I was just (January 3, 2018) checking on today’s price for Bitcoin—what can I say, I’m morbidly fascinated by the spectacle of thousands of people shooting craps with their retirement savings—and was once again struck by the sheep-like acceptance of the term “market cap” by financial wonks. Does nobody else object to the crypto-currency mafia appropriating this term and using it in a wildly misleading way? It is the miracle of decentralization that nobody is legally responsible for the sales pitch.
First of all, the idea of market capitalization applies to equities. It is the number of outstanding equity shares in a company multiplied by the current price of a share. Its main use is for sorting companies into buckets by size, with the aggregate value of the shares being a rough proxy.
The key word in the definition is “outstanding,” which means shares that are out in the world and can be traded. It specifically does not include shares that a company holds in itself. This makes sense; the shares a company holds in itself might as well not exist—they’re like money that the government hasn’t printed yet. When a company does decide to sell shares that it holds, it is a big deal because it dilutes the value of the shares that are out there. Conversely, buying back shares (which is not uncommon for companies doing well) is an effective way to return money to the shareholders because it increases the value of the shares that are not bought back.
This isn’t a quibble about using the wrong term when everyone actually knows what you are talking about; applying it to currency is truly bogus. OK, but you could argue that Bitcoin has a market price, and while it’s not an equity, each Bitcoin is still one unit out of the total mass of Bitcoins outstanding. Is that so different from an equity share representing one unit of the total value of a corporation? You could further argue that because there is no central authority that holds piles of Bitcoins that have not been released to the public, all of the Bitcoins mined thus far are “outstanding.” Therefore, if you multiply the number of coins that exist by the price, it’s reasonable to call it “market cap.”
You could argue that but it’s a highly dubious way to look at it. The catch is that while there is no Bitcoin Inc, there is a small group of insiders (the famous whales) who together hold a large but unknown proportion, possibly the majority, of existing Bitcoins, and who are widely believed to work together to keep the market stable, i.e., the price up.
That should sound familiar if you read the second paragraph above. The only meaningful difference between coins that a cartel of big speculators bought for pennies years ago and shares a company owns in itself, is the few pennies each that the coins cost. The coins have never been in play, and just as a company’s share price would crash if it dumped shares it owns, Bitcoin’s price would crash if these holders dumped theirs. Supply and demand. Likewise, at least until the price hit its current stratospheric level, the big speculators also bought, not just to own, but to keep the price up. The big difference is that if the board of directors of IBM decided to sell previously unreleased shares, or bought up share in itself, it would be a matter of public record.
If any reasonable analog of market cap for Bitcoin and similar currencies is possible, it would require some accepted way to compute the number of coins that can be fairly considered to be a part of the supply available for use and purchase.
The trouble is, it’s not cut-and-dried. For instance, the first one-million coins originally mined by Nakamoto are generally assumed to be lost, and probably most people would agree that they should not be regarded as “outstanding” unless proven otherwise. On the other hand, a coin that was part of a transaction yesterday certainly should be. But what about stacks of coins sitting at the same address for year after year since soon after they were first mined, back when the price was pennies and nobody but a few techies had ever heard of Bitcoin? They’re either lost or they’re just sitting there to be cashed out when the time is ripe. Does it make sense to think of them as being out in the marketplace when they have never contributed to the community’s collective judgment of the market price? Releasing them would be almost like printing money. What about coins that were acquired for non-negligible money, say, a buck or two, a couple of years into Bitcoins inception? How about the same ownership pattern at ten bucks? It’s a Sorites problem. If an address holds a dozen coins bought for a dollar each, it’s probably a hobbyist who’s decision to hold should be regarded as tactical for the owner, not strategic for Bitcoin—they’re in the market, it’s just that the owner hasn’t seen the right price yet. But what if that address is one of 10,000 addresses, with 25 coins each, filled one after another, five minutes apart, and never touched since? My sense of it is that coins acquired at significant cost are always outstanding because they have been in the marketplace, but coins that are acquired at a negligible cost usually are not, particularly if they are held in large numbers. The key thing is whether a given coin has been in play since the value ceased to be negligible.
The blockchain has all the information you’d need because it records the address associated with every coin at every moment since the inception, but deciding what constitutes “outstanding,” would require the wisdom of Solomon. Nobody benefits from a more refined market cap number other the hapless schnooks pouring money in from the outside. There’s no constituency for a fair number.
Even if the crypto-currency fairy came down and made it happen by magic, market cap would be an incomplete idea the primary function of which is to tart up what is basically a distributed Ponzi scheme with official-sounding terminology. For it to be useful, you’d need a second number to go with it, which is the complimentary estimate of the number of Bitcoins that exist but are not counted as outstanding. The ratio of the two could be called the undertow—a measure of the force sucking your money out to sea.