Cryptoassets: The Financial Metaverse

Cryptoassets
The Financial Metaverse
NICHOLAS WATTS FINTECH 5 AUGUST 2021

About the team
Nicholas Watts
Nicholas re-joined the Redburn Financials team from Barclays where
he covered African Banks. Prior to this, he spent six years at Redburn
covering Investment Banks. He started his City career in Citigroup’s
Equity Capital Markets team. Nicholas is a chartered accountant and
has an MBA from the University of Cambridge.
T +44 20 7000 2187

M +44 7557 316 531
E nicholas.watts@redburn.com
Charles Bendit
Before joining Redburn, Charles was an Insurance analyst at
Berenberg. He started his career at Nomura. Charles graduated from
the University of Bristol with a BSc in Economics and Finance.
T +44 20 7000 2171

E charles.bendit@redburn.com
Russell Quelch (Specialist Sales contact)

Russell joined Redburn from Bank of America Merrill Lynch where he
worked in Equity Trading and subsequently as a Financials Specialist
Salesperson. He holds an BEng in Mechanical Engineering from the
University of Nottingham and is a CFA Charterholder.
T +44 20 7000 2116

E russell.quelch@redburn.com
Cryptoassets / 5 August 2021
Cryptoassets
The Financial Metaverse
Money is a social construct. The idea of open, borderless and permissionless

money is an anathema to some and a foreign concept to the vast majority. The
concepts contained in the original Bitcoin white paper and the technology
behind it have powered the rise of cryptoassets, which now are starting to
alter perceptions of money and how value can be transferred.
A financial metaverse is being created that holds potential to be applied
into the real world. For public sector guardians of the traditional monetary
system, this is an uncomfortable time. Rather than shaping events, they are
responding to them.
For the financial sector, which extracts an annual toll of c7% of global GDP,
radical change may be afoot. Interest in cryptoassets and the associated
technology are broadening from retail into institutional and corporate
markets. The concept of Decentralised Finance (DeFi), which envisages a
financial world shorn of centralised intermediaries, is garnering growing
interest and investment.
Real-world complexity will act as a handbrake on wilder technology
ambitions. However, history has repeatedly shown that technology-fuelled
change usually meets resistance, its impact is almost always underestimated
and significant unintended consequences arise. We do not think disruptions
in the technology of money and value transfer will be any different.
Investment opportunities will abound for those with a high risk tolerance.
We assess Coinbase, a leading crypto exchange with over 10% of global
crypto assets held on its platform, as being well positioned to benefit from the
coming change and rate the stock a Buy.
Nicholas Watts
+44 20 7000 2187
nicholas.watts@redburn.com
Important note: see regulatory disclosures on page 123 of this report. 3

Redburn 3D: Coinbase

Fundamentals
Coinbase (price: USD230.18, market cap: USD48.0bn) summary financials and valuation
Y/E December (US$m) 2020 2021E 2022E 2023E 2024E
Revenue 1,277 5,942 5,990 6,839 8,341
EBITDA (adjusted) 527 2,922 2,676 3,045 3,902
Pre-tax profit 409 2,466 2,251 2,548 3,341
Net profit 322 1,922 1,733 1,962 2,573
EPS (US$, diluted) 1.57 7.31 6.51 7.29 9.46
Consensus EPS (US$) 8.08 5.00 6.21 7.60
Price/EPS (x) 31.5 35.3 31.6 24.3
EV/EBITDA (x) 19.5 20.5 17.2 12.6
DPS (US$) - - - -
Dividend yield - - - -
BVPS (US$) 14.1 21.9 30.5 41.5
Price/BVPS (x) 16.3 10.5 7.5 5.5
FCF yield per share, adjusted 0.6% 4.1% 3.5% 3.9% 5.0%
Net debt/(cash) (adjusted) 954 3,293 5,424 7,860 10,981
Source: Redburn, company
IDEAS Charts
Score: 30/100 Value (implied change) 33 1m 3m 12m
Growth 4 Relative performance -4.4% -23.1% -12.3%
Ests. Mom (EPS) 91
Ests. Mom change (3m) -2
Quality (returns) 39
Relative Estimates Momentum Price relative

100 100
80 95
90
60
85
40
80
20 75
0 70
Sep Oct Nov Dec Jan Feb Mar Apr May Jun
11 12 13 14 16 17 18 19 20 21
Ests. Mom. EPS Ests. Mom. Sales Price Rel (RH)
Note: see redburnideas.com for an explanation of The IDEAS Wave, The IDEAS Note: Coinbase vs S&P 500 since listing. Data correct as at 4 August 2021. Please see
Score and Estimates Momentum. Data correct as at 4 August 2021. Please see www.redburntoday.com/charts for live information
www.redburnideas.com for live information
4 Important note: see regulatory disclosures on page 123 of this report.

Contents
Contents
The idea .......................................................................................................................... 6
01/ A new way to transfer value and record transactions ......................................... 18
Distributed ledger technology – the underpinning .....................................................................................19
DLT and Blockchain ........................................................................................................................................21
The Blockchain layers ......................................................................................................................................22
Investment and applications ...........................................................................................................................24
02/ The money debate and regulation........................................................................ 26

The fragmentation of money ..........................................................................................................................27
The emergence of Central Bank Digital Currencies....................................................................................30
Regulation – critical, but likely to lag ............................................................................................................34
03/ The crypto landscape ............................................................................................ 43

Digital numismatics .........................................................................................................................................44
The emerging crypto infrastructure ..............................................................................................................61
Use cases and institutional engagement .......................................................................................................63
04/ DeFi ....................................................................................................................... 67

An overview.......................................................................................................................................................68
The current status .............................................................................................................................................70
The opportunity................................................................................................................................................73
05/ Crypto exchanges .................................................................................................. 78

Spot and derivative markets............................................................................................................................79
Exchange rankings ...........................................................................................................................................82
06/ Coinbase ................................................................................................................ 84

Overview ............................................................................................................................................................85
Developing a broader crypto offering ...........................................................................................................86
Development and growth of the overall crypto market..............................................................................91
Fade rate of retail transaction margins ..........................................................................................................93
Benchmarking and valuation..........................................................................................................................98
Coinbase financials ................................................................................................... 102

Appendix 1 – Key ideas in Bitcoin ............................................................................ 106
Appendix 2 – Bitcoin mechanism ............................................................................. 107
Appendix 3 – Ethereum 2.0....................................................................................... 112
Appendix 4 – Altcoins ............................................................................................... 117
Appendix 5 – Glossary .............................................................................................. 119

The idea
The idea
“A purely peer-to-peer version of electronic cash would allow online payments to
be sent directly from one party to another without going through a financial
institution.” Extract from ‘Bitcoin: A Peer-to-Peer Electronic Cash System’,
Satoshi Nakamoto, 2008
Satoshi Nakamoto’s Bitcoin paper published in 2008 has led to the development of an
entirely new asset class and conceivably a new way of operating a financial system. Or
has it?
“The rule is that financial operations do not lend themselves to innovation … The
world of finance hails the invention of the wheel over and over again, often in a
slightly more unstable version” Extract from ‘A Short History of Financial
Euphoria’, John Kenneth Galbraith, 1990
As framed by Galbraith, the financial system does have a long history of false dawns.
The Nakamoto/Galbraith comments usefully frame thinking about the cryptoasset
industry. Nakamoto, a shadowy figure(s) who briefly existed in the ether, before
disappearing. Galbraith, every inch an establishment figure. In assembling this report,
we have been mindful of this dichotomy between the new and the established.
Digital numismatics
The market for cryptoassets has exploded in recent years in both number of assets
(CoinMarketCap listing over 5,700) and the value thereof (Fig 1). Interest in the sector
continues to be led by Bitcoin and Ethereum, which together account for over 60% of
cryptoasset market capitalisation (Fig 2).
Bitcoin remains the flag-bearer of the crypto industry, despite its dominance falling.
Its role has changed from that originally envisaged in Nakamoto’s white paper of a
peer-to-peer payment network. The lack of scalability around the Bitcoin network
(which processes around three transactions per second) has led to markets rethinking
the rationale of Bitcoin. Its constrained supply (in an era of rampant global money
supply expansion), global reach and portability allied with the computing power that
backs its proof of work consensus mechanism has led to a strong view in some
quarters of the financial markets that it could be a significant store of value.
This could change. The Lighting Network, a layer-2 network, built on top of the
Bitcoin blockchain could conceivably support Bitcoin functioning as a payments
system. The pending upgrade (known as Taproot) to the Bitcoin network, the first in
four years, may enhance Bitcoin’s appeal in the area of smart contracts, currently
dominated by Ethereum.
Considerable criticism has been levelled at Bitcoin given the prodigious level of
electricity consumption demanded by its proof of work consensus mechanism. This
mechanism underpins Bitcoin’s security and its decentralised nature. Given the

The idea
economic incentives and flexibility around Bitcoin mining (evidenced recently by

Bitcoin mining shifting away from China following a crackdown there on energy
consumption concerns), we anticipate a degree of immunity to this criticism, although
over time we expect Bitcoin energy consumption to be shifted to more renewable
sources, while the efficiency of the mining process will continue to improve.
Fig 1: Crypto market cap, 2013 to date Fig 2: Major cryptoassets by market cap, 30 July 2021
3,000
2,500
Market capitalisation (U$b)
2,000
1,500
1,000
500
0
Apr-13
Apr-14
Apr-15
Apr-16
Apr-17
Apr-18
Apr-19
Apr-20
Apr-21
Oct-13
Oct-14
Oct-15
Oct-16
Oct-17
Oct-18
Oct-19
Oct-20
Bitcoin Ethereum Tether

Total Excluding BTC Binance Coin Cardano XRP
USD Coin Dogecoin Other
Source: CoinMarketCap, Redburn Source: CoinMarketCap, Redburn
Ethereum has emerged as the workhorse of the crypto industry, despite it not
(currently) offering dramatically better transaction processing capacity than Bitcoin.
Reflecting its design, it is the network of choice for running decentralised applications
(DApps), digital applications that run on decentralised networks. Growth of the
Ethereum network has led to severe capacity constraints, and in order to solve this (as
well as to try to resolve what is known as the blockchain trilemma – the inability of
blockchains to simultaneously deliver security, decentralisation and scalability), a
reboot of Ethereum is currently under way. Known as Ethereum 2.0, this upgrade is a
series of interconnected projects expected to run into 2022. Collectively they are
expected to massively increase the scalability of Ethereum (Fig 3), as well as switching
from a proof of work consensus mechanism to a less energy-intensive proof of stake.
Fig 3: Ethereum, theoretical transaction throughput

Basic ETH transfer ERC-20 token transfer
Theoretical throughput on Ethereum 1.0 54 TPS 23 TPS
Ethereum 2.0
Theoretical throughput before sharding 6,293 TPS 4,720 TPS
Theoretical throughput after sharding 146,626 TPS 109,976 TPS
Source: Redburn, vitalik.ca

The idea
The past few years have seen a proliferation in the number of assets across the crypto
industry. Away from Bitcoin and Ethereum, the most important has been the
emergence of stablecoins, a subset of the wider cryptoasset industry, designed with
the goal of improving the traditional fiat currency model by using a scalable and
price-stable intangible digital asset as a medium of exchange. The most common
stablecoins are fiat currency (usually US dollar-backed). Originally conceived as a
utility token pegged to fiat currencies at a 1:1 ratio offering the benefit of cross-border
payment facilitated by blockchain technology, stablecoins rapidly gained popularity as
a location to park funds in a ‘safe haven’ in the highly volatile crypto market. Tether
and USD Coin are the two largest stablecoins.
The rapid growth of stablecoins whose value now exceeds US$100bn and questions
around the backing thereof (notably that of Tether, the largest stablecoin) have led to a
considerable degree of regulatory scrutiny. Despite these questions, stablecoins are
likely to remain an important part of the crypto industry, albeit we expect this part of
the industry to be subject to certain regulatory standards, especially around backing
assets. For example, a recent Bank of England discussion paper on digital money
specifically considers allowing for the creation of stablecoins, albeit with certain
regulatory requirements wrapped around them.
To support the operations of individual cryptoassets as well as the broader crypto

ecosystem, a broad crypto market infrastructure has developed in recent years (Fig 4).
In terms of construct, it exhibits a strong resemblance to the wider global capital
market infrastructure.
Fig 4: Crypto capital markets overview
Pre-trade Trading Post-trade
Data & Analytics Exchange (centralised) - Spot

- CoinMarketCap - Coinbase
Clearing & Settlement
- Cryptocompare - Binance
- ErisX
- Skew - Arwen
Exchange (centralised) - Derivative
- CME
Investor
Investor
Indices - Binance
- Solactive/CoinMarketCap
- Bloomberg/Galaxy Exchanges (decentralised)
Custody
- Uniswap
- Paxos
Research - Coinbase
Lending
- Investment banks
- Genesis
- Boutique providers
Technology services (Fireblocks)
Regulatory and compliance services (Chainalysis)
Prime brokerage (Coinbase Prime; Galaxy Digital)
Interface with payment rails (Silvergate, Clearbank)
Source: Redburn

The idea
However, despite the extremely rapid growth in value of cryptoassets and the
infrastructure supporting them in recent years, it remains to a large extent a
self-contained universe with still limited connectivity to the traditional finance
industry and a finite number of real-world use cases. The largest potential opportunity
for the crypto industry is whether it can disrupt or exert a material influence on the
global financial services industry.
Decentralised Finance
We estimate financial services account for c6.6% of global GDP, or cUS$5.6trn based
on 2020 global GDP. Potentially the greatest opportunity for the crypto industry lies in
the area of Decentralised Finance (DeFi), which envisages a world of finance shorn of
centralised intermediaries. Fig 5 shows the potential addressable market size for DeFi
in 2030 if value starts to leak from the traditional finance sector towards DeFi. While
any shift will be messy and is unlikely to be linear, it underscores that the prize for any
shift in finance towards a decentralised model is enormous.
Fig 5: DeFi addressable market assuming share shift Fig 6: Total value locked in smart contracts on
from mainstream finance markets, 2030E* Ethereum network, 2017 to date
U$ bn 100
2,000
1,800
80
Total value locked in (U$b)
1,600
1,400
60
1,200
1,000
40
800
600
20
400
200
0 0
Aug-17
Aug-18
Apr-18
Aug-19
Apr-19
Aug-20
Apr-20
Apr-21
Dec-17
Dec-18
Dec-19
Dec-20
5% 10% 15% 20%

Quantum of shift from CeFi to DeFi
* Based on 2030E global GDP and assumes financial services account for 6.6% of Source: Defi Pulse, Redburn
global GDP (i.e. consistent with current levels)
Source: Redburn, OECD, IMF
DeFi has seen exponential growth over the past year, albeit largely within the confines
of the crypto industry. Ethereum is the bedrock of DeFi, with the value of smart
contracts locked in Ethereum rising from a negligible amount in early 2020 to a peak
of around US$90bn in May 2021 (Fig 6). The planned upgrade of Ethereum is
expected to provide further support to the potential growth in DeFi.
DeFi aligns with the concept of the Web 3.0 which is expected to be built on new
technology innovations: edge computing, decentralised data networks and artificial
intelligence. Critically, it envisages the individual as a sovereign on the Web operating

The idea
in a decentralised manner with a much-reduced need for third parties (Fig 7),
although this concept is likely to meet strong resistance from current
centralised incumbents.
Fig 7: The second inning of tech decentralisation
App explosion
Apps
High
Trigger, iPhone,
Android, SaaS
App & data decentralisation

Trigger, AI, Distributed Ledger
Apps Technology (DLT), Blockchain,
Scale and impact of
decentralisation
Smart Contracts, Bitcoin, GS
Initial internet Data

Apps
Data
Data concentration
App Data Trigger, Cloud computing, Trust
IaaS, Visualization, AI/ML
AI
AI AI AI AI
1 2 3 ...
Apps/data
1 Google 5 Tencent
2 Facebook 6 Alibaba Data
3 Amazon 7 Microsoft
4 Apple 8 ...
Low
Today
Web 1.0 Web 2.0 Web 3.0

Birth: 2004 Birth: 2004-2020 2008-
Source: Philipp Stauffer, FYRFLY Venture Partners
Factors behind crypto’s emergence

While the rapid development of the crypto industry seems to have almost emerged
from nowhere, the ideas that form its underpinning, notably digital ledger technology
(DLT), have a long history dating back to 1983, when David Chaum first published on
the idea of anonymous electronic money. These ideas percolated in academia and the
cypherpunk movement for a quarter-decade; technology issues were considered and
addressed. However, it was not until Nakamoto developed a solution to the double-
spend problem that the idea of a trustless payment system would become a reality.
However, this on its own would arguably not have been enough to trigger the growth
the crypto industry witnessed over the past decade. Critically, the Bitcoin proposals
coincided with the coming of age of millennials, the first technology-native generation.
It also coincided with the global financial crisis and the start of an extraordinarily
interventionist era in the functioning of the global financial system by central banks
that continues to this day (Fig 8).
While not broken, harder questions are being asked of the fiat money regime in
developed markets than at any time in the past half century. Development of the
crypto market has seen the emergence of private currencies as a potential alternative to
the two current dominant forms of money – cash and commercial bank deposits (Fig 9).
The allergic reaction of regulators, politicians and central banks to Facebook’s original
10 Important note: see regulatory disclosures on page 123 of this repor

The idea
Libra cryptocurrency proposal is a recognition of this challenge to sovereign

formalised control of money.
Fig 8: Central bank balance sheet evolution, 2000 to date Fig 9: The fragmentation of money
U$bn Government Commercial bank Private
35,000 CBDC b-money Cryptocurrency
e-currency e-currency i-money
30,000
(reserve-backed) (deposit-backed) (asset-backed)
25,000 e-currency
(asset-backed)
20,000
15,000
10,000
5,000
0
Sep 01
May 03
Sep 06
May 08
Sep 11
May 13
Sep 16
May 18
Jan 00
Jan 05
Jan 10
Jan 15
Jan 20
US Federal Reserve SNB ECB BoJ BoE PBoC
Source: central banks, Bloomberg Source: Redburn
CBDCs and regulation

In response to this challenge, central banks globally have ramped up efforts around the
development of central bank digital currencies (CBDCs – a digital version of currency
plus reserves, potentially extending the ability to hold reserves at the central bank to
households and corporates). Depending on design features, CBDCs hold the potential
to significantly alter the financial architecture of countries in which they are
introduced. For example, if implemented at a retail (rather than wholesale) level,
central banks could usurp key roles played by commercial banks, notably around
deposit taking. Despite the uncertain implications of introducing CBDCs, based on
initiatives under way we assess a degree of inevitability around their ultimate
introduction, although there are varying degrees of urgency across countries.
Regulation of crypto markets has been nascent, reflecting their formative state and the
small size of cryptoassets relative to credit, equity and derivative markets (Fig 10).
However, the strong growth seen in crypto markets, the concept of private currencies
and the challenge embedded in various ideas in the crypto industry to the traditional
finance industry has triggered a surge in regulatory interest and myriad related
proposals over the past couple of years.
We expect regulation around the crypto industry to largely follow well-established

principles, notably: (1) maintaining financial and economic stability; (2) maintaining
appropriate standards of investor protection; and (3) guarding against illicit activity.
What is likely to complicate regulatory development is the ‘chameleon’-like nature of
cryptoassets, which do not neatly fit traditional financial definitions. As an example, in
Important note: see regulatory disclosures on page 123 of this report.

The idea
the US, certain blockchain-based cryptoassets such as Bitcoin and Ether are not
considered securities and as such do not fall under the purview of the Securities and
Exchange Commission (SEC), while other cryptoassets that have more security-like
characteristics do (note: in this report we use the term ‘cryptoasset’ rather than
‘cryptocurrencies’1). The regulatory environment and development will also be
impacted by the borderless nature of the crypto industry and that it operates 24/7,
neither characteristic sitting comfortably with the way in which traditional financial
regulation is constructed.
Fig 10: Size of global credit, equity, gold, derivative and cryptoasset markets, 2020
U$trn U$trn
180 800
160 700
140 600
120
500
100
400
80
300
60
40 200
20 100
0 0
Credit Equity Gold Crypto Crypto Crypto Derivative
markets**** markets markets (end markets markets markets (RH
2020) (peak)* (current)** Scale)***
* 10 May 2021
** 30 July 2021
*** Notional value of outstanding in OTC and exchange-traded derivative markets
**** Government, corporate and financial sector bonds
Source: Redburn, BIS, IMF, World Gold Council, CoinMarketCap
Crypto exchanges
Crypto exchanges have been among the prime beneficiaries of the growth in interest in
crypto markets in recent years, benefiting from rising volumes and cryptoasset prices.
Historically dominated by spot markets, the past two years have seen explosive growth
in derivative markets, which industry data suggest now exceeds spot markets in
volume. This development is one factor underscoring growing institutional interest
in cryptoassets.
Lacking the strict regulation of the mainstream exchange operators, questions exist
about the veracity of data from some venues; this view is underscored by industry
surveys showing there is considerable variation in the quality of exchanges, a dynamic
that hampers assessment across exchanges. Given the tighter regulation likely to be
1
The terminology used in the crypto industry can often be conflated. We view cryptocurrencies as a subset of cryptoassets. The primary
types of cryptoassets are cryptocurrencies, utility tokens, security tokens and stablecoins.
12 Important note: see regulatory disclosures on page 123 of this repo

The idea
applied to the crypto industry as it grows, quality as well as strength of regulatory/legal

framework under exchanges operating will become more of a differentiating factor.
Fig 11: Crypto exchange volumes (spot and derivative), Fig 12: Top-tier exchanges – monthly spot volume,
November 2018-June 2021 November 2018-June 2021
12,500 90% 3,000
Monthly volume traded (U$b)

2,400
10,000 78%
1,800
7,500 66%
1,200
5,000 54% 600
0
2,500 42%
Nov-18
Feb-19
May-19
Aug-19
Nov-19
Feb-20
May-20
Aug-20
Nov-20
Feb-21
May-21
0 30%
Mar-19
Jul-19
Mar-20
Jul-20
Mar-21
Nov-18
Nov-19
Nov-20
Binance Coinbase Bitfinex

OKEx Huobi Global Bitstamp
Derivatives Spot % spot BeQuant Kraken LMAX Digital
Source: CryptoCompare Source: CryptoCompare
Coinbase
Founded in 2012, Coinbase is one of the largest crypto exchanges globally. It is a top
five player in volume terms on spot markets where it plays an integrated role acting as
an exchange, brokerage and market-maker on behalf of retail and institutional clients.
85% of its revenue is generated by the trading activity it facilitates. It also operates a
wider crypto infrastructure including custodial services, where it holds over 10% of
global cryptoassets on its platform.
Growth has been exceptionally strong, fuelled by both retail and institutional activity
in cryptoassets (Fig 13). While institutional trading activity on Coinbase has grown
more rapidly than retail, from a revenue (and profitability) perspective, the engine
room is the retail business given its much higher margin (Fig 14).

The idea
Fig 13: Coinbase – quarterly trading volume, Q1 2018- Fig 14: Coinbase – retail and institutional transactional
Q2 2021E revenue as % of trading volume, Q1 2019-Q1 2021
U$m 1.60%
450,000
400,000 1.40%
350,000 1.20%
300,000 1.00%
250,000
0.80%
200,000
0.60%
150,000
0.40%
100,000
50,000 0.20%
0 0.00%
Q1 18
Q2 18
Q3 18
Q4 18
Q1 19
Q2 19
Q3 19
Q4 19
Q1 20
Q2 20
Q3 20
Q4 20
Q1 21
Q2 21E
Q1 20 Q2 20 Q3 20 Q4 20 Q1 21
Retail Institutional
Retail Institutional
Source: company, nomics.com Source: company
As a result, a pivotal question in the short to medium term around the investment case
is how this margin evolves. In the long term, we expect retail transaction margins to
fall, fuelled by more intense competition from both crypto exchanges and mainstream
financial participants moving in the crypto trading arena. However, a variety of factors
argue for a degree of persistence of retail transaction margins at higher levels than the
market perceives. These include: (1) a degree of pricing complexity that favours
incumbents; (2) the importance of quality and liquidity in unregulated markets;
(3) security (which takes on a different dimension in crypto markets); (4) branding;
and (5) the technical complexity of connecting building infrastructure for new
cryptoassets. Relative to the broad crypto exchange universe, on multiple of these
measures, Coinbase screens as best in class or in the top handful.
Its transactional orientation results in Coinbase currently carrying considerable

operational and financial gearing to cryptoasset prices. A core priority for Coinbase is
to develop a broader crypto infrastructure offering, diversifying its revenue base and
supporting its goal to serve as its customers’ primary financial account in the crypto
economy. Initially, we expect the focus to be in three areas: geographic, service and
asset expansion.
 Geographic expansion. Coinbase has steadily grown its number of verified users in
recent years (Fig 15). The number of monthly transacting users has also grown,
albeit this correlates more directly to cryptoasset pricing. We anticipate an effort to
significantly expand presence and grow user numbers in other markets, especially
outside its geographic areas of strength in the US, UK and Europe.

The idea
Fig 15: Coinbase – verified users and monthly Fig 16: Coinbase – assets held on platform and as % of
transacting users, Q1 2018-Q1 2021 crypto market cap, Q1 2018-Q1 2021
(m) (m) 250,000 14%
60 7
12%
50 6 200,000
10%
5
40 150,000 8%
4
30
3 100,000 6%
20
2 4%
50,000
10 1 2%
0 0 0 0%
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
18 18 18 18 19 19 19 19 20 20 20 20 21 18 18 18 18 19 19 19 19 20 20 20 20 21
Verified users (LHS)
Monthly transacting users (MTU, RHS) Assets on platform As % of crypto mkt cap
Source: company Source: company
 Asset expansion. Alongside geographic expansion, further expansion of unique

assets offered on Coinbase’s platform will be an additional contributor to growth.
 Service/Product expansion. Of all the expansion areas, the most important in our
view is service/product expansion. While Coinbase is termed an exchange, it
effectively operates as a broker dealer, exchange, market-maker and custodian. The
opportunity on the service/product side is to build out an infrastructure that
straddles the entire crypto infrastructure arena (Fig 4). Here, a key strategic
advantage is that Coinbase already holds on its platform c11% of cryptoasset
market cap with a strong presence in both the retail and institutional markets
(Fig 16).
The expansion areas outlined above all effectively fall under the first pillar of
Coinbase’s strategy – ‘crypto as an investment’ (Fig 17). The company’s ambitions are
much broader than this, encompassing two further pillars:
 Crypto as a new financial system. This involves developing a much broader

financial services offering built on crypto rails, including DeFi, payment, earning
and borrowing/lending. The opportunity here will key off, in particular,
development of DeFi. As a hypothetical example, if by 2030, per the analysis in
Fig 5, 10% of financial services shifted into DeFi and Coinbase captured 5% of that
(noting a c11% share of cryptoassets on its platform), it implies a US$45bn revenue
opportunity.
 Crypto as an app platform. This is an even more formative area of investment,

which involves driving crypto innovations and products beyond financial use cases.

