1. technology and computing

November 6, 2014
Ron Glantz
Director of Research
Dan Morehead
Chief Executive Officer
Bitcoin’s volume-weighted price on the Bitstamp exchange fell 12% in October. Year-to-date,
bitcoin is off 55%, although it is still 1.7 times higher than one year ago. Below we discuss the
analogy between Bitcoin and the Internet, sidechains, and the recent, welcoming attitude of U.S.
regulators toward Bitcoin.
INTERNET ANALOGUE
The current $295 million run rate is over 2.9x the sum invested in 2013 and 29x the amount
invested in 2012. Bitcoin venture capital investments are outpacing the investment rate of
internet companies in 1995. The impact of this capital influx will be an increase in the general
quality and caliber of the Bitcoin ecosystem’s companies and entrepreneurs.1
Just for fun… some of the companies funded in 1995 include Yahoo!, Amazon, and eBay.
Ultimately, we believe Bitcoin startup funding should have a strong positive impact on the
industry's future. Increasingly well-capitalized startups will continue to generate novel, cost-
cutting, and interesting use cases for Bitcoin — ideas and applications that will encourage
adoption over the medium-term. 1
Few groundbreaking technologies reach maturity without a chorus of criticism along the way.
Bitcoin is no exception. The Bitcoin naysayers of today are like the internet naysayers of the
early 90s. The first years the internet was slow and had almost no consumer-friendly programs.
The 14k, 8,000 band dial-up modem (“Pshhhkkkkkkrrrrkakingkakingkakingtsh
chchchchchchchcch*ding*ding*ding*”) is today’s bitcoin. Eventually developers built thenunimaginable applications on top of the TCP/IP protocol. The same is likely to happen with the
Bitcoin protocol. We believe, over time, applications will make it as useful as other important
technology innovations.
Venture money is funding at least 4,5002 Bitcoin projects around the world, almost three times
the amount one year ago. Why? 2

Bitcoin is built for the internet. If Bitcoin had existed in the 1990’s, we believe it would
have been built-in as the standard way to pay for goods and services online.

Innovation moves at a much more rapid pace than in the 1990’s. Social media and
massive global Internet penetration means that ideas spread like wildfire.

Part of Bitcoin’s promise is that it directly attacks areas of the economy which enjoy
monopoly profits. Just as low-cost online stockbrokers drove commissions down and
VOIP made landline telephones all but obsolete, we believe that low-cost bitcoin
transactions will force down monopoly rents.

The banking and financial systems that Americans take for granted are unavailable for
about six billion people around the world. Bitcoin can give these people access to stateof-the-art financial tools at almost no cost.

Bitcoin is attractive as a store of value for people in countries like Argentina, Venezuela,
and Zimbabwe, where inflation has destroyed savings and government controls prevent
purchase of more-stable currencies.

