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The Nature of Value Creation in the Cryptocurrency Market
Every real dollar of inflow into the crypto market generates at least 2 additional dollars of crypto market capitalization. The multiplier does not fall below 2x even in the crisis years of 2015, 2018, and 2022. The investment does not have a direct impact on capitalization year after year: external factors can lead to an imbalance when real funds come to the market, but capitalization continues to decline, as was the case in 2018.
Venture investments, miners' profits, and the issue of stablecoins formed 103% of the inflow of funds in 2013-2022, or 90.1% of the inflow if we subtract the negative balance of inflows to crypto exchanges.
We estimate that a total of $331 billion of real funds entered the crypto market in 2013-2023, which led to an increase in capitalization by $1.2 trillion at the end of June 2023, and by $2.2 trillion at the peak of 2022.
The capitalization of the crypto market as of June 30, 2023 was $1.2 trillion. The crypto market, which has formed over the past 10 years, has grown to 3.2% of the US stock market (S&P500), $37.2 trillion. However, the volume of funds that were invested in the crypto market: fiat funds that entered the market through exchange gateways, is significantly lower. We estimate that a total of $331 billion of real funds entered the crypto market, which led to an increase in capitalization by $1.2 trillion at the end of June 2023, and by $2.2 trillion at the peak of 2022.
Until the first half of 2023, every year the balance of inflows was positive for the crypto market. 2021 was a record year, when the volume of emission in world economies led to the accumulation of $216.6 billion in funds on the crypto market, with a total capitalization of $2.2 trillion. In 2021, the capitalization of the crypto market increased by 190%, but it was “supported” by only $329 billion accumulated from 2013 to 2021, which is 14.9%.
We assessed the total inflow of funds into the market through two indicators: direct and indirect.
Direct involves direct investment in the crypto market. It includes:
— Venture investments in crypto projects, incl. private investments of "angels". Among the largest funds: Coinbase Ventures (333 rounds), Animoca Brands (274), Digital Currency Group (243), Andreessen Horowitz (a16z) (199) and Pantera Capital (178);
— Public placement of tokens on ICO, IDO, IEO. Key investments are concentrated on three blockchains: Ethereum (2010 projects, $12 billion), BNB (2409 projects, $6 billion), Polygon (575 projects, $0.7 billion);
— Investments in crypto products through “traditional finance”. Investments by institutional and individual investors in ETPs, including investment trusts, and cryptocurrency futures funds. Key providers: Grayscale ($14.5 billion AUM for 2023), CoinShares ($1.4 billion), 21Shares ($0.8 billion), Proshares ($0.6 billion);
— Investments in stablecoins. Issue of tokens backed by assets. The two largest fiat-backed stablecoins, USDC and USDT, accounted for 89% of the market at the end of Q2 2023. At the end of 2022, Binance's fiat stablecoin BUSD held 14.5% of the market with a peak capitalization of $23.4 billion.
Indirect inflow includes:
— Miners’ profit for confirming blocks of the BTC and ETH chains (until September 2022);
— A net influx of funds to crypto exchanges, which indirectly takes into account the activation of investor funds and affects the p2p transfer market.
The key categories of inflows for 2013-2023 (H1) were: stablecoins (38%, $124.6 billion), venture investments (36%, $117.9 billion), and miner profits (29%, $97.3 billion). The outflow of funds from crypto exchanges: -$46.1 billion (-14% in the structure) demonstrates that investors are accumulating funds in their own wallets during periods of instability in the market, and are increasingly giving preference to decentralized exchanges. In the record year of 2021, 65.4% of funds from the cumulative inflow over the last 10 years entered the market – $216.6 billion, against $31.2 billion in 2020. Investment activity paused in 2023 amid tightening monetary policy by the Federal Reserve and the ECB and growing uncertainty, both economic and geopolitical, which led to investors being cautious about risky assets.