The idea
Fig 17: Three pillars of Coinbase’s strategy
Source: company
Valuation in the crypto arena is unequivocally more art than science given the limited
track record and lack of listed comps. In framing thinking about Coinbase’s valuation
to support our DCF valuation, we also benchmark against a group of fintech-oriented
companies. Relative to this peer group on the basis of 2023E EV/revenue, Coinbase
screens at the bottom end (Fig 18) and broadly in line with more established
companies on 2023E P/E (Fig 19).
Fig 18: Coinbase vs selected comparators, enterprise Fig 19: Coinbase vs selected comparators, price/2023E
value/2023E revenue EPS
50x >100x >100x
100x
90x
40x
80x
70x
30x
60x
50x
20x 40x
30x
10x 20x
10x
0x 0x
Paypal
Bill.com
Visa
Shopify
Coinbase
Silvergate
Mastercard
Square
Bill.com
Adyen
Mastercard
Visa
Paypal
Shopify
Silvergate
Square
Coinbase
Adyen
Source: Redburn, Visible Alpha (2 August 2021), Bloomberg Source: Visible Alpha (2 August 2021), Bloomberg
These relatively muted ratings, despite the promise embedded in the crypto industry,
stem in part from the market assuming Coinbase generates little revenue growth
between 2021 and 2023, reflecting a presumption that retail margins (and revenue)
compress, offset by institutional and subscription revenue growth. Little allowance is
being made for the substantial opportunity for the business to broaden its asset, client

The idea
and infrastructure across the crypto industry as well as the potential vast opportunity
around DeFi. We derive a DCF-based valuation for Coinbase of US$335 per share and
rate the stock a Buy.
Five predictions
Based on the work in this report, we make five predictions for the crypto industry:
1 Growth in DeFi. While still nascent, we forecast that over the next half-decade,
value will start to leak out of the traditional financial industry into DeFi at an
accelerating pace.
2 Crypto market cap will grow. Despite growth seen in recent years, the value of
cryptoassets is tiny compared to other asset classes. Given the potential of the
technology underpinning the crypto industry, we expect the value of cryptoassets
to continue to expand, albeit with an ongoing degree of volatility.
3 Crypto exchanges. We expect crypto exchanges will remain highly profitable.

However, engine rooms of growth will likely emerge elsewhere – in offering
infrastructure capability and DeFi services.
4 CBDCs and Stablecoins. CBDCs are likely to be introduced by some central banks
within the next half-decade, with significant (albeit still unknown at this stage)
implications for existing financial services architecture. Stablecoins are likely to
become a more established part of the financial landscape although with a more
comprehensive regulatory overlay.
5 Regulatory friction. We expect regulation around the crypto industry to gradually

emerge, but it will significantly lag the pace of development of the industry. As a
result, ‘grey areas’ will abound for the foreseeable future, as will a degree of friction
between this industry and regulation. Crypto-native participants that can offer
products and services that can compete in ‘grey areas’ while operating with legal
and compliance standards closer to traditional financial services are likely to be the
ones that build competitive advantage.
Returning to our opening debate and the comment that “the world of finance hails the
invention of the wheel over and over again”, the difference this time perhaps is that the
world of technology is imposing its innovation on the world of finance.

01/
01/ A new way to transfer value and record transactions
A new way to transfer value

and record transactions
Most of the concepts underpinning Satoshi Nakamoto’s original
Bitcoin paper were not, in their own right, new. What was
groundbreaking was the way in which cryptography, computer science
and economic incentives were stitched together to create an idea that
challenges existing notions about money and value transfer. This
holds the potential to significantly disrupt components of the global
economy, notably the financial system. This chapter examines these
underpinnings – Distributed Ledger Technology, blockchain and the
layers that make up a blockchain.

Distributed ledger technology – the underpinning

Distributed ledger technology (DLT) is a means of recording transactions and storing
information. It has certain characteristics, as defined below.
“Distributed ledger technology is a decentralised peer-to-peer digital system for

recording transactions between parties in multiple places at the same time. ‘DLT’
deploys cryptography and consensus mechanisms to allow participants to share an
immutable replica of the same ledger. It gets rid of the need for a centralised store
of data and dispenses with the requirement for a central authority to carry out
administrative functions, as is necessary with traditional databases.” Risk.net
Historically, transaction recording (and value transfer) has been centralised with a
single trusted entity (in the case of finance usually a bank) holding the master record.
However, this is a system replete with problems, ranging from theft and error to risks
around the trusted entity itself. The original Bitcoin white paper was published in
2008, two months after the failure of Lehman Brothers and a near implosion of the
global financial system.
A conceptual alternative to challenges posed by centralised recording is to move to a

distributed system (Fig 20) where information and records are maintained,
administered and utilised by all members of that system. This gives rise to its own
challenges, notably how to ensure consistency of records across the distributed system.
Fig 20: Different types of databases

Centralised Centralised Decentralised
(Master) (Master-Slave) (Multi-Master)
Central
Distributed Distributed Distributed

(Enterprise) (Private) (Public)
Distributed
(DLT)
Source: www.serokell.io
The original concepts underpinning DLT date back as far as 1983 when computer
scientist and cryptographer David Chaum first published on the idea of anonymous
electronic money. These ideas have been evolved over the subsequent decades (see
Appendix A for a chronology). Core concepts were set out in a paper by Haber
and Stornetta in 1991 (abstract below) in which they proposed mechanisms for

time-stamping digital data including introducing the idea of using cryptographically

secure hash functions.
“The prospect of a world in which all text, audio, picture, and video documents
are in digital form on easily modifable media raises the issue of how to certify
when a document was created or last changed. The problem is to time-stamp the
data, not the medium. We propose computationally practical procedures for
digital time-stamping of such documents so that it is infeasible for a user either to
back-date or to forward-date his document, even with the collusion of a time-
stamping service. Our procedures maintain complete privacy of the documents
themselves and require no record-keeping by the time-stamping service.” Abstract
from How to Time-Stamp a Digital Document, Haber and Stornetta, Journal of
Cryptography, 1991
A decade later, Mazieres and Shasha took these ideas further2, examining how blocks
can store data, setting out the framework for blockchain. Much like the development
of the building blocks of the internet, the emergence of DLT and blockchain had a
long gestation (Fig 21).
1997 saw the Hashcash proposal by Adam Back (proposed more formally in 2002),
which introduced a cryptographic hash-based proof of work system originally
intended to limit email spam and denial-of-service attacks. 1998 saw computer
scientist Wei Dai introduce the concept of b-money in an essay:
“The protocol proposed in this article allows untraceable pseudonymous entities to

cooperate with each other more efficiently, by providing them with a medium of
exchange and a method of enforcing contracts.” B-money, Wei Dai, 1998
Also in 1998, computer scientist Nick Szabo proposed ‘bitgold’, a new blockchain-like
currency that proposed minimising dependence on trusted third parties. However, this
proposal struggled to overcome the double-spending problem of electronic
transactions, whereby digital currency holders could duplicate transactions and spend
the currency more than once (a dynamic that is not an issue in a centrally controlled
system).
Nakamoto’s Bitcoin white paper solved for this via a consensus mechanism (and
incentivisation layer). This consensus mechanism is underpinned by miners who
collect pending Bitcoin transactions, verify their legitimacy and assemble them into
‘block candidates’. The miners are not altruistic; their goal is to earn newly created
Bitcoin units through this activity – this can be achieved by convincing all other
network participants to add his/her block candidate to their copies of the Bitcoin
blockchain. This is achieved by solving mathematically complex problems that
demand high levels of computational power.
2
Building secure file systems out of Byzantine storage, David Mazieres and Dennis Shasha, NYU Department of Computer Science.

This consensus mechanism is known as ‘proof of work’. In turn it allows the formation
of consensus in a distributed manner in a way that had not previously been possible,
effectively solving the double-spend problem. The success of Bitcoin has spawned an
entire industry based on these underpinnings and has stimulated an enormous
amount of innovation in related areas.
Fig 21: Timelines – internet and crypto

Internet Crypto
Ethernet (1974) Blind Signatures For Untraceable Payments (Chaum), 1983
TCP/IP* (1974) Digital Time-Stamping (Haber/Stornetta), 1991
HTTP** (1990) Hashcash (Back), 1997/2002
SSL*** (1994-96) Bitgold (Szabo), 1998
TLS **** (1999) B-money (Dai), 1998
Bitcoin (Nakamoto), 2008
Note: TCP/IP – Transmission Control Protocol/Internet Protocol; HTTP – Hypertext Transfer Protocol; SSL – Secure Sockets Layer; TLS –
Transport Layer Security
Source: MIT, Acunetix, Redburn
DLT and Blockchain

Fig 22 set out some potential configurations of DLT ranging from a traditional single
entity overseeing record keeping (and value transfer) to a much more open
infrastructure more reminiscent to that used by Bitcoin. While the terms DLT and
blockchain tend to be used interchangeably, blockchains are a sub-set of DLT (Fig 23)
with certain characteristics that may not be present in other DLT (e.g. block structure).
Fig 24 provides an overview of the main types of blockchains segmented by permission
model. We would note blockchain purists would reject this view, arguing the
blockchain term should only be used to describe a permissionless system.
Fig 22: Potential configurations of DLT arrangements

Only approved entities Only approved
can use the service (can entities can use the Any entity can use
Description of One entity maintains be assigned distinct service (entities can the service and
arrangement and updates the ledger restricted roles) play any role) play any role
Operating of the
--------------------- Single entity ---------------------- ------------------- Multiple entities ------------------
arrangement
Access to the arrangement --------------------------------------- Restricted ---------------------------------------- Unrestricted
Technical roles of nodes -------------------- Differentiated --------------------- ----------------- Not differentiated ------------------
Within a single entity or
Validation and consensus Within a single entity -------------- Across multiple entities --------------
across multiple entities
Source: BIS

Fig 23: Blockchains and distributed ledgers are subsets of distributed databases
Distributed databases
1. Adversarial Model
Presence of malicious nodes assumed
Distributed ledgers (DLTs) 2. Data structure and diffusion

Chain of cryptographically linked blocks,
and/or global data broadcast
Blockchains 3. Permission model

Read: public vs private
Write/commit: permissionless vs permissioned
Permissioned
blockchains
Source: serokell.io
Fig 24: Main types of blockchains segmented by permission model

Read Write Commit Example
Public
---- Open ----
----------- Blockchain type -----------
Open to anyone Anyone Anyone* Bitcoin, Ethereum

permissionless
Public All or subset of
Open to anyone Authorised participants Sovrin
permissioned authorised participants
Restricted to an
All or subset of Multiple banks operating
----- Closed ------
Consortium authorised set of Authorised participants

authorised participants a shared ledger
participants
Private Fully private or Internal bank ledger
permissioned restricted to a limited Network operator only Network operator only shared between parent
(‘enterprise’) set of authorised nodes company and subsidiaries
* Required investment in either mining hardware (proof of work model) or cryptocurrency itself (proof of stake model)
Source: CCAF (Cambridge Centre for Alternative Finance)
The Blockchain layers

Fig 25 presents one view of blockchain architecture from the hardware layer through
the application layer. There is considerable nuance in the way blockchains and the
constituent functions can be presented and a detailed review of industry sources
underscores there is considerable terminology flex within the blockchain and crypto
community.
Given the view of some market participants that DLT and Blockchain potentially form
critical building blocks for the ‘Internet of Money’, there is some debate around where
value will potentially accrue as this technology and its intersect with finance evolves. In
this context, the development of the internet offers an interesting analogy – it is built
on a series of open protocols, such as HTTP, TCP/IP, SSL, STMP etc, which allow
different applications to communicate and work together – effectively facilitating

smooth functioning of the internet. However, most of the value within the internet is
captured by the applications that run on top of it (e.g. by companies such as Facebook,
Amazon, Netflix and Tencent). This gives rise to the idea that the internet is composed
of thin protocols and fat applications (Fig 26).
By contrast, in the blockchain stack, most of the value sits in the protocol layers with
much more limited value in the application layer. Factors behind this are: (1) the
operation of a shared data layer in blockchain (which constrains centralisation); and
(2) the introduction of cryptographic tokens, which effectively ties success of the
applications to the protocol layer. Decisions around where business logic is
implemented also play a role (Fig 27). Whether the blockchain dynamic of ‘fat
protocols, thin applications’ holds as technology and ecosystem mature remains to be
seen; this dynamic is likely to be of importance in dictating where value accretes.
Fig 25: Blockchain architecture Fig 26: Value capture – internet vs Blockchain
Application layer The Web Blockchain
Smart Chaincode
Dapps
contracts Application layer
Consensus Layer
Propagation protocol
Value captured
Value captured
Applications layer
Mining protocol
Protocol layer
Consensus protocol
Proof of Work Proof of Stake PBFT* DPoS**
Network Layer Protocol layer
Data layer
Merkle Asymmetric
Data blocks
Trees encryption
Hardware / Infrastructure Layer
* Practical Byzantine Fault Tolerence Source: Union Square Ventures

* Delegated proof of stake
Source: Redburn
Fig 27: Advantages and drawbacks of implementing business logic at different layers
Advantages Disadvantages
Protocol layer - Smart contracts can self-enforce on the network - Larger attack surface
- Smart contracts cannot be changed or stopped - Confidentiality and privacy issues
- Deterministic outcome of computation is visible - Higher network burden in terms of data storage,
to everyone transmission and processing (depending on data
diffusion model)
Application layer - Smaller attack surface - Smart contracts cannot be directly enforced by the
- Bugs do not affect the entire network network
- Greater confidentiality and privacy - Smart contracts can be potentially changed
- Better scalability
Source: CCAF

Investment and applications

Although small relative to the wave of money that has swept into the broader
cryptoasset arena, venture capital investment into blockchain technology has been
increasing. Q1 2021 attracted more funding than the entirety of the preceding year,
underscoring the growing interest in this area (Fig 28).
Fig 28: Venture capital funding in blockchain start-ups

U$m
3,500
3,000
2,500
2,000
1,500
1,000
500
0
2016 2017 2018 2019 2020 Q1 21
Source: CB Insights
The level of investment shown above likely significantly understates broader spend on
this technology. The strongest use cases for DLT are expected to reside in the financial
services area (Figs 29 and 30) and incumbents have become increasingly active in this
arena. The activities of existing mainstream financial companies have included:
 Forming Blockchain consortia. One of the best known is R3, which developed
Corda, a purpose built DLT application development platform focused on financial
services. It was set up in 2015 and is backed by a number of the world’s largest
banks.
 Small-scale experimentation with DLT technology. For example, in April 2021 the
European Investment Bank (EIB) announced it had placed a €100m bond using
blockchain technology. The transaction consisted of issuance by the EIB of a series
of bond tokens on a blockchain with investors purchasing the tokens using
traditional fiat currencies. The transaction used the Ethereum platform.
 Acquisitions. For example, Deutsche Börse announced in June 2021 that it will be
acquiring a two-thirds shareholding in Crypto Finance AG, a financial group under
consolidated Swiss FINMA supervision that “offers trading, storage, and

investment in digital assets to institutional and professional clients”. The

acquisition allows Deutsche Börse to extend its digital asset offering.
Fig 29: % of DLT service providers targeting different

sectors/use cases Fig 30: Industries seen as leaders in blockchain*
Capital markets
Financial services
Insurance
Industrial products &
Trade finance
manufacturing
Payments
Regulatory compliance/audit Energy & utilities
Digital identity
Healthcare
Healthcare
Public sector Government
Supply chain
Energy Retail & consumer
Intellectual property
Entertainment & media
Other
0% 20% 40% 60% 80% 0% 10% 20% 30% 40% 50%
Source: CCAF * Response to question: Which of the following industries are the most advanced in
developing blockchain today?
Source: PwC Global Blockchain Survey (2018)
For financial service incumbents, the appeal of adopting DLT usually has its roots in
the potential efficiencies and cost savings this technology can offer, albeit broader
adoption of this technology will entail significant upfront investment, which means
the process is likely to be evolutionary. This also reflects the regulatory scrutiny
changes to the technology underpinnings of the financial system is attracting. These
dynamics are discussed in depth in Chapter 2.

02/
02/ The money debate and regulation
The money debate and

regulation
Distributed Ledger Technology marks a major innovation in the
‘technology of money’ and raises the spectre of private money
competing with the dominant forms of money issued by central and
commercial banks. A primary response to this challenge has been the
development of Central Bank Digital Currencies, albeit with differing
levels of urgency across jurisdictions. The rapid growth of cryptoasset
markets has triggered varying degrees of regulatory response around
the world, although the characteristics of these markets pose certain
unique challenges in the regulation thereof.

The fragmentation of money

The rise of cryptoassets in recent years has triggered debate around whether these are
‘money’ (hence the phrase cryptocurrencies). To meet the generally accepted
definition of money, the instrument in question should be able to fulfil three criteria,
acting as: (1) a medium of exchange; (2) a store of value; and (3) a unit of account. The
primary forms of money are cash and bank deposits, which together constitute the vast
majority of money in most countries. Gold enthusiasts argue gold is the purest form of
money and should be on the list given its track record through millennia. Central
banks, the current guardians of the money system, are generally of the view that
cryptoassets are not money as they effectively do not meet any of the criteria needed to
function as money.
However, as discussed in Redburn’s recent economics report on globalisation:
“Distributed Ledger Technology marks a major innovation in the ‘technology of

money’. It has opened up the possibility of ‘peer-to-peer’ payments outside the
banking system and expanded the definition of ‘money’ beyond cash and bank
deposits to incorporate myriad forms of ‘e-money’ and cryptoassets (Fig 31).
‘Fundamental’ money (bank reserves) now co-exists alongside not only
‘convertible’ money (bank deposits) but also ‘exchangeable’ money, including
standalone crypto currencies and stablecoins.” The Arrow, Melissa
Davies/Clemmie Elwes, 12 May 2021
Fig 31: The fragmentation of money

Government Commercial bank Private
Central Bank Digital Currencies (CBDCs) b-money Cryptocurrency
e-currency (reserve-backed) e-currency (deposit-backed) i-money (asset-backed)
e-currency (asset-backed)
Source: Redburn
As noted in that report, while bitcoin is often cited as the archetypal cryptocurrency,
based on DLT, the seed of the idea for a decentralised currency came from a white
paper written by Wei Dai in 1998 on ‘b-money’ (Szabo’s bitgold proposal echoing
similar ideas). We quote it here as it captures the very essence of globalisation and the
role digital currencies have to play in it, potentially greatly diminishing the role of the
state in validating and facilitating the exchange of value:
“Unlike the communities traditionally associated with the word ‘anarchy’, in a

crypto-anarchy the government is not temporarily destroyed but permanently
forbidden and permanently unnecessary. It’s a community where the threat of
violence is impotent because violence is impossible, and violence is impossible
because its participants cannot be linked to their true names or physical locations.”

The allergic reaction of regulators and politicians to Facebook’s original Libra proposal
in 2019 suggests they recognise the potential embedded within DLT and the
cryptoassets built thereon to disrupt the current monetary order.
“We write to request that Facebook and its partners immediately agree to a
moratorium on any movement forward on Libra - its proposed cryptocurrency
and Calibra - its proposed digital wallet. It appears that these products may lend
themselves to an entirely new global financial system that is based out of
Switzerland and intended to rival U.S. monetary policy and the dollar. This raises
serious privacy, trading, national security, and monetary policy concerns for not
only Facebook's over 2 billion users, but also for investors, consumers, and the
broader global economy.” Extract of letter from US House of Representatives
Committee on Finance Services to Facebook, 2 July 2019
Efforts by regulators in that case were successful, with many of the original Libra
Association members withdrawing. The original proposals were significantly scaled
back and the initiative has been rebranded ‘Diem’. However, we argue the challenge
potentially posed by private money to central bank and bank money is far from
diminished and tension between the private and state sectors on the issue of money is
likely to recur as cryptoasset markets develop further.
Perversely, central banks themselves are arguably architects of the emerging challenge
to their monetary dominance; more than a decade of ultra-low interest rates (Fig 32)
and relentless money printing (Fig 33) has led to a disquiet around the implications for
the fiat environment over which they preside as well as indirectly providing ample and
cheap funding support to backers of DLT and the wider crypto industry.
Fig 33: Central bank balance sheet evolution, 2000 to

Fig 32: The global interest environment, 1992 to date date
8.0% U$bn
35,000
7.0%
6.0% 30,000
5.0% 25,000
4.0%
20,000
3.0%
15,000
2.0%
1.0% 10,000
0.0% 5,000
-1.0% 0
Jul-05
Jul-08
Jul-11
Jul-14
Jul-17
Jul-20
Jan-04
Jan-07
Jan-10
Jan-13
Jan-16
Jan-19
Sep 01
May 03
Sep 06
May 08
Sep 11
May 13
Sep 16
May 18
Jan 00
Jan 05
Jan 10
Jan 15
Jan 20
US Europe UK Japan China US Federal Reserve SNB ECB BoJ BoE PBoC
Source: BIS Source: Central banks, Bloomberg

As governments draw on central bank support to fuel recovery from the COVID-19
pandemic and address myriad economic challenges, we argue central banks are likely
to move further down the stimulus continuum rather than back up it (Fig 34) with the
line between monetary and fiscal policy likely to blur further3. This will continue to
facilitate a supportive environment for digital asset innovation and experimentation,
including central banks’ developing their own digital currencies.
Fig 34: The stimulus continuum

Fed BoJ ECB BoE
Interest rates Corridor
Floor
Tiering
Forward guidance Duration

Threshold
Open-ended
Repos Bills
Government bonds
ABS/MBS
Corporate bonds
Loans
Equities/ETFs
Quantitative Easing Bills

Government bonds
MBS
Corporate bonds
Commercial paper
Loans
REITs
Equities/ETFs
Yield curve control Duration

Threshold
Open-ended
Cooperation with the Treasury Issuance timing

Remittances
Direct purchases and earmarked funds
MMT Monetary financing
Central Bank Digital Currencies No physical cash

Note: yellow = prior to COVID-19 crisis; grey = since COVID-19 crisis
Source: Redburn
3
For a more in-depth discussion of the stimulus continuum please refer to:
‘Bankonomics - The Nationalisation of Risk’, 17 January 2020 (Melissa Davies/Nicholas Watts)
‘Economics – Inflationology’, 16 July 2020 (Melissa Davies)
‘Economics – The Arrow’, 12 May 2021 (Melissa Davies/Clemmie Elwes)

One risk to cryptoasset markets, specifically the value thereof, potentially arises if
central banks were to start raising rates most likely in response to rising
inflation/inflation expectations. Our economics view around this is that deflationary
structural pressures are stronger than inflationary ones, and as such a structural
resurgence of inflation is viewed as unlikely (refer to ‘Redburn Economics –
Inflationology’, 16 July 2020 (Melissa Davies) for more detail on this). Additionally,
the burden of debt in most developed market economies is so high that central banks
are likely to be significantly constrained in the extent to which rates could be raised.
Finally, we would not expect interest rate shifts to significantly diminish the interest in
and pace of innovation around crypto markets given the potential growth
opportunities it offers.
The emergence of Central Bank Digital Currencies

One core response of central banks to the challenges posed by digital innovation has
been the development of the concept of Central Bank Digital Currencies (CBDCs) –
activity in this area commencing in 2016-17 and ramping up in recent years (Fig 35).
A CBDC is a digital version of currency plus reserves, potentially extending the ability
to hold reserves at the central bank to households and corporates.
Fig 35: Timeline of central bank activities on CBDCs
Live CBDC Research report Speech

Pilot Pilot report
Jamaica
2014 2015 2016 2017 2018 2019 2020 2021

1
Excluding activities of national central banks within the Eurosystem
Source: BIS
Central banks have been exploring the merits and demerits of a CBDC, its potential
impact on the financial system and ways to mitigate possible financial stability risks.

Some within central banks advocate the introduction of a CBDC could enhance a
central bank’s ability to conduct monetary stimulus for the following reasons:
1 A CBDC allows a central bank to overcome the ‘effective lower bound’ by opening
up the possibility of implementing negative interest rates on digital cash (a
replacement to physical currency) and reserves held by households and corporates
as well as banks.
2 It would facilitate ‘helicopter money’ drops by allowing the central bank to directly
credit individuals’ accounts at the central bank, reducing the reliance of the central
bank on the commercial banking sector to transmit the stance of monetary policy.
This dynamic has taken on greater importance given the effects and experiences in
the COVID-19 pandemic.
3 More broadly, a CBDC could reduce the systemic importance of banks and their
significance in transmitting the stance of monetary policy to the real economy, by
removing their role in deposit creation.
Opinions among economists and market participant are understandably divided on

multiple aspects of CBDC, notably point 3 above and whether it would be a desirable
outcome, given it would transfer a substantial amount of risk out of the private sector
financial system and into the public sector and potentially put the central bank in the
position of a major financial intermediator.4
Much of the impact of CBDC will be dictated by the specific designs – Fig 36
providing an overview of certain of these. Decisions around design features range from
whether they should be built on existing infrastructure or using DLT to whether
account-based ledger to digital tokens should be used.
Fig 36: Key design features of CBDC

--- Existing central bank money -- ------------- Central bank digital currencies ---------------
Reserve and -------------- General ----------- Wholesale-only
Cash Settlement balances Token Accounts token
24/7 availability ✓ × ✓ (✓) (✓)
Anonymity vis-à-vis central bank ✓ × (✓) × (✓)
Peer-to-peer transfer ✓ × (✓) × (✓)
Interest-bearing × (✓) (✓) (✓) (✓)
Limits or caps × × (✓) (✓) (✓)
Note: ✓ =existing or likely feature; (✓) = possible feature; x = not typical or possible feature
Source: BIS
4
For a more detailed examination on the economic and monetary aspects of CBDC please refer to the following Redburn reports:
Bankonomics – ‘The Nationalisation of Risk’, Melissa Davies/Nicholas Watts (17 January 2020)
Economics – ‘Globalisation – The Arrow’, Melissa Davies/Clemmie Elwes (12 May 2021)

Fig 37: CBDC pyramid
From consumer needs… Retail …to CBDC design choices

Cross- or
border
into subsequent decisions

Lower-level choices feed
wholesale
payments interlinkages?
Accessible to all Account or token-based

Ensure privacy in lawful exchange access technology?
Resilient and robust operations DLT-based or conventional central

bank infrastructure?
Convenient real-time payments Architecture: indirect or direct claims, and
Cash-like with peer-to-peer functionality What operational role for central bank?
Source: BIS
One of the most critical decisions will be whether CBDCs should be wholesale (i.e.
available to only to financial institutions) or retail based. Adoption of the latter
approach would potentially be much more disruptive to existing financial system
architecture. Depending on precise structures adopted central banks could usurp key
roles played by commercial banks, notably around deposit taking. Pre-pandemic the
weight of opinion was wholesale CDBC was more likely, however more recent surveys
suggest retail CBDC’s are potentially more likely (Figs 38 and 39).
Fig 38: Likelihood of CBDC issuance – retail Fig 39: Likelihood of CBDC issuance – wholesale
90% 90%
2018 2019 2020 2018 2019 2020
80% 80%
70% 70%
60% 60%
50% 50%
40% 40%
30% 30%
20% 20%
10% 10%
0% 0%
Likely Possible Unlikely Likely Possible Unlikely Likely Possible Unlikely Likely Possible Unlikely
--------Short-term*-------- -------Medium-term**------- --------Short-term*-------- -------Medium-term**-------
* Short term = 1-3 years * Short term = 1-3 years
** Medium term = 1-6 years ** Medium term = 1-6 years
Source: BIS Source: BIS
Timelines for potential CBDC adoption vary widely. Among the largest economies,
the US has arguably been the slowest initial mover. While multiple speeches have been
made on the subject, little substantive action has been taken, although work is ongoing
behind the scenes.

