This post was last updated on September 11th, 2019 at 03:43 pm
Today’s episode is a departure from the usual format. Instead of an interview, you’ll hear an audiobook created from a long-form article that I published with Nathaniel Whittemore a few weeks ago, entitled “Crypto Market Cap: An In-Depth Review & Survey Of Emerging Alternatives”.
The article sparked a lot of discussion, but some of the feedback suggested that the length of the article may have made the content less accessible. Listening to the article, however, provided a much different experience. What you’re going to hear on today’s show is the article read by a professional voice actor who has experience narrating Audible books. In this piece Nathaniel and I review the following topics:
- Why Metrics Matter
- The Non-Crypto Origins of Market Cap
- 4 Major Critiques of Market Cap:
- A Review Of Market Cap Alternatives
Topics Discussed In This Episode
- Why the conversation about Market Cap matters
- The origin of Market Cap
- How Market Cap became the dominant measure of value
- How Market Cap is evaluated
- The differences between tokens and stocks, and why this matters as a critique of Market Cap
- How inflation schedules matter as a critique of Market Cap
- Why the challenges of determining what number to use for supply lead to a major critique of Market Cap
- The problem of Redemption Impact when it comes to cryptocurrency
- How a Fully Diluted Market Cap could improve on the current Market Cap system
- How using Realized Capital could provide a more accurate picture of circulating supply by removing lost, dormant, or never-activated coins.
- How The Market-Value-to-Realized Value (MVRV) could incorporate market cycle analysis into market capitalization
- The case for measuring volume and liquidity instead of market cap
- Measuring security expenses as a measure of assessing value
- Measuring community and network health as a means of assessing value
Links Relevant To This Episode
- Cryptoinvestor Weekly Newsletter
- Clay Collins
- Nathaniel Whittemore
- The Nomics Update
- Fidelity Digital Assets
- Cryptolab Capital
- Rethinking Metcalfe’s Law applications to cryptoasset valuation
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Clay: Welcome to Flippening, the first and original podcast for full time professional and institutional crypto investors. I’m your host Clay Collins. Each week, we discuss the cryptocurrency economy, new investment strategies for maximizing returns and storage from the frontlines of financial disruption. Go to flippening.com to join our newsletter for cryptocurrency investors and find out just why this podcast is called Flippening.
Announcer: Clay Collins is the CEO of Nomics. All opinions expressed by Clay and podcasts guests are [00:00:30] solely their own opinion and do not reflect the opinion of Nomics or any other company. This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions.
Hey, this is Clay. Today’s episode is unlike anything we’ve done to date. It’s a bit of an experiment and I’m not sure frankly how it’s going to turn out. I’m crossing my fingers that you like it. Anyway, we’re just about to get into the main content but before we do that, I want to provide two announcements regarding nomics.com the company that produces and funds this podcast. The first announcement is that [00:01:00] we’re experimenting with offering 7-day trials of our paid commercial API.
If you’re fond of Family Office Exchange, FinTech developer or investor and you’re interested in using the cleanest, fastest and highest fidelity crypto market dataset available, then email us at email@example.com. The catch with this free trial is that we require you to meet with us for 30 minutes to help us learn about your use case and allow us to onboard you and an engineer who’ll be developing against our API.
[00:01:30] That said, I don’t think meeting with us is burdensome and regardless of the outcome, I think you’ll walk away with a better understanding of how you can leverage market data to increase returns for your investors. Again, if you’re interested, just send an email to firstname.lastname@example.org. The second announcement is that I’ve launched a brand new podcast which you can find at nomicsupdate.com. As the URL suggests, the podcast is called the Nomics Update. I release this podcast every single weekday.
It’s my personal audio journal as CEO of Nomics. [00:02:00] During each episode, I tell stories from inside our startup including the ups and downs and highs and lows. I also discuss our product roadmap, announced new partnerships and features, and speak to important new ideas shaping the future of Nomics and crypto asset data in general. As a bonus, you’ll sometimes hear me ranting about business strategy, startups wasting too much money, philosophy and venture capital. I also sometimes share stories from my personal life and then immediately regret it like the time I discussed my use of [00:02:30] Adderall which was completely legal by the way. To subscribe to the podcast, go to nomicsudpate.com, find the link to your favorite podcasting platform and hit the subscribe button. Now, to our regularly scheduled program.
