Insight
August 26, 2022
Greg Cipolaro & Ethan Kochav

Research Weekly - Deciphering the Digital Lexicon

IN TODAY'S ISSUE:

We look at some common terms in crypto and how they may differ from conventional definitions, such as:

  • Inflation rate
  • Deflationary currency
  • Supply
  • Real yield

Deciphering the Crypto Lexicon

The digital asset class can be a bewildering place for investors. A dizzying array of technical concepts, open databases that may be difficult to decipher, and conflicting opinions from even the most level-headed thought leaders can make it difficult for newcomers to get up to speed in the digital asset industry. Complicating matters can be the digital asset industry’s often confusing use of economic terms, which, while already having common agreement amongst traditional financial market practitioners, have been appropriated and altered by the digital asset community with sometimes unclear implications.

Inflation Rate

In traditional economic terms, the concept of inflation refers to the change in price levels of goods and services. Inflation itself means that the price of goods and services increases (purchasing power of currencies decline), deflation means that the price of goods and services decreases, and reflation (disinflation) refer to the acceleration (deceleration) of those changes. The crypto community, however, uses the term “inflation rate” to mean the growth in the supply of digital assets relative to its current level, usually in annual terms. For example, the inflation rate of bitcoin is presently about 1.7% annually, meaning the supply of bitcoins is growing by 1.7% every year. This rate, which halves every four years, will drop to 0% in the year 2140 when no new bitcoins are produced.

Deflationary Currency

A currency is considered “deflationary” when the value of goods relative to the currency decreases over time. Because of its fixed supply cap of 21 million bitcoins, bitcoin is often said to be a “deflationary currency.” But what this is and how it can be true can be a bit confusing. Using the crypto definition of “inflation rate,” the supply of bitcoins outstanding grows every 10 minutes and will do so until the year 2140. In this sense, the supply of bitcoins is not “deflating” or declining. However, because private keys are lost over time, the supply of bitcoins available to users can decrease. Now, the concept of lost assets is not exclusive to fixed supply digital assets, but capping the supply is certainly a factor in this deflationary mechanism.

The other way for bitcoin to become “deflationary,” and the one that aligns with the traditional financial definition of deflation, is through price appreciation of bitcoin. As the price of bitcoin has risen over time, the number of bitcoins required to buy similar goods and services has declined, creating a deflationary effect for the consumer. To illustrate the point, the 2 pizzas that Bitcoin developer Laszlo Hanyecz famously bought for 10,000 bitcoins in 2010 now costs only 0.001 bitcoins. What allows this deflation to occur is that fiat currencies like the US dollar are still the unit of account for both bitcoin and goods and services. One would expect that as the demand for bitcoin increases, either for investment or transactional purposes, the price would also rise given the inelastic supply function and continued growth of the overall economy. In a world where assets are denominated in bitcoin, this would cause deflation in the traditional sense.

Supply

One of the most basic measures of a digital asset, how many exist, is often a source of controversy. This is especially problematic for newly issued digital assets that may have ill-defined conflicting information about token sales, lockups, or supply functions, while it is typically less problematic for assets like bitcoin, which had a much less complicated network launch than most other cryptocurrencies. Complicating matters for all digital assets, however, is that investors often like to know many tokens are presently available for purchase or use in the free market. Often called circulating supply, a measure that in principle is not that dissimilar from the notion of free float for financial indices, it has no commonly agreed upon definition across data providers. While the free float for the same stock may differ from one index provider to the next, the common concept is that indices are trying to exclude shares of a stock that cannot or are unlikely to be purchased because they are in the hands of long-term holders. And we likely have better holder data for stocks than we do for digital assets due to shareholder reporting requirements. While circulating supply may differ depending on the data provider, the following graph of the declining share of bitcoin in the free float illustrates an important takeaway for investors.

Market Capitalization

Market capitalization is generally used to refer to the total market-based value of a company’s equity. It is calculated as the number of shares outstanding times its share price. Notably, this definition is not equivalent to the “size” of a company. Company assets can also be funded through debt, and higher or lower profitability can impact also impact equity value.

The digital asset industry similarly defines market cap as the price of a digital asset times its supply. At a high level, this looks the same as the calculation for the market cap of a company. In equities, the same company can have different share counts depending on how “shares” are defined (basic, fully-diluted, float-adjusted), but these are well-defined terms. Digital assets, meanwhile, suffer from the supply measurement issues mentioned previously. Further complicating matters, as mentioned above, since there is no concept of equity in a currency, the “market cap” of bitcoin is simply not an appropriate term. For example, no one refers to the “market cap” of the U.S. dollar. We would have preferred the term “network value,” as it is less awkward and definitionally more correct than market cap.

Real Yield

Real yield is generally defined as the risk-free rate after accounting for inflation. Over the past few weeks, the term “real yield” has been trending in DeFi social circles, but unfortunately, this emerging term has little to do with the orthodox definition of “real yield.” In the DeFi sense, the term “real yield” refers to a dividend paid to holders that’s sourced from an application’s revenue, rather than coming from supply growth, the latter being also known as dilution, which has been the case for most applications. While it is encouraging to see DeFi recognize the issues of dilution (though returning profit to investors potentially invokes the specter of securities regulation), yields that are paid from revenue have little to do with money-neutral yields that are commonly understood as real yields.

Market Update

Bitcoin saw losses on the week, most of which came from last Friday, dropping 7.5%. Equities also saw losses, as the S&P 500 fell 2.0% and the Nasdaq decreased by 2.5%. Bonds fell on the week as well: Investment Grade Corporate Bonds lost 1.0%, High Yield Corporate Bonds decreased by 0.8%, and Long-Term Treasuries dropped 1.8%. Gold fell by 1.1% on the week as real yields and inflation expectations increased.

Important News This Week

Companies

Investment Bank Cowen Nabs 2 Crypto Hires for Digital Asset Team — CoinDesk

Crypto ATM Operator Bitcoin Depot to List in $885M SPAC Deal — WSJ

Coinbase to Create Liquid Staking Token for ETH — Coinbase

Sam Trabucco Resigns as Co-CEO of Alameda — Sam Trabucco

Tether Does Not Freeze Tornado Assets — Tether

Crypto Lender Voyager Can Pay Employees 'Retention' Bonuses — CoinDesk

Crypto VC Names Ex-SEC Chair Clayton as Adviser — Bloomberg Law

Singapore Court Recognizes Three Arrows Liquidation Order — Bloomberg

Investing

Hacker Stole From Clients Making Deposits On Bitcoin ATMs — The Block

Call for Two New Maintainers on Bitcoin Core Code — GitHub

Seven S. Korean Brokerages to Start Crypto Exchanges — CoinDesk

DBS Exchange Says Bitcoin Trading Surged Amid Global Selloff — Bloomberg

Regulation and Taxation

Rep Emmer Writes Letter to Treasury on Tornado Sanctions — Rep. Emmer

Afghan Authorities Shut Down 16 Crypto Exchanges in One Week — CoinDesk

Alleged Tornado Developer to Stay In Jail, Dutch Judge Rules — CoinDesk

Upcoming Events

September 2nd – United States Non-Farm Payrolls

September 13th – July CPI data is released

September 21st – Next FOMC interest rate decision

September 30th – CME bitcoin futures and options expiry

Thanks for joining us again this week. Please reach out with any questions or comments.

Sincerely,
The NYDIG Team

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