“Multidisciplinary teams at the Federal Reserve are investigating the technological

and policy issues associated with digital innovations in payments, clearing, and
settlement, including the benefits and risks associated with a potential U.S.
CBDC.” Lael Brainard, Federal Reserve Board Member, 24 May 2021
The Federal Reserve is expected to publish a discussion paper this summer examining
the prospect of a US CBDC.
The European Union has been active in this area at both a national as well as a supra-
national level, although, as highlighted by the comment below, the timeframe for
progression to a digital euro is likely to be a protracted one.
“If the Governing Council gives us the green light in July, we’ll start a formal
investigation phase focusing on the design of a digital euro. After two years, we’ll
get back to the Governing Council, and in the meantime we’ll interact with other
European authorities and institutions – the Parliament, the Commission, the
Council, the Eurogroup – all those who are involved, because the digital euro will
require legislative changes. So at the end of these two years, ideally, we would have
more clarity on the steps which would be necessary to issue a digital euro, if the
decision were taken to launch it. Then we expect to have, by and large, three
years to be able to implement what we have decided on.” Fabio Panetta,
Executive Board Member of ECB, 20 June 2021
China is arguably most advanced. It has already trialled a CBDC, the Digital Currency
Electronic Payment (DCEP), in mainland China and the Greater Bay Area (Fig 40).
The ‘push’ factor for developing the DCEP has been as a response to the rapid rise of
Chinese technology companies such as Alipay and WePay with their own payments
ecosystems, which have drawn deposits out of the traditional banking systems. A key
pull factor has undoubtedly been a desire to broaden RMB usage, although steps in
this direction are likely to be carefully controlled given China’s relatively closed capital
account.
Irrespective of the pace of development in different countries, it does appear that there
is an air of inevitability around CBDCs. Despite financial market perception around
the power of central banks and popular mantras like ‘don’t fight the Fed’, adoption of
CBDCs would be an example of technology development imposing a significant
change on central banks.

Fig 40: China’s DCEP trials

Number of Validity period of
Year Location red envelopes Total amount red envelopes Application scenarios
2020 Luohu district, 50,000 10 million yuan 18h00, 12 Oct – 24h00, 20 Oct 3,389 designated businesses in
Shenzhen Luoha district
2020 Suzhou 100,000 20 million yuan 20h00, 11 Dec – 24h00, 17 Dec Nearly 10,000 physical stores and
JD.com
2021 Futian district, 100,000 20 million yuan 08h00, 7 Jan – 24h00 17 Jan Over 10,000 designated businesses
Shenzhen in Shenzhen
2021 Longhua district, 100,000 20 million yuan 09h00, 1 Feb – 24h00, 9 Feb Over 3,500 designated businesses
Shenzhen in Longhua district
2021 Beijing 50,000 10 million yuan 21h00 11 Feb – 24h00, 17 Feb Designated businesses on
Wangfujing and JD.com
2021 Suzhou 150,000 30 million yuan 18h00, 10 Feb – 24h00, 26 Feb Over 16,700 designated businesses
in Shenzhen
2021 Chengdu 200,000 40 million yuan 08h00, 3 Mar – 24h00, 19 Mar Over 11,000 designated businesses
in Chengdu and JD.com
Source: https://forkast.news/china-dcep-digital-yuan-pros-cons/
Regulation – critical, but likely to lag

The other major response from central banks (and other regulators) to the rise of
digital assets is around regulation. While the pace has picked up recently, regulation
around digital asset markets is nascent and significantly lags the pace of innovation
and experimentation in these markets. This is typical of the emergence of new markets
and technologies. As an example, in the US, although credit cards were first
introduced by Bank of America in the late 1950s and usage grew rapidly through the
1960s, it took until the 1970s for the major pieces of credit card legislation and
regulation to emerge (Fair Credit Report Act 1970; Fair Credit Billing Act 1974; Fair
Debt Collection Practices Act 1977).
In framing thinking around regulation, it is worth noting the size differential between
the major components of global financial markets (debt, equity and derivative
markets) and cryptoasset markets. Historically cryptoasset values have been extremely
small relative to mainstream capital markets (Fig 41), and of little systemic relevance.
The growth in the size of crypto market capitalisation, coupled with the spectre of
private currencies competing with mainstream forms of money, has triggered a
regulatory response we anticipate will intensify.
However, the approach to regulation is complicated by the ‘chameleon’-like nature of

the crypto market. For example, are these instruments securities, currencies or
commodities? How should a stablecoin be thought of and regulated relative to an
unbacked coin? These markets are anchored in a virtual 24/7 world and operate in a
borderless manner, an anathema to regulators whose focus tends to be largely
domestic and anchored in traditional market structure thinking. Even where forums
exist to try and achieve a degree of regulatory harmonisation (e.g. the Financial

Stability Board), this concept is likely to be challenged by the desire of certain counties
and jurisdictions to achieve economic competitive advantage by embracing this
technology.
Fig 41: Relative size of global derivative, credit, equity, gold and cryptoasset markets, 2020
U$trn U$trn
180 800
160 700
140 600
120
500
100
400
80
300
60
40 200
20 100
0 0
Credit Equity Gold Crypto Crypto Crypto Derivative
markets**** markets markets (end markets markets markets (RH
2020) (peak)* (current)** Scale)***
* 10 May 2021
** 30 July 2021
*** Notional value of outstanding in OTC and exchange-traded derivative markets
**** Government, corporate and financial sector bonds
Source: Redburn, BIS, IMF, World Gold Council, CoinMarketCap
Discussions with digital asset industry participants underscore that a frustration in

many quarters is the absence in multiple areas of a regulatory framework (or the
existence of a very immature one). Ultimately, new regulatory frameworks will
emerge, but it is likely to be a slow and relatively haphazard process, and we expect
this market in coming years to be characterised by friction between the pace of
innovation in this market relative to the pace of regulatory development.
While traditional frameworks may be more challenging to operate in this market for
the foreseeable future, we anticipate regulators will frame and develop regulation
around well-established principles, notably: (1) maintaining financial and economic
stability; (2) maintaining appropriate standards of investor protection; and (3) guarding
against illicit activity.
Financial (and economic) stability

Given their mandate to maintain financial stability and the competitive threat posed
by private money, much of the response on the part of central banks has been on
developing CBDCs (discussed in the preceding section). However, perhaps in
recognition that the challenge of private money will not disappear, the central banks
have also been examining alternatives, notably around the concept of stablecoins. In a
recently released discussion paper on digital money, the Bank of England in addition

to a CBDC also allows for the possibility of stablecoins, although it stresses the need
for public confidence therein:
“Like existing forms of money, new forms of digital money that are systemic could
be publicly or privately provided. In this Paper, the term ‘systemic stablecoin’ –
often referenced as ‘stablecoin’ for simplicity – is used to refer to those that are
issued by private companies…New forms of digital money could be preferred by
the public to commercial bank deposits, but they will endure only if they can be
trusted as a store of value and as an accepted means of payment. This means that
stablecoins must promise, credibly and consistently, to be fully interchangeable
with existing forms of money. In other words, they must be anchored. This is
essential for ensuring that users have the same confidence in stablecoins as
commercial bank money.” Extract from ‘New forms of digital money’, Bank of
England discussion Paper, 7 June 2021
In the US, regulators have underscored the need for a greater oversight of private
sector stablecoins; some recent commentary around them has been relatively
constructive (see comment below). This is not mirrored in all quarters, with certain
politicians adopting a more sceptical stance. For example, Senator Elizabeth Warren in
a recent Senate hearing likened stablecoins to ‘wildcat notes’ issued by banks in the US
in the 19th century, which left many holders with large losses.
“In my judgment, we do not need to fear stablecoins. The Federal Reserve has
traditionally supported responsible private-sector innovation. Consistent with this
tradition, I believe that we must take strong account of the potential benefits of
stablecoins, including the possibility that a U.S. dollar stablecoin might support
the role of the dollar in the global economy.” Extract from speech by Randal
Quarles, Federal Reserve Vice Chair for Supervision, 28 June 2021
One of the central concerns of regulators about private stablecoins is the backing
thereof, a dynamic we discuss in more detail in Chapter 3. From a financial stability
perspective, a central risk in the event of largescale adoption of stable coins would be
the displacement of commercial bank money (a similar phenomenon could be seen in
the event of a successful retail CBDC), with implications across the financial system,
not least for credit formation (Fig 42).
“A large-scale displacement of commercial bank money by new forms of digital

money could mean a higher fraction of money in the economy backed by high-
quality liquid assets (HQLA) rather than by loans to the real economy. In that
event, real economy loans could be financed instead by more stable, and
expensive, sources of funding, reducing the efficiency with which commercial
banks extend credit. As a result, there could be a greater reliance on non-banks for
credit provision.

Overall, there may be a trade-off between the optimal provision of transaction

services – that is, payments – and intermediation services – that is, credit. On the
one hand, the introduction of new forms of digital money may improve the range
of transaction services available to people. On the other hand, it might reduce the
efficiency of credit provision in the economy.” Extract from ‘New forms of digital
money’, Bank of England discussion paper, 7 June 2021
Fig 42: Overview of implications of stablecoins for macroeconomic stability

Deposits migrate
Commercial banks • Greater resilience of payments (✓) Stablecoins
• Potential to enhance the transmission of
monetary policy (✓)
Replace deposits with long-term • Potential for larger deposit runs in stress
debt ()
• Reduced chance of sharp fall in • Risk of short-term disruption in money
bank credit conditions (✓) markets ()
• Potential to make it more difficult to ease
financial conditions ()
Funding costs rise • Risk to confidence in money and
payments if expectations not met (×)
Lending rates rise Non-banks

Provision of lending shifts
• Potential for more productive credit
allocation (✓)
• Some borrowers may find it too costly to
borrow from non-banks () (✓) Opportunity
Banks’ provision of credit falls () Risk in transition
(×) Risk
Source: Bank of England
The use of CBDC and possible much more widespread use of stablecoins would
potentially trigger changes to financial system architecture (especially banking) in a
way that has not been seen before. This is usefully framed by the outgoing Bank of
England Chief Economist:
“On financial stability, a widely-used digital currency could change the topology
of banking fundamentally. It could result in something akin to narrow banking,
with safe, payments-based activities segregated from banks’ riskier credit-
provision activities. In other words, the traditional model of banking familiar
for over 800 years could be disrupted. While the focus of debate so far has been
on the costs of this disruption, largely in the form of disintermediation of existing
agents, there are significant potential benefits to be had too.” Extract from speech
by Andy Haldane, Bank of England Chief Economist, 30 June 2021
Given the importance of the banking system to financial stability, regulators are also in
in the process of clarifying the regulatory treatment of cryptoassets for banks. In June
2021, the Basel Committee on Banking Supervision published its proposed prudential
treatment of cryptoasset exposures. The high-level proposals are detailed in Fig 43.

The proposed 1250% risk weighting of bitcoin garnered much attention, but the
publication of the broader proposals is arguably more interesting and symptomatic of
greater official acknowledgement being placed on an emerging asset class.
Fig 43: An overview of the prudential treatment of cryptoasset exposures

Group 2 cryptoassets
(not fulfilling Out of
Group 1 cryptoassets (fulfilling classification conditions) classification conditions) scope
Group 1b: Cryptoassets with Cryptoassets that do
Prudential Group 1a: Tokenised stabilisation mechanisms not qualify as Group 1
requirements traditional assets (i.e. stablecoins) (e.g. bitcoin) CBDCs
New guidance on application
Capital requirements at New conservative prudential
of current rules to capture the
least equivalent to those of treatment based on a 1250%
Credit and market risk risks relating to stabilisation
traditional assets (with risk weight applied to the n/a
requirements mechanisms (with further
further consideration for maximum of long and short
consideration for capital
capital add-ons) positions
add-ons)
Other minimum requirements
Application of the existing Basel Framework requirements with additional guidance where
(leverage ratio, large n/a
applicable
exposures, liquidity ratios)
Additional guidance to ensure that risks not captured under minimum (Pillar 1) requirements
Supervisory review n/a
are assessed, managed and appropriately mitigated (including through capital add-ons)
New requirements for banks to disclose information regarding cryptoasset exposures on a
Disclosure n/a
regular basis
Source: BIS
Preventing illicit activity

The second major area of regulatory focus is in guarding against illicit activity, which
includes anti-money laundering (AML) measures and preventing terrorism financing.
Fig 44 shows an estimate of illicit activity in the cryptoasset arena. Fig 45 shows a
breakdown of this activity, which estimates show as being concentrated in four areas:
1 Stolen funds.
2 Darknet markets, the most notorious historical example being the Silk Road which
was shut down by the FBI in 2013. Bitcoin was the currency of choice on this
website.
3 Ransomware. This is the category of illicit activity that has seen the most rapid
growth in recent years and holds the potential to be a source of intense regulatory
scrutiny for crypto markets.
4 Scams. We discuss investor protection in the next section.

Fig 44: Total cryptocurrency value sent and received by

illicit entities vs illicit share of all cryptocurrency Fig 45: Total cryptoasset value received by illicit
activity, 2017-20 entities*, 2017-20
U$bn U$m
2.50% 25 12,000
2.00% 20 10,000
8,000
1.50% 15
6,000
1.00% 10
4,000
0.50% 5
2,000
0.00% 0
2017 2018 2019 2020 0
Total illicit value (U$bn, RHS) 2017 2018 2019 2020
Share of total cryptocurrency transfer value (LHS) Darknet markets Ransomware Scams Stolen funds
Source: Chainalysis * Top four

Source: Chainalysis, Redburn
Given the scrutiny and pressure regulators have bought to bear on the traditional
financial sector in the area of illicit activity, it is realistic to expect a similar approach in
the cryptoasset arena.
Fig 46 shows data compiled by the Financial Action Task Force (FATF), an
inter-governmental body that sets international standards to prevent money
laundering and terrorist financing. Its latest survey work, based on data from April
2018, found that out of 128 jurisdictions, 58 reported they had introduced legislations
to implement FATF standards imposing AML/CFT (anti-money laundering and
counter-terrorism financing) on VASPs (Virtual Asset Service Providers). This was up
from 33 jurisdictions in the prior year.
We expect the number of jurisdictions wrapping prevention of illicit activity

legislation around the cryptoasset industry to continue to climb. From an AML/CFT
perspective, we also expect regulators to intensely scrutinise and exert pressure on fiat
on-off ramps.
Inside the crypto markets themselves, notably in the DeFi arena (which we examine in
Chapter 4), we anticipate AML and Know Your Customer (KYC) procedures to be an
evolutionary process given the characteristics of these markets with a degree of friction
with official sector proposals. An example of this evident in recent industry
commentary on certain March 2021 issued FATF proposed guidelines of virtual assets
and VSAPs.

“Adan strongly supports the development of appropriate and proportionate

guidelines which mitigates criminal and other illicit use of virtual assets. However,
these proposed guidelines are at best impractical, at worst, impossible to
implement for individuals and DeFi startups which neither have the competence,
know-how or resources to perform due diligence on users with whom they have no
point of contact. Indeed developers or deployers of smart contracts which enable
the transfer of assets – such as decentralized exchanges, decentralized stablecoins
or any number of DeFi applications – have no practical means to identify users or
their operations. This broad and vague definition of VASP creates legal
uncertainty for virtual asset users and developers participating in the DeFi
ecosystem.” Extract from ADAN (Association for the Development of Digital
Assets) publication, 21 April 2021
Fig 46: Progress in implementing AML/CFT* regulatory regimes for VASPs*

FATF* FRSB* Total
Jurisdiction has necessary legislation for AML/CFT regime for VASP
Permit and regulate VASPs 27 25 52
Prohibit VASPs 1 5 6
Jurisdiction is in the process of introducing necessary legislation/regulations for AML/CFT regime for VASPs
Jurisdiction has decided its approach on VASPs, but has not yet commenced the necessary legislative/regulatory process
Jurisdiction is yet to decide what approach to take for VASPs

Approach to VSAPs under consideration 1 31 32
Total 38 90 128
* AML/CTF – anti-money laundering and counter-terrorism financing; VASP – Virtual asset service providers; FATF – Financial Action Task Force; FRSB – FATF-Style
Regional Bodies
Source: Financial Action Task Force (July 2021)
Investor protection
The other major area of regulatory focus around cryptoassets is investor protection. As
highlighted in Fig 45, the largest area of losses in the cryptoasset arena has been
around scams. The composition of cryptoassets, their borderless nature and high levels
of innovation in these markets generate an usual set of challenges for regulators, as
traditional investor protection frameworks are more challenging to fit cryptoassets and
markets.
As with other areas of regulation, we expect adoption of investor protection around

cryptoassets to be an uneven process, with this area potentially seeing the greatest
variation in regulation across countries. For example, Canada has already authorised a

range of cryptoasset exchange-traded funds (ETFs), while multiple developed market

locations are still grappling with whether or not to authorise them.
A brief country-by-country summary

There are myriad proposals around the cryptoassets and markets globally. Below we
briefly summarise select developments in a few major economies.
US
Within the US, while there has been significant engagement by a variety of regulatory
agencies on the subject of cryptoassets, little formal rulemaking has occurred. At a
federal level, regulation is complicated by differing mandates. For example, the SEC is
responsible for securities regulation, including securities exchanges. However, crypto
exchanges do not fall under its purview, with the largest cryptoassets Bitcoin and Ether
not considered securities. The Commodities Futures Trading Commission (CFTC),
which is responsible for the oversight of US derivative markets, does not oversee these
markets either, although it does oversee crypto trading on the major US derivative
exchanges (for example, CME’s Bitcoin futures & options products). How oversight of
these assets and markets evolves is unclear, although in April 2021 the US House of
Representatives passed a bill that would create a digital asset working group between
the SEC and CFTC. Some pockets of guidance have been issued. For example, in July
the Office of the Comptroller of the Currency (OCC) issued guidance allowing US
banks to provide cryptoasset custody services.
State-level rules also exert an impact in the US. Here, there have typically been two
approaches. Some states have been highly supportive of cryptoassets, passing
favourable regulations exempting them from state securities laws and money
transmission statutes. Others have adopted more restrictive approaches, although
regulation at this level can shift. For example, in 2020, New York amended its
‘BitLicense’ rules, which were first introduced in 2015, the amendments aimed at
making it easier for companies to undertake crypto business in the state.
EU
Limited specific regulation has been passed by the EU that governs crypto activities.
The EU’s fifth AML directive, which came into effect in 2020, specifies that crypto
exchanges must follow the EU’s AML regulations. In September 2020, the European
Commission (EC) published a new digital finance package, one component of which
includes legislative proposals for an EU regulatory framework on cryptoassets.
UK
Cryptoassets are considered property in the UK, but currently no specific cryptoassets
laws exist and they are not considered legal tender. Firms carrying out specific
cryptoasset activities (e.g. crypto exchanges) in the UK are permitted and are required
to register with the Financial Conduct Authority (FCA) from January 2020. The FCA
has granted temporary registration until 31 March 2022 to existing firms whose

applications are pending determination. In October 2020, the FCA passed regulation,
which became effective in January 2021, prohibiting the sale to retail clients of
investment products (derivative and exchange-traded notes) that reference cryptoassets.
China
Among the major economies, China is the most restrictive in its approach to
cryptoassets, with the People’s Bank of China (PBoC) having banned financial
institutions from handling Bitcoin transactions in 2013 and then outlawing Initial
Coin Offerings (ICOs) and domestic cryptoasset exchanges in 2017. Crypto-mining
activities are still permitted, with the majority of mining operations (as measured by
Hash Rate) based in China. However, there has been a crackdown on such operations
in recent months, partly influenced by energy consumption concerns.
Japan
The Financial Services Agency (FSA) oversees all crypto trading platforms in Japan. In
2017 Japan made an amendment to its Payments Services Act and introduced a
regulatory regime for virtual currency businesses, making Japan the first developed
market to do so.

03/
03/ The crypto landscape
The crypto landscape

The cryptoasset market has exhibited exponential growth in recent
years, led by interest in Bitcoin and Ethereum, with the number of
cryptoassets exploding. A broad crypto market infrastructure has
sprung up to support growth of this industry, which has exhibited high
levels of innovation. However, real-world use cases remain limited
and the cryptoasset industry’s ability to mount a challenge to
mainstream finance is unproven. Investment in the sector has
primarily been retail-led, although the past year has seen a surge in
institutional and corporate interest and activity in this industry.

Digital numismatics
The crypto landscape (as measured by the market capitalisation of the various
cryptoassets) has grown exponentially, aggregate capitalisation reaching cUS$2.5trn in
May 2021, before a sharp correction (Fig 47). The dominant assets accounting for over
60% of market capitalisation are Bitcoin and Ethereum (Fig 48). Bitcoin remains the
highest profile currency, although its dominance has fallen (Fig 49).
Fig 47: Crypto market cap, 2013 to date Fig 48: Major coins by market cap, 30 July 2021
3,000
2,500
2,000
1,500
1,000
500
0
Apr-13
Apr-14
Apr-15
Apr-16
Apr-17
Apr-18
Apr-19
Apr-20
Apr-21
Oct-13
Oct-14
Oct-15
Oct-16
Oct-17
Oct-18
Oct-19
Oct-20
Bitcoin Ethereum Tether

Total Excluding BTC Binance Coin Cardano XRP
USD Coin Dogecoin Other
Source: CoinMarketCap, Redburn Source: CoinMarketCap, Redburn
Fig 49: Evolution of total crypto market capitalisation by major coin, April 2013 to date
100%
% of global market cap
80%
60%
40%
20%
0%
Nov-2013
Nov-2014
Nov-2015
Nov-2016
Nov-2017
Nov-2018
Nov-2019
Nov-2020
May-2013
May-2014
May-2015
May-2016
May-2017
May-2018
May-2019
May-2020
May-2021
Bitcoin XRP Dogecoin Tether

Ethereum Binance Coin Cardano USD Coin
Polkadot Others
Source: CoinMarketCap, Redburn
In the sections that follow, we examine Bitcoin, Ethereum, Stablecoins and other
Altcoins in more detail.

Bitcoin
Bitcoin is the flag-bearer of the cryptoasset market, and despite a falling share of the
total cryptoasset market, it currently exerts the greatest influence. Its proof of work
consensus mechanism is fuelled by a level of computing power exponentially higher
than that of other cryptoassets (Fig 50). The associated energy demand to support this
has climbed (Fig 51), with estimates suggesting the energy consumption of the miners
(who underpin Bitcoin’s consensus mechanism) rivals that of Norway. This has
triggered a number of questions, especially from an ESG perspective, and has been a
contributory factor in the fall in Bitcoin’s price from record levels seen in April 2021.
Fig 50: Bitcoin network Hash Rate, 2009 to date Fig 51: Bitcoin energy consumption, 2017 to date
200 150
Annualised energy usage (TWh)
Exahash per sec. (EH/s) = 1million TH/s
120
160
90
120
60
80
30
40
0
Jul-17
Aug-19
Apr-21
Feb-17
May-18
Mar-19
Jan-20
Jun-20
Nov-20
Dec-17
Oct-18
0
Jan-09
Jan-11
Jan-13
Jan-15
Jan-17
Jan-19
Jan-21
Minimum Actual - Estimated
Source: Blockchain.com, Redburn Source: Digiconomist, Redburn
The rapid appreciation of Bitcoin’s value and subsequent awareness has resulted in an
increase in the number of users (measured in Fig 52 as total active addresses), which is
around all-time highs5. While originally conceived as a peer-to-peer electronic transfer
system, the transaction throughput of the Bitcoin network is limited, averaging c3.5
transactions per second in recent years, a level that precludes it operating as a payment
network given the vastly higher output of other networks (Fig 53). This lack of
scalability has been an issue that has pervaded the Bitcoin network for years and a
exemplifies the blockchain ‘trilemma’ (a term coined by Vitalik Buterin, the founder of
Ethereum), a dynamic that forces blockchain creators to sacrifice one of three core
characteristics – decentralisation, security, scalability – in order to achieve the other
two. In the case of Bitcoin, its decentralisation and security are delivered at the cost
of scalability.
5
There are challenges in gauging user and ownership numbers across the Bitcoin network. Many reports focus on the distribution of Bitcoin
network address. This approach does not allow for certain important considerations: (1) an individual’s self-custody address will be treated
the same as an exchange’s address, which may hold funds from hundreds of thousands of users; and (2) a single user may have multiple
addresses.