Today’s interview isn’t an interview at all. It’s a short audio book about cryptocurrency market caps. Here’s the back-story, a few weeks ago Nathaniel Whittemore and I published an article entitled Crypto Market Cap an in depth review and survey of emerging alternatives. [00:03:00] The article received a lot of coverage, at least by my standards. It was tweeted and retweeted by thought leaders in the space, shared by several newsletters, and the topic of discussions on forums.
Nathaniel and I were frankly pleased and a little surprised by the reception. But one piece of feedback we received is that the article was very long, perhaps too long. This is a fair critique given that the article is just under 6.5000 words. That’s about one fifth of the length of the average book. According to the website Read-o-Meter, they should take the average person about 45 minutes to read which is quite a lot of time in the interruption filled world of web content.
The first time I heard this critique, I recalled an experience I had listening to the book. You see, to proofread articles I often use a text-to-speech engine to read them aloud to me. When I listen to an article that I’ve written, I often spot mistakes that I otherwise wouldn’t catch. So the very first time I listened to the Google speech engine read our article, I had a very different experience with the text. The content was just much more vivid and I was able to pick up my feet and just experience our article in a new way.
[00:03:30] It was around then that I hired a professional voice actor who has experience narrating audiobooks on Audible to create the content that you’re about to hear. So what you’re about to hear is a guide to the metric that dominates discussions of value in crypto currencies namely market capitalization. In this piece, Nathaniel and I review: (1) why metrics matter. (2) the non-crypto origins of market cap. (3) four major critiques of market cap. (4) a review of market cap alternatives. So here without further ado is [00:04:00] our article read by Mark Chan. Enjoy.
Mark: Crypto market cap, an in depth review and survey of emerging alternatives. This piece is a guide to the metric that dominates discussions of value in crypto currencies, market capitalization, written by Nathaniel Whittemore and clay Collins, narrated by Mark Chan.
Chapter one, an introduction. How we measure success shapes the actions we take to achieve it. This truism is felt daily by students around the world forced to push any intrinsic joy of discovery [00:04:30] to the side in favor of accumulating the knowledge that will allow them to perform on whichever standardized tests they next face. It is felt in the creative war rooms of advertising agencies, shelling clickbait content marketing when what they believe the brand really needs is to better define its purpose.
This impulses also will play in public markets where companies are effectively competing to achieve the metrics and key indicators that keep shareholders excited. In a mature and emerging markets [00:05:00] the reflexivity takes on a whole new dimension. In the traditional startup world, companies are easily caught in the beauty contest of trying to raise the most money from the most prominent investors. Regardless of whether they, strictly speaking need that money and premised on the theory that higher raises attract more attention and better talent.
Cryptocurrency is of course and even less mature and even more ill defined market than web and [00:05:30] mobile startups. It is a market where speculation and the promise of the future massively outweighs any rational assessment of current utility. What’s more, the unit at the center of the crypto assets space tokens is a phenomenon different than either shares of equity coming with no guarantees or rights to future cash flows or money as defined in the fiat world. Even those crypto tokens that are attempting to be new money and a global digital reserve currency compete in part by [00:06:00] emphasizing some properties of money over others.
The result is an industry where any objective determination of value is extraordinarily difficult if not impossible. By extension, this heightens the reflexivity of crypto as assets value assessment is largely a function of how value is perceived by market participants. In this setting, there is one metric that is commonly applied across all crypto assets, market capitalization. On the one hand, market cap makes sense [00:06:30] just like you can multiply shares outstanding by current price to get it compared to a sense of how the entirety of a company’s stock is valued.
It makes some intuitive sense that you could multiply the supply of a crypto assets token by the price of those tokens to get an overall value of the network. If this heuristic holds, it makes it easy to compare assets to themselves over time and to the market of alternatives at any given moment. Undoubtedly, market cap has been [00:07:00] the most consistent and dominant metric in this young industry. Whether trying to capture the fear and fomo of a retreat or the excitement of a surge. Headlines inevitably plum for changes in either asset price or market cap.
There are reasons however to be skeptical for almost as long as crypto has used market cap as a metric, there have been those who have critiqued this use and pointed out why at best. It can be misleading and at worst, it can incentivize a host of [00:07:30] unproductive even damaging behaviors. The conversation about market cap matters more today than it ever has. The war drums of Wall Street are beating louder than ever.
