With the explosion in the popularity of cryptocurrency, investors are trying to figure out what’s the best way to value a cryptocurrency. Now, most investors and financial media use traditional valuation methods (such as market cap) to report the current value of bitcoin. You’d read headlines like “Bitcoin now has a $1 trillion market cap.”
However, using the market cap of bitcoin is possibly the most misleading number you can assign to bitcoin.
The Biggest Drawback About Using Market Cap For Bitcoin
Obviously, the use of market cap in cryptocurrency was borrowed from the world of common stocks. However, cryptocurrencies have one distinct feature that make them different from stocks: A large fraction of crypto coins is actually lost forever.
Shares, of course, don’t ever get lost because the Depository Trust and Clearing Corporation (DTCC) keeps track of every investor’s stock certificates. However, there’s no such thing as DTCC for bitcoin. (It’s by design to remain decentralized.) So this means when bitcoins are lost, they are lost forever. As a result, there are stories of bitcoin owners who lost their hard drives or forgot the passwords that hold access to millions of dollars worth of cryptocurrency. Unfortunately, these bitcoins are long gone forever.
A Telling Graph About “Lost Bitcoins”
This graphic reveals there are currently over 1.7 million bitcoins that have never been removed from their original miners’ addresses:
With the “Miner Unspent Supply” line flattening, analysts believe that 9.5% of the circulating supply of bitcoin will never re-enter circulation. Why? Of course, these miners might have lost these bitcoins. What’s more, Portfolio Insider analysis reveals that nearly 95% of these “lost” bitcoins were mined more than 10 years ago. And yet, they never left original miners’ accounts.
So, it’s reasonable to conclude that most of these bitcoins are indeed lost.
New And Improved Calculation For The Market Cap
As a result, “on-chain analysis” becomes a pivotal field in crypto. It leverages information found on the public blockchain, and analysts study blockchain data such as transaction details, block details, and smart contract info to draw up valuable insights.
And an improved version is called “Realized Capitalization.” The realized cap measures each bitcoin’s value at its price the day it was last moved.
So, Bitcoin moved on the blockchain today will contribute today’s price to the market cap, while Bitcoin that moved in, say April 2013, is valued at $410. It’s not a perfect measure by all means, but it’s arguably more accurate.
Another Benefit Of Realized Capitalization
One benefit of the realized cap metric is that it’s less influenced by sudden price spikes, such as Bitcoin’s red hot run in 2017. It accounts for the fact that few coins were trading at such unusually high prices, and that this small amount of coins did not reflect the entire network’s value at the time.
It’s similar to how Warren Buffett prefers to measure the book value of Berkshire Hathaway (rather than share price). Why? It’s a more conservative way to measure its intrinsic value — which is less volatile than random price movements.
Is Realized Cap A Closer Measurement Of Bitcoin’s Intrinsic Value?
Some analysts believe that Realized Cap is a true measure of bitcoin’s intrinsic value because of how the price behaved in the last decade. Namely, when the market cap of bitcoin went below its realized cap, the price quickly rose back above.
In other words, investors seem to believe that bitcoin is undervalued if the market cap is below the realized cap.
“Deep Cold Storage”: The Biggest Drawback About Realized Cap
This cutting-edge metric is not without drawbacks, though. The biggest challenge is determining the deep cold storage of coins. It involves storing bitcoins offline— which is entirely separate from any Internet access. The biggest source of “deep cold storage” is believed to be the personal stake of Satoshi Nakamoto — the pseudonym used by the individual or group of people who developed bitcoin.
His stake in bitcoin is so enormous that when Coinbase went public on Wednesday as a direct listing on the Nasdaq, it released documents saying that Satoshi Nakamoto could cause significant damage to the company. More specifically, the filing mentioned Nakamoto’s personal stash of bitcoins, which totals over 1 million would make him theoretically one of the wealthiest people on Earth.
Therefore, Nakamoto could destabilize the entire crypto market and throw Realized Cap into shambles if the creator decided to transfer his bitcoins, which are valued at tens of billions of dollars. For this reason, it’s recommended to compare the traditional market value against the realized value — both as a ratio and separately.
Realized Cap Is An Excellent Way To Measure Bitcoin’s True Value
Regardless of some drawbacks, the realized cap offers an excellent way to eliminate some of the lost, unused, unclaimed coins from our total value calculations and arrive closer to a true valuation of bitcoin.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Go to Source
Author: Portfolio Insider