Holders of bitcoin do have to endure heightened volatility; however, they have been rewarded for that risk with outsized returns. The below table shows the compounded annual return over multiple time periods.
In addition to superior risk-adjusted returns compared to other major asset classes, bitcoin is almost totally uncorrelated to every other asset class. Bitcoin would provide return and diversification benefits when added to a portfolio. This is especially true in an era when most assets are highly correlated – “risk on/risk off” world.
Many of you have asked about Etherium and The DAO. The appendix to this letter has Steve Waterhouse’s thoughts on them, thought-provoking excerpt from The DAO attacker’s statement, and Coin Center’s thoughtful statement on The DAO
THE DAO OF ETHERIUM – By Steve Waterhouse
Bitcoin was originally conceived in 2008 in a white paper. The first version of the Bitcoin codebase was released in January 2009. The last seven years has seen many changes, including revisions to the code base as bugs have been found and scalability concerns addressed. Over the last year a fierce debate has raged over how to move Bitcoin forward, all centered around the size of a block – which currently sits at 1MB. Changing the block size would require a “fork” in the code base – in which all participants of the network would be required to upgrade their software in order for their transactions to be valid and accepted. The arguments have reached such frenzy at times that they have led to resignations of key developers and strong words exchanged in public forums. Proponents of a larger block size point to the congestion in the Bitcoin network and the desire for extra functionality in the Bitcoin blockchain.
Ethereum smart contracts have many interesting applications and have captured the imagination of developers, corporations, and investors. Many of Pantera’s portfolio companies are using Ethereum in their blockchain development and we have been a supporter of the concept since its inception, but with some ongoing concerns over security and scalability.
In 2016 a great deal of attention was brought to Ethereum – initially with a strong rise in its market cap from $60mm in Jan 2016 to over $1bn by May 2016. In April 2016 a new project was launched on Ethereum – “The DAO” or “Decentralized Autonomous Organization”. This was originally conceived as a way for a specific project – “Slockit” which was developing a smart lock which could be remotely controlled using smart contracts – to raise money. The DAO evolved beyond this concept and became a general purpose fund in which the investors had a vote in which projects received investment.
By 21st May 2016 the DAO had raised over $150m and attracted 11,000 investors and significant attention. The DAO raised several questions about how such an organization would conduct itself. In addition in May 2016 a paper was published noting several security vulnerabilities and recommending that investors hold off before the vulnerabilities could be resolved. Further attention was brought to these and other vulnerabilities in June 2016 and fixes developed.
Before the fixes could be voted in and adopted however, a developer / “attacker” published a smart contract which drained $50m from the DAO into a separate “child DAO”. Because of an unforeseen issue in the DAO codebase the attacker was able to call a function to withdraw ether from the DAO which unfortunately recursively called itself again – thus withdrawing more and more ether every time it was called.
If this sounds complicated – it is – but thats the problem with developing new programming languages and virtual machines – its hard. In a future version of Etherum we might have a validating complier which checked for weaknesses such as this, but in general every time we push for more functionality in Blockchains we run into potential issues like this.
The “stolen” funds are still in question right now. The child DAO cannot have its ether withdrawn for 27 days so there is some time to figure out a solution. Proposals include:
1. Forking the entire Ethereum codebase (see earlier comments about Bitcoin forks) which is essentially putting the entire principle of Ethereum of being contracts without people, just code, into question. This would also shut down the DAO forever and return funds to the investors.
2. Allowing the attacker to keep the funds – which is complex because 11% of all the Ethers were invested in the DAO and many insiders invested in the project. This would allow the DAO to keep going with its mission however, albeit with reduced funds.
Clearly option (1) is a challenge for Ethereum in general as a platform. By upgrading the network just to return some funds to investors in the DAO calls into question the entire principle of Ethereum and sets a precedent for future situations where a judge or lawyers may use the same principle to override a smart contract which is supposed to run only on code.
Excerpt From Attacker’s Statement
I am disappointed by those who are characterizing the use of this intentional feature as “theft”. I am making use of this explicitly coded feature as per the smart contract terms and my law firm has advised me that my action is fully compliant with United States criminal and tort law. For reference please review the terms of the DAO:
“The terms of The DAO Creation are set forth in the smart contract code existing on the Ethereum blockchain at 0xbb9bc244d798123fde783fcc1c72d3bb8c189413. Nothing in this explanation of terms or in any other document or communication may modify or add any additional obligations or guarantees beyond those set forth in The DAO’s code. Any and all explanatory terms or descriptions are merely offered for educational purposes and do not supercede or modify the express terms of The DAO’s code set forth on the blockchain; to the extent you believe there to be any conflict or discrepancy between the descriptions offered here and the functionality of The DAO’s code at 0xbb9bc244d798123fde783fcc1c72d3bb8c189413, The DAO’s code controls and sets forth all terms of The DAO Creation.”
A soft or hard fork would amount to seizure of my legitimate and rightful ether, claimed legally through the terms of a smart contract. Such fork would permanently and irrevocably ruin all confidence in not only Ethereum but also in the field of smart contracts and blockchain technology.”
Peter Van Valkenburgh, Director of Research, Coin Center:
“DAOs are an important experiment in community governance—governance by code rather than law or norms. Experiments come with risks and rewards and we only learn from the process by letting them run, succeed or fail.”
“It looks like The DAO is failing, but there are some bright spots and the community is already learning critical lessons.”
“For one thing, it’s good to see that delays were built into the code so that even though funds are being “stolen,” they are stuck in limbo for at least 27 days because of the code that governs the system. That will give the community of users, miners, and developers time to decide what to do. It could mean that we accept the loss, or that changes are made to Ethereum’s protocol to return the funds. But those decisions will be made by a decentralized community that votes.”
“This is a laboratory for community governance, and it won’t always be pretty. But it’s important we let the process play out, and take a longer view of the evolution of these fantastic new tools.”