In August, NYSE parent company, ICE, announced Bakkt which will begin futures trading in December. Last month the world’s third largest asset manager Fidelity just announced its new custody in buying solution, Fidelity Digital Assets. These are some of the first but will not be the last major [00:08:00] financial institutions to jump into crypto at scale.
Today, the lack of sophistication of our measures, like market cap, sets up a system that is in many ways waiting to be gamed. to continue the metaphor, well up until now that game has been played like tee ball, these institutional movements mean that soon will be in the big leagues. The tremendous force of attention and volume of capital poised to enter means we need to have better tools to actually understand the comparative value of [00:08:30] crypto assets and strength of crypto asset networks.
This essay is a comprehensive look at market cap as a measure of crypto network value, it profiles what’s useful about it, dives into the specific critiques, and explores the alternatives that people are proposing. This last category includes not only better versions of market cap metrics but entirely different ways to conceptualize value. How we measure success shakes the actions we take to achieve it. [00:09:00] Our hope in writing this is that we might do better by the incredible transformative potential of Bitcoin and other crypto assets by aligning our actions with the best possible metrics.
Chapter two, the origins of market cap. What is market cap and why did it become the dominant measure of value? The roots of market cap go back far beyond the crypto markets. In the 1880s and 1890s, Charles Dow began experimenting [00:09:30] with a metric to indicate the overall health of the stock market. The first iteration published in 1884 in the customer’s afternoon letter, the precursor to the Wall Street journal, included nine railroads and two industrial stocks.
In 1896, Dow calculated the first industrial average of strictly industrial stocks with 12 original participants. The Dow is not the mean of the now 30 constituents stocks, but the sum of the price of one share of each. [00:10:00] The problem with the simple stock price comparison is that it doesn’t take into account outstanding supply. Put differently, a stock price doesn’t indicate what percentage of the equity available in the company a single share represents.
Standard and Poor’s designed its market cap weighted index in part as a reaction to the limitation of this approach. The company had experimented with indices since the early 1920s, but published the first S&P 500 in March 1957. [00:10:30] Rather than simply look at a composite of the prices, S&P weighted it’s indexed by their comparative market capitalization. Interestingly, a report from WisdomTree argued that the particular methodology might have been an accident of history do as much to the constraints of the availability of information and calculation tools as to intentional design.
In other words, the team designing the index could look through the annual reports of 500 companies [00:11:00] and multiply the shares outstanding by the current price. What emerged is a metric that whose simple clarity has made it an important market indicator to this day. By normalizing for supply, market cap allows us to understand the overall public market value of a company as compared to other companies.
Market cap also allows us to understand a company’s value as compared to itself over time. The simplicity of the measure also lends itself to quick high level [00:11:00] comparisons of asset value across sub categories such as tech versus retail stocks. It is perhaps no surprise that the crypto markets quickly adopted a version of market cap to measure their emerging assets against one another.
Chapter three, how market cap is calculated. The basic idea of market cap is to multiply the supply of an asset by the price of that asset in order to get a total value. In the crypto markets, the [00:12:00] exact methodology depends to some extent on who is calculating. Price is generally calculated as a composite of the spot price from some index of crypto exchanges. In some cases, such as the small handful of index fund products currently available, there is a more complex and robust system by which those prices are calculated to account for variation in the price of the trading pair.
In other words, it is easy to create a composite price for an asset that trades against US dollars, [00:12:30] but more complicated when that asset only trades against other crypto pair like BTC or ETH. Check out Nomics’ and Bitwise’s thorough articulation of their respective methodologies. Token supply is somewhat more complicated than price. While most stocks have a fixed issuance, most protocols are designed to continuously expand and inflate their token supply over time. Either until a fixed cap is hit as in the case a Bitcoin’s fixed supply of [00:13:00] 21 million or in perpetuity.
In the early years ranking sites tended to favor calculations of total supply as a way to normalize different inflation schedules. As we’ll see, that led to one anticipated consequences in how crypto protocols designed their emissions schedules. Today, the more popular approach is to measure circulating supply. The total supply of tokens currently available to the market. To review, for all intents and purposes, [00:13:30] when someone speaks today about the market cap of a crypto, they’re talking about the price of that token multiplied by the circulating supply of that token.
Chapter four, the four major critiques of market cap. If their positives of using market cap as a measure are things like simplicity and ease of understanding, it should come as no surprise that their critiques as well. For our purposes, I’ve organized them into four primary buckets. Critique number one, [00:14:00] tokens do not equal stocks. There is a fundamental problem with the crypto market cap to stock market cap analogy. To put it simply, tokens are not stocks.
