Want to deflate the token bubble? Fix the market cap indicator.
by Zach Herbert and David Vorick of Sia
The token world is getting crazy, but last week’s Gnosis ICO pushed us over the edge. Gnosis investors bought up approximately 4.2% of the total GNO token supply for $12.5 million (250,000 ETH), giving the project a market capitalization of $298 million (as of April 24).
To be clear: this means ICO investors valued Gnosis — an unproven platform that is yet to be launched — at about $300 million. Moreover, the GNO token does not have any actual purpose except to exchange for WIZ tokens at some point in the future.
We at Sia feel that this ICO insanity cannot continue in its current form — something must give. If the bubble bursts, it will inflict damage on every token, including those that are most reputable.
Many in the community want to slow and eventually stop this trend. We think that, while investors are by no means rational, they need access to the best possible information in order to make informed decisions. However, it is clear that investors are completely misvaluing most tokens. So what gives?
Our hypothesis: the market cap indicator is highly flawed.
Market cap is so powerful because it allows investors to quickly assess total valuation of an asset. A flawed market cap calculation means that investors are not able to properly value a token without doing extensive research.
There are two major inputs to market cap: total supply, which is required to properly calculate present market cap, and inflation, which can be used to predict future total supply and therefore future market cap.
Total Supply
Every site we could find that lists out tokens by price, volume and market cap does so based on circulating supply rather than total supply. Circulating supply indicates how many coins are in circulation, but does not include coins held by the project. By contrast, total supply includes coins in circulation + coins held by the project.
Even worse, these sites don’t specifically tell users the differences between total and circulating supply. It seems that everyone is doing it wrong, and all but the most informed investors are being misled.
This flies in the face of basic valuation principles. When valuing a stock, for example, we value the market cap by calculating (share price)*(shares in circulation + shares held by company). We call this combo shares outstanding. We are not currently portraying token market caps this way, and it really throws off the results.
See for yourself above. Coinmarketcap.com seems to be the the only site that allows users to opt to view tokens by total supply in existence, rather than just the supply in circulation. When we view the top tokens by circulating supply (left), the list looks fairly predictable: Bitcoin, Ethereum, Ripple, and so on. But when we view by total supply (right), we see some crazy results:
- Ripple’s market cap has more than doubled.
- FargoCoin is in the top five.
- Gnosis’ market cap increased from $95 million to $861 million.
- Stellar Lumens’ market cap increased from $45 million to $487 million.
- Golem’s market cap increased from $186 million to $230 million.
- Storjcoin’s market cap increased from $23 million to $228 million.
We recommend updating all default metrics from circulating supply to total supply.
Implementing this fix allows us to get a better picture of market cap today, but it does nothing to help us value future market cap. For this, we turn to inflation.
Inflation
Inflation is the major driver of future market cap. As more tokens are brought into existence, outstanding tokens are diluted. Tokens with healthy inflation rates can often preserve their price per token, but tokens with extremely high levels of inflation should decrease over time.
In the token world, we have the wonderful benefit of codified inflation rates. This allows us to estimate the inflation over time for most tokens, and therefore estimate the future market cap. However, sites and exchanges are not properly conveying this information to investors, and therefore the majority of investors are likely not factoring this into their valuations.
Take Zcash for example. It has a current market cap of $110 million with a total supply of 1.2 million ZEC, but over the next five years 11.1 million ZEC will enter existence. This super-high inflation will drastically increase supply each year, which in turn will affect the market cap. There is no way, however, for the average investor to quickly discover this inflation factor.
We recommend adding a new metric called inflation factor that indicates how the market cap could be affected over the next five years by token inflation.
Inflation factor = (new supply over 5 years) / (current total supply) * 100%.
For example, there is currently a total supply of 25.6 billion Siacoin. In the next five years, the supply will have increased by 21.9 billion. Therefore the Siacoin inflation factor is (21.9 billion) / (25.6 billion) * 100% = 85.5%
This means that the total Siacoin supply will increase by about 85.5% over the next 5 years. Investors should factor this information into the current Siacoin price.
Below are inflation factor calculations for the top fifteen tokens by circulating supply (we used circulating supply rather than total supply because those are the top coins with which most investors are familiar):
Introducing the inflation factor metric would allow investors to more easily evaluate how a token’s total supply will change over time, and therefore build that inflation risk into the token price.
Action Plan
We suspect that investors are overvaluing many tokens due to the unclear market cap statistic.
Here is our list of recommendations to remedy this issue:
- Replace the existing flawed market cap metric with total market cap on sites such as coinmarketcap.com.
- Add a new field called inflation factor.
- Add both metrics to exchanges.
Over the next week, we will be reaching out to coinmarketcap.com, coincap.io, cryptocompare.com, and others to request that they institute these recommendations. We will also reach out to Poloniex, Kraken, Bittrex, and other major exchanges.
It will most likely take a unified effort in the crypto community to fix the market cap metric, but together we can get every site and exchange to provide this crucial information to investors. We recommend you email or tweet to your favorite comparison site or exchange, and share this blog post with your network.
Together, we can hopefully stop this bubble before it bursts.
Correction: we initially underestimated Zcash’s max new coins at 9.8 million. We updated this to the correct 11.1 million on May 10 at the request of their founder, Zooko Wilcox.