Fig 52: Number of active addresses used in successful Fig 53: Bitcoin transaction rate per second*, 2016 to
transactions on Bitcoin*, 2009 to date date
1,500 5
Number of active addresses (000)
1,200 4
Transactions per second

900 3
600 2
300 1
0 0
Jun-16
Jun-17
Jun-18
Jun-19
Jun-20
Jun-21
Dec-16
Dec-17
Dec-18
Dec-19
Dec-20
Jan-09
Jan-11
Jan-13
Jan-15
Jan-17
Jan-19
Jan-21
* Seven-day moving average * Seven-day moving average

Source: Glassnodes, Redburn Source: Blockchain.com, Redburn
Various proposals have been advanced to improve the scalability of the Bitcoin
network, the most prominent being the Lightning Network, which effectively sits on
top of the Bitcoin blockchain and is intended to be a decentralised system to facilitate
instant, high-volume micropayments. The past 12 months have seen an increase in the
Lightning Network’s capacity, although it remains relatively small (Fig 54).
Less well known is that the Bitcoin network currently supports smart contracts, albeit
with limited functionality. In June 2021, the first Bitcoin upgrade in four years was
approved by miners that underpin the Bitcoin’s consensus mechanism. Known as
Taproot, it is expected to take effect in November 2021 and allow for competitive
smart functionality. Key changes planned as part of this upgrade are: (1) a switch from
Elliptic Curve Digital signatures to Schnorr signatures, a change that will afford greater
privacy and, crucially, make transactions more data-lightweight (more specifically,
Schnorr signatures forego the current need to record the individual participants in a
multi-signature transaction and instead uses a single ‘combined’ signature);
(2) modifying the data structure of the network, through the implementation of
Merklized Abstract Syntx Trees, to enable users to write more complex smart contract
conditions and further increase user privacy; and (3) swapping to a new, less-
restrictive, network programming language called Tapscript. All in, Taproot holds the
potential to improve the Bitcoin network appeal as a venue for smart contracts, an area
where Ethereum (discussed in the next section) dominates.
The constrained supply of Bitcoin (supply is capped at 21 million, Fig 55), the
computing power deployed behind the network, and its global reach and portability
have given rise to the idea that Bitcoin could function as a store of value – effectively
digital gold. The conservative approach adopted by the Bitcoin development

community, analysis that suggests much of Bitcoin is being held for the long term,
supports this idea (Fig 56), although unsurprisingly the official sector view differs
sharply:
“Unlike gold, however, which has industrial uses and aesthetic attributes quite
apart from its vestigial financial role, Bitcoin’s principal additional attractions are
its novelty and its anonymity. The anonymity will make it appropriately the
target for increasingly comprehensive scrutiny from law enforcement and the
novelty is a rapidly wasting asset. Gold will always glitter, but novelty, by
definition, fades. Bitcoin and its ilk will, accordingly, almost certainly remain a
risky and speculative investment…” Extract from speech by Randal Quarles,
Federal Reserve Vice Chair for Supervision, 28 June 2021
Fig 54: Lightning Network – total daily capacity in Bitcoin and US$, January 2018 to date*
1,875 75
Capacity in BTC (lhs) Capacity in U$ (rhs)
1,500 60
1,125 45
750 30
375 15
0 0
Sep-18
Sep-19
Mar-18
May-18
Jul-18
Nov-18
Mar-19
May-19
Jul-19
Nov-19
Mar-20
May-20
Jul-20
Sep-20
Nov-20
Mar-21
May-21
Jan-18
Jan-19
Jan-20
Jan-21
* Seven-day moving average

Source: Bitcoin Visuals, Redburn
Fig 55: Bitcoin inflation vs time

Year
2009 2013 2017 2021 2025 2029 2033 2037
100%
20
90%
80%
Inflation rate (annualised)
70% 15
Bitcoins (millions)
60%
50% 10
40%
30%
5
20%
10%
0% 0
0 210 420 630 840 1050 1260 1470 1680
Blocks (thousands)
Inflation rate Monetary base
Source: StackExchange

Fig 56: Bitcoin – liquid and illiquid supply

Illiquid Liquid Highly liquid Price ($)
$20,000
17.5m $8,000
$4,000
15m
$1,000
$600
12.5m $200
$80
10m $40
$10
7.5m $6
$2
5m $0.80
$0.40
2.5m $0.10
$0.06
0 $0.02
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Source: Glassnodes
Ethereum
First proposed in a white paper by Vitalik Buterin in 2013, Ethereum has evolved into
the second largest cryptoasset, currently accounting for c20% of the crypto market,
having experienced a meteoric price rise (Fig 57) since the project was formally
launched in 2015. The thinking behind Ethereum, articulated in the comment below,
was much broader than Bitcoin, with some framing it as the world’s computer.
“The concept of an arbitrary state transition function as implemented by the

Ethereum protocol provides for a platform with unique potential; rather than
being a closed-ended, single-purpose protocol intended for a specific array of
applications in data storage, gambling or finance, Ethereum is open-ended by
design, and we believe that it is extremely well-suited to serving as a foundational
layer for a very large number of both financial and non-financial protocols in the
years to come.” Extract from Ethereum white paper
Although it currently uses a proof of work (PoW) consensus mechanism, similar to

Bitcoin, Ethereum’s is far less energy-intensive (Fig 58), its PoW algorithm being
memory-intensive, a step that penalises application-specific integrated circuits
(ASICs), which dominate Bitcoin’s PoW mechanism. A switch of the Ethereum
network from PoW to Proof of Stake (PoS) is planned as part of the Ethereum 2.0
project (discussed in the next section and Appendix 3), which will dramatically lower
Ethereum’s energy consumption.

Fig 58: Number of Petahash per second (PH/s)

Fig 57: Ethereum market price, 2015 to date performed by the ETH network*, 2015 to date
4,500 0.75
Petahash per sec. (PH/s) = 1,000 TH/s

3,600 0.60
Average daily price (U$)
2,700 0.45
1,800 0.30
900 0.15
0 0.00
Jul-15
Sep-16
Apr-17
Aug-19
Feb-16
Nov-17
Jun-18
Jan-19
Mar-20
May-21
Oct-20
Aug-15
Aug-16
Aug-17
Aug-18
Aug-19
Aug-20
Feb-16
Feb-17
Feb-18
Feb-19
Feb-20
Feb-21
Source: Etherscan, Redburn * Seven-day moving average
Source: Etherscan, Redburn
The transaction rate on the Ethereum network, while higher than that of Bitcoin, is a
fraction of that of payment networks (Fig 59). Reflecting Ethereum’s orientation, it is
the network of choice for running Decentralised Applications (DApps), digital
applications that run on decentralised networks (Fig 60).
Fig 59: Transaction rate per second on the Ethereum

network, 2015 to date Fig 60: Decentralised apps built on Ethereum
25 150 3,000
No. new DApps added per month
120 2,400
20
Transactions per second
90 1,800
15
60 1,200
10
30 600
5
0 0
Apr-15
Aug-16
Apr-17
Aug-18
Apr-19
Aug-20
Apr-21
Dec-15
Dec-17
Dec-19
0
Aug-15
Feb-16
Aug-16
Feb-17
Aug-17
Feb-18
Aug-18
Feb-19
Aug-19
Feb-20
Aug-20
Feb-21
Ethereum platform (lhs) Total DApps (rhs)
* Seven-day moving average Source: StateoftheDapps, Redburn

Pivotal to the functioning of Ethereum is the widely used ERC-20 tokenisation

standard, which is defined below.

“The ERC-20 standard outlines the common set of criteria and technical
specifications an Ethereum token must follow to function optimally and
interoperably on the Ethereum blockchain. It enables the creation of tokenized
assets that can be bought, sold, and exchanged alongside cryptocurrencies like
bitcoin (BTC) and ether (ETH). The ERC-20 standard utilizes smart contracts to
issue tokens that can be exchanged on the Ethereum network as well as used
interoperably between Ethereum-based dApps. It is the most commonly used
Ethereum token standard, and has been used as a framework to create many
notable digital assets.” Extract from Gemini cryptopedia
Daily transfer of ERC-20 tokens hit a record high in H1 2021, reflecting growth in the
Ethereum network, in particular its use as a base for DeFi. This is also reflected in the
exponential growth in value locked in smart contracts on the Ethereum network
(Figs 61 and 62). We discuss DeFi dynamics in Chapter 4.
The growth of the Ethereum network has resulted in capacity constraint and surging
transaction costs (Fig 63). To improve the scalability of the network, a prerequisite if
Ethereum is to take on a bigger real-world role as many in the crypto industry hope, a
significant upgrade of the Ethereum network is in progress.
Fig 61: Daily number of ERC-20 tokens transferred on Fig 62: Total value locked in smart contracts on
ETC network, 2017 to date Ethereum network, 2017 to date
1,250 100
Number of tokens transferred (m)
1,000 80
750 60
500 40
250 20
0 0
Aug-15
Mar-16
Sep-19
May-17
Jul-18
Feb-19
Apr-20
Nov-20
Jun-21
Dec-17
Oct-16
Aug-17
Aug-18
Aug-19
Aug-20
Apr-18
Apr-19
Apr-20
Apr-21
Dec-17
Dec-18
Dec-19
Dec-20
* Seven-day moving average Source: DeFi Pulse, Redburn


Fig 63: Ethereum – average transaction fees, 2015 to Fig 64: Ethereum, average price for a single unit of gas
date on the Ethereum network, 2015 to date
50 450 0.0010
360 0.0008
40
Average transaction fee (U$)
Gwei = 10^-9 Ether

270 0.0006
30
180 0.0004
20
90 0.0002
10
0 0.0000
Aug-15
Aug-16
Aug-17
Aug-18
Aug-19
Aug-20
Feb-16
Feb-17
Feb-18
Feb-19
Feb-20
Feb-21
0
Aug-15
Aug-16
Aug-17
Aug-18
Aug-19
Aug-20
Feb-16
Feb-17
Feb-18
Feb-19
Feb-20
Feb-21
Gas price in ETH (lhs) Gas price in $U, rhs
Source: Etherscan, Redburn Source: Etherscan, Redburn
Rebooting Ethereum
We previously mentioned the blockchain trilemma in the context of Bitcoin and, as
discussed above, the situation for Ethereum is near-identical: decentralisation and
security of the network is achieved at the cost of scalability. Demand for constrained
network resources has led to an unwanted growth in fees (Figs 63 and 64), whilst the
popularity of the network has rapidly increased the disk space required to participate
in securing the network – in consequence, centralising the network. Ethereum 2.0, or
Eth2 or Serenity, is Vitalik Buterin’s solution to these issues, a reboot of the network
with improved architecture that sustainably solves the Blockchain trilemma.
The upgrade itself is the launch of several interconnected projects expected to finish in
late 2021/early 2022. Scalability improvements will come from: (1) sharding the
transaction database and (2) integrating layer-2 solutions, specifically rollups.
Sustainability and security are addressed by the same project – a movement from an
energy-intensive PoW consensus mechanism towards a more energy-efficient PoS
consensus mechanism coordinated by the Beacon Chain. Security improvements will
come from a random staking algorithm provided by the Beacon Chain.
The Beacon Chain is the lynchpin of the Ethereum upgrade, responsible for
coordinating communication in the sharded database and successfully implementing a
PoS consensus mechanism. We discuss these constituent parts of Ethereum 2.0 in
more detail in Appendix 3, as well as the London hard fork which will help bridge the
current version of Ethereum to Ethereum 2.0.
In Figs 65 and 66, we show the impact on transaction throughput of upgrading the
current Ethereum infrastructure to version 2.0. The first column (respectively second

column) shows transaction metrics for the transfer of ether (transfer of ERC-20-based
tokens) between two users. Throughout, we assume that (1) each block contains a
single type of transaction (either ether- or ERC-20-based token transfers) and (2) each
block is maximally filled or, equivalently, the miner is aware of the true gas cost of
each transaction in the network and exhausts the entire gas limit of the block. This is
optimistic. Indeed, it is unlikely that a block would only contain a single type of
transaction and be filled maximally. Nevertheless, the modelling below provides useful
insights into the capability of next-generation blockchain networks.
Fig 65: Ethereum 1.0 (current version), theoretical transaction throughput

Gas limit per block 15,000,000 15,000,000
Gas cost per transaction 21,000 *50,000
Transaction ceiling, per block 714 300
Theoretical throughput on Ethereum 1.0 **54 TPS **23 TPS
* The gas cost for transferring ERC-20 tokens is not clear-cut, unlike ETH transfers. Here, we use an estimated average
** Transaction throughput = transaction ceiling, per block/block time, assuming a block time of 13 seconds
The output of Fig 65 is an upper bound for throughput on the current version of
Ethereum. If, hypothetically speaking, the network only supported transfers of ether
between addresses and a new block was added to the network every 13 seconds, its
throughput would be c54 TPS. Expanding network functionality to include ERC-20-
based token transactions decreases that number to c23 TPS. For context, the midpoint
of c25-55 TPS is some 2.5x higher than the actual average throughput of the network.
In Fig 66, we compute the scalability gained from upgrading to Ethereum 2.0 in two
steps. On the one hand, if each block contains the largest possible rollup, and we
assume that new blocks are added to the network every 12 seconds, then rollup
integration could increase transactions per second on Ethereum by a factor of 100.
Instead, consider the increase in network space for new transaction data due to
sharding, 60kB/s versus 1,398kB/s. Then, sharding the ledger could increase network
throughput 20x. Together, the upgrades in Ethereum 2.0 look to yield a maximum
throughput in excess of 100,000 transactions per section.

Fig 66: Ethereum 2.0, theoretical transaction throughput

Gas limit, per block 15,000,000 15,000,000
Gas cost per ZK rollup *500,000 *500,000
Remaining gas, per block 14,500,000 14,500,000
Gas cost per byte of transaction data 16 16
Transaction data ceiling, per block 906,250 906,250
No. of bytes per transaction included in rollup 12 16

Transaction ceiling, per block 75,520 56,640
Theoretical throughput before sharding **6,293 TPS **4,720TPS
Network space, before sharding (kB/s) 60 60

Network space, after sharding (kB/s) 1,398 1,398
Theoretical throughput after sharding ***146,626TPS ***109,976 TPS
* Here, we use a specific type of rollup for modelling, a ZK rollup, but note that there is another category of rollups called optimistic rollups
** Transaction throughput = transaction ceiling, per block/block time, using an estimated Ethereum 2.0 block time of 12 seconds
*** After sharding throughput = before sharding throughput * (network space, after/network space, before)
What is a realistic estimate for potential Ethereum 2.0 throughput? We think the
answer is close to 45,000. To get to this number, we combine the spread between
actual and estimated throughput from Fig 65 and the bottom line of Fig 66.
Other cryptoassets
While Bitcoin and Ethereum dominate the total market capitalisation, there has been a
proliferation of other cryptoassets (both altcoins6 and stablecoins). Coinmarketcap
currently lists 5,878, (as at 30 July 2021). The top 15 cryptoassets (including Bitcoin
and Ethereum) account for c86% of total cryptoasset market cap.
Fig 67 presents an overview of the largest cryptoassets by market cap, and in the
section that follows we present short biographies for the sixth largest altcoins (with
biographies for another 11 of the largest altcoins set out in Appendix 4.
6
An altcoin is an alternative coin, or any cryptocurrency launched after Bitcoin.

Fig 67: Overview of the largest cryptoassets, 30 July 2021

Release Consensus Fixed Circulating Mkt cap
Platform date Native token Native blockchain mechanism quantity? supply (m) (US$bn) Use case
Standalone
Bitcoin Jan-2009 Bitcoin Bitcoin PoW Yes (21m) 19 744.5
Ethereum Jul-2015 Ether Ethereum PoW No 117 280.0
Binance Coin Jul-2017 Binance Coin Binance Chain Tendermint (BFT) Yes (c171m) 168 53.4
Dogecoin Dec-2013 Dogecoin Dogecoin PoW No 130,639 26.9 Online gratuity
Bitcoin Cash Aug-2017 Bitcoin Cash Bitcoin Cash PoW Yes (21m) 19 10.0 Payments
Litecoin Oct-2011 Litecoin Litecoin PoW Yes (84m) 67 9.4
Asset-backed (Stablecoin)
Tether Feb-2015 Tether Bitcoin, Ethereum PoW, ERC-20 No 61,797 61.8
and other and other
USD Coin Sep-2018 USD Coin Ethereum ERC-20 No 27,237 27.2 Payments
Binance USD Sep-2018 Binance USD Ethereum ERC-20 No 12,253 12.2 Payments
Dai Dec-2017 Dai Ethereum ERC-20 No 5,597 5.6
Diem (Libra) n/a Diem Diem (formerly DiemBFT (BFT) No n/a
Libra)
Utility token
Cardano Oct-2017 Ada Cardano PoS Yes (45,000m) 32,065 41.4
Ripple Jun-2012 XRP RippleNet XRP Ledger Yes 46,312 34.4 Payments
(BFT) (100,000m)
Polkadot May-2020 Dot Polkadot Relay PoS No 979 14.9 Digital privacy
Chain
Uniswap Nov-2018 Uni Ethereum ERC-20 Yes (1,000m) 587 11.9 Token trading
liquidity
Chainlink May-2019 Link Ethereum ERC-677 Yes (1,000m) 442 8.8
Solana Mar-2020 Sol Own blockchain PoH & PoS Yes (489m) 273 8.7
Polygon May-2020 Matic Ethereum Plasma Yes (10,000m) 6,411 6.6 Blockchain
Framework & PoS infrastructure
Stellar Jul-2014 Lumens Stellar Stellar Consensus Yes 23,374 6.5 Payments
Lumens Protocol (c50,002m)
Theta Mar-2019 Theta and Ethereum ERC-20 Yes (THETA 1,000 5.9 Video
Network TFuel = 1,000m) streaming
Internet May-2021 ICP ICP Protocol PoS No 137 5.6
Computer
VeChain Jun-2018 VET and VeChainThor PoA & PoS Yes (VET = 64,316 5.4
VTHO c87,000m)
Source: Redburn, various
Binance Coin (standalone coin, market capitalisation US$53.4bn)

Binance Coin (BNB) is the native asset on Binance Chain, Binance’s original
blockchain, and the newly launched smart contract blockchain, Binance Smart Chain
(BSC). Its primary use is analogous to that of arcade machine prize tickets; traders use
fiat monies to purchase BNB, which, in turn, is spent on other cryptocurrencies and

transaction fees inside the Binance ecosystem. Incentives to use the coin include
significantly lower network fees for smart contracts and sizeable discounts on
exchange-related transaction fees.
Cardano (utility coin, market capitalisation US$41.4bn)

Cardano, and associated coin Ada, is a purpose-built blockchain aiming to eliminate
sustainability, interoperability and scalability issues that burden legacy platforms. Use
cases range from education to healthcare, with the common denominator being high
degrees of centralisation. The platform is still in development phase and currently
Ada’s only use is as a medium of exchange. Notable early project work includes
Ourobous Hydra, an off-chain solution that the University of Edinburgh claims can
scale the network to over one million transactions per second.
XRP (utility token, market capitalisation US$34.4bn)

XRP is the digital token used to facilitate payment settlement, asset exchange and
remittance via the Ripple-designed infrastructure RippleNet. The token itself is a
placeholder for anything that carries the definition of a unit of value; natural examples
include fiat currencies and commodities, less obvious are mobile minutes and air
miles. Its clear benefits to financial institutions have helped Ripple gather hundreds of
customers including Santander and American Express. Whilst the network is
decentralised and uses a distributed consensus mechanism to validate transactions, it
does not use blockchain technology. In December 2020 the SEC filed an action against
Ripple Labs, alleging the company raised US$1.3bn through an unregistered digital
asset security offering. The lawsuit is ongoing.
Dogecoin (standalone coin, market capitalisation US$26.9bn)

The joke coin that was created to mock wild cryptocurrency speculation in 2013 has
continued to bear fruit, becoming one of the largest cryptocurrencies by market
capitalisation in early 2021. By design, it has no differentiating qualities. It has,
however, found a use case in online gratuity where coin donations provide a reward
for the owners of content on social media platforms such as Twitter and Reddit and
Amazon-owned streaming platform Twitch.
Polkadot (utility token, market capitalisation US$14.9bn)

Polkadot is an ecosystem of connected blockchains, designed to allow specialised
blockchains to communicate, exchange value and share functionality within one
network. For example, a permissioned blockchain designed to store an individual’s
background information and a blockchain optimised for smart contracts pertaining to
job vacancies could communicate directly on Polkadot to automatically trigger an
interview request should a job-seeking candidate meet all the requirements. The native
currency Dot is used for network governance, the consensus mechanism and fees.

Uniswap (utility token, market capitalisation US$11.9bn)

Uniswap is a decentralised exchange designed as tool for the crypto community to
transfer Ethereum-based tokens without fees in addition to those charged by the
network or the use of an intermediary. Differentiating the platform is its use of
liquidity pools (automated market making via deposits wrapped up in smart contracts)
to remove the dependence of volume and consumer interest on token pricing. In
return for providing liquidity to the network, users are rewarded with UNI tokens that
are used to vote on network development decisions.
Stablecoins
Stablecoins are an important subset of the wider cryptocurrency universe, designed
with the goal of improving the traditional fiat currency model by using a highly
scalable and price-stable system of intangible digital assets as a medium of exchange.
Leveraging the benefits of blockchain technology, stablecoins theoretically promise
improved transparency, security, immutability and low cross-border fees. Here, price-
stability is derived from collateralisation or on-chain mechanisms and stablecoins can
typically be categorised in one of four buckets: (1) fiat-collateralised stablecoins; (2)
commodity-collateralised stablecoins; (3) crypto-collateralised stablecoins; and (4)
non-collateralised stablecoins. We provide basic details for the ten largest stablecoins
by market capitalisation in Fig 68.
Fig 68: Major stablecoins listed in order of decreasing market cap

Mkt cap
Coin Blockchain (US$bn) Collateral Detail
Tether Ethereum, 61.8 Fiat 1:1 peg to USD, with deposits held in centralised Tether treasury
Bitcoin & others
USD Coin Ethereum 27.2 Fiat 1:1 peg to USD, with deposits in decentralised (private) accounts
Binance USD Ethereum 12.2 Fiat 1:1 peg to USD, with deposits held by FDIC-insured banks
Dai (single) Ethereum 5.6 Crypto Ether is held in a CDO with value of >150% DAI borrowed
Dai (multi) Ethereum Crypto Protocol-approved coins are held in a CDO with value of >130-150% DAI borrowed
TerraUSD Ethereum 2.0 None On-chain stabilising mechanism involving arbitrage and two coins, UST and LUNA
True USD Ethereum 1.3 Fiat 1:1 peg to USD, with deposits held in escrow accounts
Paxos Standard Ethereum 0.9 Fiat 1:1 peg to USD, with deposits held by FDIC-insured banks
HUSD Ethereum 0.6 Fiat 1:1 peg to USD, with deposits held by FDIC-insured banks
Source: Redburn, CoinMarketCap (30 July 2021), companies
Stablecoins are predominantly backed by fiat currencies with a fixed peg between the
coin and the collateralising asset (or basket of assets). In theory, there is a reserve
controlled by the parent of the stablecoin that allows the holder to redeem their fiat
deposit via a transfer from the reserve and the destruction of the equivalent coin. The
structure is simple, allowing for more widespread adoption, and has two main
advantages: (1) capital efficiency, since users can buy at scale with the exchange rate
pegged at 1:1; and (2) theoretically low default risk, since the underlying fiat currency
should be readily available for redemption. Providing the economy (economies) of the
country (countries) a stablecoin is backed by remains stable, it is almost certain that

the cryptocurrency will remain stable too. Notable examples include Tether, USD
Coin and Binance USD, all of which are backed by the US dollar.
A similar idea governs commodity-collateralised stablecoins, but here the currency

basket is replaced by other tangible assets such as oil, real estate and gold. The key
point of differentiation is that unlike a basket of fiat currencies, the underlying asset
here has real value that may appreciate (although the converse potentially applies as
well). The knock-on effect is that it provides an incentive to users to hold these coins
as a store of value. Popular examples include Digix Gold (DGX) and Tiberius Coin,
where each DGX coin corresponds to 1g of real gold stored in an audited vault in
Singapore.
More complicated are crypto-collateralised stablecoins, backed by other

cryptocurrencies, primarily ether. Unlike the previous two types of stablecoins, which
require a centralised issuer, this category reaps further benefits from being on the
blockchain by integrating trustless issuance. To that end, the price volatility risk of
cryptocurrencies requires the holder to over-collateralise the asset, limiting growth
and exposing a key drawback versus other stablecoin categories. The lynchpin example
is Dai, which has a soft peg to the US dollar, is collateralised by 18 approved
Ethereum-based assets and has a debt ceiling of 668 million coins. Here, purchasing
$100 of Dai requires a deposit of at least $150 of ether, allowing the holder to
withstand drawdowns of as much as 50% in the underlying before their holding is
automatically liquidated via a smart contract.
A decentralised alternative to crypto-collateralised coins are those that fall under the
category of non-collateralised coins. In addition to integrating trustless issuance, these
coins remove the need for the holder to post collateral by utilising on-chain
mechanisms such as supply adjustment and rebasing to maintain the peg. However,
without collateral or liquidity backing the asset, volatility is amplified and a crash in
the price of the coin would result in all holders losing their entire investment.
An early appeal of stablecoins was their use as an escape vehicle from high-volatility
cryptoassets in the event of a market decline. They provided users with a low-cost
method of rapidly converting their holding to a price-stable asset within a single
platform. The only alternative to users in this scenario is converting their holding
directly to fiat currency, a task that is burdened with fees. Additionally, not all crypto
exchanges support the use of fiat currencies to purchase digital assets. These dynamics
are evidenced by high levels of volume between the major stablecoins and bitcoin
(Fig 69). Fig 70 highlights the exponential growth in the aggregate market
capitalisation of the top ten stablecoins.

Fig 69: Monthly Bitcoin volume traded into fiat or Fig 70: Aggregate market capitalisation of and daily
stablecoins, 2018-21 volume traded in ten largest stablecoins, 2015 to date
100% 350 125
Aggregate market capitalisation (U$b)

Volume traded (BTC m)
80%
Aggregate daily volume (U$b)

280 100
60%
210 75
40%
140 50
20%
70 25
0%
May-18
Sep-18
May-19
Sep-19
May-20
Sep-20
May-21
Jan-18
Jan-19
Jan-20
Jan-21
0 0
Aug-15
Aug-16
Aug-17
Aug-18
Aug-19
Aug-20
Feb-15
Feb-16
Feb-17
Feb-18
Feb-19
Feb-20
Feb-21
USDT USD EUR JPY KRW
USDC GBP AUD TRY PLN Daily volume (lhs) Market capitalisation (rhs)
Source: CryptoCompare, Redburn Source: CoinGecko, Redburn
Stablecoins, however, are not without their faults. Of most concern is the validity of
stablecoin reserves, particularly for fiat collateralised stablecoins since reputable
auditors are reluctant be involved and there is no standard reporting framework. Even
basic tasks such as verifying the existence of digital assets is challenging since by design
cryptocurrencies are maintained on a distributed leger without a central authority to
consult.
Tether
Particular scrutiny has been bought to bear on Tether, the original and most popular
stablecoin, which has been the centre of an investigation by the New York Attorney
General (NYAG) and is involved in an on-going case led by the US Department of
Justice regarding market manipulation. The NYAG concluded that (1) sister exchange
Bitfinex and Tether had misled their clients by issuing false statements of assurance
that their capital was being safeguarded by a third-party when in fact $850m of it was
missing and is likely unrecoverable, and (2) Tether was not fully backed at all times as
claimed.
“… starting no later than mid-2017 [note that the stablecoin started trading in
February 2015], Tether had no access to banking, anywhere in the world, and so
for periods of time held no reserves to back tethers in circulation at the rate of one
dollar for every tether, contrary to its representations…”
… On November 1, 2018, Tether publicized another self-proclaimed ‘verification’

of its cash reserve … linked to a letter [from Deltec Bank & Trust Ltd. of the
Bahamas] … which stated that tethers were fully backed by cash, at one dollar for
every one tether. However, the very next day, on November 2, 2018, Tether began

to transfer funds … from Tether’s bank accounts to Bitfinex’s accounts. And so, as
of November 2, 2018 — one day after their latest ‘verification’ — tethers were
again no longer backed one-to-one by U.S. dollars in a Tether bank account.”
Extract from New York Attorney General press release, 23 February 2021
In consequence, Bitfinex and Tether were required to pay an $18.5m penalty, to

increase reserve transparency and to cease trading activity in New York. Consistent
with other major fiat stablecoins, Tether has recently had its claims of being fully
backed assured by an international accountancy firm. It has also released further
unaudited details on the composition of its reserves shown in Figs 71 and 72.
Whilst Tether has moved away from claiming the stablecoin is entirely backed by cash,
purportedly representing c3% of total reserves, its new reserve structure reveals
significant counterparty risk and liquidity concerns given that only 24% is locked up in
high-quality liquid assets.
Fig 71: Tether reserve breakdown, 31 March Fig 72: Tether cash and cash equivalents
2021 and other breakdown, 31 March 2021
1.64% 2.73% 2.23%
9.96% 2.94%
12.55%
18.36%
49.60%
75.85%
Cash & Cash Equivalents and Other Commercial paper
Secured Loans Fiduciary deposits

Cash
Corporate Bonds, Funds & Precious Metals
Reverse repo notes
Other Investments (including digital tokens)
Treasury bills
Source: Tether, Redburn Source: Tether, Redburn
USD Coin
Partly influenced by the factors discussed above, other new fiat-collateralised
stablecoins have taken significant market share from Tether over the past few years
(Fig 73). The largest gainer is USD Coin (USDC), which currently represents c20% of
the market. USDC’s technology and IP is owned by Circle, a blockchain-focused
payment company, and governance is managed by CENTRE Consortium. Like other
stablecoins, USDC tokenises its collateralising asset (the US dollar) to provide a
low-cost on/off ramp for blockchain transactions and to facilitate fiat currency
cross-border.