Stocks represents ownership of an economically generative entity. Specifically possessing start give the owner one, a claim on future cash flows and profits. Two, a claim to participate in the upside of a liquidity event such as the sale or public listing. Additionally, stocks come with a set of shareholder rights [00:14:30] around things like information and disclosures. Tokens on the other hand, represent participation in a voluntary value network. They do not come with any claim to future cash flows or liquidity event participation.
In part because the issuing entities are often not structured as centralized economically generative entities, but is decentralized networks or non profits do not, at least in general or so far. come with rights, tokens do have a price, but that price is [00:15:00] not based on the anticipated real value of future profits but instead, speculation about the overall future worth of the voluntary value network, i.e., the long term likelihood that the token stores value and/or is used for exchange.
Now, there are many projects emerging that are attempting to design equity stock like mechanisms into their tokens that would make the stock token analogy more apt. What’s more, there are many experiments with tokens as guarantors of rights to participate in network [00:15:30] governance. These experiments however remain nascent and not even close to the norm of crypto assets that use market cap as a measure. For what it’s worth, the tokens do not equal stock critique doesn’t mean that tokens are less interesting or less valuable than stock, but simply that they are fundamentally different. It’s apples and orangutans.
Critique two, inflation schedules. Another place the token stock [00:16:00] analogy breaks down has to do with issuance. In the realm of equity, the total supplier stocked issued is fixed and can only be changed through a stock split where new shares are issued in proportion to the owner’s previous holdings. It is worth noting that for the purpose of this article, assume every sentence starts with in general. Our goal isn’t to be hyper comprehensive about every edge case and how public markets and private crypto markets work, but simply to paint enough of a comparison [00:16:30] to help understand how tokens are and aren’t different.
Tokens on the other hand are designed with built in emission schedules. In other words, the supply of a crypt those tokens is continuously inflating based on some set of predefined in programmatic rules. This has a couple of important implications. First, anticipated inflation makes it hard to use market cap as a way to compare the value of a crypto asset network over time because there are two moving variables price [00:17:00] and supply. In other words, a larger market cap today doesn’t necessarily mean the crypto is doing better than it was previously. It could simply be that there is more of it.
Second is the issue of comparison across crypto currencies. When comparing the market caps of two different stocks, one can be confident that the comparison is valid because in each case, the price is the price set by the market and the supply represents the total number of shares available for the company. [00:17:30] When comparing crypto assets however, two assets can differ wildly in terms of A, their emission schedules and approaches to inflation. B, how long they have been issuing tokens. In other words, a lower market cap might reflect simply that less of a token has been emitted. This is problematic to the extent that we associate a higher market cap with a more successful cryptocurrency as it creates an incentive for those crypto asset networks to design emission schedules [00:18:00] that distribute more tokens faster to keep their market cap high regardless of whether that decision is right for the network.
Critique three, the challenge of circulating supply. As we saw in the inflation schedules problem, one of the biggest areas of critique with regard to market cap as a metric for crypto asset networks has to do with the challenges of determining what number to use for supply. The concept of a circulating supply the approach which today dominates estimates of [00:18:30] supply used by ranking sites like CoinMarketCap and Nomics was actually a reaction against the previous approach as articulated by Ethereum curator Vitalik Buterin. The previous metric of total supply created a scenario in which it behooved crypto currencies to pre-mine the majority of their tokens and simply hold them in reserve in order to artificially inflate their market cap.
In turn, making them appear like a more successful project and increase demand for the token. [00:19:00] Circulating supply was meant to put an end to that particular type of market manipulation by only counting liquid supply. The challenge, is that there is a number of problems with determining just what is liquid. First, circulating supply approaches tend not to have a way to deal with washed coins. For example, every coin ranking site today list Bitcoin as having between 17 and 18 million in circulating supply. [00:19:30] At the same time however, nearly every credible estimates suggest that some 2.4 to 4 million bitcoins are lost treating these tokens as lost forever would reduce Bitcoins market cap by 10% to 25%.
