Weiss Ratings — A Bull enters the China Shop

22.02.2018

Not a bull in the sense commonly understood by cryptocurrency traders; no, a bull that comes crashing into a room where it hasn't been before, and where its white eyes seems to register the delicate porcelain around it but understanding neither the full use nor purpose.

Having finally been able to catch up on the first ever legacy ratings firm's bold and welcomed attempt to rate cryptocurrencies, I have gathered my opinions on the matter below. It is of course not hard to predict that any public ranking would give rise to near tribalistic responses from advocates of certain coins that happens to be ranked low. This response however is not one of those, as will become apparent.

First, before looking at specific coin ratings, it should be clarified that Weiss Ratings ultimately uses four different indices that when combined produce the coin rating from F (worst)to A (best). Since coins are in the spot light in this case, people tend to forget that assumptions need to be judged as well. If an investor should be able to draw relevant conclusions from a rating grade, the parts that builds that grade needs to be relevant.

The Cryptocurrency Risk Index. A composite of sub-indexes that measure (a) relative and absolute price fluctuations over multiple time frames, (b) declines from peak to trough in terms of frequency and magnitude, market bias, whether up or down, and other factors.
The Cryptocurrency Reward Index. A composite of sub-indexes that evaluate (a) returns compared to moving averages, (b) absolute returns compared to a benchmark, smoothed returns compared to a benchmark, and other factors.
The Cryptocurrency Technology Index. A composite of sub-indexes calculated by a manual analysis of publicly available white papers, public discussion forums or announcements, and open source code to evaluate the protocols underlying each cryptocurrency. Factors considered include the level of anonymity, sophistication of monetary policy, governance capabilities, the ability or flexibility to improve code, energy efficiency, scaling solutions, interoperability with other blockchains and many more.
The Cryptocurrency Fundamental Index. A composite of sub-indexes that evaluate transaction speed and scalability, market penetration, network security, decentralization of block production, network capacity, developer participation, public acceptance, plus other key factors.

My main initial criticism is that half of the indices are just leaning on price parameters. It builds on the assumption that past price movements can tell us anything about future ones. With regards to the risk index, that seems more plausible, as small coins tend to have larger volatility than big coins, just like small cap stocks have larger volatility than large cap stocks. The reward index though is somewhat out of place and could be discarded. It is very unlikely that returns compared to some crude moving averages or benchmarks are good indications on future price movements. Anyone who have been in this game for a while know the kind of coordinated pump and dumps that occur on mainly smaller coins. So anyone trying to invest on the grounds of prior price movements will by definition take on the risk of these coordinated movements. That is just the most obvious example. Even with no market manipulation, a reward index seems superfluous.

Despite the questionable index composition, it was not until Weiss Ratings had to publicly justify their grades (after even a preemptive DoS attacks on their web page) that the flaws of their understanding became more apparent to the public. Lets look at some examples.

They rate Bitcoin C+, Ethereum B, and Steem B-. The first china vases are heard crashing to the floor. Firstly, it is unclear whether market cap is included in any of their indices. If the grade A can be seen as equivalent as Buy, as stated by Weiss Ratings, then it is completely necessary to have some kind of reference point with regards to market valuation, in order to know if the coin is undervalued or not relative to other coins, as well as relative to the estimated fair value of the cryptocurrency market as a whole. For example, Bitcoin is vastly better than Steem, for reasons I can't fit in this article, maybe in another one later on. But bear in mind that Steem is valued (~1B USD) far below that of Bitcoin (~200B USD), so can the better rating for Steem just be a reflection of this fact, that yes, it is a worse chain in almost all regards, but the value is so low that it is more undervalued than Bitcoin? I wish I could give Weiss Ratings the benefit of the doubt here, but I don't think they actually have standardized the ratings for market cap properly. If they had, why was that not the first issue to bring up in the articles responding to the criticism? The massive backlash they got for the Bitcoin C rating could have just been discarded by references to Bitcoins superior market valuation.

In a second article, they defend some of their ratings once again.