We believe developers will come up with applications that we can’t even imagine today.
But how does this affect the price of a bitcoin? Unlike currency, the Bitcoin code is designed to
ensure that there will always be a limited number of bitcoins. If demand for bitcoins goes up, so
will the price.
In addition, Bitcoin, like TCP/IP, follows a network effect. Improvements to network protocols
over the years were folded into the dominant networking protocol over time. 10 Gigabit Ethernet
doesn’t look like the original Ethernet but it is still Ethernet.
SIDECHAINS
1
Source: PricewaterhouseCoopers, National Venture Capital Association, CoinDesk, Dow Jones VentureSource,
VentureScanner.
2
Source: bitcoinpulse.com
2
Generating a great deal of buzz in the community, The Blockstream Project recently released its
official white paper (PDF) on the subject of sidechains.
Sidechains are lesser blockchains (relative to the Bitcoin blockchain) that are interoperable with
each other and the Bitcoin blockchain. Sidechains are widely considered one of the most
significant and useful innovations of blockchain technology since Bitcoin’s inception. Sidechains
can theoretically prevent Bitcoin liquidity shortages, market fluctuations, market fragmentation,
security breaches, and outright fraud typically associated with altcoins. Sidechains are also an
optimal development, testing, and deployment environment for new blockchain applications.
Below we delve into a simplified yet somewhat technical analysis of how they work, their impact
on altcoins, more on their general significance, and, finally, how they fit into the Bitcoin network
effects picture.
The digital currency ecosystem includes the Bitcoin blockchain and other, alternative, lesser,
competing blockchains. Why Bitcoin became king is attributed to its “first-mover advantage” — it
was the first digital currency and so is the most established, popular, etc. Each alternative
blockchain has its own unit of account. For the Bitcoin blockchain, the unit of account is obvious
— bitcoins. Units of account that are not bitcoin but that are transferred on alternative
blockchains are called altcoins. For example, the Litecoin blockchain generates and transfers
litecoins.
To understand how sidechains work, we must first understand a special feature of Bitcoin
mining called “merge mining”.
Merge mining is a process by which hashes (attempts to solve a block and earn that block’s
reward) of a Bitcoin block are sent to hash blocks of an alternative blockchain. The hashes are
recycled in a sense. By recycling Bitcoin blockchain hashes in this way, the alternative
blockchain then enjoys greater hashing power and, in effect, greater network security than if it
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relied solely on its own mining. Because of this, alternative blockchains are heavily incentivized
to be merge mined.
Merge mining can be implemented by a small tweak of mining hardware and some altcoins are
already merge mined. A notable merge-mined altcoin is Namecoin.
Sidechains, although merge mined like some altcoins, differ from merge mined altcoins. Merge
mined alternative blockchains, when hashed, generate their distinct units of account —
namecoins, etc. These units of account are only as valuable as people determine (similar to
bitcoins, gold, fiat, cowhides, etc.). The difference between sidechains and altcoins is subtle: for
a Bitcoin merge mined sidechain, the units of account derived from that sidechain, instead of
depending on intrinsic valuation, can only be valued in terms of bitcoins. Sidechain units of
account can be thought of as “bitcoins-by-extension”.
In the case of a decentralized bitcoin casino application, a sidechain is used in the back-end for
the application’s chipping system. The developers of the application send bitcoin to the
sidechain’s address. These bitcoins are issued to players as chips (the sidechain’s units of
account). A hand at the table is processed by a sidechain block, conducting raise, fold, buy-in,
buy-out, etc. transactions between the players and the house. Bitcoin miners are contracted to
merge mine sidechain blocks and receive bitcoin-redeemable chips as compensation for their
hashpower. Players can cash out their chips for bitcoin or, if they prefer, their funds can remain
on the sidechain for additional hands. The application is decentralized by virtue of its use of a
sidechain and hence has far greater network security than other non-sidechain applications.
Why Sidechains are Significant
We believe altcoins that fail to match the security of the Bitcoin network will ultimately perish or
be reformed as Bitcoin sidechains. We believe that, with the adoption of sidechains, altcoin
market share of all digital currencies will decrease to near zero. Altcoins currently represent only