Second, lost coins aren’t the only illiquid coins that tend to be included in circulating supply. When a cryptocurrency forks from a previous chain, some amount of the newly distributed tokens are never claimed. Meaning that supply estimates that [00:20:00] include those tokens also often significantly over estimate circulating supply. Third, as regulatory scrutiny around ICOs and token sales increases, one strategy projects are turning to distribute their currency is AirDropping where users are sent a certain amount of tokens from a project for free directed or wallet address.
AirDrop had their own difficulty to supply accounting owing to the fact that many if not most AirDrop [00:20:30] participants simply collect all the free tokens they can get with the hope that some become market leaders and they can go back and cash in. In other words, AirDrops tend to increase distribution but also illiquidity. The common thread in each of the above challenges with circulating supply is an over accounting for the supply that is actually available at any given time.
Critique four, redemption impact. It wouldn’t be a long read unless we attempted to coin a new term right? [00:21:00] Even more than inflation, even more than overestimated supply, the biggest challenge to the market cap metric is that for the vast. Vast majority of crypto currencies buy or sell orders of any significant volume at the market cap price would have a dramatic impact on the price.
Redemption impact score is a measure of how likely significant buy and sell activity around a token is to change that token’s [00:21:30] price. It is a measure of liquidity and the realness of a price. The more liquid an asset is and the more distributed supply of that asset is, the better able to absorb meaningful exchange volume without seeing a price shock. Many have commented on the gap between the math of market cap and the practice of how that math would function in the real world. Redemption impact is a way to put some teeth around the idea of what would actually happen.
It was inspired by ETF specialist go [00:22:00] Borger box who wrote one liquidity and redemption metric that large ETFs and multi billion funds test for is the ability to redeem X percent of total assets in Y days with Z percent impact on the underlying market price. In analysis, X is generally between 5% and 10%, Y is one to three days and Z optimized to 0.1% to 1% range. If possible, [00:22:30] when an asset has a low redemption impact score it means that it can sustain its current price through a meaningful redemption of that asset.
When an asset has a high RIS, it means that a significant redemption would have a significant impact on the market price. The vast majority of crypto assets have high RIS which means that their price doesn’t reflect the true ability to act at scale against that price. Reinforcing the idea that market cap is simply a theoretical construct that if anything [00:23:00] is more distracting than illuminating about the reality of an asset.
Chapter five, market cap alternatives. Introduction. In the first part of this section, we’ll look at alternative measures of value that are for all intents and purposes better approaches to a market capitalization style metric that addresses some number of the critiques above. In the second, we’ll look at a group of alternative measures of value whose proponents [00:23:30] argue might be either better or at least complementary ways to look at the overall value of crypto asset networks.
Market cap improvements: improvement number one, approximate fully diluted market cap. Summary: fully diluted market cap is an attempt to normalize circulating supply by measuring the market cap at a fixed point in the future sufficiently far away that supplies of today’s assets become comparable. Originators and proponents, [00:24:00] Messari owned OnChainFX is one of the primary proponents of fully diluted market cap using the year 2050 as their supply benchmarking point.
Their methodology has been applauded by many including recently USVs Fred Wilson. More info: approximate fully diluted market cap is an attempt to fix the disparity and emission schedules and lifetime circulating supply between different assets because tokens are mined, minted or [00:24:30] released on a specific timeframe. Market cap and specifically circulating supply can fail to tell the story of how one asset compares to another. One of the assets may simply be newer.
To reiterate, this doesn’t matter in a world where market cap isn’t used to judge the strength of an asset. When it is however, it creates an incentive for protocols to emit more of their supply faster. Approximate fully diluted market cap is a methodology [00:25:00] to address this problem by normalizing all supply schedules for a specific date in the future. Using the published emission and inflation schedules for various assets, you can calculate what the anticipated circulating supply will be.
Originally, OnChainFX called, This year 2050 market cap. Selecting 2050 as the point sufficiently far in the future to make different assets comparable. The term was confusing as they assume that year 2050 [00:25:30] meant some projections of the future price or success of the asset rather than simply a mathematical zoom out of the supply based on available data. The name, approximate fully diluted market cap was adopted to better reflect the idea. We say approximate to reflect the idea that in some cases, the measure is simply mostly diluted.
This owes to the fact that certain protocols have ongoing emission schedules extending far into the future. [00:26:00] Approximate fully diluted market cap is not without its critiques. The first is that, even selecting for relatively far out point like 2050, there are still many protocols that are designed to continue to inflate their supply in perpetuity making it difficult even for a future point of comparison to be a true apples to apples supply comparison.