Fig 73: Stablecoin market share split by market cap, January 2018 to July 2021
100%
80%
60%
40%
20%
0%
Jul-18
Sep-18
Jul-19
Sep-19
Jul-20
Sep-20
Jul-21
Jan-18
Mar-18
May-18
Nov-18
Jan-19
Mar-19
May-19
Nov-19
Jan-20
Mar-20
May-20
Nov-20
Jan-21
Mar-21
May-21
USDT USDC BUSD DAI UST TUSD PAX LUSD HUSD FEI
Source: CoinGecko, Redburn
To date, c830 billion USD Coins have been transferred on-chain, of which transactions
YTD represent c80% or c660 billion USD Coins, and total value in circulation is now
c$27bn. Given the reserve question that dogs stablecoins, Circle publishes a monthly
reserve account report that is independently reviewed. An overview of the reserves
backing USDC’s US$22.2bn of issued coins at May 2021 is shown in Fig 74. On 8 July
2021, Circle announced an intention to IPO via a SPAC with Concord Acquisition
Corp in a transaction that values Circle at US$4.5bn; the company is looking to rapidly
grow account numbers and revenue (Fig 75). Coinbase holds a relationship with
Circle, having a 50% interest in the Circle Consortium LLC (having been a founding
member of the Circle consortium) and it also acts as the principal reseller of USDC.
Fig 75: Circle – account number and revenue forecasts,

Fig 74: USDC reserve breakdown, May 2021 2021E-23E
US$bn Allocation 2021E 2022E 2023E
Cash & Cash Equivalents 13.4 61% Circle accounts 2,786 10,028 30,084
Yankee CDs 2.9 13%
US treasuries 2.7 12% Circle revenue (US$m) 115 407 886
Commercial Paper 2.0 9% Of which: USDC income share and
19 56 108
Corporate Bonds 1.1 5% transaction costs (US$m)
Muni Bonds & US Agencies 0.1 0.2%
Total 22.2 100% Adjusted EBITDA (US$m) (76) (97) 76
Source: Circle Source: Circle Internet Financial Investor Presentation, June 2021
Given growth dynamics, over time we expect greater regulation to be wrapped around
stablecoins, particularly if their popularity continues to expand. A recent Bank of
England discussion paper provides a view of different possible future regulatory
models for stablecoins (Fig 76). Greater regulatory certainty around stablecoin

structures could be an important factor in helping this segment of the crypto market
become more mainstream, although we expect regulatory attitudes to stablecoins to
vary from country to country.
Fig 76: Possible regulatory models for stablecoins

Level of prudential regulation increases
Restrictions on backing assets increase
Stablecoins
Regulatory model
Bank model HQLA model CBL model DB model
Backing assets
Broad range of backing assets Narrower range of backing

Funds placed in reserve at Funds placed in trust at
including loans, HQLA and assets, including HQLA and
central banks commercial bank(s)
reserves reserves
Relationship with central bank

No reserves (from stablecoins)
Partially reserve-backed Fully reserve-backed custody bank is partially
reserve-backed
Access to contingent liquidity Indirect access to contingent
Access to contingent liquidity
not required liquidity via custody bank
Bank of England
Source: Bank of England
The emerging crypto infrastructure

Fig 77 provides a conceptual mapping of the cryptoasset ecosystem and its intersect
with mainstream financial markets. Each cryptoasset (such as those discussed in the
preceding section) operates its own local ecosystem, a very simplified representation of
Bitcoin and Ethereum also shown in Fig 77. These single-asset ecosystems will
typically intersect with other ecosystems via gateways – crypto exchanges are the most
widely used mechanism to facilitate this. The on-off ramps into the broader
cryptoasset ecosystem are dominated by crypto-exchanges (e.g. Coinbase, Binance,
Kraken), with certain payment service providers (e.g. PayPal, Square) also starting to
facilitate this.

Fig 77: Conceptual mapping of monetary flows into and around crypto ecosystem
Cryptoasset ecosystem
Bitcoin
Exchanges Ecosystem Crypto-only Ethereum
Exchanges Ecosystem
Investors dApps/
ICOs
Miners
Miners
Users
Storage
Providers
Multi-
segment
Consumers
Payment
Service
Providers
Merchants Businesses
Fiat gateways Cryptoasset gateways Cryptoasset users
On/off-ramps
Source: CCAF (Cambridge Centre for Alternative Finance)
To support the operations, both individual as well as the broader crypto ecosystem, a
broad crypto market infrastructure has developed in recent years (Fig 78). In terms of
construct, it exhibits a strong resemblance to the wider global capital market
infrastructure (Fig 79).

Fig 78: Crypto capital markets infrastructure

- ErisX
- Skew - Arwen
- CME
Investor
Investor
Indices - Binance
Custody
- Uniswap
- Paxos
Research - Coinbase
Lending
- Investment banks
- Genesis
Regulatory and compliance services (Chainalysis)
Source: Redburn
Fig 79: Capital markets infrastructure
Data & Analyics Exchange Clearing & Settlement

- Bloomberg - CME - LCH
- Refinitiv - ICE - OCC
- Factset - HKEX - DTCC
Indices Custody
Investor
Investor
OTC
- S&P - Clearstream
- Investment banks
- MSCI - Euroclear
- Interdealer brokers
- FTSE Russell - DTCC
Research Platforms
Data
- Investment banks - Tradeweb
- Trading venues
- Boutique providers - MarketAxess
Technology services (e.g. OMS / EMS)
Regulatory and compliance services
Prime brokerage
Interface with payment rails
Source: Redburn
Use cases and institutional engagement

Despite the extremely rapid growth in value of cryptoassets in recent years, it remains
to a large extent a self-contained universe with still limited connectivity to the
traditional finance industry and a limited number of real-world use cases. The largest
potential opportunity for the crypto industry is whether it can disrupt or exert a
material influence on the global financial services industry.

We estimate financial services accounts for c6.6% of global GDP, or cUS$5.6trn based
on 2020 global GDP estimates (Fig 80), underscoring the potential for this industry if
it can achieve greater real-world adoption.
Fig 80: Financial services as a % of GDP, 2011-19

9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
2011 2012 2013 2014 2015 2016 2017 2018 2019
Global US China
Interest in the cryptoasset arena has to date been largely retail-led, with uncertainty
around regulation and volatility of this new asset class (Fig 81) acting as barriers to
institutional and corporate adoption. Over the past year this has started to change
materially. Hedge funds, high net worth individuals (HNWI) and family offices, most
of whom have more investment flexibility than mainstream institutions (e.g. pension
funds), have started to deploy funds in the cryptoasset arena and have indicated a
willingness to grow this (Figs 82 and 83), even though the concerns that pervade this
arena remain (Fig 84).
More mainstream institutional adoption of cryptoassets will take longer, with key
influences being regulation and strengthening of infrastructure around this asset class.
In this regard, the banking, particularly the investment banking, sector will play a role.
Analysis here suggests product offerings are starting to be developed, particularly by
the largest US investment banks (Fig 85).
Beyond considerations around crypto as an asset class, a more interesting (and much
broader) debate is whether it represents a potentially new way of constructing a
financial system. We discuss this in the next section on DeFi.

Fig 82: Hedge funds – % of cash holdings expected to be

Fig 81: Bitcoin and Ether volatility vs other assets*** stored in cryptocurrency
90 2% 2% 3%
80
11% 14%
70
60
50
40 33%
35%
30
20
10
Over 20% 11%-20% 6%-10% 3%-5%
0
Ether Bitcoin Oil** Silver S&P500 Gold DXY*** 1%-2% Up to 1% None
* Average of 30-day volatility from January 2015 (March 2018 for Ether) Source: Intertrust Group
** WTI
*** US Dollar Index
Source: Bloomberg, Redburn
Fig 83: US financial advisors – plans to allocate crypto Fig 84: US financial advisors – issues with increasing or
to client accounts in 2021 making first allocation to cryptoassets*
2021 survey 2020 survey
2%
Regulatory concerns 54% 56%
15% Too volatile 39% 43%

15% No idea how to value
36% 41%
cryptocurrencies
Lack of easily accessible investment
37% 39%
vehicles (e.g. ETFs)
28% Custody concerns/fear of hacks 30% 34%
40%
Definitely yes Probably yes Unsure

Probably not Definitely not
Source: Bitwise Investments * Response to question: What is preventing you from either increasing your
investment in cryptoassets or making your first allocation? (top five issues raised
shown)
Source: Bitwise Investments

Fig 85: Investment banks – offerings of crypto services

Crypto products for Crypto custody
wealth clients Crypto futures trading Crypto spot trading accounts
JP Morgan
Goldman Sachs
Morgan Stanley
Citigroup
Bank of America
Credit Suisse
Deutsche Bank
BNP Paribas
HSBC
UBS
Note: yellow = yes; black = no; grey = considering
Source: Bloomberg (18 June 2021)

04/
04/ DeFi
DeFi
Potentially the greatest opportunity for the crypto movement lies in
the area of Decentralised Finance (DeFi), which envisages a world of
finance shorn of centralised intermediaries. With financial services
accounting for c7% of global GDP and built on a centralised model,
the prize for any shift in finance towards a decentralised model is
enormous. DeFi has seen exponential growth over the past year, albeit
largely within the confines of the crypto industry. Use cases are being
made and the pace of innovation is extremely high, but execution is
likely to be fraught with real-world complexity.

04/ DeFi
An overview
One of the areas in the crypto arena that has experienced the most rapid growth and
highest level of interest over the past two years is Decentralised Finance (DeFi).
“DeFi is a general term for decentralized applications (Dapps) providing financial

services on a blockchain settlement layer, including payments, lending, trading,
investments, insurance, and asset management. DeFi services typically operate
without centralized intermediaries or institutions and use open protocols that
allow services to be programmatically combined in flexible ways.” Extract from
DeFi Beyond the Hype, Wharton
Given the value (c7% of global GDP) that accrues annually to the global financial
services industry, which itself is built on a centralised model, the appeal of DeFi as an
alternative opportunity from a business, financial and, to many, a philosophical
perspective is clear. DeFi and definitions around it are still at an early stage of
development. Given often conflicting explanations and definitions, Fig 86 provides a
framework for considering what constitutes a DeFi service.
Fig 86: Distinguishing characteristics of DeFi

Directly mediates the transfer of value? Auxiliary (e.g. price oracles) or
no
Non financial (e.g. distributed storage)
yes
service
Settlement on a public blockchain?

no Traditional finance (e.g. banking)
yes
Assets cannot be unilaterally expropriated/moved

no Custodial service (e.g. fiat-backed
by third parties?
stablecoins)
yes
Open source code and application programming

interface (API)? no Private service or standalone digital asset
yes
DeFi service
Source: Wharton Blockchain & Digital Asset Project (University of Pennsylvania), World Economic Forum
DeFi aligns with the concept of the Web 3.0 (originally termed the Semantic Web by
Tim Berners-Lee, inventor of the Web). The Web 2.0 saw the rise of the ‘Web as a
Platform’ fuelled by mobile, social and cloud dynamics; a key feature of this iteration
of the Web is a heavy level of centralisation. Web 3.0 is expected to be built on new
technology innovations: edge computing, decentralised data networks and artificial
intelligence. Critically, it envisages the individual as a sovereign on the Web operating
in a decentralised manner with a much-reduced need for third parties (Fig 87).

04/ DeFi
Fig 87: The second inning of tech decentralisation
App explosion
High
Trigger, iPhone, Apps

Android, SaaS
App & data decentralisation

Trigger, AI, Distributed Ledger
Apps Technology (DLT), Blockchain,
Scale and impact of
decentralisation
Smart Contracts, Bitcoin, GS
Initial internet Data

Apps
Data
Data concentration
App Data Trigger, Cloud computing, Trust
IaaS, Visualization, AI/ML
AI
AI AI AI AI
1 2 3 ...
Apps/data
1 Google 5 Tencent
2 Facebook 6 Alibaba Data
3 Amazon 7 Microsoft
4 Apple 8 ...
Low
Today
Web 1.0 Web 2.0 Web 3.0

Birth: 2004 Birth: 2004-2020 2008-
Source: Philipp Stauffer, FYRFLY Venture Partners
However, the realty within financial systems is that there are host of trade-offs between
running a decentralised network versus a centralised network (Fig 88). While the
benefits of decentralised networks include lowering economic rents and avoiding
single points of failure (the cost of which was amply demonstrated in the global
financial crisis), they face issues in critical areas such as security and scalability. A
more detailed contrast of Centralised Finance (CeFi) versus DeFi is set out in Fig 89.
Fig 88: Framework for comparing costs and trade-offs of centralised and decentralised
networks
Decentralised Centralised
Source: MIT, Coase

04/ DeFi
Fig 89: Comparing Traditional Finance to DeFi

Traditional Finance DeFi
Custody of assets Held by a regulated service provider or custodian on Held directly by users in non-custodial wallets or via
asset owners’ behalf smart contract-based escrow
Units of account Typically denominated in fiat currency Denominated in digital assets or stablecoins (which
may themselves be denominated in fiat money)
Execution Intermediaries typically process transactions between Via smart contracts operating on the user’s assets
parties
Clearing and settlement Processed by service providers or clearinghouses, Writing transactions to the underlying blockchain
typically after a period of time completes the settlement process
Governance Specified by the rules of the service provider, Managed by protocol developers or determined by
marketplace, regulator and/or self-regulatory users holding tokens granting voting rights
organisation
Auditability Authorised third-party audits of proprietary code or Open-source code and public ledger allow auditors to
potential for opensource code that is publicly verified verify protocols and activity
Collateral Requirements Transactions may involve no collateral, or collateral less Over-collateralisation generally required, due to digital
than or equal to the funds provided asset volatility and absence of credit scoring
Cross-service Interaction Limited. Movement toward Open Finance via Any service may integrate with any other service on the
application programming interfaces or dedicated same blockchain, and potentially across chains
intermediaries
Access and Privacy Identity checks conducted by service providers. Identity verification requirements under discussion by
Personal data subject to national privacy laws anti-money-laundering regulators. User balances and
transaction activity are generally public
Security Vulnerable to hacks and data breaches in software Vulnerable to hacks and other technical and operational
systems controlling assets risks of smart contracts
Investor Protection Government-mandated disclosure and consumer Users assume all risks as a default, although private
protections, anti-fraud enforcement, exposure limits, redress arrangements such as DeFi insurance offer
and insurance schemes some protection against losses
Source: Wharton Blockchain & Digital Asset Project (University of Pennsylvania), World Economic Forum
The current status

An overview of the Defi stack is set out in Fig 90, while Fig 91 presents a view of major
participants in different segments. The majority of Defi services are currently built on
the Ethereum network, although other networks are being used, some in the crypto
industry pointing to Solana as particularly promising network.
Fig 92 shows the recent evolution of the level of value locked in the DeFi universe. It
has grown exponentially over the past year, reflecting an intense level of interest in
DeFi and its potential applications as well as inflation in the value of the underlying
currency (ether), with the vast majority of this value locked in the Ethereum network
(Figs 93 and 94).
However, DeFi is still in its infancy in terms of its development and primarily is
focused on serving the crypto markets. Linkage and applicability to the mainstream
financial systems are in a nascent state and it is in this area where DeFi has to prove
itself, a dynamic many in the crypto industry acknowledge.

04/ DeFi
Fig 90: The DeFi stack
User-centric platforms that connect to several applications and protocols. They usually provide tools to
compare and rate services, allowing users to easily perform otherwise complex tasks by connecting to several
Aggregation protocols simultaneously Develop tools and other non-end user
Layer facing protocols designed to facilitate
interoperability. Allows the native
Yield Aggregators Multi-Protocol Interfaces Non-Custodial Wallets
blockchain’s DeFi ecosystem to
trustlessly interact with external assets
and information
Applications and interfaces for specific use-cases, usually implemented as a set of smart contracts
Borrowing and Derivatives and Price oracles
Application Insurance
Lending Synthetics
Layer …
Decentralised Relayer networks Interoperability
Prediction Markets Payments
exchanges Facilitators
Asset Tokenisation Services
Tokens issued on top of the settlement layer, including the native asset and those based on token standards
supported by the blockchain Asset Wrapper Services
Asset Fungible token: Non-fungible
ETH Cross-Chain Bridges
Layer ERC-20 token: ERC-271
…
Tokenised Real-
Wrapped Assets Stablecoins KYC & Identity
World Assets
…
Allows the network to securely store ownership information and ensures that any state changes adhere to the
Settlement
network’s rule set. The foundation for trustless execution and a settlement and dispute resolution layer
Layer
Ethereum Network Bitcoin Network …
Source: BCG, Fabian Schar, crypto.com
Fig 91: DeFi Stack – product and application view
Source: StakingRewards

04/ DeFi
Fig 92: Total value locked in smart contracts on Fig 93: Total value locked in DeFi by product area,
Ethereum network, 2017 to date January 2020 to date
100 100

80
80
60
60 40
20
40
0
Mar-20
May-20
Jul-20
Sep-20
Mar-21
May-21
Jul-21
Jan-20
Nov-20
Jan-21
20
Lending Decentralised Exchanges

0
Derivatives Payments
Aug-17
Aug-18
Aug-19
Aug-20
Apr-18
Apr-19
Apr-20
Apr-21
Dec-17
Dec-18
Dec-19
Dec-20
Assets
Source: DeFi Pulse, Redburn Source: DeFi Pulse, Redburn
Fig 94: Number of new DApps added per month, by platform, 2015 to date
175 4,000
No. new DApps added per month
140 3,200
105 2,400
70 1,600
35 800
0 0
Apr-15
Aug-15
Apr-16
Aug-16
Apr-17
Aug-17
Apr-18
Aug-18
Apr-19
Aug-19
Apr-20
Aug-20
Apr-21
Dec-15
Dec-16
Dec-17
Dec-18
Dec-19
Dec-20
Ethereum platform (lhs) Other platforms (lhs) Total DApps (rhs)
Source: State of the DApps, Redburn
While DeFi purists may have a vision of a completely decentralised world of finance,
there is a high degree of dependence on other market participants, with centralised
characteristics as highlighted in Fig 95. Additionally, while potentially solving for
problems in CeFi and lowering value transfer costs, Defi itself creates new financial
risks, for example, operational risks stemming from underlying blockchains and smart
contract-based vulnerabilities.

04/ DeFi
Fig 95: DeFi protocols – map of interconnected risks

Administration, governance, development, bug fixes
Banks holding stablecoin reserves
from tokenholder DAOs, foundations, or corporates
Depend on Depend on
Stablecoins/stablecoin issuers
DeFi Applications
Run on
Rely on
Miners/validators
Arrange transactions
into blocks
Public blockchains
Depend partially on
Human oversight, governance, periodic Grey: decentralised, blockchain based

intervention
Yellow: centralised
Source: DeFi Protocol Risks: The Paradox of DeFi (Carter/Jeng)
The opportunity
Fig 96 shows the potential addressable market size for DeFi in 2030 if value starts to
leak from the traditional finance sector towards DeFi. While any shift will be messy
and is unlikely to be linear, it underscores that the prize for any shift in finance
towards a decentralised model is enormous.
Fig 96: DeFi addressable market assuming share shift from mainstream finance markets,
2030E*
U$ bn
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
5% 10% 15% 20%
Quantum of shift from CeFi to DeFi
* Based on 2030E global GDP and assumes financial services account for 6.6% of global GDP (i.e. consistent with current levels)
In the sections that follow, we examine the potential opportunity DeFi presents in
several major financial sectors: payments, credit and exchanges.

04/ DeFi
Payments
Payment is frequently cited as one of the segments of financial markets carrying the
richest opportunity for disruption. Globally it is estimated that fees earned by payment
intermediaries equate to somewhere between 0.5% and 1.0% of global GDP.
The highly complex payments system, which extracts sizeable fees and which
historically was bank-dominated, is already going through a period of profound
change as technology-led payment-focused businesses (such as PayPal, Adyen, Alipay
and Klarna) disrupt the industry (Fig 97). Please refer to Redburn’s report, ‘Payments:
Trust the Processors’ (12 March 2021, Fahed Kunwar and Chris Hartley) for an
in-depth analysis of this market.
Fig 97: An overview of the payment process, participants and economics

Customer Merchant Acquirer Network Issuer
Digital Wallet Payment Method Gateway Processing Acquiring Data Transfer Card Issuing Issuer Processing
PROCESS
Authorisation 1) Customer presents card (physically 2) Merchant transfers data to acquirer 3) Acquirer performs risk mgmt. and 4) Network transfers data to relevant
process begins via NFC / QR code, or online) via gateway transfers data to network issuer
Authorisation 8) Merchant provides customer with 7) Acquirer forwards authorisation to 6) Network forwards authorisation to 5) Issuer checks customer account and
process ends payment confirmation the merchant the acquirer provides authorisation to network
Flow of funds
Settlement initiated daily Merchant 97.5- Customer initiated in
by merchant Flow of funds during settlement process 100% turn by issuer
Account 99% Account
PARTICIPANTS
Nexi / Worldline / Adyen / Barclays / JP Morgan / WorldPay / First Data /

Apple Pay Global Payments Visa / Mastercard Nexi / Worldline
Klarna / Paypal / Square Domestic Networks Banks

Alipay
ECONOMICS
Merchant 97.5-99% Processing Fee 25-100bps Network Fee 50bps Interchange Fee 25-100bps
The merchant retains 97.5- Charged by the acquirer for enabling the merchant to accept payments via a Charged by the network for Charged by the issuer for taking
99% of total spend. variety of payment methods, providing the merchant with access to a transferring data between on the credit risk of the customer.
physical or online gateway, providing the merchant with the technological the acquirer and the issuer.
capability to process the payment, performing risk management and taking
on the credit risk of the merchant, and in the case of card payments for
transferring transaction data to the relevant card network.
Source: Redburn
DeFi holds the promise of imposing additional disruption and cost pressure on the
payment industry. Fig 98 shows a simplified version of the current payment value
chain versus what is could look like in a DeFi world with much lower costs.

04/ DeFi
Fig 98: CeFi vs DeFi payments value chain
Pays $100 gets Pays $100 in

$0.2 rewards (e.g.) LTC
$0.2 Retains
interchange
Consumer rewards Consumer
Buys goods or $0.1 Buys goods or

services scheme services
Issuing fee
Retains services
$1.2
Charges fees
$1.5 to issuer and Goods and
Goods and interchange acquirer services
services Network Validator
fee services nodes
Retains Retains $0.02-003
Retains $0.2 in network fees
$0.4
$0.1
scheme
Provides goods or Acquiring fee Provides goods or
services services services
Earns
markup
$2 merchant
service fee Receives $99.98 in
Merchant Merchant
Receives $98.00 LTC
Source: BCG, Crypto.com
This view is highly theoretical and there are a large number of technical, commercial
and regulatory obstacles to achieving it. Existing payments systems are already highly
efficient, there is already considerable innovation within the payment environment
and regulators are mindful of the systemic important of payment rails.
The area we argue is most likely to see efforts to apply DeFi principles is cross-border
payments, particularly remittances, a segment of the payment universe characterised
by elevated fees, a social imperative to improve and an area where regulators openly
acknowledge broader system inefficiencies.
Credit
Credit is another area cited as ripe for potential disruption; the opportunity here is
principally the spread generated by the banking system. Fig 99 shows hypothetically
what a Defi credit arrangement could look like, one of the critical benefits of the Defi
credit arrangement being the minimal ongoing costs once the borrowing/lending
contract is established as it is completely automated.

04/ DeFi
Fig 99: CeFi vs DeFi lending value chain
Requests a Requests a
loan
Borrower loan Borrower
Interest 4.02%
Loan Interest 2.9%
Loan and network fees
Collateral $6-14
Risk Service
Provides a scoring fees
Interest rate pass-through: 20-30% 0.2%
loan
Bank Credit Validator Protocol
assessment Service Gover- governance
fees nodes nance
Provides risk Provides

Deposit/ services
Interest 0.5% governance
equity/ Deposit Interest 3.82%
bonds
Makes a Makes a Liquidity

deposit deposit provider
Investor /lender
Basic DeFi credit protocols have formed. For example, Compound is a protocol that
allows users to lend or borrow from a pool of assets in a smart contract; interest rates
are determined algorithmically and based on supply and demand. A limited amount of
outstanding borrow is held by the protocol to incentivise governance.
However, applicability and use are anchored in the crypto universe with little real-
world connectivity at present. As with payments, there are a large number of technical,
commercial and regulatory obstacles to moving mechanisms that operate in the crypto
universe into the real world at scale. For example, at present DeFi lending is usually
backed by digital asset collateral, with over-collateralisation a feature (in part reflecting
cryptoasset price volatility). The ability of a system built on this basis to, for example,
extend uncollateralised consumer loans is unclear.
Exchanges/brokerage
Brokerage and exchanges could also see disruption in multiple areas, ranging from
trading to clearing. Fig 100 shows differences in the construct of a centralised versus a
decentralised exchange value chain. Recognition of the potential technology changes
pending has been evidenced by various exchanges looking to apply DLT to parts of
their operations (e.g. the Australian Stock Exchange is planning to use this technology
as part of the overhaul of its equities clearing and settlement system).
Crypto exchange Binance started offering tokens for trading certain listed companies
(including Apple and Microsoft), perhaps offering a glimpse of what a tokenised
exchange future could look like. This particular initiative is in the process of being
closed after it attracted considerable regulatory ire about encroachment into regulated
securities markets, underscoring a degree of real-world complexity that crypto purists

04/ DeFi
arguably overlook. However, the idea encapsulated around a concept like security
tokenisation is unlikely to disappear.
Fig 100: CeFi vs DeFi exchanges value chain

Pays $100 Gets $97 Pays $100, gets $99.50
0.5% taxation
Retains fees
interchange
Investor Investor
$1 fee
Buys $100 in Estimated Clearing Buys 1 ETH Decentralised $0.5
Apple shares house with 100 DAI network
exchange fees (fixed)
Retains Broker
$2
Ownership DAI ETH

Exchange Validator
nodes
Retains
Retains $
$2
$1 fee
Estimated
Sells $100 in Sells 1 ETH
Apple shares Broker for 100 DAI
Earns Blockchain
markup Registry
$3 service fee
Liquidity
Investor Sells $100, gets $97 provider Pays $99.50, gets $99.50

05/
05/ Crypto exchanges
Crypto exchanges
Crypto exchanges have been among the prime beneficiaries of the
growth in interest in crypto markets in recent years, profiting from
rising volumes and cryptoasset prices. Historically dominated by spot
markets, the past two years have brought explosive growth in
derivative markets, which industry data suggest now exceed spot
markets in volume. Lacking the strict regulation of the mainstream
exchange operators, questions exist about the veracity of data from
some venues; this view is underscored by industry surveys showing
there is considerable variation in the quality of exchanges.

