How to use the J-curve for macro analysis in the cryptocurrency industry?

Original Title: 《The Crypto J-Curve》

Author: Chris Burniske, Partner at Placeholder

Translator: CryptoOcean, H.Forest Ventures

As the market for crypto assets evolves, we will continually see the overlap of booms and busts, as people's enthusiasm fluctuates. The ups and downs are part of the entire journey to the moon.

Bitcoin has gone through several boom-bust cycles, most notably during the euphoric period at the end of 2013. At this time, Bitcoin first broke the $1,000 mark, but soon began a painful decline that lasted until January 2015, when Bitcoin hit a low of $175. However, with Bitcoin now approaching $4,000, having nearly quadrupled in just one year in 2017, we are once again entering a period of euphoria.

" For crypto assets with real utility value, this ebb and flow pattern will create a price chart resembling the familiar pattern: the J-curve. "

In private equity, the J-curve refers to the cash flow of a portfolio, while in economics, it is often used to describe the impact of currency depreciation on a country's deficit. In cryptocurrency, a new J-curve has also emerged.

The basic concept of the cryptocurrency J-curve stems from the market's long-term valuation of crypto assets. As I explained at the Token Summit, I believe the price of a crypto asset consists of two forms of value: "Current Utility Value" (CUV) and "Discounted Expected Utility Value" (DEUV), with some preferring to call the latter speculative value. (Note: The term speculative value can only be downplayed when acknowledging that the pricing of most high-growth stocks is primarily composed of "speculative value" surrounding future cash flows).

In trading, enthusiasm for crypto assets is high, and this enthusiasm often lasts for a while. At this stage, the asset's CUV is minimal, and it does not exist without the protocol. Subsequently, the asset becomes primarily composed of DEUV, exposing it to the whims of Mr. Market. This initial high enthusiasm period is the first (small) peak of the cryptocurrency J-curve, as shown in the figure below.

Note that in the figure above, "high %DEUV, low %CUV" refers to the percentage composition of the price, not absolute values. From my work valuing different crypto assets, it is not uncommon for the value composition in the early stages to look something like the situation below. Initial price inflation—DEUV inflation.

Translator's Note: The author theoretically explains the rationale behind "buy the expectation, sell the fact" from the price composition of high DEUV and low CUV.

As crypto assets progress over time, development teams and crypto networks inevitably encounter unforeseen roadblocks. Building distributed systems is challenging, as is managing the people within them. With such roadblocks, market enthusiasm wanes, impacting DEUV. Mathematically, the compression of DEUV can be attributed to any number of variables.

• Raising the discount rate, as the chances of success are perceived to be smaller, thus increasing the asset's risk.
• The target market penetration of the asset declines, as people worry that the protocol will not win as many users as initially imagined.
• The total market size is cut down due to the components of the roadmap and planned functionalities being deemed unrealistic.

No matter how you explain it, when times get tough, speculators choose to exit, DEUV gets suppressed, and with the current utility value being low, the price of the token gets crushed. Ask any Bitcoin player about 2014— that was not an interesting year.

However, a dedicated development team will hunker down, lower their profile, and remain indifferent to the whims of Mr. Market. As a result, the protocol improves, and more users (not speculators) flood in.

" With the increase in usage, the CUV of crypto assets quietly grows. "

Even if the DEUV of the token continues to compress, there can be instances of CUV growth. If the market is bearish enough, the asset price may compress DEUV down to zero, leaving only CUV and a sharply declining price. The market may even discount the asset below CUV, somewhat akin to stocks trading below book value.

However, often outside of the developers, users, and the broader "utility community," there remains a group of die-hard investors holding on, representing a small portion of the former DEUV (as shown in the figure below). I believe and can see that this is what happened with Bitcoin in the first three quarters of 2015 based on the low of $200. This is the bottom of the cryptocurrency J-curve.

The ascent from the bottom of the J-curve can be a slow process, with a long uphill climb. When Mr. Market wakes up to the continuously growing CUV of the asset, injecting more DEUV into the price, the curve will begin to steepen.

This process is the opposite of the three situations mentioned above, perhaps due to a decrease in the discount rate, or an expansion of the expected penetration rate of the target market, or an increase in optimistic sentiment about the total addressable market. However you slice it, DEUV will expand on the basis of CUV growth, driven by expectations of future utility value. The following shows Bitcoin's development from 2013 to now.

Since 2013, the speed and differences in market changes have become significant. Ideally, CUV and DEUV will expand in sync, finding a healthy balance. However, in a strong bull market, DEUV often begins to grow rapidly and surpass CUV. In this case, speculators start to flood back in, accelerating the expansion of DEUV and causing CUV to drift away from reality. This is why the J-curve of cryptocurrencies tends to steepen in later stages.

Typically, by this time, a complete cycle has played out. A crypto asset starts primarily composed of DEUV at launch, drops to the depths of a bear market, bottoms out supported by CUV, and finally expands again to be primarily composed of DEUV. During this period, the percentage composition of the price of the crypto asset is shown below:

The J-curve is the price manifestation of the aforementioned shifts in market sentiment and utility value. When initial expectations are high, prices also tend to be high, but are often primarily composed of DEUV; however, as expectations wane, even if CUV grows, prices will decline; finally, as DEUV expands again, supported by more CUV, the asset should exceed its previous price peak.

" In other words, under the current high utility value, the amplifying effect of discounted expected utility value can be greater. A more intense bull market is expected in the coming years. "

After this, the cycle will play out again, time and time again. In the macro and micro landscapes, I expect many J-curves to unfold, differing only in the time scale. The macro pattern I refer to spans a decade. Each previous peak will pale in comparison to the next peak of DEUV, forming a continuously refreshing J-curve. This J-curve will consist of many micro J-curves, whose periodicity is still being determined.

Ultimately, in a steady state, a crypto asset should primarily consist of CUV, with a little speculation on the margins. At this point, the J-curve over decades should begin to shrink, eventually resembling an S-curve as the utility lifespan increases. Ongoing quantitative speculation around future utility will depend on the number of target markets captured and the number of protocols that have become rigid. Of course, this is all theoretical, so don't expect a perfect model to exist in reality. However, as long as utility improves in the long term, we can reach a full moon (perfection).

Thanks to Joel Monegro, Cathie Wood, Brett Winton, and Stephen McKeon for helping me think about the cryptocurrency J-curve from different perspectives.