Perhaps an even bigger challenge for the metric is that when calculating expanded supply, it holds price constant. [00:26:30] As thought available supply didn’t have a direct impact on price. In reality, more supply being emitted would almost assuredly impact the price making it challenging to make conclusive assessments of overall network value from asset to asset comparisons. These critiques are not to delegitimize the value of a proximate fully diluted market cap which is an earnest and thoughtful attempt to improve market cap. Instead, it’s to point out that even when one tries to fix one problem of crypto market [00:27:00] cap, another problem tends to pop up. Perhaps then, we need a bigger change.
Improvement number two, realized capital. Summary: realized capital is an attempt to get a more accurate picture of circulating supply by removing the lost, dormant, or never activated coins. Originators and proponents: realized capital was developed by Nic Carter and Antoine Le Calvez and unveiled by Nic Carter at [00:27:30] Baltic Honey Badger 2018. More info: one of the biggest problems with the circulating supply number most market cap formulas use, is that it tends to significantly overestimate actual supply by including tokens that aren’t actually available to anyone.
Realized capital takes advantage of UTXOs or Unspent Transaction Outputs. Gavin-Andresen defines UTXOs like this. UTXO is geek speak for Unspent Transaction Output. [00:28:00] Unspent transaction outputs are important because fully validating nodes use them to figure out whether or not transactions are valid. All inputs of a transaction must be in the UTXO database for it to be valid. If an input is not in the UTXO database, then either the transaction is trying to double spend some Bitcoins that were already spent or the transaction is trying to spend Bitcoins that don’t exist.
Realized capital aggregates all UTXO at their price of [00:28:30] last movement to come up with the sum total for the value of the crypto asset network. For UTXO, a 14.7 BTC last moved on Halloween in 2011 when BTC was $3.12 would add approximately $45.86 to the realized cap. For Bitcoin, the granddaddy of cryptos, realized cap is a good way to address coins that have been lost over time. For forks like Bitcoin cash, realized [00:29:00] cap addresses tokens that were never claimed or activated. In his Baltic Honey Badger presentation, Nic Carter pointed out that while BCH is market cap topped out around $60 billion, its realized cap peaked at more like $11 billion.
The difference between the two wasn’t lost coins like in the case of BTC, but owed to the fact that many people never activated BCH, AirDropped to them in August 2017. In the same presentation, Carter calculated the [00:29:30] realized cap of BTC at approximately $88 billion as compared to a then market cap of approximately $110 billion. This ratio as we’ll see in the next section becomes more relevant.
This ratio, as we’ll see in the next section becomes more relevant. One weakness of realized capital that Carter himself pointed out, was that it can’t tell the difference between coins that are long lost and coins that are long held with intention. Net-net, the inaccuracy of a version of market cap that includes lost coins is almost assuredly [00:30:00] more egregious than that which includes long-term holders.
Improvement #3: Market-Value-To-Realized-Value Ratio. Summary: the market-value-to-realized-value, MVRV ratio, is an attempt to incorporate market cycle analysis into market capitalization by determining how comparatively over or undervalued an asset, specifically bitcoin, is at any given moment. It is calculated simply by dividing the [00:30:30] market cap by the realized cap. Originators and proponents: David Puell and Murad Mahmudov proposed MVRV based on the realize capital work of Carter and Le Calvez.
More info: in their introduction to MVRV, Puell and Mahmudov make the point that both market cap and realized cap tell a different story. Market cap tells the story of the state of the [00:31:00] relative hype and excitement in the market, in both exuberance and despondency. Realized cap, on the other hand, not only strips out the lost coins, but also indicates where groups of long-term legitimate buyer-holders entered into their bitcoin positions, with local and immediate emotions and manias stripped out.
The relationship between these two measures becomes particularly interesting for understanding the market cycle. As hype grows, new demands floods the market, driving the price up, [00:31:30] expanding the market cap, and ultimately increasing the MVRV ratio. On the other hand, when the market contracts and becomes despondent, the price, market cap, and ultimately MVRV ratio come down to earth.
Puell and Mahmudov suggest that the historic MVRV ratio indicating bitcoin being overvalued, is 3.7. To them, however, the even more interesting number is when MVRV equals one or lower. Those are the period, historically, [00:32:00] where the market has underpriced bitcoin relative to its base level value to the buyer-holders who aren’t subject to market manias. Consequently, these periods have tended to be good times for accumulation. MVRV contributes to market cap alternatives and ability to add market cycle context to otherwise static measures.
