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| By Juan Villaverde and Martin D. Weiss |
On January 24, 2018, the first Weiss Cryptocurrency Ratings were released. Bitcoin got a C+ (“fair”). And many in the crypto community fiercely denounced the grade as overly punishing.
Charles Hoskinson, the creator of Cardano and a founder of Ethereum, put it this way:
“Any rating that doesn’t give Bitcoin an A has got some screws loose. Nearly ten years of wealth creation, innovation, massive growth, proven resiliency against crashes and billions worth of infrastructure. And all without a leader. Bitcoin is the standard.”
We welcome all industry feedback, and this paper is our response. The key question we answer: What explains the gap between the “A” suggested by Mr. Hoskinson and the Weiss Cryptocurrency Rating of “C+”?
Although no ratings model can be a perfect replication of the real world, and fundamental disagreements are inevitable, we believe the best way to bridge the gap is to provide greater transparency, beginning with our “C+” for Bitcoin.
Cryptocurrencies as Investments
From the outset, we have stated our goals in “The Weiss Cryptocurrency Ratings Explained,” as follows:
“The end result [of our model] is a letter grade for each cryptocurrency that’s ultimately designed for all stakeholders in the cryptocurrency space, beginning with individual investors who are new to cryptocurrencies but willing to take the obvious risks.
“For these investors, the Weiss Cryptocurrency Ratings provide unbiased guidance free of any conflicts of interest. They are designed to help lead investors to potentially rich rewards with lower-than-average price volatility and sustainable technology.”
So the main reason we issue cryptocurrency ratings is to give investors, particularly those new to the space, guidance on whether or not they can expect to make money — and do so with reduced volatility.
That’s not the kind of rating that cryptocurrency developers and advocates expected. Several have told us they are rarely concerned about price volatility, attributing it to extrinsic factors beyond their control. Instead, they feel a rating should mostly reflect the relative quality of their work and its success in the real world.
The perspective of traditional asset investors is quite the opposite. Many have conveyed to us that what they want is simply a score that assesses the probabilities of making or losing money.
In order to address the concerns of both audiences in a balanced manner, the Weiss Cryptocurrency Ratings uses four indexes:
1. The Reward Index evaluates (a) investment returns compared to moving averages, (b) absolute returns compared to a benchmark, (c) smoothed returns compared to a benchmark, and other factors.
2. The Risk Index measures (a) relative and absolute price fluctuations over multiple time frames, (b) declines from peak to trough in terms of frequency and magnitude, (c) market bias, whether up or down, and other factors.
3. The Adoption Index measures transaction speed and scalability, market penetration, network security, decentralization of block production, network capacity, developer participation, public acceptance, plus other key factors.
4. The Technology Index is based on an analysis of publicly available white papers, public discussion forums or announcements, and open source code to evaluate the protocols underlying each cryptocurrency. Factors considered include the level of anonymity, sophistication of monetary policy, governance capabilities, the ability to improve code, energy efficiency, scaling solutions, interoperability with other blockchains and many more.
The first two indexes are based on traditional asset analytics; the latter two, on crypto asset analytics. All four contribute to an overall grade representing our opinion on the medium- and long-term viability of each cryptocurrency as an investment.
New Weiss Ratings Feature: More Transparency
To provide even better transparency to users of our ratings, we not only disclose our evaluations on all four of the component indexes, but also provide the following three grades for each coin:
- Overall Cryptocurrency Rating. For long-term investors who wish to compare each cryptocurrency from the broadest possible perspective, including all four critical indexes.
- Risk/Reward Grade. For short-term investors and traders, we break out a separate grade derived strictly from our risk and reward indexes, excluding our evaluations of the technology and adoption.
- Technology/Adoption Grade. For the DLT industry, we also break out this grade, derived strictly from our technology and adoption indexes, ignoring any market price fluctuations.
Here’s how Bitcoin performs on each …
Reward Index: Weak. Bitcoin has recently been losing ground to competing altcoins and currently ranks low. Bear in mind that the index is purely quantitative, based on the kinds of formulas that are widely accepted in the investment community and applied fairly to all cryptocurrencies covered.
Risk Index: Weak. Given the extreme volatility of its price history, it should come as no surprise that Bitcoin does not achieve a stellar grade on this index.
Risk/Reward Grade — D+. No one doubts that Bitcoin has been a winning investment, delivering superlative gains since it started trading in the markets. But those gains came with great volatility. And from its 2017 peak, Bitcoin lost as much as 70% of its value.