According to the results of the first half of 2023, every $3.6 of the crypto market capitalization was created as a result of the “entry” of $1 real. While $2.6 was formed as a result of price multiplication. In the entire history of the crypto market, the multiplier has never fallen below 2.0x: in 2015 – 2.1, in 2018 – 2.0, in 2022 – 2.2. Even during the crisis years, the capitalization of cryptocurrencies stopped after a decline at around 2-2.2x to invested funds.
As of 2023, the multiple has grown to 3.6x, which is close to the values of 2016, and mid-2020 before an active bull market. It is worth noting that capitalization does not directly correlate with the influx of funds into the market, year after year. Thus, in 2018, with a positive balance of inflows of $39 billion, the capitalization of the crypto market decreased by $466 billion. And in 2020, with a similar inflow of $39 billion, market capitalization increased by $570 billion.
Ukraine's losses due to the lack of regulations for crypto market in 2016-2022
Despite the decentralized nature of the crypto market, its development in the country is closely related to government support, not to mention the legalization of instruments. A decentralized market will not exist without the inflow and outflow of funds into traditional banking instruments: accounts and cash through payment providers. The moment access to them is blocked, in an individual format, or through crypto exchanges, the viability of the crypto market in a particular country deteriorates significantly.
We estimate that since 2016, Ukraine has lost $48.8 billion in direct income for individuals and companies, and $4.1 billion in tax revenue due to the lack of crypto regulations. This equates to $7.0 billion and $0.6 billion annually. At the same time, income is distributed unevenly, and most of the “lost” income occurs in the bull years of 2017 ($23.3 billion) and 2020 ($14.9 billion).
The capitalization of the cryptocurrency market at its peak in November 2021 was $2.9 trillion, while the influx of real funds into it, we estimate at $330 billion. To calculate the lost funds in Ukraine, we calculated the potential profits for the population from investing in cryptocurrency, the income of mining farms, and the issue of stablecoins within the country. As a result, $49 billion of lost inflows were formed by 80% ($39 billion) from lost income of the population, 14% ($7 billion) from lost income of miners, and 6% ($2 billion) from lost income of companies issuing stablecoins. The key factors of missed opportunities are cheap electricity during the infancy of cryptocurrency mining, the lack of investment instruments without reference to centralized structures for the population, and the limited liquidity of foreign exchange instruments within the country. It is important to note that the above estimates are conservative due to the assessment of domestic demand without taking into account the potential influx of external investment.
We believe that the venture market and the market for public offerings would not be a priority for Ukraine and investments in it, even with full legalization, would be insignificant due to regulatory risks.
Households investments in cryptocurrency
The price of BTC increased from 2016 to 2023 by 38 times from $435 to $16.5 thousand. The cumulative accumulated savings of Ukrainians, “cash currency outside banks” amounted to $83.1 billion in 2016, and $108.4 billion in 2022. At the same time, the dollar inflation (in the United State) during this period was 26.3%. This means that $100 saved in January 2016 could buy the same amount of goods as $126.3 in January 2023. The reasons for holding savings in an asset that is losing value are concerns about centralized institutions amid a series of falls in banking institutions since 1991.
We estimate that the legalized access of Ukrainians to an alternative instrument for saving investments not associated with centralized institutions: cryptocurrency, stimulated the placement of from 1%-2% of savings at the stage of the market’s inception, to 5% since 2019. As a result, investments in cryptocurrency have ranged from $0.9 billion to $4.9 billion annually. We assume that 100% of investments will be concentrated in BTC, avoiding riskier assets like the blue chip alternative ETH, or other fast-growing altcoins: SOL, ADA, et cetera.
We assessed profits through the growth of investment capitalization from January 1 to December 31 and the conditional fixation of positions and the opening of new ones on January 1 of the following year. The cumulative profit in 2016-2022 would have amounted to $39.1 billion. It is important to take into account that saving positions in 2018-2022 would have allowed us to avoid recording losses.
