And Why Markets are still immature
Some interesting action in privacy coin markets today as a new currency took centre stage thanks to a severe code bug. MimbleWimble based privacy coin Beam saw its blockchain halted, as miners began improperly propagating invalid blocks. Beam has only been live on mainnet since January 4th, so it is not surprising to see significant issues with its client. More importantly, these issues triggered some interesting reactions in the market.
To put some of this in context, MimbleWimble is a blockchain protocol built around the concept of confidential transactions. Outlined anonymously in a 2016 whitepaper, its privacy is based around Pederson commitments and Zero Knowledge range proofs (the same mechanisms implemented in Monero, on top of their RingCT system). It merges transaction data into raw UTXO outputs in each block, such that the size of the blockchain is considerably reduced. Beam is an implementation of MimbleWimble protocol, being the first version to reach a mainnet launch with a live currency.
The aforementioned client bug was caused by an issue with the way in which the mining client was managing the UTXO outputs in each block, as these outputs were not being processed correctly. Blocks were producing balance changes which were completely different from those expected by the network, and the blockchain was halted as these invalid blocks were rejected by the network. Nodes had to be shutdown, and an update was quickly released on the Beam github in order to solve the bug. Some have considered the possibility that the vulnerability was deliberately exposed by an attack, but it seems more likely that this was just a software issue to be expected of a nascent protocol (and especially one built on new tech like MimbleWimble). Logically, you’d think a software issue with this level of consequence would have serious implications for Beam’s valuation — but what actually happened was probably different to what many expected.
To give some context, Beam’s implementation of MimbleWimble was definitely the first to reach a serious mainnet launch. Grin, the second major MimbleWimble based privacy currency, is considered Beam’s major competitor within its niche, sporting similar goals in providing a decentralised anonymous medium of exchange. The two coins are about as similar as currencies can be without being hard forks of the same blockchain. Whilst Beam released to a small community and limited fanfare on January 4th, Grin’s release on the 15th was met with strong support from the industrial mining community — with the mining algorithm being ASIC friendly and rewards being nominally high.
The interesting market activity came when Beam’s issues surfaced, as we saw some negative price action on Beam — but a far clearer spike in the price of Grin over a similar time frame. The relative changes in the price were completely different, as the Grin spike far outweighed the smaller dump of Beam. Obviously there is the question as to whether the surge in Grin’s price is directly related to the failure of Beam’s protocol, but based on the timing of both — the answer is obvious. Basically no news has surfaced on Grin other than mining updates in the past 24 hours, whilst Beam’s issues were announced and live tweeted via the protocol’s official account. See the graph below for a closer look — and observed how similar the timings are:
Whether Grin is a better privacy currency than Beam is not necessarily the point here. Individuals looking to profit off negative events and sentiment are forced to look at an asset’s direct competitors at the moment rather than taking a pure short position. This is quite evident in relative lack of movement in Beam prices, as the currency followed a similar pattern to the market for most of the day. Taking a position in Grin was the logical move for traders looking to profit off Beam’s issues — and as such we saw a considerable short term spike in the price of Grin.
More generally, these kind of market movements are demonstrative of the immaturity of Crypto. The lack of sophisticated derivatives, options and other mechanisms available in traditional financial markets makes complex trading and risk management difficult to execute if not impossible. Whilst there are a few avenues to purchase options and futures on large currencies like Bitcoin and Ethereum, the liquidity available on these instruments is not sufficient to service the risk management requirements of potential institutional investors.
In a context like this where currencies are low market cap, even the options to just buy and sell the currency are limited to a few small exchanges with questionable security. The ability for investors to get involved with these currencies whilst being able to manage risk (this bug is a perfect example of one) is crucial for the growth of these currencies. We expect the flow of institutional money to follow the development of these derivatives and instruments that allow for effective hedging — hence our major excitement for Bakkt and the other institutional grade exchanges coming into the space.