Harvester separating the wheat from the chaff. Source

As used today across the crypto-world, market capitalization (market cap) can be an extremely misleading, even deceptive, metric that’s nonetheless used nearly exclusively to compare cryptocurrency valuations.

This is a brief overview of market cap and its inherent flaws as a cryptocurrency comparison metric, and an outline of some alternative metrics with promise to provide improved comparison between cryptocurrencies.

Market cap

Derivation 1. market capitalization = total coin supply * daily trading price Dv. 1 units: $USD = COIN * ($USD/COIN)

Traditional assets are often valued according to their market capitalization. However, owing to the peculiarities of cryptocurrencies relative to traditional assets, a number of rather serious issues arise when applying an analogous metric to cryptocurrencies.

The cryptocurrency market cap metric is defined by Derivation 1: where the COIN unit substitutes for the particular coin in question, e.g. BTC, BCH, ETH.

It is a simplistic metric that can be profoundly misleading (and often intentionally deceptive) when applied to cryptocurrency valuations.

Basically, there are two primary problems with cryptocurrency market cap:

All new forks initially inherit their parent blockchain’s coin supply, regardless of the actual initial uptake, adoption, and use of the airdropped coins.

2. Many centralized shitcoins can trivially manipulate their own market cap due to limited liquidity or by simply expanding their supply of coins.

Note: the above ‘coin’ euphemism of course simply refers to unspent transaction outputs (UTXOs; or virtual UTXOs, for account based coins).

Essentially, the first fault allows anyone who can trivially fork Bitcoin to create an alt-coin with apparently equal historical context to that of Bitcoin. However, an examination of the underlying metrics of forked blockchains reveals pronounced deficits, relative to Bitcoin, which are all but ignored by the market cap metric.

For example, only a small fraction of newly airdropped coins are ever even activated (spent on new fork), i.e. there is extremely low uptake and adoption of airdrops. Nonetheless all the historical coins present at the time of the fork count towards the new altcoin’s market cap.

One of the primary measures of how valuable a currency is is how widely it is used. It doesn’t take a great amount of research to discover that the vast majority of forked blockchains have no real use case and, as such, are not being used. The smoking gun: negligible activity of their coins, indicated by underlying activity metrics such as active addresses, bitcoin days destroyed (BDD), transaction and payment counts, etc.

As a direct result of the first flaw, for those coins with negligible real-world usage, the second flaw allows for the direct manipulation of their market cap because of their inherent lack of liquidity.

Additionally, centralized altcoins may manipulate their market cap by simply removing their coin cap (if any) and inflating the supply of their scamcoin, at will, ad infinitum.

Because of these two inherent flaws, others researchers have decided to stop using the term ‘market capitalization’ altogether (coinmetrics.io uses the term network value instead). I toyed with the idea of calling it ‘market crap’ throughout; but upon review, decided this would likely introduce needless bias.

Case study

BCash, a relatively recent fork of Bitcoin, has been able to piggy-back off Bitcoin’s blockchain history for over a year now. By no means is it the only forked shitcoin that owes its seeming success (and continued existence) almost exclusively to the misuse of market cap. Similarly illustrative comparisons may be applied to the shitcoin of your choosing.

I’m picking on BCH here because I recently published an article that serves as a good case study to illustrate this point: Bye bye BCash: good riddance to bad actors. I apologize if it’s a little over the top; but honestly BTrash, you guys started it by continually trying to hijack the Bitcoin brand for personal gain.

Tl;dr:

As for the main BCH chain, the following [metrics] tell a story of plummeting prices… falling volumes… decimated transaction and payment counts… sputtering active addresses… negligible block sizes… dust-level fees… and nose-diving mining difficulty.

Yet, despite all the above BCH metrics clearly signalling the floundering state of the BCash blockchain, it remains in the top five leader-board of all major exchanges, by market cap. All major exchanges continue to use the flawed metric, ubiquitously and nearly exclusively, to compare valuations between cryptocurrency markets.

Figure 0. Monkeys hitching free ride. Source

Partners in crime

By continuing to promote the mainstream use of market cap, I would argue that these exchanges are not only enabling this deception but are often directly responsible for the present plague of utterly useless altcoins, scamcoins, and shitcoins. I view them as a hoard of hitchhiking monkeys on the back of Bitcoin, see Figure 0.

Undoubtedly, most have been used by exchanges and thieves to confuse and scam the public, tarnish the Bitcoin brand (along with a meager handful of other useful coins), and generally mire adoption of cryptocurrency.

This bad state of affairs need not continue; what follows is a brief overview of a few proposed alternative metrics that I believe allow for a more grounded, informative, and transparent comparison between cryptocurrencies.

Note: usefulness is certainly subjective; for example, shitcoins are very useful to their lead scam-heads. I don’t wish to become mired in the perpetually raging shitcoin-wars but instead to highlight a few alternative crypto-valuation metrics.

One potentially useful thing that all public blockchains are good at generating is data. So without further ado, let’s get researchy!

Methodology

The researchers at coinmetrics.io have put together a comprehensive plotting tool for quickly comparing a wide range of metrics and cryptocurrencies. Owing to its ease-of-use, I’ve opted to primarily use figures generated with their plotting tool, rather than compile data and generate figures myself. This allows me to spend more time on interpretation, less on coding; thanks coinmetrics.io, you da real MVP!

For more information regarding their data compilation methodology, see coinmetrics.io utility description and FAQ.

The metrics discussed below have been conceived by others (see Acknowledgments section). Here, I’ve simply tried to further clarify their derivation formulas (Dv. 1, 2, 3, 4), respective units (which can often add significant clarity and intuition to equations), original purposes, and potentially novel applications.

NVT

Derivation 2. NVT = market cap / total daily transaction throughput Dv. 2 units: DAY/COIN= $USD / [($USD / COIN) / DAY]

Network value to transactions ratio (NVT; Dv. 2; Fig. 1) was first proposed by Willy Woo, who in Sep. 2017 published an article in Forbes explaining NVT. The idea behind NVT is to be semi-analogous to the price-earnings ratio (PE Ratio) used to valuate traditional assets. It can also be thought of as a measure of “inverse monetary velocity.”