Index 3. Adoption — excellent. This is the one area in which Bitcoin shines. It does very well in terms of network security, usage, developer participation, and user popularity.
Index 4. Technology — fair. Bitcoin does well with regards to the security of its blockchain, but loses points due to deficiencies related to scalability and sustainability. It does not have adequate governance. It cannot easily upgrade or adapt. And despite some workarounds, it’s mostly stuck in technology that’s falling behind the times.
Technology/Adoption Grade — B. This is literally a “good” grade. And as we stated above, it’s probably a key reason why the Weiss Cryptocurrency Ratings were initially misunderstood. We do recognize Bitcoin’s strengths. But unlike many others in the industry, we do not sugarcoat its weaknesses.
Now, here’s more detail on Bitcoin’s adoption and technology …
Bitcoin’s Performance on the
Weiss Adoption Index: Excellent
As we explained earlier, our Adoption Index covers factors such as network security, transaction speed, adoption by end users and developers, history, scalability, plus a host of other metrics. Bitcoin excels in most (but not all) of these areas.
To explain why, we will summarize how our Adoption Index works, provide the rationale for six of the sub-indexes we include in this category, and review how Bitcoin performs in each.
Network Security Sub-Index: To evaluate network security for Bitcoin and other Proof of Work blockchains, one key measure we use is the total hashrate of the network, estimating the corresponding energy consumption. The reasoning is that, in order to attack the network, a malicious actor would need to expend a similar amount of electricity. All else being equal, the more electricity the network uses as a whole, the safer it is from external attack.
The strength of Proof of Work is that anyone seeking to create a block needs to consume electricity, performing intense computational work in order to validate the block. This greatly discourages miners from breaking the rules of consensus and dissuades outside attackers from altering the state of the network. They would need to invest vast sums on hardware and electricity just for the remote chance of altering the blockchain.
Bitcoin clearly outperforms on this metric. More electricity is spent on Bitcoin per year than consumed in the entire country of Ireland. This is a fact that helps make the Bitcoin blockchain an ultimate store of value.
Network Capacity Sub-Index: In order for cryptocurrencies to gain and maintain mainstream adoption, they need high throughput — on the order of hundreds of thousands of transactions per second. The transactions also need to be cheap. Thus, one of the metrics in our Network Capacity Index looks at the number of transactions in the blockchain over a recent period, along with the total fees paid.
To evaluate how the blockchain is performing in real time, the Fundamental Index uses metrics of actual transactions going through the blockchain — not the theoretical maximum under ideal conditions. For instance, Lightning Network, though live, is still distant from broad adoption, as the developers themselves warn not to over-rely on a solution that is still experimental.
Currently, Bitcoin is holding its own with 250,000 to 300,000 transactions daily, orders of magnitude greater than most other cryptocurrencies. We give it due credit for this achievement.
But this comes at a high cost — the highest fees in the entire space, averaging approximately US $10 per transaction.
Has Bitcoin’s congestion eased recently? Yes. However, the decline can be attributed mainly to a steep slide in Bitcoin’s market price — not improvements in its technology. As the price of a major cryptocurrency falls, speculators lose interest and demand declines. This helps explain much of the recent decline in fees.
What’s even more troubling is that an extremely large percentage of current usage is fueled by speculators. We’re left to wonder, therefore: How loyal would these “supporters” be in the event of another major market crash? What would happen if these speculators become convinced that altcoins are superior speculative investments? What impact would that have on the viability of Bitcoin? All worrisome questions.
Overall, Bitcoin’s network capacity performance is not bad. Nor is it very good. The objective data, along with the real world experience of users, indicate that the network is saturated and has been for some time. This is leading to a rollback in adoption by merchants and payment services that previously accepted Bitcoin. The reasons they consistently give — high fees and slow confirmation times — validate the findings of our Network Capacity Index.
Developer Participation Sub-Index: This uses a variety of sources and metrics to evaluate the developer community surrounding each cryptocurrency. Bitcoin earns points here as well, thanks to a loyal, active, and thriving developer community.
History Sub-Index: Every cryptocurrency is experimental, but in varying degrees. One of the ways to assess this aspect is to measure how long it’s been around. All else being equal, the extent that it survives the test of time is seen as one indication that underlying protocols and security are up to the task of supporting a future global payment network.
As the first cryptocurrency created, Bitcoin gets points for History. Its advocates can make the strongest claim that it’s been through the ringer and survived.
Concentration Sub-Index: Cryptocurrencies are created to be decentralized money that no central authority controls. In order to change the way these systems work, consensus is required. There’s no central authority deciding who gets to participate and who gets blacklisted.
