Rethinking Bitcoin's $10 Billion Market Cap

Amid increasing hype about blockchains and distributed ledgers, the  value of global cryptocurrency markets has risen rapidly so far in 2016. As of mid-June, the value of all blockchain-based currencies in circulation was $14.37bn, and the price of bitcoin was, as it has been historically, a leading driver of this growth. At June's highs of $700, the price of bitcoin had risen almost $300 since the end of May. As the value of bitcoin continues to surge, many have looked at  bitcoin’s market capitalization as an indication of bitcoin's value.  With a total value of all bitcoins in existence at $10bn, the bitcoin market is currently more valuable than one of the largest social media companies in the world, Twitter. Some have argued, however, that it's unclear exactly where exactly  the bitcoin market cap stands now, asserting it's impossible to  determine with any sense of accuracy the value of all usable or  spendable bitcoins. Due to factors – including the notion of "zombie" bitcoins and the  number of bitcoins stored by long-term, buy-and-hold investors – these  market observers believe it's difficult to make summary statements about  the vitality of the market or its current trajectory. While this may be a minor thing, this difficulty in profiling the  size and character of the bitcoin market is telling of the challenges  the digital currency has in defining itself to the broader public. In  addition, it points to pitfalls bitcoin will likely have to clear in its  near-future. More importantly, the discussion of how to capitalize a finite,  virtual currency speaks to the debate of what the future of digital  commerce may look like. 

Defining capitalization

To understand the significance of a capitalization to a market, one  must understand what a market capitalization is and how it is  calculated. Market capitalization is defined traditionally as the price per share  for the commodity at the time of the capitalization, multiplied by the  current number of outstanding shares in the market. For most  publicly-traded companies and securities, the capitalization is an  simple way to ascertain the health of the market in comparison to where  it was previously and comparative to other securities being traded. The problem with the bitcoin market, however, lies in the definition of "outstanding shares." Most analysts use the traditional definition of "number of tradeable  units that were active in the last two weeks" to determine market cap.  While this is a perfectly acceptable for most securities, this  definition has two unavoidable holes when it comes to bitcoins. First, if bitcoins are a digital currency, the outstanding shares definition fails to adequately account for dormant coins. In 2014, NVIDIA engineer John Ratcliff theorized  that approximately 30% of the current bitcoin supply is made up of  "zombie bitcoins" that have been inactive for more than a year. This  number includes bitcoins connected to inaccessible wallets,  government-seized bitcoins, “burned” bitcoins and bitcoins abandoned  during the early days of bitcoins – including Nakamoto’s mythical stash  of over a million bitcoins. Due to bitcoin’s security and lack of centralized authority, any  attempt to access these lost coins – short of brute-forcing their  wallets' passwords – is impossible. As such, these coins exist, but they  are effectively unusable by anyone except those in possession of the  related private keys. These bitcoins, combined with those that are intentionally dormant –  as either commercial reserves or as personal savings – account for coins  that were used in good faith, but are currently not "active" in the  market. Today, intentionally or unintentionally dormant coins are not reflected in most calculations of the bitcoin market cap. Second, if bitcoins are a commodity, then the bitcoin market  capitalization – as it is calculated today – is a reflection of trade  volume of newly mined and short-term traded coins, and not long-term  investments. As previously argued, this would exclude intentional  dormancy, making the bitcoin market cap a reflection of the current  fluidity of the market and not its overall worth. Still, Stephen Holmes, CTO of the Digital Banking Lab at IT  consulting firm VirtusaPolaris, argues that using the market  capitalization to estimate the bitcoin market’s worth is missing the  point. “Bitcoin is a store of wealth. The advantage is that it is a finite  currency so it cannot be deflated because of the printing of additional  bitcoins, unlike today’s flat currency," said Holmes, adding: 

"Scarcity is the real value of bitcoin… exchange rates will by definition fluctuate over time.”

Security concerns

One of the characteristics that directly affects the value and  capitalization of cryptocurrencies is that they are scarce, meaning that  they are goods that exist in a finite quality. If one was to say that a cryptocurrency is a commodity in the  traditional sense, one would expect to be able to trace a  cryptocurrency's units to an actual physical entity that would confirm  the unit’s uniqueness and ownership. What prevents this from happening  is the blockchain, an openly shared register that stores and verifies  the transactions of every cryptocurrency unit. The blockchain makes the  notion of simply copying a bitcoin meaningless. This reinforces the notion of an electronically-assured digital good,  but it also creates a situation that may not be friendly to newcomers. For example, a novice user who has lost their wallet’s password or a  casual user who has had their laptop stolen will also lose access to his  or her bitcoins. Though there are storage solutions available, this  feeds fears that investors who buy into the market could lose custody of  funds, something they may not have with more traditional assets. "It's a double-edged sword," said Chris McAlary, chief executive officer of Coin Cloud, a bitcoin trading and ATM company. He continued: 

"People are drawn to bitcoin because it empowers them to  take on the advantages that come with existing outside of the  traditional banking system. With that come some risks which novice users  may not be ready for. Successful bitcoin companies will build products  that minimize that risk."

Zombies and the future

The question of “zombie” bitcoins is also important because of what  it represents about this emerging technology. It is theoretically  possible for digital goods, such as downloadable videos, music and  games, to be digitally protected using a blockchain. Such a scheme could make media ripping and non-authorized sharing – such as peer-to-peer downloading – pointless. This, however, opens up the possibility that assets are lost. If a  product is expected to be sold digitally, many would agree that there  must be a mechanism in place to facilitate recovery – something a  blockchain in its present form cannot do. "With any asset there is a risk of losing it. Bitcoin is no different," said Holmes, adding: 

"The only real difference is that with bitcoin you have  to carefully secure the bitcoins and that means putting them in a wallet  and best practice is to hold them offline. Key management has been an  ongoing challenge in the IT industry so it could be argued that this is  one of the potential weaknesses of any cryptocurrency."

In considering the true value of the bitcoin market, one must take  seriously the question of lost wealth and the validity of the efforts to  recover it. Due to the fact that the market has not embraced wealth  recovery as a requirement, it may ultimately be impossible to truly  quantify the size of the market. To some bitcoin enthusiasts, this is a perfectly acceptable situation. "A few years ago, I lost my key to my home safe," Holmes said. "After  carrying the heavy safe to a number of locksmiths and getting nowhere I  finally visited one and literally within two minutes he had opened the  safe. Locksmiths and wallet crackers are actually a healthy development,  providing that the cracking is done with consent." He added that these concerns, as with bitcoin's market cap question,  are simply issues that will be solved over time, concluding: 

"As it did at the beginning of the dot-com boom, the market will provide what it needs to survive."

Market graph image via Shutterstock

Source: http://bit.ly/29xHdqx