Written in close collaboration with Alex Felix.On July 20th, 2016 the market capitalization of Steem briefly reached $386M and over subsequent weeks quietly retreated to under $150M.Many other cryptocurrencies followed a similar pattern at one time or another.But regardless of the speculative hype cycle that drives prices in either direction, the more fundamental question I’d like to examine is the perceived connection between a cryptocurrency’s market cap and its measure of a network’s value.The term market capitalization originally comes from the stock market.To simplify the picture significantly, a stock gives its owner a share of ownership in some company.Ownership in this case has a very specific meaning.It refers on one hand to having the right to a portion of the company’s future income distributed in the form of dividends.On the other hand, if the company is sold, the stockholder will receive a portion of the proceeds.Value of future income and growth X earned by the company can ideally be expressed as a stock price Y today.

This would somehow account for various risks and unknowns, a factor that increases significantly as the time horizon extends into the future.The total value of all the shares of a company’s stock, its market capitalization, is a proxy measure for the currently expected capacity of the company to produce both income and growth.In theory, market efficiency means that everyone will use some version of this approach to valuate a company, which in conjunction with high liquidity means that markets do not deviate too far from this picture.But what about cryptocurrency?When we multiply the price by supply and call it market capitalization, what have we achieved?What does this measure really mean for Bitcoin, Ether or Steem?The confusion arises when we think of the market cap of cryptocurrency along those same lines: as the measure of value of the currency’s decentralized network.Firstly, neither Bitcoin, nor Ether, nor Steem give you any promise of future passive income.No dividends are associated with any of these currencies (for Steem, it is slightly more complicated, but Steem inflation payments are still not the same as dividends).

The typical argument you hear amounts to the claim that the market capitalization of cryptocurrency reflects expectations of the future use of its network.Let’s go back to July 20th and see whether this argument holds water.Steem economics back then was pretty complex (it still is, but with better parameters now after several major iterations).It had a special feature that Steem could be made to earn significant returns if it was locked up and made illiquid for an extended period of time.The lockup period was 2 years and unlocking your funds happened at equal weekly intervals.Consequently anyone who followed this model had no way of selling their funds any time soon.As demand for Steem grew due to investors and new users rushing to buy into the network, its supply remained extremely thin and locked up in individual accounts.When supply is thin price moves reflect outsized effects from small changes to investor activity.This creates a market dynamic that is far from being an efficient indicator of true value.What’s even more important is the fact that some part of the supply can always remain dormant in the wallets of founders and crowdsale participants.

This is the case with Ether where a large portion of the supply is held by the Ethereum Foundation, and for Bitcoin, whose early mined coins are held in anonymous wallets with humongous present value.bitcoin lavoroThis is fundamentally different from the common practice in the stock market whereby a significant percentage of company’s stock is held long-term by founders and other large shareholders.bitcoin zurichThe difference is that while stock owned by founders earns dividends and dilutes the other shareholders’ portion of income, cryptocurrency laying dormant in someone’s wallet has no interaction or bearing on the market whatsoever.If the liquid supply of the cryptocurrency is small it will prompt the coins to be spent more often.ethereum chart predictionThis phenomenon is called the velocity of money and underlies the important distinction between stocks and currencies.buy bitcoin with ach

For currency the share of the network’s value is correlated to the number of times coins are spent, considering that every transaction captures some unit of network’s utility.bitcoin usd preevVelocity is market-driven and will allow the market to function under a broad range of possible liquid supplies.mercedes benz bitcoinIt is also conceivable that in some cases reducing the liquid supply may drive prices up (as was the case with Steem) further exaggerating the effects I am describing.These observations point out the fact that there are fundamental differences between stocks and cryptocurrencies.For stocks, the total supply, or number of shares outstanding, is grounded in a real meaning: it defines a distribution of a company ownership.For cryptocurrencies, the price dynamics, velocity, and the fact that illiquid supply does not interact with markets in any way mean that the market cap is not a good measure of value, if at all.

For example, it would be pointless to compare the market cap of one currency with the market cap of another (without regard to all these other factors) and on that basis alone make conclusions about the relative value of their networks.More than eight years ago, Satoshi Nakamoto introduced to the world his “peer-to-peer electronic cash system,” Bitcoin.From this description, Satoshi’s obvious intention was to replace cash by creating a new way of making payments.Whether it was to purchase a yacht or a latte, Bitcoin was created to be a frictionless and decentralized means of transferring any amount of value between two people without the need for a middle man.But Bitcoin is not simply a payments system.Satoshi purposefully set up Bitcoin with many of the characteristics of gold, including its limited supply and the requirement that energy is needed to increase that supply.This makes Bitcoin supremely qualified to be a long-term store of value.A government can increase the money supply of its currency at the whim of those in charge.

Bitcoin’s supply, however, cannot be manipulated, allowing its value to remain strong for years, even decades.Thus Satoshi created both a strong cash system and an excellent store of value.Not long after Bitcoin was released, people began to realize that the underlying technology behind Bitcoin — often referred to as “blockchain technology” — could have many other real-world, non-financial, applications.For example, contracts could be stored on the blockchain, voting could be managed via the blockchain, and other aspects of modern life could become a part of Bitcoin.Bitcoin, therefore, developed three use cases: an electronic cash system, a store of value, and various blockchain-based non-financial applications.These are the legs on which Bitcoin stands or falls.However, in recent years two of those use cases — an electronic cash system and non-financial applications — have become increasingly difficult to justify with Bitcoin.Transaction fees, which originally were minuscule, have grown over time and recently topped $1 on average.

