The Importance of Monetary Supply, Velocity, and Target Markets in the Evaluation of Crypto Assets

Kyle Oberholzer
Stalk me

We did an initial dive into the absolute valuation method for crypto assets in the piece that was published the week before last. The primary issue at hand is determining whether a high off-chain speed, such as that asserted by Vitalik Buterin, threatens market continuity. We will investigate this question further by delving deeper into the central ideas of money supply, velocity, and the addressable target market in order to gain a better understanding of how to proceed. 

Currency Availability 

The current supply of a crypto asset is used to calculate the value of the letter M in the equation MV = PQ. (M) denotes the monetary base, which is necessary for the operation of an economy. If the production process of a cryptocurrency is predetermined, it is simple to calculate how much of that cryptocurrency will ever be available (Bitcoin and Poisson, etc.). There are two main sources of supply: newly minted coins that enter circulation as a result of mining, staking, or selling reserve coins, and existing coins that are liquidated onto the market from existing wallets. The “M” system’s goal is to calculate an estimate of the total number of coins in circulation and available for purchase each year. This element is commonly referred to as a float. The float is made up of two components: the flow and the stock. The flow is the amount of the crypto asset that will be issued each year, while the stock is the amount that has already been issued.¬†

Based on the supply schedules encoded in the protocols of each cryptocurrency asset, this research projects the supply of each cryptocurrency asset over the next ten years. It also assumes that the supply of each cryptocurrency asset remains constant throughout the year. In contrast, a more detailed analysis would attempt to forecast future circulating supply by computing the float or circulating supply of each cryptocurrency. This would be done so that accurate predictions could be made. Before calculating the float, it is necessary to deduct “handled” assets or assets that are being hoarded. For example, if 100 million coins are minted and 60% of them are stored in never-used wallets, the total amount of coins in circulation, denoted by M, is equal to 40 million coins. This change affected Coinbase users who purchased Bitcoin in 2016. In 2016, 57 percent of Coinbase users chose to keep their bitcoin as a speculative asset or value-preserving store of wealth rather than as a medium of exchange.¬†

Velocity 

The letter V represents the velocity of each individual unit of money that makes up the monetary base. If Alice sends one bitcoin to Bob every year, a velocity of one is considered to be achieved. If Bob gave Eve the same bitcoin he had, the annual velocity would rise to 2. The total discounted supply is inversely related to the value of a coin, and the value of a coin is also inversely related to its velocity. As a result, a currency whose velocity increases will lose value in comparison to any other currency whose velocity does not increase to the same extent. 

The velocity is a critical variable that influences many of the reports. The velocity was estimated to be 10 by Vision &. To put this in context, the velocity of the M1 money supply in the United States is approximately 5. Friction is what causes velocity to decrease. Because crypto-assets are intrinsically digital, the friction associated with their use will be lower than that of real cash. When compared to physical currencies, this will result in an increase in velocity. Physical fiat currencies, on the other hand, have high inflation rates, which promote high velocity. This is due to the fact that high inflation rates raise the value of the currency. The velocity of cryptocurrencies with low inflation rates and rising purchasing power will be subject to downward pressure. 

The velocity of each coin is assumed to be constant for the next ten years in this report. When calculating the velocity value, the calculation takes into account each coin’s 2019 on-chain velocity. To calculate velocity, divide the annual trade volume in dollars by the volume of on-chain transactions on the network, and then take the annual average for 2019. A more detailed analysis would attempt to forecast the average amount of assets hoarded for each currency on an annual basis. Because hoarded crypto assets move at the speed of zero, they reduce the average yearly velocity of each coin. As previously stated, the velocity of the 57 percent of Coinbase users who kept their Bitcoin in their wallets throughout 2016 was zero. Because staked coins move at zero velocity, coins that include staking, such as Dash, must also have their velocity reduced.¬†

Addressable Target Market

(P) represents the average cost of a consumer good in the economy. The price of currency, utility, and stablecoins refers to the amount of money required to purchase the item or receive the service. 