Spot and derivative markets

Fig 101 presents an overview of crypto exchange volume evolution over the past three
years. We highlight that the term ‘exchange’ in crypto markets is somewhat
misleading, as typically these businesses play a much broader role than that associated
with exchanges in mainstream capital markets. In crypto markets, many of the largest
businesses act not only as exchanges but also broker dealers, market-makers, custodial
business and data providers.
Growth has been exceptionally strong, reflecting growth in underlying volumes fuelled
by rising investor interest as well as strong appreciation in the price of cryptoassets.
One notable trend has been the much more rapid growth of derivatives volumes
relative to spot volumes. This rapid growth reflects the roll-out of new derivative
products, new venues listing derivative products and growing institutional interest.
Fig 101: Crypto exchange volumes (spot and derivative), November 2018-June 2021
12,500 90%
10,000 78%
7,500 66%
5,000 54%
2,500 42%
0 30%
Jul-19
Sep-19
Jul-20
Sep-20
Jan-19
Mar-19
May-19
Jan-20
Mar-20
May-20
Jan-21
Mar-21
May-21
Nov-18
Nov-19
Nov-20
Derivatives Spot % spot
Source: CryptoCompare
In contrast to heavily regulated trading venues such as traditional stock exchanges,

crypto exchanges are largely unregulated and largely privately owned, complicating
the assessment of the relative volume performance. Wash trading (where an investor
simultaneously buys and sells the same financial instrument, thereby artificially
inflating volume) is a particular issue, with both academic research and submissions to
regulators by market participants highlighting this. We would expect issues such as
this to be resolved as regulation around the crypto industry becomes more formalised.
Fig 102 shows on-chain volume for Bitcoin and Ethereum, which we overlay against
aggregate exchange volumes, as the trends are directionally very similar.

Fig 102: Top tier exchange volume compares to Bitcoin + Ethereum on-chain volumes,
November 2018-June 2021
4,200 1,200
3,500 1,000
2,800 800
2,100 600
1,400 400
700 200
0 0
Jul-19
Sep-19
Jul-20
Sep-20
Nov-18
Jan-19
Mar-19
May-19
Nov-19
Jan-20
Mar-20
May-20
Nov-20
Jan-21
Mar-21
May-21
Top-tier exchange vol. (U$b, lhs) BTC +ETH on-chain vol. (U$b, rhs)
Source: CryptoCompare, Coin Metrics, Redburn
Fig 103 shows the evolution of spot volume handle by the largest crypto exchanges, the
rapid growth in cryptoasset values fuelling the rise in activity with April and May 2021
the highest on record.
Fig 103: Top tier exchanges – monthly spot volume, November 2018-June 2021
3,000
2,400
1,800
1,200
600
0
Jul-19
Sep-19
Jul-20
Sep-20
Jan-19
Mar-19
May-19
Nov-18
Jan-20
Mar-20
May-20
Nov-19
Jan-21
Mar-21
May-21
Nov-20
Binance Coinbase Bitfinex OKEx Huobi Global

Bitstamp BeQuant Kraken LMAX Digital
Fig 104 shows volume of the major exchanges in the crypto derivatives market.
Reflecting the growth in volumes, open interest has also expanded, hitting a record
high in April 2021 before falling back in May and June.
The dominant derivative product in crypto markets is perpetual futures contracts.

These futures are cash settled and differ from regular futures in that they lack a

pre-specified delivery date and can therefore be held indefinitely without the need to
roll over contracts as they approach expiration. While terms differ across exchanges,
this market is often characterised by very high levels of leverage. Data from Bitcoin
Futures Info, based on the breakdown of open interest at 16 July 2021, show that
approximately 62% of Bitcoin open interest was in perpetual futures contracts.
The largest open interest in more regular Bitcoin futures is on CME Group, which, in
contrast to most crypto exchanges, is heavily regulated as the world’s largest futures
and options exchange. Figs 106 and 107 show the progression of volume and open
interest respectively of the major crypto futures contracts listed on CME since their
introduction on the exchange. The trends broadly mirror those of wider market. CME,
however, applies by crypto standards strict margin requirements, disclosing on the Q1
2021 call that an initial margin of 38% is required for Bitcoin and micro-Bitcoin
futures.
Fig 104: Exchanges – monthly crypto derivative volume, Fig 105: Exchanges – crypto open interest, October
November 2018-June 2021 2020-June 2021
6,000 40
4,800 32
Open interest (U$b)
3,600 24
2,400 16
1,200 8
0 0
May-19
Aug-19
May-20
Aug-20
May-21
Nov-18
Feb-19
Nov-19
Feb-20
Nov-20
Feb-21
Mar-21
Apr-21
May-21
Jun-21
Oct-20
Nov-20
Dec-20
Jan-21
Feb-21
Binance Huobi Global Deribit Binance Huobi Global Bybit

BitMEX OKEx FTX OKEx CME BitMEX
CME bitFlyer Bybit Deribit Kraken
Source: CryptoCompare Source: CryptoCompare

Fig 106: CME Group – Bitcoin and Ethereum futures Fig 107: CME Group – Bitcoin and Ethereum open
trading volumes, May 2018-June 2021 interest, May 2018-June 2021
40,000 60,000
Monthly average daily traded volume
Open interest (contracts)

32,000 48,000
24,000 36,000
(contracts)
16,000 24,000
8,000 12,000
0 0
Jul-18
Sep-18
Jul-19
Sep-19
Jul-20
Sep-20
Jul-18
Sep-18
Jul-19
Sep-19
Jul-20
Sep-20
May-18
Nov-18
Mar-19
May-19
Nov-19
Mar-20
May-20
Nov-20
Mar-21
May-21
May-18
Nov-18
Mar-19
May-19
Nov-19
Mar-20
May-20
Nov-20
Mar-21
May-21
Jan-19
Jan-20
Jan-21
Jan-19
Jan-20
Jan-21
Bitcoin Futures Ethereum Futures Bitcoin Futures Ethereum Futures
Micro Bitcoin Futures Micro Bitcoin Futures
Source: CME Group Source: CME Group
Exchange rankings
At discussed earlier in this report, there is limited regulation around the cryptoasset
industry. Industry data provider CryptoCompare undertakes a periodic review of over
160 crypto exchanges on a variety of metrics, ranging from know your customer
(KYC) through market quality. Fig 108 shows a summary of results for the ten
exchanges that screened best in the most recent survey, published in February 2021.
Fig 108: Exchange rankings (top ten) – February 2021

KYC/ Quality/
transaction diversity Legal/ Data Team/ Negative Market
Exchange risk of assets regulation provision Security exchange reports quality Total
Coinbase 13.3 4.8 12.9 8.8 15.0 13.7 0.0 17.0 85.3
Gemini 15.0 4.5 12.5 10.6 13.8 12.1 0.0 14.4 82.9
Bitstamp 15.0 4.3 11.4 10.3 11.8 12.3 0.0 15.4 80.5
Kraken 9.9 4.8 11.4 10.6 10.9 13.7 0.0 14.6 75.9
itBit 13.3 4.0 10.7 10.6 10.7 14.7 0.0 11.6 75.6
Luno 9.9 4.0 11.8 11.1 12.0 12.6 0.0 14.0 75.4
Liquid 13.3 3.5 13.6 11.1 4.3 13.9 0.0 14.0 73.8
Cex.io 11.1 4.8 10.4 10.6 12.5 11.0 0.0 13.2 73.5
LMAX Digital 13.3 4.0 11.4 10.3 10.7 11.0 0.0 12.4 73.1
Bitﬁnex 13.6 3.5 9.6 11.4 7.1 10.7 0.0 15.6 71.6
Pricing from the top five exchanges based on this ranking are used as inputs to CME’s
regulated Bitcoin and Ether contracts.

“CME CF Crypto Currencies Indices have been generating BRR and BRTI rates
since November 2016 with several bitcoin exchanges and trading platforms
providing pricing data, including Bitstamp, Coinbase, Gemini, itBit, and
Kraken. Both the BRR and BRTI are registered benchmarks under the European
Benchmarks Regulation (EU BMR).” CME Group
“CME CF Ether-Dollar Reference Rate & CME CF Ether-Dollar Real-Time Index.

Ether is based on formidable blockchain technology and the CME CF Ether-
Dollar rates will provide a standardized reference rate and spot price index to
bring confidence to any trading strategy. Major cryptocurrency exchanges
Bitstamp, Coinbase, Gemini, itBit, and Kraken provide the pricing data to bring
our dependable and regulated rates to the market.” CME Group
In Chapter 6, we examine the investment case around Coinbase, which obtained the
highest score in the above ranking.

06/
06/ Coinbase
Coinbase
Coinbase is a leading global crypto exchange, a top five player in
volume terms on spot markets, and it holds over 10% of global
cryptoassets on its platform. In addition to gearing to crypto industry
expansion, the company has a multitude of growth opportunities –
geographic, asset and service/product based. Coinbase is well
positioned to deal with a more demanding regulatory environment.
Concerns exist around the sustainability of retail transaction margins;
however, our analysis underscores a variety of factors that support
this. We start coverage with a Buy rating.

06/ Coinbase
Overview
Coinbase was founded in 2012 with the idea of making investment in and holding of
Bitcoin simple and easy. Brian Armstrong, Chairman and CEO, had initially teamed
up with Ben Reeves (who founded blockchain.com); however, that partnership
dissolved. Armstrong subsequently partnered with Fred Ehrsam to build up Coinbase
(Ehrsam left in 2017 but is still a board member). Following a series of funding rounds,
the company went public in April 2021.
The company’s stated mission is to increase economic freedom in the world by

building “a more fair, accessible, efficient and transparent financial system enabled by
crypto”. It is easy to be cynical about such a lofty goal; however, considering c1.7
billion adults globally are unbanked and the annual c7% toll on GDP the global
financial system extracts to facilitate financial value transfer and safekeeping,
Coinbase’s mission has a point. There is something of a contradiction at the heart of
Coinbase – a company that offers a number of centralised services promoting and
supporting the idea of decentralised financial services. This seeming incongruity is not
unique to Coinbase, but, as discussed in prior sections, it is a common feature of crypo
markets. Coinbase, in its relatively short history, has proven adept at handling this.
c85% of Coinbase’s revenue is generated by trading activity it facilitates. After a

difficult 2018, from a low in Q1 2019, trading activity handled by Coinbase has grown
exponentially, fuelled by renewed interest from both retail and institutional investors
in cryptoassets (Fig 109).
Fig 109: Coinbase – quarterly trading volume, Q1 2018- Fig 110: Coinbase quarterly trading volume and Bitcoin
Q2 2021E price*, Q1 2018-Q1 2021
U$m U$m U$
450,000 400,000 50,000
400,000 45,000
350,000
350,000 40,000
300,000
300,000 35,000
250,000 30,000
250,000
200,000 25,000
200,000
150,000 20,000
150,000
15,000
100,000 100,000
10,000
50,000 50,000 5,000
0 0 0
Q1 18
Q2 18
Q3 18
Q4 18
Q1 19
Q2 19
Q3 19
Q4 19
Q1 20
Q2 20
Q3 20
Q4 20
Q1 21
Q2 21E
Q1 18
Q2 18
Q3 18
Q4 18
Q1 19
Q2 19
Q3 19
Q4 19
Q1 20
Q2 20
Q3 20
Q4 20
Q1 21
Retail Institutional Trading volume (LHS) Bitcoin price (RHS)
Source: company, nomics.com * Average Bitcoin price in the quarter

Source: company, Bloomberg, Redburn

06/ Coinbase
In assessing the investment case around Coinbase, two considerations heavily inform
the current debate:
 The strong correlation between crypto prices (especially that of Bitcoin) and
trading activity of Coinbase (Fig 110). This is not unique to Coinbase and can be
applied across the industry.
 The sustainability of transactional margins (Fig 111), particularly that generated

from retail trading, which in 1Q21 was over 30x that of institutional trading. In
2020, retail trading accounted for c80% over total revenue.
Fig 111: Coinbase – transactional revenue as % of trading volume, Q1 2019-Q1 2021

0.90%
0.80%
0.70%
0.60%
0.50%
0.40%
0.30%
0.20%
0.10%
0.00%
Q1 19 Q2 19 Q3 19 Q4 19 Q1 20 Q2 20 Q3 20 Q4 20 Q1 21
Source: company
As such, we argue three considerations are of particular importance in thinking about

the Coinbase investment case:
1 Development of a broader crypto offering.
2 Exposure to growth of the overall crypto market.
3 Fade rate of retail transaction margins.
Developing a broader crypto offering

In framing thinking about how Coinbase is likely to develop a broader crypto offering,
we examine this through three lenses, which are interrelated: geographic, asset and
product/service expansion.

06/ Coinbase
Geographic expansion
Coinbase has steadily grown its number of verified users in recent years (Fig 112). The
number of monthly transacting users has also grown, albeit this correlates more
directly to cryptoasset pricing. Despite the growth in user numbers and operating a
global platform (it offers services in over 100 countries), its dominant geographies are
the US (c81% of Q1 2021 revenue) and UK & Europe (which generates the majority of
the rest).
We anticipate an effort to significant expand presence and grow user numbers in other
markets (Fig 113), with recent commentary from CEO underscoring this:
“We put a huge amount of effort into working with regulators in the US, UK, EU,
etc. which has generated an enormous amount of value for customers in these
regions, but it can also lead to products that are hyper focused on the western
world. We’re going to flip this approach on its head by shipping more products in
international markets on day one, while still partnering with regulators in more
established markets to ensure our products are compliant with their local rules.”
Extract from Coinbase CEO blog post, 29 June 2021
These efforts will be supported by a ramp-up in marketing spend well beyond

historical levels.
“So, historically, we spent less than 5% of revenue on sales and marketing, if you
look at our financial results for 2019 and 2020. As we shared in our outlook, we’re
planning to make significant investment to increase our spend here, up to 12% to
15% of our net revenue.” Alesia Haas, Coinbase CFO, 13 May 2021
Fig 112: Coinbase – verified users and monthly Fig 113: Coinbase – adopting an international first
transacting users, Q1 2018-Q1 2021 mindset
(m) (m)
60 7
50 6
5
40
4
30
3
20
2
10 1
0 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
18 18 18 18 19 19 19 19 20 20 20 20 21
Verified users (LHS)
Monthly transacting users (MTU, RHS)
Source: company Source: company (June 2021)

06/ Coinbase
Asset expansion
Alongside geographic expansion, further expansion of unique assets offered on
Coinbase’s platform will be an additional contributor to growth. Relative to peers,
Coinbase was slow to roll out new assets in the period 2017-18, despite a proliferation
in the number of cryptoassets and evidence that other crypto exchanges were
capitalising on this. The appointment of Balaji Srinivasan (who joined via the
acquisition of Earn.com) as CTO in 2018 saw a pick-up in the pace of adding new
cryptoassets. Srinivasan subsequently left Coinbase in May 2019; however, the pace of
new asset additions has continued and remains a priority.
“And asset addition is something that’s near and dear to my heart. There are
more and more assets being created in the crypto economy. I think it’s going to be
something, kind of, like apps in the App Store or on the iPhone where there are
eventually millions of these assets created over time and so we’re putting a lot of
work and thought into how do we accelerate our pace of asset addition, and one of
those is Doge, as you mentioned, which has been getting a lot of attention recently.
So, to answer your question directly, we plan to list Doge in the next six to eight
weeks. And then more broadly, we’re going to be focused on how we can accelerate
asset addition in the future.” Brian Armstrong, Coinbase CEO, 13 May 2021
Fig 114: Coinbase – unique assets on the platform, 2019-Q1 2021

120
100
80
60
40
20
0
2019 2020 Q1 2021
Source: company
Product/service expansion – becoming a broad infrastructure provider

Of all the expansion areas, the most important in our view is product/service
expansion. As discussed in Chapter 5, although Coinbase is deemed an exchange, it
effectively operates as a broker dealer, exchange, market-maker and custodian. The
opportunity on the product side is to build out an infrastructure that straddles the
entire crypto infrastructure arena (Fig 115).
In this regard, it has certain strategic advantages including:
 That of incumbency. The business holds on its platform c11% of cryptoasset

market cap with a strong presence in both the retail and institutional markets.

06/ Coinbase
 A high-value currency to facilitate acquisitions to boost its infrastructure and

ecosystem.
Fig 115: Crypto capital markets

- ErisX
- Skew - Arwen
- CME
Investor
Investor
Indices - Binance
Custody
- Uniswap
- Paxos
Research - Coinbase
Lending
- Investment banks
- Genesis
Regulatory and compliance services (Chainanalysis)
Source: Redburn
Fig 116: Coinbase – assets held on platform and as % of Fig 117: Coinbase – assets held on platform (retail and
crypto market cap, Q1 2018-Q1 2021 institutional), Q1 2018-Q1 2021
U$m
U$m
250,000
250,000 14%
12% 200,000
200,000
10%
150,000 150,000
8%
100,000 6% 100,000
4%
50,000 50,000
2%
0 0% 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q1 20 Q2 20 Q3 20 Q4 20 Q1 21
18 18 18 18 19 19 19 19 20 20 20 20 21
Assets on platform (LHS) As % of crypto mkt cap (RHS) Retail Institutional
Source: company Source: company
A summary of Coinbase’s acquisition history is set out in Fig 118. The pace of
acquisitions has increased in the past two years and has been focused on the
institutional arena. Little data are available to assess the track record of acquisitions to
date, although they have undoubtedly contributed to growth in number of institutions
on the platform from 1,000 at end-2017 to 7,000 at end-2020. As Coinbase further

06/ Coinbase
scales up, we expect M&A to become a more important tool and potentially an
important area for value creation.
Fig 118: Coinbase major acquisitions

Business acquired Date Cost Business
Earn.com April 2018 cUS$100m* Paid email business model. This was subsequently closed in favour of in-house-
developed counterpart Coinbase Earn
Neutrino February 2019 US$13.5m* Blockchain intelligence platform
Xapo August 2019 US$55m Institutional custody business with over US$7bn of assets under custody
Tagomi July 2020*** US$41.8m** Institutional brokerage for cryptoassets
Bison Ventures February 2021*** US$457.3m** Platform-as-a-service company that provides a suite of easy-to-use crypto
infrastructure products and services on multiple blockchains to custodians,
exchanges and funds
Skew April 2021**** Not disclosed Institutional data visualisation and analytics platform for cryptoassets
* Based on media reports
** Preliminary consideration
*** Completed
**** Announced
Source: Redburn, company, Coindesk
The expansion areas outlined above all effectively fall under the first pillar of
Coinbase’s strategy: ‘crypto as an investment’ (Fig 119). Despite the opportunities and
initiatives outlined above, the company offers a broad and thoughtfully curated set of
services for the retail (e.g. Coinbase Exchange, Coinbase Wallet) and institutional
market (e.g. Coinbase Prime, Bison Trails) as well as ecosystem partners (e.g. Coinbase
Commerce).
However, the company’s ambitions are much broader than just ‘investment’ and they
encompass two further pillars:
 Crypto as a new financial system. This involves developing a much broader

financial services offering built on crypto rails, including DeFi, payment, earning
and borrowing/lending.
 These are at varying stages of development, with a nascent revenue

contribution. For example, in Q1 2021 Coinbase generated US$10m in staking
revenue (which falls under the earning category above).
 The opportunity here will key off, in particular, development of DeFi. As a

hypothetical example, if by 2030, per the analysis in Fig 5, 10% of financial
services shifted into DeFi and Coinbase captured 5% of that (noting a c11%
share of cryptoassets on its platform), this implies a US$45bn revenue
opportunity.
 Crypto as an app platform. This is an even more formative area of investment that
involves driving crypto innovations and products beyond financial use cases.

06/ Coinbase
Fig 119: Three pillars of Coinbase’s strategy
Source: company
The pace and depth of development of these three pillars (especially the latter two) will
depend heavily on development of the overall crypto market.
Development and growth of the overall crypto market

In the near term, Coinbase’s performance will likely remain geared to fluctuations in
cryptoasset prices (Fig 120) and development of the DeFi industry (Fig 121). As
framed in the first five chapters of this report, we are optimistic on the broader
development of the crypto industry, particularly the opportunity for it to broaden
beyond just being seen as a proxy for Bitcoin (Fig 122).
Fig 121: Total value locked in smart contracts on

Fig 120: Crypto market cap, 2013 to date Ethereum network, 2017 to date
3,000 100
2,500
80
2,000
1,500 60
1,000
40
500
20
0
Apr-13
Apr-14
Apr-15
Apr-16
Apr-17
Apr-18
Apr-19
Apr-20
Apr-21
Oct-13
Oct-14
Oct-15
Oct-16
Oct-17
Oct-18
Oct-19
Oct-20
0
Aug-17
Apr-18
Aug-18
Apr-19
Aug-19
Apr-20
Aug-20
Apr-21
Dec-17
Dec-18
Dec-19
Dec-20
Total Excluding BTC
Source: CoinMarketCap, Redburn Source: DeFi Pulse, Redburn

06/ Coinbase
Fig 122: Google search volume

100
Relative search interest (100 being peak interest
over the period beginning Jan 2017)
80
60
40
20
0
Jul-17
Jul-18
Jul-19
Jul-20
Jul-21
Mar-17
May-17
Sep-17
Mar-18
May-18
Sep-18
Mar-19
May-19
Sep-19
Mar-20
May-20
Sep-20
Mar-21
May-21
Jan-17
Nov-17
Jan-18
Nov-18
Jan-19
Nov-19
Jan-20
Nov-20
Jan-21
Uniswap NFT Coinbase Ethereum Bitcoin
Source: Google Trends, Redburn
While we expect no let-up in the pace of innovation of the crypto industry, the speed
of adoption will be influenced by real-world developments especially around
regulation (as discussed in Chapter 2). Here, Coinbase screens favourably relative to
most other exchanges (Fig 123).
Fig 123: Ranking of crypto exchanges on legal/regulatory and KYC/transaction risk criteria
(top ten shown)*
30
25
20
15
10
0
LMAX Digital
Liquid
Independent Reserve
Bittrex
CoinCorner
AAX
Gemini
Coinbase
bitFlyer
Bitstamp
* Maximum possible score = 30

Note: the number of exchanges ranked was 163
Source: CryptoCompare (February 2021)
This reflects a philosophical orientation that has been applied at Coinbase since its
inception, to operate as compliantly as possible within the regulatory frameworks of
the countries in which it operates. However, as discussed in Chapter 2, this is often not

06/ Coinbase
straightforward as, in most instances, legal and regulatory frameworks do not exist for
cryptoassets and crypto-native businesses. As regulatory scrutiny on the crypto
industry tightens, a significant competitive advantage is likely to emerge for those
exchanges with the strongest legal and regulatory governance and processes.
The relative lack of regulatory clarity that exists around the crypto industry may, in the
near term, offer crypto incumbents a degree of competitive advantage as larger
financial service incumbents restrain broader entry into this market until greater
regulatory clarity emerges. However, any economic benefit derived from lower
competitive intensity is likely to be transitory, although it exerts an influence in
thinking about transaction margins, especially retail margins.
Fade rate of retail transaction margins

The engine room of Coinbase’s performance since inception has been the generation
of transaction fees from its retail business. While we expect the relative contribution
from this business to fall over time as other sources of revenue grow faster, a pivotal
consideration will be how retail transaction margins evolve. The market’s expectation
is that they will steadily fall (Fig 125).
Fig 124: Coinbase – retail and institutional

transactional revenue as % of trading volume, Q1 2019- Fig 125: Coinbase – retail transactional revenue as % of
Q1 2021 trading volume, 2020-24E
1.60% 1.60%
1.40% 1.40%
1.20%
1.20%
1.00%
1.00%
0.80%
0.80%
0.60%
0.40% 0.60%
0.20% 0.40%
0.00% 0.20%
Q1 20 Q2 20 Q3 20 Q4 20 Q1 21
0.00%
Retail Institutional 2020 2021E 2022E 2023E 2024E
Source: company Source: Visible Alpha (27 July 2021)
It is tempting when evaluating exchange costs to look at fees and little else. However,
there are a variety of other important considerations. In the long term, we expect retail
transaction fees to fall, fuelled by more intense competition from both crypto
exchanges and mainstream financial participants moving in the crypto trading arena.
However, a variety of factors argue for a degree of persistence of retail transaction
margins at higher levels than the market perceives. These include:

06/ Coinbase
 Difficulty in comparing complex pricing structures across exchanges given

complexity of the crypto landscape as well as use of the ‘rails’ into and off it.
 The importance of market quality, particularly dynamics around bid ask spreads
and execution slippage, which assume greater importance in an unregulated
setting.
 Security is a core consideration given the nature of cryptoassets and the fact that
exchanges are often performing the function of custodian.
 Branding.
We consider each of these in more detail below.
The points below summarise the fee structure for a variety of leading exchanges. For
the sake of brevity, we only provide detail for non-stablecoin US dollar-denominated
transactions. We would highlight that evaluating the fees paid by a customer of a
crypto exchange are not straightforward – there are an array of charges, tiering
structures and other factors that directly impact the price paid.
 Coinbase Exchange – bid-ask spread plus the ‘Coinbase fee’ (the greater of a fixed
transaction fee of $0.99-2.99 for purchases below $200 and a variable fee of 1.49-
3.99% depending on payment method).
 Gemini Web – ‘convenience fee’ of 50bp (a bundled platform and bid-ask spread)
and a fixed transaction fee of $0.99-2.99 for purchases below $200 and a variable fee
of 1.49% thereafter.
 Kraken – bid-ask spread plus the ‘Kraken fee’ (1.50-4.49% variable fee depending
on payment method).
 Coinbase Pro – taker fee (4-50bp) or maker fee (0-50bp) instead of bid-ask spread,
determined by the trailing 30-day dollar trading volume. Fee tiers are updated after
each trade.
 Bitstamp – taker fee (0-50bp) or maker fee (0-50bp) instead of bid-ask spread,
each trade.
 itBit – taker fee (6-35bp) or maker fee (-3-25bp) instead of bid-ask spread,
each trade.
 Kraken Pro – taker fee (10-26bp) or maker fee (0-16bp) instead of bid-ask spread,
determined by the trailing 30-day dollar trading volume. Fee tiers are updated at
midnight 7pm EST/midnight GMT.

