The market for fixed supply crypto-assets is viciously competitive for alt-coins which exist in the shadow of Bitcoin’s commanding reputation, liquidity, and market dominance. Bitcoin’s first-mover advantage and hardcore monetary policy undoubtedly make it the front-runner in a new age of digitally native scarce assets.

The question that continues to attract investor attention is whether alt-coins, that also have fixed supplies and deterministic supply curves, have even a remote chance of competing or co-existing with Bitcoin as sound money or do they represent a complete misallocation of capital.

In this article, I compare the observable monetary premium of Bitcoin, Litecoin, Decred, Dash and BCash in the context of the stock-to-flow relationship developed by PlanB based on Bitcoins historical data. This model has shown extremely high correlation factors upwards of 95% and with reasonable verification against sub-sets of Bitcoins data and comparisons to the uncorrelated precious metals markets.

Digital Scarcity

The notion of stock-to-flow as a measure of scarcity is a topic of great interest in both the commodities (precious metals in particular) as well as in the fixed supply cryptocurrency markets. Saifedean Ammous explored this concept in great detail considering the historical evolution of money in The Bitcoin Standard and how scarce assets have shown to develop a monetary premium as a result of high stock-to-flow ratio.

Nick Szabo beautifully articulated the idea of using the concept of ‘unforgeable costliness’ which describes the unavoidable and expensive coats of production which must exist for an asset to attain a monetary premium.

“What do antiques, time, and gold have in common? They are costly, due either to their original cost or the improbability of their history , and it is difficult to spoof this costliness” Nick Szabo (2008)

Precious metals and collectibles have an unforgeable scarcity due to the costliness of their creation. This once provided money the value of which was largely independent of any trusted third party” Nick Szabo (2005)

Unforgeable Costliness

The unforgeable costliness of an object can have its origins from a number of areas, some notable examples of scarcity are:

Banky’s Shredded Girl with Balloon has an underlying character narrative of the artist, social and contextual capital and a one of a kind event of creation (Unique).

Establishing and operating a gold mine requires a significant outlay of CAPEX and OPEX costs as well as significant time and human effort required from exploration through to production (Very Scarce).

Bitcoin’s proof-of-work ensures that bitcoin issuance is impossible without expending computational resources and electrical demands. Furthermore, the immaculate conception by Satoshi Nakamoto captures the unforgeable costliness characteristics of a Unique origin story as well as the physical costs of mining creating an unparalleled digital scarcity.

It is an underlying assumption of this paper that a crypto-asset must have an unforgeable costliness of coin production that is at least reasonably comparative to that of Bitcoin, given the inability to replicate the Satoshi Nakamoto immaculate conception.

As such, I have selected the following fixed supply alt-coins with deterministic issuance schedules to assess whether an appreciable unforgeable costliness exists to develop a competitive monetary premium.

Modelling Scarcity as a valuation metric

Recently, PlanB has completed a number of exceptional studies into the relationship between Bitcoin’s stock-to-flow ratio. What was established is that a power-law, with a correlation factor in excess of 95%, exists with a fairly reasonable agreement with precious metals commodities markets. Further analysis showed that the model fit was robust enough that taking many sub-sets of Bitcoin’s data (accounting for lost coins, various timescales etc) returned a comparable power law distribution.

These analyses establish confidence that scarcity (as measured by stock-to-flow ratio) strongly influences human perception of value which is subsequently expressed through price.

Power laws are rare but important relationships and distributions that often describe natural phenomena such as earthquake magnitude frequencies, variation of orbital speed (Kepler’s 3rd Law) and biological variance as well as many observed distributions in human behaviour and finance.

Plan B modelling for the Bitcoin stock-to-flow vs market value power law

A Natural phenomena

Bitcoin is one of the most organic free market assets that the world has ever seen. It has grown from its cypher-punk roots and a market value of exactly zero to a total market value which exceeded $320 Billion in less than 10 years. Bitcoin has attained value because it provides a useful service for people given its soundness as money and ever-increasing scarcity.

It’s adoption is not mandated, it is freely chosen. 

In the age of accessible information, Bitcoin has beautifully captured the attention and investment of millions of people, by choice. Thus, it seems reasonable to assume that Bitcoin has carved out a sort of ‘centre of gravity’ for the relationship between scarcity and human perception of value. Bitcoin may well be a natural phenomenon against which other scarce assets may be compared.

Alt-coins and Monetary Premiums

The mania phase of the cryptocurrency market in 2017 was largely an unrealistic pursuit for ‘the next Bitcoin’ which is likely to have skewed the actual valuations of these assets (hype, liquidity events etc). Furthermore, many of these coins do not have the lifespan as yet to properly assess is a power law relationship is developing on the basis of the alt-coin data alone.

As such, I do not believe that a sensible, nor organic relationship between S2F and Market Value can be determined for each alt-coins using their data in isolation. Plan B identifies this low correlation in his discussion with Stephan Livera.

A position I find more compelling, is undertaking a comparison between the raw S2F vs Market Cap data for each altcoin and Bitcoin’s ‘centre of gravity’. An alt-coin that performs favorably relative to this power law relationship may well be considered to have an appreciable monetary premium. Conversely, coins that do not perform, I argue, are not favoured by the free market and their unforgeable costliness may well be insufficient to support sustained growth.