While such a fee is nothing if you are transferring thousands of dollars, it is prohibitive if you wish to make small payments using Bitcoin.Who would pay $1 to buy a $3 cup of coffee?The reason for the higher transaction fees — congested blocks — has also had another impact: decreased use of the Bitcoin blockchain for non-financial applications.For example, the Australian political party Flux hopes to use the Bitcoin blockchain to give people a direct say in the political process.The party recently announced it was performing a “stress test” on the Bitcoin blockchain before going live with its voting system.The reaction from a good deal of the Bitcoin community was surprisingly negative.Users were worried it would further increase transaction fees and would delay confirmations for other payments.Luke Dashjr, an influential Bitcoin core developer, even reported the organization to the Australian cyber-crime agency on the grounds that the stress test was spam!Thus, two of Bitcoin’s legs have become diseased.

In such a situation, three things can happen: the diseased legs can be healed, they can be amputated, or the disease spreads to the rest of the body and Bitcoin dies.The underlying reason for the disease that impacts both the cash system use case and non-financial applications is the congested block size.No one disputes this.However, there are two different solutions for this problem, and advocates of each one in general strongly oppose the other.One proposed solution is for Bitcoin to deploy Segwit to manipulate transactions such that blocks can handle more than 1MB of data.In addition to Segwit, a 2nd-layer network such as Lightning Network would be created so that most transactions would happen off-chain, thus relieving pressure on the blockchain itself.The other solution is simply to increase the block size to meet current demand.Of course, it’s possible to implement both solutions concurrently, but, as I mentioned, most advocates for each idea have demonized the proponents of the other solution to an extent that such a reasonable compromise no longer appears possible.Simply put, if Bitcoin is to be fully restored to health, then the block size will have to be increased.

Originally, Satoshi implemented the 1MB block size limit as a temporary anti-spam measure.It is ludicrous to believe that such a limit placed years ago must remain as fixed as Bitcoin’s 21 million coin supply.How much the block size limit should be increased — and at what pace it increases — is a legitimate discussion, but keeping it at 1MB is refusing to recognize the cause of the disease.And the block size isn’t the only issue.The sickness that infects Bitcoin right now isn’t simply technical, it’s also economic and social.The developers of Bitcoin — whether that is Core or Unlimited or some other group going forward — must humble themselves and recognize their limitations.Bitcoin is a social experiment that requires multiple areas of expertise, and also requires a cohesive community.For example, programmers are not economists and economists are not programmers.Trying to mandate that certain uses — which abide by all the rules of the Bitcoin blockchain — are “spam” and therefore undesirable is central planning at its finest.

Further, alienating vast numbers of users by demonizing and censoring any who disagree is not a path to long-term success.Unless the stewards of Bitcoin recognize these issues, the prognosis for a full recovery is doubtful.Healing isn’t the only option, however.Another possibility — one that is becoming increasingly more likely — is amputation, i.e., simply removing use cases from the Bitcoin ecosystem.As already noted, the current impasse that Bitcoin is facing has made two of the use cases of Bitcoin — a peer-to-peer electronic cash system and non-financial applications — increasingly less feasible.But instead of trying to heal Bitcoin by restoring those two use cases to health, the stewards of Bitcoin could simply allow the cryptocurrency to become only a store of value, with no other real world usage.After all, high transaction fees and slow confirmation times don’t impact this particular use case, as gold — the most traditional store of value — has far higher barriers for use in transactions.

Thus, Bitcoin no longer is used as a cash system or for non-financial applications and learns to live with one leg as “digital gold.”Of course, this doesn’t mean that the need for those other use cases simply disappears.And if Bitcoin will not embrace those use cases, then other cryptocurrencies will.We can see in the market that this is already happening.Look at the two highest market cap cryptocurrencies after Bitcoin: Ethereum ($2.5 billion market cap) and Dash ($500 million market cap).Ethereum is primarily intended for smart contracts, and Dash is primarily intended to be a peer-to-peer electronic cash system.As the market has begun to recognize that two of Bitcoin’s legs might be amputated, it has looked to find other legs to stand on.This might be bad for Bitcoin, but it’s not bad for users, who just want solutions, no matter where they come from.But healing or amputation are not the only possible outcomes.There is also…Can Bitcoin die?I can already hear the response: Bitcoin has been declared dead over 100 times!

Of course, I’m not declaring Bitcoin dead, I’m just arguing that it could die at some point in the future.Only arrogance would claim this is not possible.How could Bitcoin’s death happen?Let’s say that Bitcoin does not resolve its current issues, and amputates two of its three use cases.At that point, other cryptocurrencies, such as Ethereum and Dash, fill the hole in the market and become the standard for those missing use cases.Bitcoin is now only a store of value.However, why should it remain so?What use would it truly have?Why would investors see Bitcoin as a safe store of value if it has no other use?It’s possible that this could happen, but it’s also possible that the market sees Ethereum and Dash (and possibly other cryptocurrencies) as better stores of value due to their greater utility.In this situation, Bitcoin’s remaining usage withers away and it becomes an interesting footnote in the history of cryptocurrencies.Currently, Bitcoin has a powerful network effect which makes it valuable.