEs.
And these free lunches weren’t, as you might imagine, totally valueless. In fact, if you run the numbers, selling these airdrops when first able for bitcoin would have yielded a return of about 26% in the last year. (Feel free to check my math. Certain assumptions and some guesswork is required.)
This simple table lists four airdrops/hard forks that have proven worthwhile for Bitcoin holders to hold on to or sell.
“Dividend yield” is calculated based on the price of the airdrop when liquidity first emerged, rather than illiquid futures prices. For instance, Clams were distributed in May 2014 but they weren’t traded until December, so the latter month is used to determine its price.
The return from the Byteball airdrop is more complicated; it is still ongoing and roughly half of the GBYTEs have been distributed over nine rounds. The Byteball dividend has varying values if held in BTC, GBYTE, or USD. You can check out the detail of those airdrops in this post.
The Byteball airdrops, assuming participation from the start, yielded between 9 and 17 percent for Bitcoin holders. The former figure assumes immediate conversion to BTC; the latter required holding GBYTEs through the various rounds.
Adding all the airdrops and hard forks together, we conclude that if a bitcoin holder participated in each over last year, their bitcoin stack would be roughly 20–30% higher.
This is assuming immediate sales of the airdropped tokens. In practice, it could have been far more, as both Byteball and Bitcoin Cash have traded much higher relative to BTC at various points.
Airdrops & hard forks: A quick taxonomy
The drivers of the “dividends” that Bitcoin holders enjoyed over the last year included hard forks like Bitcoin Cash (BCH) and more exotic projects like Stellar (Lumens, XLM) or Byteball (Bytes, GBYTE).
It may be useful to categorize these projects based on their intent relative to Bitcoin.
I propose labeling contentious hard forks hostile spin-offs, as they directly compete with the parent brand and use-case while introducing relatively little technological innovation.
Hard forks with novel tech and a non-competitive bent, like the upcoming Bitcoin Gold hard fork (which aims to create an ASIC-resistant chain) might be labeled friendly forks or neutral spin-offs.
Lastly, totally novel tech with vastly different intended uses like Stellar or Byteball might just be called airdrops. Airdrops (as we classify them here) borrow Bitcoin’s timestamped UTXO set to mediate distribution in a way that avoids an ICO.
Hostile spin-offs that lay claim to the original network may not be value creation events, as they compete for a share of the existing network. However, friendly forks can coexist with the parent chain (albeit with the potential for brand dilution) as well as conventional airdrops like Stellar and Byteball which set out to do different things from Bitcoin entirely.
So where does this value come from?
I propose that the value capture potential of an airdrop or hard fork for bitcoin holders depends on whether they challenge the original chain for prominence or not.
The potential value capture(for bitcoiners) is likely highest for airdrops (e.g. Stellar and Byteball), moderate for a friendly fork like Bitcoin Gold, and potentially value destructive for hostile spin-offs like Bitcoin Cash or the upcoming S2X hard fork.
In July, I claimed that Bitcoin Cash was “not a free lunch” and that any value from the novel chain would probably come from siphoning users and value from the original chain, thus rendering new value creation implausible.
As is the case for many predictions in this space, price action proved me wrong. Bitcoin Cash traded as high as 20% of Bitcoin’s value, before settling at around 10%. The joint value of the two has well surpassed Bitcoin’s value on August 1st. Time will tell whether this ratio will persist in the future.
So who funds these “dividends”? After all, someone has to take the other side of the trade. Bitcoiners only earn a return from these airdrops if investors buy the competing or novel chain. However, the winner-take-all nature of the Bitcoin brand means that it’s unlikely a direct competitor persists for a long time.
Thus the value presented by Bitcoin Cash may prove more ephemeral than that found in a project with novel tech like Byteball. Since the market has a large appetite for new projects, Bitcoin holders have thus far been able to earn a healthy yield in exchange for membership of the network.
So why do these airdrops work? Bitcoin is a large public database. Using its UTXO set to distribute some or all of the tokens in a new issue is a way to instantly get people to care about them. Recall the fervor with which individuals demanded their bitcoin cash from exchanges prior to August 1st, even though no one knew how Bitcoin Cash was going to trade. Mere ownership tends to cause individuals to ascribe a greater value to something — a phenomenon known as the endowment effect. I wouldn’t normally care about Stellar Lumens or Byteball; I’d be inclined to care if I came to own some.
Why airdrop to bitcoin holders?
Bitcoin has some unique qualities that aren’t recaptured in other cryptoassets. It was the first and longest lasting cryptocurrency. It had a “fair” launch — Satoshi Nakamoto didn’t have an unfair advantage in obtaining tokens once the network was up and running.
Satoshi announced Bitcoin to an obscure mailing list of cryptography enthusiasts. He mined the then-valueless bitcoins to keep the network alive. He did not secretly mine 30% of the tokens prior to release, or make it difficult or impossible for other miners to participate (as other projects have done). The whole process was transparent.