Potential Miner Income
We estimate Ukraine's loss of profit from miners in 2016-2022 at $7.5 billion, which is 7.8% of their total profit for the same period. Ukraine’s key competitive advantage, lower prices for electricity, was not realized due to regulatory uncertainty. At the same time, the Ukrainian energy system is capable of generating additional capacity to cover the demand of miners, versus, for example, Kazakhstan, where energy for miners is limited.
A key assumption assumes that Ukraine could attract 20% of the miners’ capacity from countries where electricity prices for enterprises are higher. The low share is associated with the difficulties of transferring technical equipment to another location, and with potential preferential prices for electricity that can be offered to mining farms in countries if they are threatened with “moving”. The price of electricity in Ukraine (excluding VAT) from 2016 to 2022 increased from 5.9 cents per kWh to 11.2 cents kWh, which critically affected the competitive advantage. Thus, a JP Morgan analyst said in 2023 that, according to “his calculations,” the average price of kWh for miners is now about 5 cents. If before 2020 Ukraine claimed 16-17% of the global miner market at current non-preferential prices (10-11 cents in the United States, 8-9 cents in China), then by 2022 the potential share has dropped to 1%.
If in 2016-2020 Ukraine was able to attract miners with low prices for electricity, then in 2020-2021, the competitive advantage was the reserve of generation capacity, both during the night “non-peak” period, and practical unused capacity. The average installed power plant capacity suggests that Ukraine could generate more than 450 TWh per year, with actual consumption of about 150 TWh. Even taking into account planned repairs of ~40% of capacity, the theoretical surplus of production was 120-140 TWh per year, which created space for attracting mining farms to the country due to preferential prices for wholesale purchases of electricity in terms of volume, size of investments, or created workers places The theoretical indicator of potential income using the entire surplus in the energy system (40% for repairs) was $170.5 billion for 2016-2021, it is important to note that the total income of BTC and ETH miners during this period was $95.8 billion.
Stablecoins and tokenized assets
The issue of stablecoins solves the problem of high commissions when transferring funds between countries, increases the liquidity of funds against cash savings, and is easily converted into other cryptocurrency assets for investment purposes. We estimate that potential stablecoin issuing companies (including non-financial sector entities) missed out on $2.2 billion in additional revenue between 2016 and 2022 due to lack of regulation. We are talking about issuing fully backed stablecoins in USD and UAH to optimize the liquidity of savings and access to a wider range of financial markets.
The volume of stablecoin issuance is conservatively taken into account solely for the needs of the domestic market, without the potential influx of external investment: from 2% of the accumulated funds of the population to 5%, which implies a total volume of stablecoin issuance of $5.4 billion by 2022, or about 5% of the total stablecoin market , on a level with BUSD (before regulatory problems), which is in the top 5 by capitalization.
The potential income of issuing companies consists of four categories:
— Income from reserves (85% of stablecoin capitalization). Stablecoins are traditionally backed by short-term AA, AAA, and other alternative investments (like MMF) to ensure a seamless conversion of fiat funds into stablecoins. We used the 1Y US bond yield as a standard. Revenue for 2016-2022 is $0.3 billion.
— Income from lending. We assume that 10% of the company's reserves will be allocated to lending to reliable companies at a rate of 1Y Treasuries + 2%, which describes a low level of risk. Revenue for 2016-2022 is $0.1 billion.
— Investment income. We assume that 5% of the company's reserves will be allocated to investments in the company's blockchain, with the expected income: 1Y Treasuries rate + 4%. Revenue for 2016-2022 is $0.07 billion.
— Turnover income. We assume that companies will charge a 0.01% commission on stablecoin turnover to maintain infrastructure. Revenue for 2016-2022 is $1.8 billion.
Additional income of the population from investing in cryptocurrencies could form up to 22% of additional income of the population. On average for 2016-2022, the potential income of the population in the crypto market would increase their total by 4.2%, that is, for every $100 earned, the direct increase in income would be $4.2. Given the household spending multiplier of 1.68, every additional $1 of spending leads to GDP growth of $1.68.