06/ Coinbase
 Gemini Active Trader – taker fee (3-35bp) or maker fee (0-25bp) instead of bid-ask
spread, determined by the trailing 30-day dollar trading volume. Fee tiers are
updated after each trade.
Fees are only one consideration in assessing a trading venue. Market quality also
matters hugely. In this regard, Coinbase screens well. Quality encompasses
characteristics such as spread, liquidity and trading behaviour. As highlighted in Figs
126, 128 and 129, Coinbase screens strongly on these metrics relative to peers. These
dynamics assume greater importance in unregulated crypto markets. Given the nature
of cryptoassets and that the exchange is often also acting as a custodian, security is a
further pivotal consideration with Coinbase’s security viewed as among the best in the
industry (Fig 127).
Fig 126: Ranking of crypto exchanges on market quality Fig 127: Ranking of crypto exchanges on security
criteria (top five shown)* criteria (top five shown)*
20 15
15
10
10
5 5
0
Coinone
OKEx
Coinbase
Bithumb Korea
Huobi Global
0
Coinone
Cex.io
Coinbase
Gemini
Luno
* Maximum possible score = 20 * Maximum possible score = 15

Note: the number of exchanges ranked was 163 Note: the number of exchanges ranked was 163
Source: CryptoCompare (February 2021) Source: CryptoCompare (February 2021)
Fig 128: Bitcoin/US$ bid-ask spread across various crypto exchanges, June/July 2021
30
Bid-ask spread (bps)
24
18
12
6
0
26/06/2021
28/06/2021
30/06/2021
02/07/2021
04/07/2021
06/07/2021
08/07/2021
10/07/2021
12/07/2021
14/07/2021
16/07/2021
18/07/2021
20/07/2021
22/07/2021
24/07/2021
26/07/2021
Coinbase Bitfinex Kraken Bitstamp Gemini LMAX Digital
Source: Kaiko, Redburn

06/ Coinbase
Fig 129: Slippage on $100,000 BTC/USD sell order across various crypto exchanges,
June/July 2021
7.50
Slippage (bps)
6.00
4.50
3.00
1.50
0.00
26/06/2021
28/06/2021
30/06/2021
02/07/2021
04/07/2021
06/07/2021
08/07/2021
10/07/2021
12/07/2021
14/07/2021
16/07/2021
18/07/2021
20/07/2021
22/07/2021
24/07/2021
26/07/2021
Coinbase Bitfinex Kraken Bitstamp Gemini LMAX Digital
Source: Kaiko, Redburn
There is also a branding dynamic to consider around crypto exchanges. In Figs 130
and 131 we have shown the Google Trends results for different exchanges. Based on
the output, Coinbase has the strongest brand awareness among the major crypto
exchanges in the US and the second highest globally behind Binance.
Fig 130: Worldwide search interest for crypto Fig 131: US search interest for crypto exchanges,
exchanges, January 2020 to date January 2020 to date
100 100
80 80
60 60
40
40
20
20
0
0
Mar-20
May-20
Jul-20
Sep-20
Nov-20
Mar-21
May-21
Jul-21
Jan-20
Jan-21
Mar-20
May-20
Jul-20
Sep-20
Mar-21
May-21
Jul-21
Jan-20
Nov-20
Jan-21
Binance Bitfinex Bitstamp Binance Bitfinex Bitstamp

Coinbase Gemini Huobi Coinbase Gemini Huobi
itBit Kraken OKEx itBit Kraken OKEx
Source: Google Trends, Redburn Source: Google Trends, Redburn
A further factor to consider is that building infrastructure for new cryptoassets is

extremely technical. Each new asset added carries its own idiosyncrasies, particularly if
the code base differs substantially from that of Bitcoin or Ethereum. One of the
undoubted competitive threats to Coinbase will emerge from sources such as digital
wallets and brokerages where crypto trading is free or near-free (for example, from
Robinhood, PayPal and Square in the US and Revolut in the UK).

06/ Coinbase
However, in the context of the aforementioned comment on complexity, it is

important to note that, in many instances, mainstream providers of crypto trading are
not building or running the crypto infrastructure themselves but white-labelling a
third-party service. As an example, PayPal’s crypto offering is underpinned by
technology provided by Paxos.
“Technology: Paxos Crypto Brokerage provides crypto custody and trading for
PayPal. Our APIs allow PayPal to offer crypto services seamlessly within the
PayPal app with its simple and intuitive user experience…
Regulatory Licensing: Paxos has pioneered a regulation-first approach in the

crypto industry starting with securing the first Trust charter to custody and offer
crypto- and blockchain-based digital assets. We’re achieving another regulatory
first again today: through Paxos, PayPal has been granted the first virtual
currency conditional license from the New York State Department of Financial
Services. Our dedication to regulatory licensing and consumer asset protection
directly enables our clients’ ability to provide crypto to their customers.” Extract
from Paxos website blog, 21 October 2020
Finally, it is worth noting that within financial markets, there has historically been a
good correlation between a lower cost of trading and volumes increasing (Fig 132). If
transaction costs in the crypto environment were to decline faster than expected, there
may well be a volume offset.
Fig 132: Financial market – relationship between cost of trading and number of trades
across asset classes
1,000
Commodity Derivatives
2007 average cost per trade ($)
100 IRD
OTC Equity
Derivatives CDS
10 Rates
FX Derivatives
FX
1 Listed derivatives
Cash Equities
0
1 10 100 1,000 10,000 100,000
Average number of daily trades (k)
Source: BCG/ICAP

06/ Coinbase
Benchmarking and valuation

Fig 133 shows the performance of an index of listed crypto stocks (the Redburn Crypto
Index7) since 2018 relative to the performance of Bitcoin and Ether over the same
period. This index has strongly outperformed the two largest cryptoassets, reflecting
the gearing these businesses carry to both cryptoasset prices and broader development
of this industry. This gearing cuts both ways; the index endured a sharp correction
since mid-April (Fig 134).
Fig 133: Redburn crypto index* vs Bitcoin and Ether, Fig 134: Coinbase price performance vs Redburn crypto
January 2018 to date* index and bitcoin, April 2021 to date
1,200 160
140
1,000
120
800 100
80
600
60
400 40
20
200
0
01 August 2021
13 April 2021
23 April 2021
03 May 2021
13 May 2021
23 May 2021
02 June 2021
12 June 2021
22 June 2021
02 July 2021
12 July 2021
22 July 2021
0
Apr 18
Jul 18
Oct 18
Apr 19
Jul 19
Oct 19
Apr 20
Jul 20
Oct 20
Apr 21
Jul 21
Jan 18
Jan 19
Jan 20
Jan 21
Redburn crypto index Bitcoin Ether

Coinbase Crypto Index Bitcoin
* Rebased to 100 at 1 January 2018 * Rebased to 100 at 1 January 2018

Source: Redburn, Bloomberg Source: Redburn, Bloomberg
A very short history, newness of the cryptoasset class and limited comps create a
challenging backdrop to valuing Coinbase. To help in framing valuation, we have
assembled a comparator group of highly rated, well-established (for the most part) and
growth-oriented financial technology stocks. Relative to this group, Coinbase has the
highest forecast growth over the period 2020-23E. However, almost all this growth is
expected to occur in 2021, with Coinbase having the lowest forecast growth rate in the
period 2021E-23E, underscoring the uncertainties around forecasting a business
geared to a young and volatile industry.
Coinbase’s consensus pre-tax margins are forecast in 2023 to be at a comparable level

to 2020 (Figs 137 and 138), reflecting the market’s view that the upsurge in margins
expected in 2021 is unlikely to be sustained in 2022-23.
7
The Redburn Crypto Index includes the following stocks whose businesses models are primarily focused on the crypto industry: Coinbase
Global Inc; Coinshares International; Silvergate Capital; Voyager Digital; Argo Blockchain; Galaxy Digital; Marathon Digital; Riot
Blockchain. It also includes two financial technology companies that have started building a presence in crypto markets: PayPal Holdings
and Square Inc.

06/ Coinbase
Fig 139 shows the valuation of Coinbase on the basis of enterprise value (EV) over
2023E revenue. Relative to this fintech peer group, it carries the lowest rating. This
rating is even lower on a growth-adjusted rating, reflecting the market’s current
assumption of negligible top-line growth in 2022-23 for Coinbase (Fig 140).
Fig 135: Coinbase vs selected comparators, 2020-23E Fig 136: Coinbase vs selected comparators, 2021E-23E
revenue growth CAGR revenue growth CAGR
80% 200%
160%
60%
120%
40%
80%
20%
40%
0% 0%
Bill.com
Bill.com
Mastercard
Visa
Mastercard
Visa
Paypal
Paypal
Bakkt*
Shopify
Silvergate
Square
Shopify
Silvergate
Square
Coinbase
Adyen
Coinbase
Adyen
Circle*
Source: Visible Alpha (2 August 2021) * Data for Circle and Bakkt per Circle investor presentation June 2021. Circle and
Bakkt announced plans in January 2021 and June 2021 respectively to list via SPACs
Source: Visible Alpha (2 August 2021)
Fig 137: Coinbase vs selected comparators, 2020 vs Fig 138: Coinbase – adjusted pre-tax profit margin,
2023E adjusted pre-tax margins 2020-23E
75% 50%
60%
40%
45%
30%
30%
15% 20%
0%
Mastercard
Visa
Paypal
Bill.com
Shopify
Adyen
Coinbase
Silvergate
Square
10%
0%
2020 2023E 2020 2021E 2022E 2023E
Source: Visible Alpha (2 August 2021) Source: Visible Alpha (2 August 2021)

06/ Coinbase
Fig 139: Coinbase vs selected comparators, enterprise Fig 140: Coinbase vs selected comparators, growth
value/2023E revenue adjusted enterprise value/2023E revenue
50x 1.5x
40x 1.2x
30x 0.9x
20x 0.6x
10x 0.3x
0x 0.0x
Bill.com
Mastercard
Visa
Paypal
Shopify
Silvergate
Square
Coinbase
Adyen
Paypal
Bill.com
Mastercard
Visa
Shopify
Coinbase
Silvergate
Square
Source: Visible Alpha (2 August 2021), Redburn, Bloomberg Adyen
Source: Visible Alpha (2 August 2021), Redburn, Bloomberg
In addition to considering Coinbase’s relative valuation, we also use a DCF valuation

methodology (Fig 141). We use an explicit four-year forecast period and a normalised
period of six years, after which we forecast a terminal-year cash flow. Our assumptions
include:
 A normalised growth rate of 20.0% and a terminal growth rate of 7.0%.
 A CoE of 10.5%. The inputs used are a risk-free rate of 3%, an equity risk premium
of 5% and beta of 1.5. Given Coinbase’s business model and debt-free balance
sheet, we do not incorporate a WACC component in valuation.
 We assume a tax rate of 23%.
Based on these assumptions, we derive a fair value of US$335 per share.
Fig 141: Coinbase DCF valuation summary

US$m
Forecast cash flows 5,406
Normalised cash flows 11,666
Terminal cash flows 67,590
Total cash flows 84,662
Other adjustments 3,503
Implied market cap 88,165
Share count (diluted) 263
Implied fair value per share (US$) 335
Source: Redburn
100 Important note: see regulatory disclosures on page 123 of this repor
06/ Coinbase
Fig 142 shows a sensitivity analysis of our DCF model. The wide range of fair value
estimates across different terminal growth and cost of equity assumptions reflects the
significant contribution made by the terminal year figure to Coinbase’s fair value.
Fig 142: Coinbase DCF sensitivity analysis (US$)

CoE/g 5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50%
9.0% 375.7 424.4 492.6 594.9 765.4 1,106.5 2,129.6
9.5% 326.6 361.6 408.2 473.6 571.6 734.9 1,061.6
10.0% 288.5 314.6 348.1 392.8 455.4 549.3 705.8
10.5% 258.2 278.2 303.1 335.3 378.1 438.1 528.0
11.0% 233.4 249.1 268.2 292.2 323.0 364.0 421.5
11.5% 212.9 225.4 240.4 258.8 281.7 311.3 350.6
12.0% 195.6 205.7 217.7 232.1 249.7 271.7 300.0
Source: Redburn

Coinbase financials
Coinbase financials
Fig 143: Coinbase summary financials
2019 2020 2021 2022 2023 2024
Shares
Share price (US$) 230.18
Mkt cap*, Y/E n/a n/a 60,284
Earnings and dividends

Net profit (30) 322 1,922 1,733 1,962 2,573
NOSH (’000s) 206 263 266 269 272
Reported EPS (diluted) 1.57 7.31 6.51 7.29 9.46
Consensus EPS 8.08 5.00 6.21 7.60
Price/EPS 31.5 35.3 31.6 24.3
EV/EBITBA 19.5 20.5 17.2 12.6
DPS - - - -
Dividend yield n/a n/a n/a n/a
BVPS 14.1 21.9 30.5 41.5
Price/BVPS 16.3 10.5 7.5 5.5
Income statement
Revenue 534 1,277 5,942 5,990 6,839 8,341
EBITDA (adjusted) 24 527 2,922 2,676 3,045 3,902
Pre-tax profit (45) 409 2,466 2,251 2,548 3,341
Net profit (30) 322 1,922 1,733 1,962 2,573
Balance sheet and cash flow

Cash and equivalents 549 1,062 4,662 6,792 9,228 12,349
ST and LT debt 130 108 118 118 118 118
Net cash/(debt) 0 954 3,293 5,424 7,860 10,981
Total assets 2,392 5,855 14,168 17,134 22,094 28,532
Total liabilities 1,330 4,329 9,896 10,759 13,328 16,693
Shareholders’ common equity 497 1,526 3,720 5,823 8,214 11,287
Tangible equity 372 1,388 3,162 5,291 7,705 10,786
Cash flows from operations (81) 3,004 6,162 3,021 5,001 6,452
Cash flow from investing (105) 51 (59) (30) (50) (60)
Cash flow from financing (17) 19 60 0 0 0
Return and margin metrics

EBITDA margin, adjusted (%) 5% 41% 49% 45% 45% 47%
RoE (%) 32% 73% 36% 28% 26%
Revenue growth (%) 139% 365% 1% 14% 22%
Cost growth, adjusted (%) 50% 304% 8% 14% 17%
* Fully diluted basis
Source: Redburn, company, Bloomberg (3 August 2021)
Coinbase financials
Fig 144: Coinbase income statement

Y/E December (US$m) 2019 2020 2021E 2022E 2023E 2024E
Revenue
Transaction revenue 463 1,096 5,280 5,091 5,621 6,679
Subscription & Services revenue 20 45 290 495 707 1,003
Net revenue 483 1,141 5,570 5,585 6,329 7,681
Other revenue 51 136 372 405 510 660
Total revenue 534 1,277 5,942 5,990 6,839 8,341
Operating expenses
Transaction expense (82) (136) (795) (764) (843) (1,002)
Technology & development (185) (272) (944) (1,100) (1,300) (1,500)
Sales & marketing (24) (57) (649) (726) (823) (999)
General & administrative (232) (280) (641) (700) (825) (950)
Restructuring (10) 0 0 0 0 0
Other opex (46) (125) (456) (450) (500) (550)
Operating expenses (580) (869) (3,485) (3,740) (4,291) (5,000)
Operating income(loss) (46) 409 2,457 2,251 2,548 3,341
Other income, net 0 0 9 0 0 0
Income /(loss) before tax (45) 409 2,466 2,251 2,548 3,341
Taxation 15 (87) (544) (518) (586) (768)
Net income/(loss) (30) 322 1,922 1,733 1,962 2,573
Proforma net income/(loss) per share attr to common st.

Basic (US$) 1.76 9.56 8.54 9.57 12.43
Diluted (US$) 1.57 7.31 6.51 7.29 9.46
Weighted average NOSH – common stockholders (pro forma)

Basic (m) 183 201 203 205 207
Diluted (m) 206 263 266 269 272
Coinbase financials
Fig 145: Coinbase balance sheet

Y/E December (US$m) 2019 2020 2021 2022E 2023E 2024E
Assets
Cash and equivalents 549 1,062 4,662 6,792 9,228 12,349
Restricted cash 34 31 31 31 31 31
Customer custodial funds 1,201 3,763 7,593 8,453 10,968 14,239
USDC 88 49 102 102 102 102
Accounts receivable 17 189 209 211 240 293
Other current assets 97 40 56 56 56 56
Current assets 1,987 5,134 12,652 15,644 20,625 27,070
Cryptoassets held 34 316 651 651 651 651
Lease right-of-use assets 123 101 111 111 111 111
Property and equipment, net 47 49 54 54 55 57
Goodwill 55 77 481 481 481 481
Intangible assets, net 70 61 77 50 28 20
Other non-current assets 76 117 142 142 142 142
Non-current assets 405 721 1,516 1,489 1,469 1,462
Total assets 2,392 5,855 14,168 17,134 22,094 28,532
Liabilities, preferred stock and stockholders’ equity

Custodial funds due to customers 1,107 3,849 7,525 8,385 10,901 14,171
Accounts payable & accrued expenses 45 85 374 377 430 525
Cryptoasset borrowings 0 271 544 544 544 544
Lease liabilities, current 24 25 30 30 30 30
Other current liabilities 47 16 85 85 85 85
Liabilities, non-current 107 83 1,339 1,339 1,339 1,339
Total liabilities 1,330 4,329 9,896 10,759 13,328 16,693
Convertible preferred stock 565 0 552 552 552 552
Total stockholders’ equity 497 1,526 3,720 5,823 8,214 11,287
2,392 5,855 14,168 17,134 22,094 28,532
Source: Redburn,company
Coinbase financials
Fig 146: Coinbase cash flow statement

Y/E December (US$m) 2019 2020 2021 2022E 2023E 2024E
Net income/(loss) for the period (30) 322 1,922 1,733 1,962 2,573
Depreciation and amortisation 17 31 45 56 70 67
Stock-based comp expense 31 71 370 370 430 500
Deferred taxes (21) 0 0 0 0 0
Other non-cash income 23 (37) (60) 0 0 0
Changes in working capital (100) 2,617 3,886 861 2,539 3,312
Cash flow from operating activities (81) 3,004 6,162 3,021 5,001 6,452
Business acquisition/disposal cash (69) 23 (26) 0 0 0

Capex (40) (19) (25) (30) (50) (60)
Proceeds/(purchases) of AFS securities 0 0 0 0 0 0
Other investing activities 2 0 0 0 0 0
Net (purchase)/disposal of cryptoassets 1 46 (8) 0 0 0
Net cash used in investing activities (105) 51 (59) (30) (50) (60)
Issuance of common stock on exercise of stock options 4 21 59 0 0 0

Cash paid to repurchase equity awards (21) (2) 0 0 0 0
Net cash used in financing activities (17) 19 60 0 0 0
Net increase in cash, cash equivalents and restricted cash (203) 3,074 6,163 2,991 4,951 6,392
Effect of exchange rates on cash (0) (2) 16 0 0 0
Cash, cash equivalents and restricted cash, beginning of year 1,987 1,784 4,856 12,285 15,276 20,227
Cash, cash equivalents and restricted cash, end of year 1,784 4,856 11,035 15,276 20,227 26,619
Cash, cash equivalents and restricted cash, end of year (breakdown)

Cash and cash equivalents 549 1,062 4,662 6,792 9,228 12,349
Restricted cash 34 31 31 31 31 31
Customer custodial funds 1,201 3,763 7,593 8,453 10,968 14,239
1,784 4,856 12,285 15,276 20,227 26,619
Appendix 1 – Key ideas in Bitcoin

Appendix 1 – Key ideas in Bitcoin
Fig 147: Chronology of key ideas found in Bitcoin
Linked Byzantine Public
timestamping, Digital Proof fault keys as Smart
verifiable logs cash of work tolerance identities contracts
1980 Merkle Chaum

Ecash [10]
Tree [33] anonymous
Byzantine
Generals [27] communication [9]
Chaum
1985 Security w/o
identification [11]
Offline Paxos[28]
Haber &
Ecash[32]
Stornetta [22]
1990 Benaloh & DigiCash

de Mare [6]
Anti-spam [15]
Bayer, Haber,
Stornetta[5] Szabo
essay[41]
1995
Micro-
Haber & mint [44]
Hashcash[2] B-money [13]
Stornetta[23]
Client PBFT[8]
puzzles[25] Goldberg
2000 Paxos made dissertation [20]
simple [29]
Sybil attack
[14]
Bit gold [42]
2005
Bitcoin[34] Computational
impostors[1]
2010 Private
blockchains
Ethereum
2015
Nakamoto concensus
Source: ‘Bitcoin’s Academic Pedigree’, Narayanan/Clark
Appendix 2 – Bitcoin mechanism

How to Bitcoin
In this section, we attempt to distil what is extremely complicated cryptography and
explain how a user transacts and stores funds on the Bitcoin network but remark that
it is very similar for other major blockchains. Our focus here shifts away from the
consensus mechanism and mining process and instead towards purchasing motions
and cryptocurrency wallets.
Cryptocurrency wallets
Bitcoin wallets, paradoxically, do not store bitcoins. It is the combination of private
and public key(s), special numbers derived from public key cryptography (PKC), that
create the concept of a Bitcoin wallet. Put another way, the wallet is more like a
keychain than a leather folio. For completeness, the coins are ‘stored’ on the
blockchain itself in bitcoin addresses. The role of the wallet, therefore, is to provide a
gateway for the user to prove ownership of the coins stored at the addresses. Note that
PKC is not unique to Bitcoin and is used by almost all blockchain networks to verify
transactions.
The main idea behind PKC is that a user, say A, generates a private key and a public
key (some numbers), say X and Y respectively, that are mathematically related8 and
such that any message encrypted with X can be decoded using Y and any message
encrypted with Y can be decoded using X. Further, Y is made freely available to all of
A’s friends whilst X is kept secret.
Assume now that A wishes to send a message M and encrypts it using X, in turn,
creating a new message N, which is broadcast publicly. Since Y can decode any
message that has been encrypted using X, any other user, say B, who also knows Y can
decode N to recover the original message M. Moreover, B knows that the only
individual able to generate N from M is the user that knows X, i.e. A has digitally
signed the message with their private key (Fig 148).
8
PKC uses one-way functions to relate the two numbers. These functions are best thought of as sequences of mathematical operations that,
given the output, are near-impossible to reverse to retrieve the input without additional information. In the proceeding text, Y is the input
and X is the output.
Fig 148: Public key cryptography – an illustration
Sender (User A) Network Receiver (User B)

Private Key Public Key Public Key Public Key
Digital signature Encrypted Message (N):

Verification algorithm
algorithm qYfbmqH9Vwr3nfYR
Message (M): Message:

RedburnToday.com RedburnToday.com
Source: PreVeil, Redburn
In the Bitcoin arena, bitcoin addresses (derived from public keys) are known by all
nodes on the network, whilst private keys are kept secret. From a private key, a user
can generate their public key and so too their bitcoin address. However, neither the
bitcoin address nor the public key can be used to generate the private key. This is the
fundamental property of public key encryption. For those that wish to continue
reading beyond the scope of this report, we include some minutiae of Bitcoin’s public
key cryptography in Fig 149. Bitcoin’s pending Taproot will modify both the hashing
algorithm (the first arrow) and the encoder (the second arrow).
Fig 149: Inside the wallet – Bitcoin’s public key encryption and one-way functions
First SHA-256 hash,
next RIPEMD-160
Elliptic curve scalar hash, then Base58
multiplication. encode.
Private Key Public Key Bitcoin address
Source: Antonopoulos, A., Chapter 4, Mastering Bitcoin: Programming the Open Blockchain, 2014, Redburn
As mentioned above, coins are ‘stored’ on Bitcoin addresses that live on the blockchain
network. The wallet provides a user-interface, comparable to online banking in the fiat
monetary system, that allows users to engage in Bitcoin transactions. In the
background, custody over the funds involved in outgoing transactions is proven using
the private key, whilst incoming coins are aggregated into a total user balance. We
enumerate the key steps involved a bitcoin transaction between two users below.
1 Obtain the recipients bitcoin address and detail the location (sender’s bitcoin
address) of the funds to be sent, the nominal value of the transaction and the
network fee via the wallet or exchange platform. Out of sight, the transaction
instructions are digitally signed using the sender’s private key.
2 The transaction is then broadcast to the entire Bitcoin network and the details
included are verified by the nodes using the sender’s public key. If the sender’s
public key is unable to decrypt the message supplied, then the user does not have
custody of the funds stored at the corresponding bitcoin address. This is the digital
signature.
3 After passing the verification stage, the transaction joins a queue to be included in
the next block. Upon reaching the front of the queue and solving the PoW
consensus algorithm, the miner propagates the new block into the network and the
recipient sees the first confirmation of the transaction.
Each subsequent block that is mined into the network generates an additional
confirmation for the recipient. Best practice stipulates that the transaction should not
be considered complete until the recipient has received three confirmations – the
rationale being that after a single confirmation there is a non-zero probability that the
transaction may be reversed due to double-spending. Three confirmations make that
outcome sufficiently unlikely.
As an aside, the process of minting new Bitcoins occurs via a unique type of
transaction called a ‘coinbase transaction’. This differs from the usual sender-recipient
address process detailed above since the miner (recipient) does not specify an origin
address for the funds in the transaction instructions. The new coins are a reward from
the network itself and have no previous owner to detail on the ledger.
Not all wallets are created equal. With coin ownership resting entirely on the security
of the corresponding private key, it is unsurprising that an ecosystem has formed
offering users a variety of storage solutions. Wallets can be partitioned two ways: hot
wallets versus cold wallets, or custodial wallets versus non-custodial wallets.
 Hot versus cold wallets: a hot wallet is connected to the internet, providing ease of
use to the consumer and decreasing the time taken to execute transactions (step 1,
above). The drawback is that funds are extremely vulnerable to cyberattacks.
Alternatively, users can store their keypairs offline using a cold wallet. Whilst vastly
increasing security, they are inconvenient to use and often expensive.
 Custodial versus non-custodial wallets: with non-custodial wallets, the users bear
the responsibility of managing the keys, whilst custodial wallets offload that duty
to a third party, often cryptocurrency exchanges. Losing the password/PIN to a
non-custodial wallet renders the associated funds useless. Custodial wallets on the
other hand likely offer the user the opportunity to reset their details in-browser.
In Fig 150 we categorise the five main types of wallets by storage type and private key
security, and in Fig 151 we rank by user convenience. Hardware wallets authorise
transactions offline using a physical electronic device that stores the private key. Any
public and private key pair can function as a wallet, even if it is written on paper; paper
wallets are often printed as QR codes, but all carry the risk of being easily lost or
damaged. Desktop wallets are programmes that store the key pairs in files saved on the
user’s computer. Web wallets function like a website, whilst mobile wallets function
via an application installed on the user’s handset.
Fig 150: Cryptocurrency wallets, split by security and

private key custody Fig 151: Cryptocurrency wallets ranked by convenience
Wallet type Storage type Private key security
Hardware wallet Cold (offline) Non-custodial Hardware wallet
Private key security
Paper wallet Cold (offline) Non-custodial

Paper wallet
Desktop wallet
Desktop wallet Hot (online) Non-custodial
Mobile
Web wallet
Web wallet Hot (online) Primarily custodial, but wallet
some are non-custodial
Mobile wallet Hot (online) Mixture of custodial and Convenience
non-custodial
Source: Redburn Source: Redburn
Purchasing cryptocurrency
In part, the rise in popularity of digital assets can be attributed to the growth in
cryptocurrency exchanges and platforms for users to transact on. Placing aside the
obvious differences between a cryptocurrency wallet and a conventional portfolio, the
purchasing motion for trading the digital coins is near-identical to trading equities and
other well-established investment products.
Bitcoins are primarily purchased and sold through cryptocurrency exchanges, like
Coinbase, either in-browser or via a mobile application (Figs 152 and 153). Other
methods include cryptocurrency ATMs, online forums, in-person events (particularly
popular in 2009-10 when there was little infrastructure) or taking delivery of the
underlying asset from a cryptocurrency future.
To open an account at an exchange, it is often required that the user provides bank
account information and valid identification documents – identical to setting up a
brokerage account.
The actual method of buying or selling crypto has simplified greatly over the years.
Most platforms/exchanges follow procedures similar to those of standard trading
platforms. The first step is to transfer or deposit money into your trading account.
Then, the user can initiate a trade by entering the coin and quantity of assets they wish
to buy or sell (Figs 152 and 153). A user-owned wallet involves an additional set,
requiring the individual to specify their keypair to complete the transaction.
Fig 152: Purchasing digital assets via an Fig 153: Purchasing digital assets via an
exchange, Coinbase mobile application exchange, Coinbase mobile application
Source: Coinbase Source: Coinbase
Typically, the exchange account acts as custodial wallet whereby any cryptocurrency
purchased is held on exchanged-owned keypairs. Reputable exchanges use cold storage
for their keypairs, but this is not always the case.
Until the cryptocurrency is transferred into a non-custodial wallet, the user’s digital
assets are nothing more than a virtual balance hidden behind a username and
password. Should the exchange be the victim of cybercrime, which is an issue in the
crypto sphere (Fig 154), the lack of key-ownership renders the user’s funds lost
forever.
Fig 154: Cumulative value stolen from exchanges in publicly confirmed heists, 2011-19
2,000 $1,814.74m
Cumulative value stolen from
1,600
exchanges (U$m)
$1,532.14m
1,200
800 $656.64m
$495.14m
400 $570.64m
$487.04m
$0.04m $0.74m $3.94m
0
2011 2012 2013 2014 2015 2016 2017 2018 2019
Source: Chainalysis, Redburn
Appendix 3 – Ethereum 2.0