In other words, cryptocurrencies were designed to be money that anyone can use anywhere without fear of censorship or repression. Bitcoin was the first such cryptocurrency, defined by its founder(s), “Satoshi Nakamoto,” as a peer-to-peer electronic cash system.
Thus, decentralization is at the very core of what defines a cryptocurrency. It is the foundational concept that inspired Satoshi to publish his thesis. It is also the focus of our Concentration Sub-Index — to measure the concentration of block production for each cryptocurrency.
How’s Bitcoin performing on this metric? Not too well. Among the cryptocurrencies we cover, the hard facts indicate that it is one of the most heavily concentrated.
Admittedly, some aspects of the cryptospace are murky, and this could be one of them; we rely on the accuracy (and honesty) of miners who report their hashrate. However, we can ascertain with relative confidence that the top five miners control some 70% of the total hashpower on the Bitcoin network.
While not an issue historically, we’re concerned that this could introduce an element of centralization — and potentially censorship — in the Bitcoin network. It also raises other questions and concerns: Is this centralization a trend? Does it help explain why it has recently been difficult to increase the block size of the main Bitcoin blockchain?
It may be premature to speculate on the answers. But it’s not too soon to affirm that concentration of block production is, in itself, a negative factor for networks that are designed to have no owner or central control.
Social Media Sub-Index: We seek to determine how popular the cryptocurrency is among end users. Ultimately, this adoption could be a decisive factor for the future success of any cryptocurrency. If people don’t use it, it could eventually fade or die out.
Bitcoin ranks high in this regard. Even among those who have never heard or used the term “cryptocurrency,” Bitcoin is recognized and discussed.
Bitcoin’s Performance on the
Weiss Technology index: Fair
Our Technology Index does not evaluate how many developers are active in the project, how safe or robust the code is, nor how battle-tested the network may be. These aspects are handled in our Adoption Index.
Think of our Adoption Index as a vehicle for measuring what the network is doing; our Technology Index, as way of evaluating what the network is capable of doing. Mobile devices serve as metaphor:
The first mobile phones weighed over one kilogram, had a battery life of 30 minutes, and took 10 hours to recharge. That was the state of the art in 1973.
With time, the technology improved, and more features were introduced. The next device we owned was capable of sending text messages. That, in itself, was revolutionary. BlackBerrys then took that innovation several steps further.
Our first iPhone 3G was also revolutionary. We could easily browse the Internet on a handheld device. What was still being called a “phone” was quickly turning into a mobile computer with communication features.
Today, users can do virtually everything with their smartphones. They pay their bills, talk to their buddies over social media, and yes, even trade Bitcoin, Ethereum or other coins.
We see a similar techno-evolution emerging in cryptocurrencies. The first generation, Bitcoin, was a payment network. With the introduction of Ethereum came the ability to run decentralized autonomous organizations (DAOs), issue shares, and run public services — all on top of the blockchain in a decentralized, trustless manner. Next, with the advent of newer cryptocurrencies, additional features and efficiencies are being added.
(The structure of the internet itself could also be a metaphor for blockchain evolution. However, unlike the internet, which is based on a single, standard protocol (TCP/IP), blockchains are built on different protocols that can interoperate despite those differences.)
Now imagine this future scenario:
Cryptocurrencies are mainstream. Billions of citizens worldwide use them in everyday life. Hundreds of local and federal governments plus thousands of companies build their operations upon blockchain technology. Nearly every major aspect of human culture is transformed.
Each citizen’s ID is on the blockchain, a private key not only to access one’s wallet addresses, but also as a link to each individual’s uniqueness as a human being — to protect health records, participate in politics, invest in projects or companies, prove unique ownership of personal assets, even store one’s genetic code. All private. All protected from prying or spying eyes.
Bitcoin is not quite ready for that future. Although it might be possible at some point to add new features to the Bitcoin Network, the industry is not currently moving in that direction. Instead, second and third generation protocols are jumping in to occupy that space.
With that in mind, we must ask: Years from today, will consumers and merchants still be satisfied with a payment network strictly designed to remit funds from point A to point B? Will they still be using the equivalent of the 1973 mobile phone? Will the world have rejected an evolutionary megatrend that already had broad utility and momentum in the late 2010s?
“No” answers to each of these questions are hard to challenge. Instead, the focus of the debate should revolve around which particular blockchains will dominate, which will survive in their own particular niche, which will join the relics of history.