In addition, Satoshi most likely didn’t spend any of his tokens. He was very committed to not using Bitcoin to enrich himself. This grants Bitcoin a quality of legitimacy lacking in most other cryptoasset projects today. Bitcoin’s age and dispersion also means that it’s probably more widely distributed than any other project, makes it a great airdrop candidate.
Other platforms do host airdrops occasionally. Waves and Ethereum (see OmiseGo) are some of the major ones. Yet, Ethereum was itself an initial coin offering (ICO) and a significant portion of its tokens were allocated to individuals who acquired them costlessly.
For projects seeking to circulate tokens to a wide variety of individuals rather than entrenching already-powerful foundations, airdropping on ICO’ed coins seems counterproductive. For these reasons, I anticipate that bitcoin will remain the standard host for airdrops, as the de facto industry reserve currency.
I also anticipate that airdrops will become simpler as standards are set out with wallets. Future wallets might have a feature enabling the instantaneous sale of any airdrop received, or the automated sale after some fixed time period. Airdrop issuers might be able to adhere to a codified standard, which would require minimal effort on the part of the user to obtain the new tokens.
This is a promising use for the network. In one sense, it’s an extension of Bitcoin’s original purpose of mediating the distribution of a digital currency. Bitcoin already serves as a reserve bank for cryptoassets; it might end up being the sole underwriter and clearing house for airdropped digital currency issues as well. It would be an interesting comparison to Ethereum, which today fills a “crypto investment bank” use case with many ICOs being launched on the platform.
While airdrops do not totally exempt founders from regulator scrutiny, cryptoassets distributed mainly through airdrop probably fail the first prong of the Howey test, ‘the investment of money.’
Fair airdrops don’t require the investment of money in the enterprise itself, just ownership of some Bitcoin UTXOs. Investors can plausibly not expect a return from airdrops, as many would seek to sell them off immediately. It’s a bit like receiving $5 in the mail; you weren’t expecting it, you aren’t relying on it, but you’ll happily keep it or use it.
What about staking? Isn’t that a form of passive income?
Airdrops are exogenous events to the host networks. The market is unable to price them in prior to announcement. Staking is the practice of obtaining block rewards in exchange for freezing some number of coins in a proof-of-stake network.
In my view, staking isn’t income, but rather protection from dilution. Put crassly, you can describe it as the redistribution of wealth from non-stakers to stakers. From the non-technical to the technical. From small tokenholders to large tokenholders.
Staking doesn’t necessarily add to the value of the users of the network; it merely reshuffles everyone’s share. I have said frequently that staking should not be called “return” or “interest” by promoters. This might mislead investors unfamiliar with dilution rates in cryptocurrency into thinking that staking represents the same sort of interest provided in bank accounts.
There is no way for staking to directly enhance the value of the network, aside from its basic utility (securing the network, serving as a consensus mechanism, and enabling tasks such as voting). Airdrops are different — they can exogenously add value. If it became popular to airdrop novel projects instead of ICO-ing them, and one chain came to underwrite those airdrops, that would enhance the prestige of that network and provide a steady stream of tokens to holders.
Caveats
There are a few conceptual problems that I can identify. It’s tempting to refer to these distributions as “dividends.” However they’re not based on the cash flows of an underlying corporate entity. There’s a zero-sum quality to returns from airdrops. Someone has to take the other side of the trade. For holders of the parent network to be compensated, a certain amount of capital must be be allocated to buying airdropped coins which are sold off.
Additionally, the essential conflict between wide distribution of ownership and outsize returns is evident here. The majority of the yield from the nine Byteball rounds came in the first round. The GBYTE:BTC exchange in round one was over 200 times greater than that of the 9th round. So early adopters again benefited to the detriment of others. Airdrop promoters need to ensure that fairness is prided and a select group don’t benefit disproportionately.
Additionally, airdrops aren’t predictable. Bitcoin hosted one in 2014, one in 2016, and three so far in 2017 (there may have been others but they weren’t notable enough to merit inclusion here). So it would be misleading to describe them as a regular source of passive income.
Lastly, airdropping may go out of favor completely. Maybe a token will be released which directly targets this use-case, and makes it very easy to distribute new airdopped issues. In this case Bitcoin’s network might be challenged. Maybe we’ll see a cooldown in new tokens and there won’t be a willing supply of buyers to take the other side of the airdrop sales.
Conclusion
I’ve laid out the argument that some cryptoassets can be interpreted as yielding assets. This is not a universal property; it only applies to a select few that are good candidates for airdropping. There are ways to airdrop coins to large populations through conventional means (see Auroracoin) but the programmable qualities of cryptoasset networks make it very convenient.
Bitcoin remains the chief airdrop network since it has excellent dispersion and its launch was provably fair. Not all UTXO-borrowing forks are made equal though, and attention must be given to their stated purpose. Some are openly hostile to the parent network and may be value-destroying.
The unique nature of widely dispersed cryptoasset networks and the mounting popularity of airdropping as a distribution method means that airdrops are unlikely to go away any time soon. Investors should be aware of their potential as passive income, and should equip themselves to take advantage.