In this section we set out key features of the pending overhaul of Ethereum, whose
goal is to address network scalability and sustainability. Similar to Bitcoin, Ethereum
has a challenge: decentralisation and security of the network was achieved at the cost
of scalability. Demand for constrained network resources has led to an unwanted
growth in fees, whilst the popularity of the network has rapidly increased the disk
space required to participate in securing the network, in consequence centralising the
network. Ethereum 2.0 or Eth2 or Serenity is Vitalik Buterin’s solution to these issues,
a reboot of the network with improved architecture that sustainably solves the
Blockchain trilemma.
The upgrade itself is the launch of several interconnected projects expected to finish in
late 2021/early 2022. Scalability improvements will come from: (1) sharding the
transaction database and (2) integrating layer-2 solutions, specifically rollups.
Sustainability and security are addressed by the same project – a movement from
energy-expensive PoW consensus mechanisms towards energy-efficient PoS
consensus mechanism coordinated by the Beacon Chain. Security improvements will
come from random staking algorithms provided by the Beacon Chain. We discuss
these in more detail below.
The Beacon Chain

The Beason Chain is the lynchpin of the Ethereum upgrade, responsible for
coordinating communication in the sharded database and successfully implementing a
PoS consensus mechanism. As an aside, in PoW, users buy hardware to become
miners. In PoS, users deposit, or stake, cryptocurrency to control validator nodes.
Mining entire blocks is an energy-expensive task due to the vast computing power
required to confirm transactions. PoS seeks to address this issue, revealing the ESG
aspect of Eth2, by requiring network participants to mine fractions of blocks related to
the quantity of ether staked in the network. To control an entire validator node on the
Beacon Chain requires a user to control and stake 32 ether, or c$80,000/c£58,000.
Under the new mechanism in Ethereum 2.0, a user who stakes 8 ether is only required
to mine 25% of the block; that is, the user quarters their energy spend. The Beacon
Chain coordinates these efforts to ensure the entire content of the block is verified, as
it would be under PoW, and uses a random allocation algorithm to assign stakers to
shards increasing security.
Worth noting is that the Beacon Chain went live in December 2020, albeit operating
independently from the Ethereum main chain. It does not yet confirm transactions but
instead uses PoS to keep a timely record of the ledger. Deposits into the Beacon Chain
are locked up until the penultimate phase of the Eth2 project. To date, the validators
on the Beacon Chain control c6 million ether, or 5% of the total circulating supply,
from c200,000 participants.
Sharding (a layer-1 solution to scaling)

The first scalability upgrade for Ethereum will arrive in the form of a layer-1 solution
or, equivalently, the underlying Ethereum protocol will receive an upgrade.
Developers have two choices when it comes to scaling a network: either appeal to
vertical scaling, increasing the size and power of each node to generate higher network
throughput; or leverage horizontal scaling techniques to distribute the load on the
network and run tasks in parallel.
Whilst vertical scaling is the easiest to implement, it implicitly increases the capital
requirement to participate in securing the network and, in turn, threatens
decentralisation. Horizontal scaling is more involved. It requires, for distributed
ledgers, new software to be implemented to partition transaction data into smaller,
easier to execute, pieces of logic, which are then distributed into the network.
Specifically, the developers involved in Eth2 are set to implement database sharding, a
technique that is commonly used in database management and is illustrated in Fig 155.
Fig 155: Database sharding – one large table split into many small tables
Product Price
Widget $118
Gizmo $85
Trinket $37
Shard 1 Shard 2 Shard 3

Product Price Product Price Product Price
Widget $118 Gizmo $85 Trinket $37
Source: Redburn, IoT Academy
In sharding the blockchain, the network will transform from a single chain containing
the entire transaction history of the network into, initially, 64 parallel chains, each
working to validate and store different pieces of transaction data. Note that the current
blockchain will be one of the 64 shards, meaning that the new infrastructure will still
contain the entire transaction history of the network. Above, the existing blockchain is
represented by the list of products and prices, the transaction data are represented by
the individual entries and the process of sharding is represented by the larger table
becoming three smaller tables. An important difference between the pre- and post
sharded database is the order in which tasks are completed. Under current
architecture, tasks are completed in series – each node on the network works the same
task at the same time. Under Eth2, tasks are split and assigned to different nodes, each
node working on a different piece of the task at the same time. The advantage is clear,
having computationally easier jobs with constant computing power implies
transaction data are verified quicker.
Combined with the PoS consensus mechanism, from the Beacon Chain, 51% attacks
are near-impossible as: (1) the probability that offending participants would be
assigned to work on the same shard is near-zero and (2) the PoS mechanism means
the capital required to control 51% of the shards would be immense.
Rollups (a layer-2 solution to scaling)

The second scalability improvement will come from a layer-2 solution whereby
additional mechanisms are overlayed atop the existing blockchain protocol to move
computations off-chain and decrease the time to verification. The Eth2 solution
involves integrating rollups, a tool whose input is transaction data relating to many
users and output is a single cryptographic proof instead of many separate
cryptographic proofs. Multiple transactions are ‘rolled up’ into one. Here, most of the
work is completed off-chain or, independent from the Ethereum network, with greater
speed and efficiency, submitting the verification that the data included in the rollup
are legal to the network for storage. The above effort is also coordinated by the
Beacon Chain.
Transaction throughput on par with payment processing majors

As a reminder, the speed of the blockchain network is measured by the transaction
throughput, defined as transactions per second (TPS).
In Figs 156 and 157, we show the impact on transaction throughput of upgrading the
current Ethereum infrastructure to version 2.0. The first column (respectively second
column) shows transaction metrics for the transfer of ether (transfer of ERC-20-based
tokens) between two users. Throughout, we assume (1) each block contains a single
type of transaction (either ether or ERC-20-based token transfers) and (2) that each
block is maximally filled or, equivalently, the miner is aware of the true gas cost of
each transaction in the network and exhausts the entire gas limit of the block. This is
optimistic. Indeed, it is unlikely that a block would only contain a single type of
transaction and be filled maximally. Nevertheless, the modelling below provides useful
insights into capability of next-generation blockchain networks.
Fig 156: Ethereum 1.0 (current version), theoretical transaction throughput

Gas limit per block 15,000,000 15,000,000
Gas cost per transaction 21,000 *50,000
Transaction ceiling, per block 714 300
Theoretical throughput on Ethereum 1.0 **54 TPS **23 TPS
* The gas cost for transferring ERC-20 tokens is not clear cut, unlike ETH transfers. Here, we use an estimated average
** Transaction throughput = transaction ceiling, per block/block time, assuming a block time of 13 seconds
The output of Fig 156 is an upper bound for throughput on the current version of
Ethereum. If, hypothetically speaking, the network only supported transfers of ether
between addresses and a new block was added to the network every 13 seconds, its
throughput would be c55 TPS. Expanding network functionality to include ERC-20-

based token transactions decreases that number to c25 TPS. For context, the midpoint
of c25-c55 TPS is some 2.5x higher than the actual average throughput of the network.
Fig 157: Ethereum 2.0, theoretical transaction throughput

Gas limit, per block 15,000,000 15,000,000
Gas cost per ZK rollup *500,000 *500,000
Remaining gas, per block 14,500,000 14,500,000
Gas cost per byte of transaction data 16 16
Transaction data ceiling, per block 906,250 906,250
No. of bytes per transaction included in rollup 12 16

Transaction ceiling, per block 75,520 56,640
Theoretical throughput before sharding **6,293 TPS **4,720 TPS
Network space, before sharding (kB/s) 60 60

Network space, after sharding (kB/s) 1,398 1,398
Theoretical throughput after sharding ***146,626 TPS ***109,976 TPS
* Here, we use a specific type of rollup for modelling, a ZK rollup, but note that there is another category of rollups called optimistic rollups
** Transaction throughput = transaction ceiling, per block/block time, using an estimated Ethereum 2.0 block time of 12 seconds
*** After sharding throughput = before sharding throughput * (network space, after / network space, before)
In Fig 157, we compute the scalability gained from upgrading to Ethereum 2.0 in two
steps. On the one hand, if each block contains the largest possible rollup, and we
assume that new blocks are added to the network every 12 seconds, then rollup
integration could increase transactions per second on Ethereum by a factor of 100.
Instead, consider the increase in network space for new transaction data due to
sharding, 60kB/s versus 1,398kB/s – then, sharding the ledger could increase network
throughput 20x. Together, the upgrades in Ethereum 2.0 look to yield a maximum
throughput in excess of 100,000 transactions per section.
What is a realistic estimate for potential Ethereum 2.0 throughput? We think the
answer is close to 45,000 TPS. To get to this number, we combine the spread between
actual and estimated throughput from Fig 156 and the bottom line of Fig 157.
London hard fork

Releasing at block height 12,965,000 are five EIPs, colloquially known as
improvements to the Ethereum blockchain and collectively known as the London hard
fork. Their aim is to bridge the gap between the current version of the network and
Ethereum 2.0. Most interesting are improvements ‘1559’ and ‘3554’, which in short
make ether a deflationary cryptocurrency and delay the rapid increase in mining
difficulty until December 2021. We provide more detail on these propositions below.
 EIP-1559: the specifics of ‘1559’ are that the network fees will no longer follow a
first-price auction model and will instead follow a fixed-price sale. In addition,
miners will no longer have a claim to the entire fee. To get here, developers will
implement three changes to the network fee model: (1) firstly, instead of network
fees deriving from volatile gas prices, each transaction will have a fixed cost
‘BASEFEE’ and an optional (variable) tip to the miner; (2) secondly, the ‘BASEFEE’
is burnt, or sent to an unobtainable public key address, permanently removing
ether from circulation and cutting miners’ income to the block reward plus income
from tips; and (3) thirdly, the block gas limit of 15m gas is removed and replaced
with a long-term target miners agree to adhere to, on average, and block gas limit
ceiling of 30m gas. This is the most important update to the network.
 EIP-3554: in 2015, the ‘difficulty bomb’ or ‘Ethereum Ice Age’ was embedded in the
Ethereum protocol. It is a mechanism designed to evaporate all economic profit in
PoW mining by parabolically increasing the difficulty of the hash function after a
certain number of blocks have been mined, in turn, rapidly increasing the block
time until no miner can confirm new transactions – an internal ‘grow or die’ force.
EIP-3554 buys the developers roughly five months to prepare the final aspects of
Ethereum 2.0. The London upgrade represents the fourth difficulty bomb delay
implemented since 2017 (EIP-649, EIP-1234, and EIP-2384), a combined delay of
c10 million blocks, due to developmental issues and bugs. Fig 158 charts the
historical block time of the network, including previous bomb delays and prior
effects of the mechanism. The wave-like pattern illustrates the call-and-response
relationship between the difficulty bomb mechanism and manual intervention.
Fig 158: Average daily Ethereum block time*, 2015-21

30
Time taken to confirm (s)
Byzantium upgrade, +3m block delay,

24 16 Oct 2017
18
12
Constantinople upgrade, +2m block delay, Muir Glacier upgrade, +4m block
6
28 February 2019 delay, 2 January 2020
0
Jul-15
Apr-16
Jul-16
Apr-17
Jul-17
Apr-18
Jul-18
Apr-19
Jul-19
Apr-20
Jul-20
Apr-21
Oct-15
Jan-16
Oct-16
Jan-17
Oct-17
Jan-18
Oct-18
Jan-19
Oct-19
Jan-20
Oct-20
Jan-21
Source: Redburn, Etherscan.io
Appendix 4 – Altcoins
A brief biography of additional large Altcoins, in addition to those discussed in
Chapter 3, is set out below.
Litecoin (standalone coin, market capitalisation US$9.4bn)

Launched in 2011, Litecoin was intended to be the silver to Bitcoin’s gold. It was
founded with the goal of prioritising transaction speed and did so with shorter block
times and a different hashing algorithm. Its common usage is almost identical to that
of Bitcoin: as a medium of exchange and store of value. With the Litecoin’s USP being
quicker transaction speeds at lower fees, the development of the Bitcoin Lightning
Network potentially undermines the value of Litecoin.
Bitcoin Cash (standalone coin, market capitalisation US$10bn)

Bitcoin Cash (BCH) is a popular spin-off of the original Bitcoin (BTC) blockchain,
differing only in total block size, with a BCH block size of 32 MB versus a BTC block
size of 1 MB. Its primary function is as a low-cost peer-to-peer electronic cash system
that is secured by the Bitcoin blockchain protocol and confirms transactions in
minutes rather than hours. Disagreements surrounding the correct block size led to a
second hard fork in 2018, creating a third currency closely associated with Bitcoin,
Bitcoin SV, whose current block size is 2 GB (1 GB = 1,024 MB).
Chainlink (utility token, market capitalisation US$8.8bn)

Chainlink is a decentralised network of nodes that collect real-world data from trusted
off-chain sources for use in on-chain smart contracts. Its use in crowdfunding is an
easy proof of concept: individuals donate monies to a fund and a smart contract is set
up to track total donations. At the end of the pre-specified period, if the desired
funding has been achieved, the smart contract executes and financing is provided to
the cause, otherwise the donations are returned. The native currency, Link, is used on
the network to compensate node operators for gathering data as well as staking.
Polygon (utility token, market capitalisation US$6.6bn)

Polygon, previously Matic Network, is a framework running atop the Ethereum
blockchain that connects compatible networks via layer-2 solutions and proprietary
PoS side chains. Whilst similar in motive to Polkadot, Polygon focuses on improving
the interoperability of the Ethereum ecosystem with the added benefit of existing scale
and an established community of developers. The Matic token is used to reward users
for computational effort and related services on the network.
Solana (utility token, market capitalisation US$8.7bn)

Solana is an open-source blockchain that provides the framework and ecosystem for
the deployment of DApps with high throughput and quick transaction speeds without
using off-chain technologies. The network’s USP is its consensus mechanism, using a
novel proof-of-history algorithm combined with PoS to achieve web-like transaction
speeds of 50,000 per second. Its use cases are similar to Polkadot and Polygon: any
DeFi application and marketplace seeking to grow quickly. Sol, the native token, is
used to pay network fees and stake.
Theta Network (utility token, market capitalisation US$5.9bn)

Theta Network is a decentralised content delivery platform using blockchain
technology to improve video streaming. Differentiating the platform from traditional
high-cost methods is a group of users, collectively nodes, that donate excess bandwidth
and other computing resources to help stream higher quality (resolution) videos with
reduced buffering. The network runs a duel coin model: Theta coin is used for
network governance and staking, whilst Theta Fuel is used for on-chain transactions
such as purchasing content and rewarding nodes for sharing their bandwidth.
Stellar Lumens (utility token, market capitalisation US$6.5bn)

Stellar Lumens, and token XLM, is a digital ledger technology tackling the issue of
moving fiat currencies across political and geographic boundaries with negligible
costs. Its primary focus is on helping those outside the scope of traditional banking
services in the areas of remittances and bank loans. A network of trusted partners, or
Anchors, are used to exchange deposits of tangible fiat monies 1:1 for digital fiat
tokens, which can be freely swapped and redeemed across the entire ledger. The
current network fee is fixed at 0.00001 XLM.
Internet Computer (utility token, market capitalisation US$5.6bn)

Internet Computer is a platform designed to allow developers to build software and
share content, i.e. data sharing, via smart contracts using a decentralised cloud
computing resource. Its primary goal is to democratise the internet, while enhancing
security and granting the ability to host back-end software internally rather than
requiring the services of giants like Google. The network’s utility token, ICP, allows
users to participate in network governance and pay for computational effort.
VeChain (utility token, market capitalisation US$5.4bn)

VeChain is an enterprise solution combining smart contracts and Internet of Things
devices to improve business operations with efficient information transfers and
product monitoring capabilities in complex supply chains. Its customers are industry-
focused and it has proven use cases in almost all verticals including in food with
Walmart China and in automotive sales with BMW. The network has two native
tokens VET and VTHO, the former used to store and transfer value (data) whilst the
latter is used to pay network fees.
Appendix 5 – Glossary
Below is a glossary of selected cryptoasset terminology.
51% attack: a 51% attack is a hypothetical scenario in which more than 50% of a
blockchain network’s nodes fall under the control of a single group. In such a
circumstance, the consensus of a network is no longer sufficiently distributed enough
to be viable, leaving the blockchain open to manipulation.
Bitcoin: Bitcoin is a blockchain network with a native cryptocurrency (bitcoin). It is

the first blockchain and cryptocurrency, hence its dominant presence within the
broader crypto ecosystem. Bitcoin was established in 2009 and pioneered Proof of
Work, a technology for reaching consensus on a decentralised network.
bitcoin (BTC): bitcoin (BTC) is a cryptocurrency that can be directly transmitted

between users on the Bitcoin network. It is spelled with a lowercase B, as compared to
the Bitcoin network, which is denoted with an uppercase B.
Blockchain: a blockchain is a public ledger of transactions that is maintained and

verified by a decentralised, peer-to-peer network of computers that adhere to a
consensus mechanism to confirm data. Each computer in a blockchain network
maintains its own copy of the shared record, making it nearly impossible for a single
computer to alter any past transactions or for malicious actors to overwhelm the
network. Sufficiently decentralised blockchains do not rely on centralised authorities
or intermediaries to transact globally, securely, verifiably and quickly, making
technology like cryptocurrency possible.
Byzantine Fault Tolerance (BFT): Byzantine Fault Tolerance refers to a blockchain

network’s ability to reach consensus and continue operating even if some of the nodes
in the network fail to respond or respond with incorrect information. A network that
is Byzantine Fault Tolerant solves the Byzantine Generals Problem, a situation in
which all parties must agree but one or more parties are unreliable. Most actively used
consensus mechanisms are Byzantine Fault Tolerant.
Cryptocurrency: cryptocurrency is a digital asset that circulates on the internet as a

medium of exchange. It employs blockchain technology – a distributed ledger of
transactions that is publicly available – and is secured by advanced cryptography. This
revolutionary asset architecture allows for certainty that cryptocurrency coins and
tokens cannot be double-spent, even in the absence of a centralised intermediary. The
first cryptocurrency to achieve mainstream success was Bitcoin, which paved the way
for the proliferation of many other cryptocurrencies.
Decentralised Autonomous Organisations (DAOs): a decentralised autonomous

organization (DAO) is a blockchain-based organisation that is democratically
managed by members through self-enforcing open-source code and typically
formalised by smart contracts. DAOs lack centralised management structures. All
decisions are voted upon by network stakeholders. DAOs often utilise a native utility
token to incentivise network participation and allocate proportional voting power to
stakeholders based on the size of their stake. As DAOs are built on top of blockchains
– often Ethereum – their transactions are executed transparently on the underlying
blockchain.
Decentralised Applications (DApps): software applications built out of smart

contracts, often integrated with user-facing interfaces using traditional web
technology.
Decentralised Exchange (DEX): a decentralised exchange (DEX) is a financial

services platform for buying, trading and selling digital assets. On a DEX, users
transact directly and peer-to-peer on the blockchain without a centralised
intermediary. DEXs do not serve as custodians of users’ funds and are often
democratically managed with decentralised governance organisation.
Decentralised Finance (DeFi): Decentralised Finance (DeFi) is a major growth sector

in blockchain that offers peer-to-peer financial services and technologies primarily
built on Ethereum.
Digital assets: a catch-all term for assets that exist digitally. The term covers a wide
spread, including cryptocurrencies, utility tokens, security tokens, digital stocks and
digital collectables. All cryptocurrencies are digital assets, while not all digital assets are
cryptocurrencies.
Distributed Ledger Technology (DLT): DLT is a decentralised peer-to-peer digital

system for recording transactions between parties in multiple places at the same time.
DLT deploys cryptography and consensus mechanisms to allow participants to share
an immutable replica of the same ledger. It gets rid of the need for a centralised store
of data and dispenses with the requirement for a central authority to carry out
administrative functions, as is necessary with traditional databases.
Ether (ETH): ether is the native cryptocurrency of the Ethereum blockchain, and it
plays an integral role in the Ethereum ecosystem. Transactions on the Ethereum
blockchain are paid for in micropayments of ETH, referred to as gas, while ether also
facilitates interactions with and between smart contracts throughout the Ethereum
platform and ecosystem.
Fork: a fork occurs when one blockchain is divided into two blockchains. This type of
split in a blockchain network happens when an update is made to the blockchain
protocol, but not all of the network participant nodes agree to adopt it. Blockchains
can experience two main types of forks: a soft fork or a hard fork. Soft forks result in
an update that is ‘backwards compatible’. This means that nodes that accept the
update are still capable of interacting with nodes that do not. In a hard fork, the update
significantly alters the original blockchain protocol such that the two versions are no
longer compatible with one another. The result of a hard fork is two unique
blockchains that diverge after the hard fork event.
Hashing: hashing is the process of taking an input of any size and using a
mathematical function (called a hash) to create an output of fixed size. Hash functions
are considered one-way. Unlike encryption, which is intended to conceal data as they
move over a network or are stored on a device, hashing is primarily used to verify the
authenticity of data. Hashing also serves an important security function in protecting
network components such as passwords and sensitive information that can be stored
as hashes – the outputs of hash functions.
Layer-1 blockchain: a layer-1 blockchain is typically a name used to describe a main

blockchain network protocol such as Ethereum or Bitcoin. The name layer-1 comes
from its relationship with layer-2 scaling solutions such as state channels, rollups,
nested blockchains and plasma side chains. Layer-1 blockchains are simply the main
network that a layer-2 scaling solution attaches to in order to improve the scalability
and transaction throughput of the main chain, or layer-1. Layer-1 blockchains can also
be known as the parent chain or root chain, among other classifications.
Layer-2 scaling solution: layer-2 scaling solutions are protocols that integrate into
blockchains like Bitcoin and Ethereum as separate, secondary layers built to increase
transaction throughput and reduce transaction costs. Examples of layer-2 solutions
include Bitcoin’s Lightning Network and Ethereum’s Plasma.
Oracles: data feeds that allow information from sources off the blockchain, such as the
current price of a stock or a fiat currency, to be integrated into DeFi services.
Stablecoins: digital assets whose values are pegged to a fiat currency, a basket of fiat
currencies or other stable-value assets.
Satoshi Nakamoto: Satoshi Nakamoto is the pseudonymous individual or group

responsible for creating the Bitcoin protocol. Satoshi Nakamoto famously published
the Bitcoin white paper in October 2008 and mined the first ‘genesis’ block on the
Bitcoin network in January 2009. The true identity of Nakamoto remains unknown.
Sharding: sharding is a mechanism that is used to partition a blockchain network or

other type of computer network or database. Its purpose is to distribute the network’s
computational and storage workload across a broader set of devices, or nodes, in order
to increase the throughput and transaction speed of the entire system.
Smart contract: smart contracts are computer programmes that run within a
blockchain protocol that automatically execute based on pre-set conditions. They
execute a predefined set of terms automatically in a trackable and irreversible manner
without the need for a third party.
Token: within the context of blockchain technology, a token generally refers to a unit
of value for a programmable asset that is managed by a smart contract and an
underlying distributed ledger. Tokens are the primary means of transferring and
storing value on a blockchain network – most often Ethereum. Tokens can also
be designed to be either fungible or non-fungible, depending on a network’s specific
needs.
Wallets: software interfaces for users to manage assets stored on a blockchain. With a
non-custodial wallet, the user has exclusive control of funds through their private keys.
With custodial wallets, private keys are managed by a service provider.
Sources: Gemini.com; Risk.net; Wharton; Redburn
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Cryptoassets: The Financial Metaverse

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Cryptoassets: The Financial Metaverse

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Cryptoassets

The Financial Metaverse

NICHOLAS WATTS FINTECH 5 AUGUST 2021

T +44 20 7000 2187

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Russell Quelch (Specialist Sales contact)

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Money is a social construct. The idea of open, borderless and permissionless

Important note: see regulatory disclosures on page 123 of this report. 3

Redburn 3D: Coinbase

Relative Estimates Momentum Price relative

4 Important note: see regulatory disclosures on page 123 of this report.

02/ The money debate and regulation........................................................................ 26

03/ The crypto landscape ............................................................................................ 43

04/ DeFi ....................................................................................................................... 67

05/ Crypto exchanges .................................................................................................. 78

06/ Coinbase ................................................................................................................ 84

Coinbase financials ................................................................................................... 102

Important note: see regulatory disclosures on page 123 of this report. 5

6 Important note: see regulatory disclosures on page 123 of this report.

economic incentives and flexibility around Bitcoin mining (evidenced recently by

Bitcoin Ethereum Tether

Fig 3: Ethereum, theoretical transaction throughput

Important note: see regulatory disclosures on page 123 of this report. 7

To support the operations of individual cryptoassets as well as the broader crypto

Fig 4: Crypto capital markets overview

Pre-trade Trading Post-trade

Data & Analytics Exchange (centralised) - Spot

Technology services (Fireblocks)

Regulatory and compliance services (Chainalysis)

Prime brokerage (Coinbase Prime; Galaxy Digital)

Interface with payment rails (Silvergate, Clearbank)

8 Important note: see regulatory disclosures on page 123 of this report.

5% 10% 15% 20%

Important note: see regulatory disclosures on page 123 of this report. 9

Fig 7: The second inning of tech decentralisation

App & data decentralisation

Smart Contracts, Bitcoin, GS

Initial internet Data

Web 1.0 Web 2.0 Web 3.0

Source: Philipp Stauffer, FYRFLY Venture Partners

Factors behind crypto’s emergence

10 Important note: see regulatory disclosures on page 123 of this repor

Libra cryptocurrency proposal is a recognition of this challenge to sovereign

US Federal Reserve SNB ECB BoJ BoE PBoC

Source: central banks, Bloomberg Source: Redburn

CBDCs and regulation

We expect regulation around the crypto industry to largely follow well-established

Important note: see regulatory disclosures on page 123 of this report.

12 Important note: see regulatory disclosures on page 123 of this repo

applied to the crypto industry as it grows, quality as well as strength of regulatory/legal

Monthly volume traded (U$b)

5,000 54% 600

Binance Coinbase Bitfinex

Source: CryptoCompare Source: CryptoCompare

Important note: see regulatory disclosures on page 123 of this report.

Source: company, nomics.com Source: company

Its transactional orientation results in Coinbase currently carrying considerable

14 Important note: see regulatory disclosures on page 123 of this repo

Source: company Source: company

 Asset expansion. Alongside geographic expansion, further expansion of unique

 Crypto as a new financial system. This involves developing a much broader

 Crypto as an app platform. This is an even more formative area of investment,

Important note: see regulatory disclosures on page 123 of this report. 3