(Q) denotes the total quantity of goods available in the economy. 

Calculating total global demand for crypto assets, also known as PQ, entails determining the size of each coin’s target addressable market (TAM) over the course of each year, as well as the percentage of each TAM that the coin will penetrate over the course of the year.¬†

However, not every coin can accommodate every cryptocurrency’s use case. First and foremost, we must distinguish between the four types of coins listed below:¬†

When we talk about a “store of value currency,” we mean a distributed ledger technology that allows users to safely hold value over time. The first layer of a currency’s distribution network typically lacks Turing-complete protocols, which enable complex smart contracts. This term refers to first-generation cryptocurrencies such as Bitcoin, Litecoin, and Bitcoin Cash.¬†

Second-generation cryptocurrencies are coins and tokens that serve a utility purpose and allow smart contracts to be executed. The automated contractual agreements known as “smart contracts” are maintained by a network of multiple computers, each of which is controlled by a different party that is frequently at odds with the other. This category of digital currency includes coins such as Ethereum, EOS, and Stellar.¬†

Stablecoins are a type of cryptocurrency from the third generation. Stablecoins are typically ERC-20 tokens built on top of the Ethereum blockchain. They are intended to maintain a reasonably stable purchasing power in relation to the economy’s real commodities and services over time. Stablecoins such as Tether and USDC are examples. Stablecoins issued on public and permissionless distributed networks, such as MakerDao Sai, are also stablecoins.¬†

The first cryptocurrencies laid the groundwork for the development of privacy coins. They have frequent price fluctuations and additional characteristics that obscure information on each transaction, such as the sender and receiver’s e-wallet addresses, as well as the amount sent or received. This includes, among other things, Dash, Monero, Zcash, Beam, Grin, and MimbleWimbleCoin.¬†

Following the determination of which coin is desired for which use case, the next step is to compute the amount of demand for each use case. The values for each target market may be additive or cannibalistic, indicating that there may be competing demands on a single supply or that the needs are incompatible and should not be added. Table 2 summarizes the assumed TAMs for cryptocurrencies, which include remittance, tax evasion, offshore accounts, store of value, online transactions, micropayments, STO and ICO funding, crypto trading, gaming, online gambling, unbanked, consumer loans, unit of account, medium of exchange, and reserve currency. Table 2: Cryptocurrency Transactional and Application Models Assumed. 

In order to project the TAM for future years, it is necessary to make a realistic assumption about the future growth of this market. This study assumes that each TAM will grow at a compound annual rate. There are some gaps in the CAGR data for some of the above-mentioned categories. Because a suitable assumption of the growth rate could be the long-term expansion of the global economy, we used an estimate based on the compound annual growth rate (CAGR) of the S&P 500 index from 2000 to 2018. Furthermore, we believe that some of the CAGR values for the other categories may be overstated as a result of the prolonged bull run that has occurred over the previous ten years. They are very likely to fall by at least 20-30% as a result of a long-overdue market correction. The V-shaped recovery caused by the Corona virus is clearly maintained by fiat currency depreciation, which is not sustainable in and of itself. As a result, the market capitalization of each TAM is likely to be an upper bound rather than a lower bound. 

The gross domestic product (GDP) is commonly used in conventional economic models to represent the quantity produced (PQ) (GDP). On the other hand, financial asset speculation is typically excluded from GDP indicators. GDP, for example, does not account for the number of foreign exchange transactions. According to estimates, investor speculation accounts for approximately 30% of a crypto asset’s on-chain transaction activity. This happens when investors transfer their cryptocurrency from one exchange to another. As a result, calculating PxQ using the volume of on-chain transactions yields a noisy signal. Furthermore, when projecting PxQ into the future based on today’s transaction volume, there is a significant margin for error. Concentrating on the target addressable markets as well as growth in those areas allows for more accurate estimation.