Chapter 6: Market Cap Versus Value Assessment Alternatives. Introduction: The market cap alternatives above are attempts to [00:32:30] provide a better macro indicator build on the price X supply heuristic. But of course, that entire heuristic is just one of the ways to look at the health of a crypto asset network. In this section, we look briefly at a handful of different approaches to determining the overall value of a network.
Alternative number 1: Volume and Liquidity. As discussed above in the market cap critique section, one of the major problems with market cap measures historically, has been that they tend [00:33:00] not to reflect the reality of true crypto asset liquidity and redemption impact. Why not then simply measure liquidity itself? The idea of liquidity and volume as an indicator isn’t new. Most coin ranking sites list 24-hour volume right alongside price in circulating supply.
One indicator that many use is Network-Value-To-Transaction Ratio or NVT, popularized by Willy Woo. NVT is measured as price times supply [00:33:30] divided by transaction count. NVT is an indicator of the strength of a crypto asset as a payment network or settlement layer as compared to its market value. When NVT is high, it means that the valuation of the network is outstripping the actual value being exchanged with the network. When NVT is low, on the other hand, it may indicate that the overall network is being undervalued compared to the utility it is providing.
Another indicator of volume [00:34:00] strength popped up recently, when a number of prominent community members pointed out a metric called Buy Support, introduced by coinmarketbook.cc. CMB defines Buy Support as the sum of buy orders at 10% distance from the highest bid price, using exchange data from a handful of prominent exchanges including BitMEX, Binance, Bithumb, Bitfinex, OKEx, Huobi, Bittrex, Poloniex, KuCoin, [00:34:30] Cryptopia. They also measure a Buy Support Ratio, which is the Buy Support of an asset as a relative percentage of the Buy Support of bitcoin. The idea is to understand how liquid the asset is by understanding how many orders are preparing to buy, and Buy Support does certainly show how illiquid most random ICO tokens most likely to hold up their market cap as a health indicator are.
On the other hand, almost as soon as CMB begin to be noticed, another [00:35:00] large portion of the community called out the problems with using public buy orders as a proxy for liquidity. The issues brought up include: (1) most people who want to buy at a price different than the current, won’t want a lock up their money on an exchange. They’ll simply wait till the price moves closer to what they want. And (2) order books are easy to pad and easy to spoof. Indeed, fake volume is one of the biggest problems in crypto. In March of this year, [00:35:30] Sylvain Ribes called it a crypto-plague and argued that more than $3 billion of volume was faked, including 93% of the volume on the then number one exchange rated by volume, OKEx.
One other interesting liquidity metric comes from anonymous trader Ray, Retail Trading Volume. The goal of Retail Trading Volume is to understand what percentage of overall trading volume, using bitcoin as a proxy, is coming from retail, i.e., infusions of new money [00:36:00] versus active traders. To determine the percentages, Ray compared volume from exchanges used most prominently by traders to a basket of exchanges used by retail investors. During the 2017 bull market, RTV averaged 46%, meaning new money was driving growth. Average retail volume in 2018 at the time of raise riding in June, was approximately 15% and that hit a low of 5.8%, indicating that most of the volume [00:36:30] was traders. Like MVRV, Retail Trading Volume adds a market cycle picture to the overall liquidity and volume health indicator.
Alternative 2: Security. A fundamental principle of blockchains is that they are costly to secure from attacks. One idea the follows from that is to look at how much money has been spent securing the network as a determinant to value. In the same presentation where he introduced realized capital, Castle Island Ventures’ [00:37:00] Nic Carter shared a rough heuristic he called Accumulated Security Spend. The principle of Accumulated Security Spend, which can’t be easily acronymized for obvious reasons, is to look at aggregate miner revenue over time as a proxy for network value. It is based on the assumption that miners have fiat denominated cost and have to immediately sell some portion of the Bitcoin they mine to cover those costs. Because there have to be buyers of that asset, the proceeds of BTC sales by miners gives the [00:37:30] minimum floor for the wealth inflows to bitcoin.