a minute 6% of all digital currencies’ market capitalization.
Source: Pantera, coinmarketcap.com
We believe, in a sidechain world, fraud that has been typically associated with weak altcoin
networks and centralized altcoin exchanges will be largely reduced. Once sidechains are
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implemented, Bitcoin adoption will hasten since no new altcoins and a reduction in number of
altcoins means less Bitcoin-detracting, consumer-confusing adoption races for primary digital
currency status.
The redeeming quality of altcoins is that some altcoin features purport to be improvements on
Bitcoin — and some of these features are indeed valuable. Alas, they won’t be lost in the move
to sidechains, as sidechains can be developed to include these valuable altcoin features. As a
matter of fact, sidechains can better promote these features as a testing, development, and
deployment environment that has a negligible risk of fraud compared today’s altcoin ecosystem.
Sidechains may also better facilitate many familiar blockchain-based applications — smart
contracts, decentralized voting, reputation verification, etc. Decentralized voting is particularly
compelling, allowing an individual’s identity to be biometrically attached to a cryptographically
secure public key/private key pairing. This would mean that an individual’s vote, obfuscated or
not, can be 3rd-party assured and audited in an environment where there can be no fraud.
In general, sidechains can be developed and implemented in a limitless number of ways. The
most promising aspect of sidechains is that they can support decentralization of anything that
couldn’t previously be decentralized because of limitations of the Bitcoin protocol.
Sidechains and Bitcoin’s Network Effects
Network effects describe the increase in value that a service provides when additional users
join the system. As the network of Bitcoin users expands, the network’s value increases, and, in
turn, more users are compelled to join the fold.
Sidechains are a major step forward in the Bitcoin network effects sequence. They are one of
Bitcoin’s network effects, in that they are the product of developers attracted to Bitcoin and
inspired to build on its technology. At the same time, sidechains cause further Bitcoin network
effects by enabling unimaginable and facilitating theoretically difficult sidechain-based
applications. We are curious to see how sidechains will exponentiate Bitcoin’s disruptive force
in the next few years.
BITCOIN PRICE ANALYSIS
The recent price decline has resulted in bitcoin being at the bottom end of its historic deviation
from trend. The spectrum in the chart below represents qualitative bitcoin valuation for each
price point, with a range from highly over-valued (gold) to highly under-valued (black).
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Since September 2012, Bitcoin has traded at an average 69% above the 200-day moving
average, peaking at 685% on April 9, 2013. Bitcoin’s price fell to a new low of 42% beneath the
200-day moving average on October 5th — the same day as a 30,000 bitcoin sale discussed
below. It is now 31% below the 200-day moving average. Historically, bitcoin has spent only 1%
of the time below this level.
Bitcoin is experiencing the longest bear cycle in its history, but not the greatest price decline.
The two previous bear cycles saw declines of 93% and 69%. We are at 68% through the end of
October.
Interestingly, there has never been a bitcoin bull cycle with less than a 3.3x return.
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OCTOBER’S LARGE BITCOIN SELLER
We want to share some of the facts regarding the large 30,000 BTC sell order placed on
Sunday, October 5.
The total number of bitcoins initially posted to Bitstamp’s order book exceeded that of the U.S.
Marshalls Service (USMS) auction. While there was a two week ramp up and tons of publicity for
the USMS bitcoin auction, the 30,000 BTC order was brought down in a single Sunday evening.
A confirmed early adopter sold 24,580 bitcoins for $7,374,000 on the Bitstamp exchange. The
early adopter moved an address' entire bitcoin balance of 31,487 BTC to Bitstamp on October
5th. Bitcoins originated at his address on April 3, 2013.
The coins were purchased either on or shortly before April 3, 2013 (at a price of ~$112.75 per
bitcoin, putting total purchase cost at $3.3 million) or in late August, early September 2012 (at a
price of ~$10-12 per bitcoin, putting total purchase cost at $330,000). If purchased in April 2013,
the early adopter made a 2.6x return, approximately $4.6 million. If purchased around
September 2012, he or she made a 27x return, approximately $7 million.
Source: blockchain.info