Bitcoin has the strongest brand and the early-mover advantage. But others have the late-comer advantage — the ability to hit the ground running with legacy challenges mostly resolved and new features for the future.
Our Technology Index is designed to evaluate these issues objectively. Among other things, it measures the capabilities of each blockchain, how they can scale, how they can interoperate with other blockchains, how anonymous they can be, what governance features, if any, they support, and more.
The Weiss Cryptocurrency Technology Index ultimately reflects our collective opinion that blockchains capable of implementing the most advanced technological features to successfully attract users to their network are the ones that will be the most sustainable over time. Our technology model is grounded in the belief that:
• Most investors and users will ultimately care little about history or legacy, be it claimed by Bitcoin or a competitor.
• They will want technology that is fast, cheap and easy to use.
• No matter how big the brand, they will sooner or later drift away from older technologies.
• Ultimately, technology that’s outdated or difficult to upgrade will generate disappointing returns for investors.
This is why the Technology Index is an important factor in our model. With this index, we move beyond a lens that focuses mostly on adoption metrics. We assess the level of innovation embedded in the technology — features that, over time, are likely to attract the most businesses and consumers.
We have identified many challenges that blockchains need to address in order to have the best chance of sustaining themselves into the future, and we summarize them in a series of sub-indexes. Here are two of the important ones:
The Scalability Sub-Index measures how quickly transactions can be confirmed plus how efficiently the blockchain manages computational resources, bandwidth, data storage and other issues.
The Sustainability Sub-Index covers protocols for upgrading the code without splitting the network, often referred to as “governance.” It also looks at the “treasury” — how the blockchain is able to fund its continuous development without reliance on external third parties.
Bitcoin’s Scalability and the Lightning Network
Bitcoin is still widely used. However, that usage is now running into a wall of sorts. More importantly, a large part of the usage is in the context of speculation on crypto exchanges. This is a far cry from Satoshi’s original vision.
Meanwhile, it is widely known that Bitcoin currently faces scalability challenges. At four transactions per second and fees near US $10 each, resistance to Bitcoin in everyday commerce continues to build.
This is not just theory. As we stated before, it is precipitating a rollback in adoption for the network, as merchants shy away or suspend its usage.
The Lightning Network seeks to overcome some of these challenges. For example, with Lightning, it should no longer be necessary for every transaction to be recorded on the blockchain. This would help add elements of decentralization, improve resource efficiency, and lower fees for some transactions. Lightning also promises to enhance privacy, thanks to its use of Onion Routing, designed to make transactions fully anonymous. However, the Lightning Network could fall short on a few fronts:
First, it does not address growing concerns regarding the rising expenditure of electric power on the Bitcoin Network.
Second, it does little to resolve a fee structure that seems to incentivize small blocks and long confirmation times so miners can get higher rewards. That structure was intended to prevent spamming on the network — not to help miners make more money.
Third, what if major exchanges or large wallet providers refuse to adopt Lightning due to difficulty in meeting compliance requirements under know-your-customer and anti-money-laundering regulations (KYC and AML)? If these issues cannot be overcome, they could hamper Lightning adoption.
Fourth, in the event that Onion Routing is discarded due to regulatory concerns and it becomes possible to trace payments through the Lightning Network, it could lead to other unintended consequences: The creation of large pools of liquidity run by financial institutions that have the resources and know-how to deploy these hubs on a large scale.
Lightning Network nodes would be heavily centralized, and users could face two difficult choices: Either (a) go through KYC/AML in order to use these nodes, or (b) get saddled with high fees and long confirmation times if they wish to send their transactions directly to the Bitcoin blockchain. In the latter scenario, Bitcoin would no longer be a neutral, decentralized, peer-to-peer, permissionless, censorship-resistant payment network. Instead, it could take on characteristics of a PayPal with perks.
Fifth is a potential problem that Lightning does not seek to address: As the blockchain gets larger, more storage and bandwidth are required to store a full copy. This leads to greater concentration of the network, as average-sized miners recognize it’s too costly for them to run a full node of the Bitcoin blockchain.
In any scenario we’re aware of, we see some roadblocks to Lightning Network adoption. While we continue to monitor its progress with interest, our Technology Index is not designed as a crystal ball of future upgrades, but as a tool to evaluate the state of the art as it stands today. Thus, as soon as the Bitcoin network becomes more efficient, our ratings model, updated daily with new performance data, will reflect the improvement.
Governance, the Elephant in the Room
While many Bitcoin analysts and advocates focus on the launch of the Lightning Network, hoping it will solve most of Bitcoin’s deficiencies, our concerns are broader. Prominent among them is the lack of adequate governance.