The Ukrainian budget lost $4 billion in additional revenue that the crypto industry would have generated if legalized. Record years for potential collections are 2017 and the crisis year 2020. Thus, the budget deficit associated with Covid-19 amounted to UAH 217 billion – $8.0 billion, which could be “closed” by 13% solely due to additional tax levies from the crypto-industry, without attractions.
As a result, the crypto industry, without additional incentives other than legalization, could generate $49 billion for Ukraine in 2016-2022, which is 4.9% of GDP. For comparison, real GDP growth in 2023, according to the NBU forecast, will be 2.9%.
Regulation and taxation of crypto assets in Ukraine. Impact on GDP and tax revenues. The shadowing factor as the main driver of efficiency growth in the industry
1. Introduction. From the point of view of global development of the crypto market, the current stage can be characterized as the beginning of the formation of a regulatory framework in most countries and intense international competition for tax revenues from crypto assets. Despite the high level of development of the crypto industry in Ukraine in all directions (from the development of world-leading products to popularity among the population and mining volumes), in recent years the country has been losing its position due to the lack of a legally regulated field. According to our calculations, in the period from 2016 to 2022, Ukraine lost significant amounts of direct income and tax revenue due to the lack of regulation of this sector: $48.8 billion in GDP and $4 billion in tax revenue, which is equal to $7.0 billion and $0.6 billion annually, respectively.
2. The problem of shadowing the crypto sector. The key problem in the development of the crypto industry in Ukraine is the high level of shadowing, due to the lack of a regulatory framework and a specific tax regime, which does not allow the full use of the tax potential from activities related to crypto assets. Particular attention should be paid to public investments in crypto-assets, mining and issuance of coins by developers, which currently continue to function, but remain outside the legislative framework. The lack of a legal framework and the ability to pay taxes at the market rate makes these segments vulnerable, reduces the transparency of their structuring and access to financing.
3. The need for a special tax regime. Tax reform for the crypto sector should be created, including the establishment of correct tax rates, which will create the preconditions for the legalization of cryptocurrencies and increasing tax revenues to the budget. Indeed, tax conditions during the war remain unpredictable, which reduces the investment attractiveness of Ukraine for foreign crypto capital. But in the current conditions, the lion’s share of domestic crypto assets for all types of activities we analyze is in the shadows. Thus, the “shadowization” of even 20-40% of the sector will lead to an increase in budget revenues.
4. The optimal way to bring crypto assets and income from them out of the shadows. The establishment of a competitive and stimulating tax regime and the legalization of the crypto market will lead to GDP growth (both by emerging from the shadows at the first stage and by increasing tax revenues, also attracting foreign investors, for whom current tax rates are secondary). The proposed tax rates in the first years of legalization of crypto assets are 5% for personal income and 18% for corporate income. A potential risk is that the special tax treatment for crypto-asset income may be abused by other domestic taxpayers (which poses a risk of base erosion for the Treasury). That is why a mechanism to control the origin of declared income is also necessary.
5. Implementation of similar cases in Ukraine. Special tax regime for Diya-City in 2022. The high level of shadowing of the IT sector similarly reduces the development potential of the industry (fragmentation, aggressive optimization of income tax/evasion). Based on actual tax rates (the effective level taking into account all the costs of optimizing and supporting a more complex legal structure), the Ministry of Digital Transformation proposed a new tax regime for Diya-City. Despite the potential risks and the introduction of the regime in the first year of the war, residents of Diya-City increased tax payments to the budget compared to 2021.
Results. The analysis confirms the possibility of implementing the proposed tax regime, taking into account the current instability and shadowing of the crypto sector. Shadowization and the creation of favorable conditions contribute to the protection and structuring of activities related to crypto-assets, and allow the organization of business processes more transparently and sustainably.
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