The Bitstamp sell wall lasted six hours and eight minutes, static at a $300 price point. 24,580
bitcoins of the initial 30,000 amount were sold on Bitstamp.
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Source: bitstamp.net
Bitstamp’s total volume on that day was its highest since March, the 11th highest volume over the
past year.
October 5 – 69k BTC
March 4 – 65k BTC
Source: bitcoincharts.com
By examining the “bitcoin days destroyed” metric and tracing the blockchain, we determined
that an early adopter indeed owned these coins. This coin sale involved the most 'old' coins
transacted in over four months.
“Bitcoin days destroyed” attempts to weigh bitcoins by how long they have been dormant; i.e.,
the amount of time since the coins last participated in a transaction. For example, if one bitcoin
hasn’t been spent in 10 days (1 bitcoin * 10 days), it counts as much as ten bitcoins that were
received and spent in a single day (10 bitcoins * 1 day). "Bitcoin-days" build up over time until a
transaction involving those coins is carried out. Once transacted, "bitcoin-days” are said to be
“destroyed". The metric is considered to give a more accurate indication of Bitcoin network
activity by adjusting transaction volume for attempts to inflate it.
There was a high correlation between bitcoin days destroyed and Bitstamp’s total volume on
October 5th.
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Source: blockchain.info, bitstamp.net
SOCOM VIRTUAL CURRENCY WORKSHOP
Our partner Steve Waterhouse spoke at the U.S. Special Operations Command’s Virtual
Currency Workshop. The event was organized in conjunction with the Business Executives for
National Security. Also attending the workshop were other executives from the Bitcoin industry
and representatives from all aspects of the U.S. government. The purposes of the workshop
were to first educate the Special Operations community on Bitcoin and second to discuss
Bitcoin and other virtual currencies in the context of terrorist financing. Although we cannot
disclose details, the general discussion was positive towards Bitcoin and the inevitable rise of
virtual currency but with a focus on how anti-terrorist efforts can recognize virtual currency
usage and track it.
While Bitcoin advocates don’t always mix with government, the meeting struck a chord with both
parties:
"This is the first time I've talked in an organized way with the U.S. military," said Jim Harper, global
policy counsel of the Bitcoin Foundation. "The bitcoin community doesn't necessarily endorse U.S.
foreign policy, and the bitcoin community doesn't necessarily endorse everything the U.S.
intelligence community does." But, he said, "things that are morally wrong, bitcoin rejects." [NBC]
CFTC HEARING ON BITCOIN DERIVATIVES
The U.S. Commodity Futures Trading Commission (CFTC) met on October 9th to determine what
extent it may have jurisdiction over Bitcoin-referencing derivatives contracts. An affirmative
CFTC ruling — that it should have jurisdiction — would be yet another step in legitimizing Bitcoin.
The Bitcoin derivatives market is still in its infancy. Several companies offer Bitcoin-derivative
products, but none of them follow the standards that Wall Street has come to expect in interestrate and commodity futures and forwards. TeraExchange created the first fully-regulated Bitcoin
swap, and Leonard Nuara, President and Co-Founder of TeraExchange, was present at the panel
to talk about his product.
One of the challenges facing TeraExchange was creating a price index that could pass rigorous
CFTC price manipulation tests. To satisfy these tests, TeraExchange created an index that
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excludes any outlier prices and includes only exchanges that follow appropriate AML/KYC
regulations. In this way, TeraExchange’s index could not be susceptible to price manipulation.
According to the vendor who provides CFTC hearing webcasts, the meeting on Bitcoin
derivatives was the single largest audience for a CFTC event historically. In fact, to the vendor’s
knowledge, this is one of the largest audiences ever for a .gov webcast. The global audience
consisted of over 500 viewers, with high Chinese and European viewership.
During the meeting, the CFTC expressed enthusiasm over Bitcoin. CFTC Commissioner Mark P.
Wetjen said, “I was interested to hear some of the remarks by [Professor Houman Shadab of
New York Law School] about applications that could be made [with Bitcoin] technology in a way
that is actually useful to our space, the derivatives space. And it just seems like based on what I
have learned, some of those applications could be so compelling that it would be a real mistake
for us as a commission to not make sure we are staying on top of these developments. Not