For this set of fixed supply alt-coins, I have established the stock-to-flow ratio over time based on measured supply data as well as the Market capitalisation with data sourced from Coinmetrics.io. Given variable hashrates and anomalies, I have applied a 28 day average to the stock-to-flow for a cleaner visualisation which has little distortion to the resulting observations.

28-day Stock-to-Flow ratio vs Market Capitalisation for select fixed supply alt-coins (data source coinmetrics.io)

Now I am of the perspective that data cannot lie, it just is. A few observations I have determined from this study comparing each coins data points and fractals to the ‘centre of gravity’ in white:

Bitcoin oscillates about the ‘centre of gravity’ with each market cycle and closely matches the line at the time of halving events. The data points are quite organic and rounded in their fluctuations suggesting natural price discovery.

Litecoin also oscillates about this line (albeit with less conviction) and similar to Bitcoin, approaches the ‘centre of gravity’ at halvings. It is worth noting Litecoin appears much less organic with more discrete ‘events’ influencing price leading to vertical moves in the data.

BCash is unable to attain any semblance of a monetary premium and the significant variation in S2F suggests frequent instabilities in hash-rate leading to irregular coin issuance.

Dash has a relatively low conviction monetary premium with only a few points where valuation has touched the line. There are also visual outliers in Dash data due to the ~monthly Masternode payout blocks that are smoothed out by the 28 day average. The data-points appear relatively organic, likely a result of the smoother issuance schedule than BTC.

Decred has maintained a monetary premium exceeding the centre of gravity to a greater extent and longer time (relative to its lifespan) than any other coin in this study, even Bitcoin. It appears similarly organic to Dash and Bitcoin, a likely result of a smooth issuance curve and consistent demand for PoS tickets.

Monetary Volatility

To further formalise these observations, I calculated the number of days that each coins market value was above the ‘centre of gravity’ to establish the proportion of its lifespan it has held an exceptional monetary premium. I also look at the maximum and minimum deviation away from this line as gauge for ‘monetary volatility’ or the ability for each coin to maintain its monetary premium over time. This is a similar study to Plan Bs S2F Multiple metric.

Deviation from the ‘centre of gravity’ mapped onto Stock-to-flow ratio

Summary of the days above the ‘centre of gravity’ and the magnitude of deviation away from this line

The first observation is that Dash and BCash experience significant downswings away from the mean which indicates an inability to retain a firm monetary premium over time. By far, BCash has the poorest behaviour (reaching only 35% growth above the mean, once) and arguably may be confidently discounted as an asset that does not have a monetary premium and is thus unattractive as any form of money.

Bitcoin and Litecoin have seen downswings to a 10x to 20x variation during bear markets and similar to the other coins (excl. BCash) have seen 90%+ upside premiums over the mean line.

The standout coin in this study, however, is Decred. Not only has Decred retained its monetary premium more than twice as long (relative to lifespan) as Bitcoin, it has retained this premium through the 2018 bear market with a remarkable maximum negative deviation of -230%. That is 10x less volatile when compared to Bitcoin with a -2000% deviation.

This suggests that Decred has performed as the least volatile monetary asset considered in this study. This is a likely result of the underlying demand for proof of stake ticket holders and participation in Decreds governance system and is a source of validation that ticket demand (and thus demand for ownership and participation) is a reliable source of buy support.

Concluding remarks

This study makes the assumption that Bitcoin’s organic growth and high conviction signal have carved out the ‘centre of gravity’ for the relationship between stock-to-flow ratio (scarcity) and human perception of value, as expressed through price. Bitcoin should be considered the benchmark against which all crypto-assets competing for a monetary premium should be assessed.

The alt-coin mania of 2017 and relatively short lifespan of alt-coins is likely to skew data to some extent and thus it is likely that study of each coins S2F-value relationship in isolation is not representative. This assumption must be revisited periodically as additional market cycles play out.

By comparing the data from five large-cap fixed supply crypto-assets Bitcoin, Litecoin, BCash, Dash and Decred, we can reasonably establish whether a monetary premium is developing with respect to Bitcoin’s ‘centre of gravity’.

This study concludes that Bitcoin has by far the most organic and undeniably important monetary premium, arguably of any financial asset. Litecoin has shown performance similar to Bitcoin however with less conviction and it remains to be seen if it can retain this premium into the future.

I remain somewhat hesitant regarding Dash given the high downside volatility and overall persistence below the power law mean. BCash is clearly unable to retain a monetary premium and may be safely disregarded. Decred has shown by far the most interesting performance and a remarkable ability to retain its monetary premium over time.

What is most important is that in most metrics assessed here, Decred has performed significantly better than even Bitcoin and this is something that I expect is grossly undervalued in the market today, however is likely to attract substantial interest once it catches on.

References

https://twitter.com/100trillionUSD

https://medium.com/@100trillionUSD/modeling-bitcoins-value-with-scarcity-91fa0fc03e25

https://coinmetrics.io/