Analyst Matteo Leibowitz has also recently explored the relationship of security and network health in the context of the Fee Ratio Multiple, which looks at what it would take for proof of work change to secure themselves exclusively through transaction fees rather than through a combination of transmit fees and block rewards. Leibowitz measures FRM as miner revenue, block reward plus transaction fees divided by transaction fees, and [00:38:00] argues that FRM implicitly measures the strength of an asset’s properties as a store of value. A low FRM suggest that an asset can maintain its current security budget, miner revenue, without having to rely on an inflationary subsidy. Conversely, a high FRM suggest that an asset will require heavy inflation via block reward subsidies in order to maintain its existing security budget.
Alternative 3: Community and Network Health. [00:38:30] Finally, as we think about the overall value in health of a crypto asset network, we can look not only at outputs but at inputs and the strength of the community of contributors to that network. In a tweet in 2016, Monero lead Riccardo Spagni, AKA fluffypony, articulated this point of view saying, “We don’t view market cap as a measure of success. Commits, [00:39:00] issues closed, and network health matter.” Some coin-ranking sites have picked up this idea and run with it.
CoinGecko, for example, pairs it’s normal market indicators with additional tabs around both social network strength and developer network strange. The social section tracks Twitter followers, Facebook fans, Telegram group members, and Subreddit subscribers. The developer section, meanwhile, looks at code changes, commits in the last four weeks, contributors, watchers, forks, [00:39:00] and starves. These community indicators, of course, do not give us the same degree of actionable information as market metrics. At the same time, they are in many ways more powerful as indicators of future network success than any immediate snapshot of price and market cap. The fact that these types of metrics are so much less prominent, is a reminder that the demand for statistics like market cap, comes from investors who want to make money now more the long-term network builders.
[00:40:00] One exploratory metric that combines price with network value is the Network Value to Metcalfe, NVM Ratio, pioneered by Cryptolab Capital, the experimental methodology tracks asset price against daily active addresses as a way to understand whether an asset is relatively overvalued or undervalued, as compared to the growth in its network of users. For more, check out Rethinking Metcalfe’s Law Applications To Crypto Asset Valuation.
[00:40:30] Chapter 7: Conclusion. Any full look at the concept of crypto market cap is bound to conclude that it is an imperfect measure at best and genuinely distracting at worst. In the short-term, it seems unlikely that we’ll see the industry move to an alternative. That said, the emergence of alternatives and speed with which they’re being considered and even integrated into coin ranking products is extremely promising for this young asset class.
[00:41:00] The conversation about market cap is more than a question about metrics. It is a conversation about value and, specifically, how to understand the overall value of crypto asset networks. If this is indeed a new asset class, it feels inevitable that the way value of that as it is measured will diverge to some extent from previous. By continuing to improve the metrics by which we measure network value, we don’t just make it easier [00:41:30] for traders to compare coins but make it easy for teams and communities to benchmark their work to make their networks value. Better metrics mean better networks.
About the authors: Nathaniel Whittemore works with cryptofunds and projects on communications and strategy, with an emphasis on understanding and utilizing market narratives. On Twitter, @nlw, he is known for his long read Sunday threads. Before accepting the call of [00:42:00] Crypto Cthulhu, Whittemore built a global impact program design center, later endowed for $100 million at his alma mater, Northwestern University, and was eventually lured to Silicon Valley to help scale impact with change.org. In his decade in SF, he bounced between venture capital and helping big corporations like Coca-Cola, L’Oréal, and Mastercard understand new technology and adapt their marketing strategies. He is glad to have his soul back.
[00:42:30] Clay Collins is currently the CEO and co-founder at Nomics, which has a crypto market cap listing of its own, and Board Chair at Drip and LeadPages. Clay host The Flippening and Nomics Daily Update podcast. Before co-founding Nomics, Clay founded LeadPages, where he drove growth to over 48,000 paying customers and 175 employees, led the company’s acquisition with Drip, and raised $38 million in venture capital financing. Clay [00:43:00] is most responsive on Twitter and LinkedIn.
This has been Crypto Market Cap, and in-depth review and survey of emerging alternatives, written by Nathaniel Whittemore and Clay Collins, narrated by Mark Chen. The end.
Clay: That’s it for this week. To sign-up for a free crypto investing newsletter, listen to other episodes, or get the show notes from this episode, please visit flippening.com. I also invite you to check out the startup that funds this podcast, [00:43:00] Nomics, at nomics.com. Finally, if you’ve got value from the show, the biggest thing you can do to help us out is to leave a five-star review with some comments and feedback on iTunes, Stitcher, or wherever you listen to podcast. Thanks for listening and see you next week.