because we want to do anything other than understand the developments[, but] because it
seems like this protocol, the Bitcoin protocol or something like it is very, very likely here to stay.”
Commissioner Wetjen has written further about this hearing and about regulatory approaches to
digital currency in general in an OpEd for the Wall St. Journal. You can read it here.
Regards,
@RonGlantz
@Dan_Pantera
BITFLASH HIGHLIGHTS
10/31/2014: Australian law enforcement officials are now in possession of 24,500 bitcoins
following the conviction of 32-year-old Warran Richard Pollard. Should the funds be forfeited to
law enforcement officials as expected, the bitcoins will be auctioned by the Victoria Department
of Justice. [CoinDesk]
10/30/2014: A new application is in the works that lets anyone create a “world citizenship”
passport. Using PGP encryption software and the Bitcoin blockchain, the project creates a
mathematically iron-clad identification paper that would be extremely difficult, perhaps
impossible, to fake. [WIRED]
10/28/2014: Arthur Levitt, the longest-serving chairman of the Securities and Exchange
Commission, has joined the advisory boards of two Bitcoin companies. [WSJ] [Levitt's Wikipedia
Page]
10/24/2014: Paul Brody, VP of Internet of Things at IBM, announced that IBM will unveil a Internet
of Things proof-of-use concept at CES in January. The concept will demonstrate use of the
Bitcoin blockchain as a device transaction recording tool. [Gigaom]
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10/22/2014: The Bitcoin Law conference held by New York Law School on Tuesday covered
topics such as compliance, banking, and regulatory outlook as they pertain to Bitcoin. This
article delves into some of the legal insight garnered from the conference's panelists. [CoinDesk]
10/16/2014: While U.S. equities markets fall and gold nears a one-month high, bitcoin has
exhibited relatively less volatility lately. [CNBC]
10/15/2014: One reason Bitcoin can be confusing for beginners is that the technology behind it
redefines the concept of ownership. Chain [1] delves into the math behind Bitcoin — the basis for
bitcoin ownership. [Chain]
10/5/2014: Opinion: Why the bitcoin price drop is really good news. An excerpt: "No one said
Bitcoin hitting the mainstream would be smooth or easy. Bitcoin is going through some growing
pains. But I needn’t go through history to show you how so many of today’s staples have gone
through bumps in the road only to come clean out on the other side, stronger than ever. There is
too much money invested, too much technology available, too many built-in advantages, and too
much corporate and global interest to stop Bitcoin at this point.... Bitcoin is not just a dollar price
because Bitcoin is much more than a mere investment. The world needs Bitcoin to succeed. And
by getting this far, it already has." [CCN]
10/1/2014: Facing criticism from those who say the U.S. Financial Crimes Enforcement Network’s
(FinCEN) efforts have sometimes stifled innovation, Director of FinCen Jennifer Shasky Calvery
assures that while her agency’s foremost goal is to protect domestic businesses and citizens,
FinCEN remains committed to minimizing the burden for Bitcoin startups that are making goodfaith efforts to comply with regulation. [CoinDesk]
UPCOMING BITCOIN CONFERENCES
We plan to be at several Bitcoin conferences over the next few months.
November 2-6: Bitcoin World at Money2020, Las Vegas
November 12: Bloomberg Bitcoin Guest Panel, San Francisco
December 1: IvyFON Family Office Forum, Miami Beach
December 2: Future of Money & Technology Summit, San Francisco
December 9: IvyFON Family Office Forum, New York City
January 16-18: The North American Bitcoin Conference, Miami Beach
PANTERA PUBLICATIONS
We tweet Bitcoin news and insights @PanteraCapital.
You can subscribe to our publications by emailing ir@panteracapital.com or through our website
[www.panteracapital.com]:


BitFlash: the day’s best Bitcoin articles, charts, and websites.
BitFlash Weekly Review: the week’s best Bitcoin articles, charts, and websites.
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
Bitcoin Letter: a monthly letter with our thoughts on significant market-related
developments.


Investor Letter: Bitcoin Letter plus additional information for accredited investors.
Venture Letter: our thoughts on Bitcoin venture capital and news on our venture
portfolios for accredited investors.

White Papers: periodic original research and academic papers on Bitcoin.
Most of our content is publicly available on our website. However, the SEC mandates that only
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The information set forth above aims to summarize certain developments, articles and media mentions with respect to Bitcoin
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