No, bitcoin is not “the ninth-most-valuable asset in the world�

You might have noticed that the bitcoin is . . . mooning.

No, we don’t mean that the bitcoin bros are showing their bottoms to the rest of the world (well, not literally anyway). What we mean is that bitcoin has been on a skyward trajectory ever since it climbed above $20,000 for the first time ever in mid-December, and on Wednesday morning reached an all-time-high of $35,751, according to Coindesk.

Here’s a chart showing bitcoin’s path over the past 12 months (screenshot also from Coindesk):

Pretty tasty huh? Hardly surprising, then, that there has been so much giddiness and excitement in cryptoland in recent days. And one of the things the bros seem most animated about — apart from their swelling digital fortunes and imminent lambos/Teslas — is the idea that bitcoin is now the 9th-most-valuable asset in the world.

Sounds like a nice idea, but how does this work? Well, it’s a matter of doing an easy calculation. Just like you would calculate a company’s market capitalisation by multiplying its stock price by the number of shares outstanding, with bitcoin you just multiply its price by its total “supply� of coins (ie, the number of coins that have been mined since the first one was in January 2009). Simples!

If you do that sum, you’ll see that you get to a very large number — if you take the all-time-high of $37,751 and multiply that by the bitcoin supply (roughly 18.6m) you get to just over $665bn. And, if that were accurate and representative and if you could calculate bitcoin’s value in this way, that would place it just below Tesla and Alibaba in terms of its “market value�. (On Wednesday!)

The only problem is, as you might have already guessed, that’s not accurate or representative and you cannot calculate bitcoin’s value in that way.

The idea of a “bitcoin market cap� makes no sense

The first problem is that bitcoin is not of course a company — nor even, we would argue, an asset — so working out its “market cap� is a non-starter. As some of you might remember, it was originally designed to be a currency that could be used to buy actual things! And although it fails to meet all the criteria that would make it a currency, it does have one thing in common with it: its price is underpinned by sheer faith. The difference being that with fiat currencies, that faith is effectively placed in the governments of the nation states who issue them, whereas for bitcoin, the faith is placed in . . . the hope that other people will keep having the faith. A faith in faith, if you will.

In the context of companies, the “market cap� can be thought of as loosely representing what someone would have to pay to buy out all the shareholders in order to own the company outright (though in practice the shares have often been over- or undervalued by the market, so shareholders are often offered a premium or a discount).

Companies, of course, have real-world assets with economic value. And there are ways to analyse them to work out whether they are over- or undervalued, such as price-to-earnings ratios, net profit margins, etc.

With bitcoin, the whole value proposition rests on the idea of the network. If you took away the coinholders there would be literally nothing there, and so bitcoin’s value would fall to nil. Trying to value it by talking about a “market cap� therefore makes no sense at all.

Another problem is that although 18.6m bitcoins have indeed been mined, far fewer can actually be said to be “in circulation� in any meaningful way.

For a start, it is estimated that about 20 per cent of bitcoins have been lost in various ways, never to be recovered. Then there are the so-called “whales� that hold most of the bitcoin, whose dominance of the market has risen in recent months. The top 2.8 per cent of bitcoin addresses now control 95 per cent of the supply (including many that haven’t moved any bitcoin for the past half-decade), and more than 63 per cent of the bitcoin supply hasn’t been moved for the past year, according to recent estimates.

What all this means is that real liquidity — the actual available supply of bitcoin — is very low indeed. That’s quite obvious even without knowing the stats above from the price moves — you don’t see smooth ups and downs like you might expect in other markets where the demand is coming from real supply-and-demand dynamics rather than speculation, but sudden lurches upwards and cliff-like drops.

So the idea that you can get out of your bitcoin position at any time and the market will stay intact is frankly a nonsense. And that’s why the bitcoin religion’s “HODL� mantra is so important to be upheld, of course.

Because if people start to sell, bad things might happen! And they sometimes do. The excellent crypto critic Trolly McTrollface (not his real name, if you’re curious) pointed out on Twitter that on Saturday a sale of just 150 bitcoin resulted in a 10 per cent drop in the price. As Trolly said to us over the phone:

If you can destroy the market like that in the space of seven or eight minutes, that shows there is no liquidity and no depth — nobody is there to take the other side of the trade when things start moving. You have these extreme moves because everyone is on the same side.

More than 2,000 wallets contain over 1,000 bitcoin in them. What would happen to the price if just one of those tried to unload their coins on to the market at once? It wouldn’t be pretty, we would wager.

What we call the “bitcoin price� is in fact only the price of the very small number of bitcoins that wash around the retail market, and doesn’t represent the price that 18.6m bitcoins would actually be worth, even if they were all actually available.

So the “market cap� is in this way nonsense multiplied. You times two things together that don’t reflect what they claim to — the “circulating supply� and the “price� — and voilà!

Bitcoin > Apple?

In other news, remember when JPMorgan said bitcoin was a fraud (or their CEO Jamie Dimon anyway)?

Well they’ve changed their minds. As of January 4 2021, bitcoin is in fact akin to “digital gold� for millennials, according to the bank, which has a long-term price target for the cryptocurrency of . . . $146,000. (To be fair the note has been slightly over-egged by the bloomin’ MSM and the bank does also talk about a “speculative mania� having taken hold among retail investors, but still, the price target is there for all to see.)

So let’s do the math on this one! If bitcoin did reach $146,000 then its “market cap� would be . . . about $2.7tn. That would make it, on paper, the most valuable asset in the world. Bigger than Apple, Amazon or Microsoft! Who can argue with that?

Related links:
“Cryptoassets� are crashing again. Is it time to start calling them cryptoliabilities instead? — FT Alphaville
What happens when bitcoin’s market cap overtakes world GDP? — FT Alphaville