Why don't we give Bitcoin an A? Actually, thanks to Bitcoins strong adoption, brand, and security, it does merit an A ... but only on our Fundamental Index.
Problem: That's just one of our four major metrics. Meanwhile, Bitcoin falls short in two other important areas: Our Risk Index, reflecting extreme price volatility and our Technology Index, reflecting Bitcoin's weaknesses in governance, energy consumption and scalability. As soon as the metrics on these improve, an upgrade for Bitcoin is likely.
Why doesn't Ripple get a higher grade? Like Bitcoin, it gets an A for fundamentals, but it scores poorly on our Risk Index due to repeated price crashes. Its Technology Index gets clipped due to heavy centralization and control by its creators.
How come Dogecoin is rated on par with the likes of Ripple? This is indeed surprising. But the numbers are the numbers, and they include surprising facts: Dogecoin's usage is greater than that of Bitcoin Cash. Its usage is also greater than that of Dash and ZCash combined. Of course, that alone is not enough to bump it up above a C. But it certainly does pull it up from the D range.

If Bitcoin falls short on the risk index, then few, if any, coins will ever be a solid Buy. With some stable coins being the exception, all cryptocurrencies are super volatile, Bitcoin being one of the least. Weiss Ratings also mentions that Bitcoin rates low due to weakness in governance, energy consumption and scalability.

The governance criticism is commonly expressed among newcomers when they start to delve into cryptocurrencies. What may look like a weakness at a first glance might very well be a strength. There is no consensus yet among experts whether on-chain or off-chain governance is generally best in the long run for a decentralized coin. Vlad Zamfir who builds a version of Ethereum's Proof of Stake dislikes on-chain governance, while for example the Tezos project has a totally different viewpoint. Since Bitcoin has no on-chain governance now other than simply full nodes running clients of their choice, the way to go if you want to change the underlying protocol is to convince the ecosystem (not just the miners as became apparent with the No2X movement). If any adversary would like to change Bitcoin to their advantage, or plainly seize control, a 'weak' governance structure like this is a positive, not a negative thing. Only when a large portion of the network accepts the change, it passes, as we saw when SegWit was locked in.

A lower grade due to high electricity consumption is ridiculous when evaluating the price potential of a coin. Of course it is highly doubtful that the Bitcoin mining is good for the environment (though there are some arguments that the concern is over emphasized, such as the possibility of utilizing excessively produced electricity for network security, while also putting downward pressure on the total resource consumption of the huge legacy financial system). Even if you cede the point that Bitcoin is consuming a lot of electricity and that it is very bad, that fact itself has nothing to do with whether the coin is a buy or a sell. The only far fetched scenario when such reasoning makes some sense is if there was a threat of over regulation by states due to this electricity consumption.

Finally, with regards to Weiss Ratings comments on Bitcoin, a low grade partially due to low scalability is also a bit misleading. Even if we for now disregard the work on the Lightning Network, already live experimentally on the mainnet, there is the important fact that maximum on-chain transactions per second is a faulty parameter to judge a coin by. Three to four transactions per second is certainly not a lot, but it is mainly a result of the decentralization of the network, not technical infrastructure. Other coins can have hundreds of transactions per second if the validating nodes are few and powerful. There is absolutely no reason to give the latter a better grade, since the whole point of cryptocurrencies is to heavily reduce or eliminate trust in third parties. Being concerned about Bitcoin fees is also a bit strange since the security of the network has to be subsidized in one way or another, either through inflation or transaction fees. Smaller coins often subsidize transaction fee payments to miners by instead have a high issuance for every block. At least high transaction fees imply that the chain offers real utility, since people are giving up so much for each transaction.

Ripple gets an A for fundamentals. Looking at what the fundamentals index consist of, we see that among the factors are network security and decentralization of block production. What security can a chain have if there is heavy centralization, as is the case with Ripple? A central point of failure is an attack point. Ripple has no mining or staking. A centralized authority decides how to build the blockchain. Ripple promises(!) to make the network less centralized in the future by giving up control of validating nodes, but if there is no block reward, where is the incentive for validators to stay online and maintain the network?

Lastly, Dogecoin does not even have developers, yet is rated C like Bitcoin. There just has to be more some harsher punishment in not having developers ready to quickly solve serious bugs.

I want to end this article on a positive note. Weiss Ratings, in their many blog posts, dare at least to question the hegemony of Bitcoin and implicitly the ridiculous notion of Bitcoin maximalism that there is something magical and untouchable about that chain. They also seem to welcomed the criticism received and their point is a good one; finally we have regular people like you and me thinking about and evaluating the properties of money. Who would have thought that would happen.