Some Bitcoin advocates may argue that Bitcoin does have some governance capabilities. However, beyond fixing specific, known bugs, the governance has proven to be insufficient to decide upon upgrades that are urgently needed to adapt to rapid, ongoing changes in the crypto ecosystem.
As the first technology of its kind, it’s likely that the early creators and adopters of Bitcoin did not think this would become an issue. Satoshi Nakamoto wrote that, if blocks ever started to get full, all that would be needed is to increase the block size. In his vision, fees would not be a problem as “there will probably always be nodes willing to process transactions for free.”
His theory was elegant in its simplicity. But the true credit to Satoshi’s vision is that it was so powerful it became a victim of its own success. It is Bitcoin’s broad popularity and adoption that have helped foster a divided community with different agendas — from miners to exchanges to retailers and speculators. Each uses Bitcoin for its own reasons; each has interests that often collide.
Bitcoin would probably not be afflicted with high fees or long confirmation times if only the community had agreed to increase the block size — even to just two megabytes. This was the rationale of the SegWit2x hard fork. But there was no effective consensus process to put it into practice in order to upgrade the network without splitting the community. So, the SegWit2x proposal was ultimately dropped.
It is widely known that Bitcoin cannot scale in its current form. It is widely agreed that the protocol needs an upgrade. And if you ask most users, a large majority would say that the block size needs an increase. Still, the governance problem persists. There is no built-in mechanism for reaching consensus.
Some Bitcoin advocates say this is a feature, not a bug. But is it, really? By consensus mechanism, we don’t mean a central authority that owns the network and decides what will happen. There are several other projects that have introduced elements of decentralized governance within their protocol.
One project has a system of master nodes that vote on how to spend part of the block reward on projects that are deemed beneficial to the community. Another has expanded this concept by requiring users to approve and vote on several issues on every block, while experimenting with more advanced governance features. For example, the size of a block can be put to a vote. Provided a super-majority of token holders agree on the change, the protocol is promptly upgraded.
In this rapidly evolving environment, is it a feature for Bitcoin to be permanently wed to its current block size? Based on his vision for Bitcoin, Satoshi would answer in the negative. Meanwhile, several altcoins have done a good job of demonstrating that they can add elements of upgradability and governance without necessarily compromising the core values of decentralization, censorship resistance, or permissionlessness.
Our model recognizes that these features are new and have not been tested in the heat of battle. But they help serve as initial proof of concept — that it should be possible to introduce voting on the blockchain without necessarily compromising security.
All things considered, there will come a threshold beyond which decentralization, lack of finality, and conflicting points of view become more of a hindrance than a feature. The hard data indicate that Bitcoin is close to, or even beyond, that threshold.
We see a divided Bitcoin community. We see attacks from the Bitcoin Cash community that claims to be “the real Bitcoin.” We see censorship on the official Bitcoin Core Reddit. We see more forks again claiming to be “the real” Bitcoin, touting their vision as the most closely aligned with Satoshi’s.
All this despite the fact that the man, woman or group that conceived the original blockchain technology under that pseudonym did not anticipate it would be this successful, and therefore did not foresee some of the core issues it is facing!
As investors and as analysts with decades of experience in traditional financial markets, we can explain why most of these things have not yet emerged as a fatal problem for Bitcoin: Its price has enjoyed a parabolic run-up, despite intermediate crashes.
But investors and analysts must not be fooled: The issues we’ve raised here need to be addressed if Bitcoin is to have relevance years from now.
Are We Against Bitcoin?
Not at all. The very reason we’re pointing out all these issues is our belief in the need for more sunlight, more debate, and more resources dedicated to resolving Bitcoin’s issues promptly.
Bitcoin kicked off this revolution; the cryptocurrency industry would not exist without it. At this juncture, however, Bitcoin undoubtedly faces challenges.
Could it ultimately wind up in the scrapheap of forgotten technologies? Or will it continue to play a pivotal role as other cryptocurrencies evolve and grow around it? We favor the latter. But sustained Bitcoin dominance in the cryptocurrency space is now debatable.
We believe that there should be room for several interdependent protocols and that these could to be immutable enough to remain secure, permissionless and censorship-resistant.
At the same time, we know that the crypto ecosystem is evolving at a very rapid pace; that older technology will be upgraded or discarded; and that, ultimately, its future is both very bright and virtually unlimited.
Best,
Juan Villaverde and Martin Weiss