Why Bitcoin Dominance is Important
Altcoins have lost some of their luster since the start of this year, as market data shows that people increasingly prefer to buy Bitcoin (BTC) over alternative cryptocurrencies. This preference for Bitcoin can be roughly measured and displayed numerically. The result is termed “ Bitcoin Dominance.”
If you follow developments in the crypto world, you’ve probably heard a lot about Bitcoin Dominance over the last few months. In this article, we’ll discuss various aspects of Dominance, including:
explain what Dominance is and how it’s measured,
the flaws inherent in the method of Dominance measurement,
the likelihood that Dominance is understated,
and finally, why Dominance is an important market signal despite its flaws.
Calculating Bitcoin Dominance
Bitcoin Dominance is derived by comparing Bitcoin’s market capitalization (which is the current BTC price multiplied by the total number of coins issued) against the combined market caps of all altcoins.
Here’s an example of how Dominance is worked out:
The BTC price at the time of writing is $10,160 and the total number of issued bitcoins is 17.9 million. By multiplying these two figures, we arrive at Bitcoin’s market cap of $181 billion.
By repeating this calculation for each of the thousands of altcoins listed on crypto exchanges and summing up their market caps – we’ll spare you the details of this process – we arrive at a total of $82 billion.
We get the total market cap including Bitcoin by adding the two results: $181 billion + $82 billion = $263.
We then get Bitcoin’s share of the total by dividing its cap by total cap: $181 billion / $263 billion = 0.68 or 68.8%.
Bitcoin Dominance is thus about 69% of the crypto market’s value when measured against all the coins featured on CoinMarketCap.
Charting Bitcoin Dominance
If something can be expressed in numbers, it can be charted over time. This provides valuable market history at a glance, granting us the proper context for the present and affording us many valuable insights. Charting also allows us to make projections for the future…
In our article, “What is Bitcoin Maximalism?” published in May of this year, we discussed Bitcoin’s up-trending Dominance value, then at 54%, and mentioned the possibility of it reaching 80% or higher. With Bitcoin poised to cross the 70% boundary, this projection looks more likely by the day.
Weekly Bitcoin Dominance values since March of 2015, courtesy of Trading View.
A few interesting points jump out from this chart:
1. Bitcoin’s Dominance was nearly absolute until the first half of 2017, when it fell below 90% for the first time.
2. As the ICO mania and “altcoin season” reached their climax, Bitcoin’s Dominance dropped to its all-time low of around 35% at the start of 2018.
3. Starting in early 2018, Bitcoin’s Dominance has steadily recovered, gaining around 35% over the 18 months from its all-time low in January 2018 until the end of August 2019.
4. Bitcoin’s Dominance has stabilized over the last 3 weeks of August 2019. Whether it will continue rising, maintain its current level, or reverse and decline, is uncertain. The outcome most likely depends on whether users continue to preferentially enter the crypto market to buy Bitcoin.
Flaws in the Bitcoin Dominance Measurement
Dominance is known to be an imperfect measure of the market, the reason being that the crypto market cap values upon which it depends are often unreliable. For this reason, some in the crypto community deny the validity of Dominance and crypto market caps in general.
Market capitalization is a concept imported from the traditional stock market but not always fully applicable to cryptocurrencies. The market cap of a company can be reliably and accurately measured by multiplying its stock price by total stock issuance. Incidentally, when you hear people speak of an X million or billion-dollar company, they’re likely referring to its market cap.
While this market cap concept can be applied to Bitcoin, as in our calculation above, it’s not a perfect fit. While there may be nearly 18 million bitcoins in existence, it’s likely that several million of those coins are permanently off the market due to the loss of their controlling private keys for various reasons. Furthermore, it’s estimated that Satoshi Nakomoto mined about a million coins and nobody knows if he still controls them.
Whereas the amount and status of company stock is a known quantity due to the centralized control of traditional stocks, no such certainty exists for crypto assets. Thus Bitcoin’s market cap is in reality a fuzzy rather than precise value, and the situation is even more blurry when it comes to altcoins.
Bitcoin’s issuance and distribution was about as fair as possible, given the following factors:
Bitcoin’s launch was publically announced,
Bitcoin mining was open to anyone with a PC from the start,
Satoshi didn’t award himself any “free” coins but mined his enormous stash,
Satoshi didn’t remain as a dominant market influencer but disappeared into obscurity.
Contrast the above factors with the situation in regards altcoins:
Altcoins are occasionally launched secretly, limiting who can get in early.
Altcoin mining is occasionally limited to those with specialized hardware, such as ASICs (and to a lesser extent, GPUs).
In what’s known as a pre-mine, altcoin developers often award themselves a chunk of the coin supply from the get-go, rather than having to earn their coins through mining or staking like regular users.
Altcoin developers with a large share of supply often remain as a market controlling or stabilizing (depending on your perspective) forces. As an exception which proves the rule; Charlie Lee, the creator of Litecoin, publically divested his Litecoin holdings to further decentralize Litecoin by reducing his market importance.
These factors combine to create some ludicrous outcomes. While Bitcoin’s market cap is fuzzy, the market cap of altcoins is sometimes a complete fiction. Consider the following example:
Mr. Nerf creates a new and rather pointless cryptocurrency, NerfTokens (NERF), which does nothing special and has no marketing. Mr. Nerf pre-mines the entire supply of 1 billion NERF to his own wallet. He then gets his token listed on an exchange and sells 1 unit of NERF for $1 to his friend. According to how market cap is calculated, the total market cap of NerfTokens now stands at $1 billion; clearly a ridiculous and false valuation!
Bitcoin’s “Real” Market Dominance is Higher than Suggested
In the above example, it’s not impossible that NerfTokens might truly be worth their $1 billion market cap… but only in the extremely unlikely case that there’s sufficient market demand to justify that valuation. While Mr. Nerf’s friend may have been willing to buy one NerfToken at $1 to support his experiment, it’s unlikely that strangers will have much interest in yet another pointless coin.
Let’s say Mr. Nerf now wants to sell the rest of 999,999,999 NERF at a price of $1 on the same exchange… It’s highly unlikely that his offer will be fully absorbed by buyers. If he wants to offload his tokens, Mr. Nerf will have to keep lowering his asking price to attract buyers. In the absence of any positive news or sentiment, the price of NerfTokens will crash.
Now let’s say that Mr. Nerf grows wise. He realizes that that continually lowering his asking price only creates the impression of a worthless token which nobody wants. So, he starts buying his own tokens, bidding the price up to $2! NerfTokens now has a market cap of $2 billion! Some suckers might take the bait and start placing bids, allowing Mr. Nerf to offload more of his worthless tokens…
This can only go on for so long until the market realizes Mr. Nerf is running yet another crypto Pump & Dump scam. In fact, there have been so many such scams, albeit with higher levels of sophistication and coordination between multiple players, that the NerfToken scam is unlikely to gain any real traction.
The upshot of all this is that market cap calculations are flawed because they don’t take liquidity into account. Bitcoin is traded by millions of people all over the world on hundreds if not thousands of different exchanges. The Bitcoin market therefore has deep liquidity; if one wanted to sell thousands of BTC at the current price around $10,000, it would be possible to do so without crashing the Bitcoin price and its related market cap.
The same can’t be said of most smaller coins, whose thinly-traded markets are a recipe for inflated valuations. Absent price support from bagholders with deep pockets, these inflated valuations are liable to burst if confronted with significant selling pressure. Following this reasoning, some in the crypto community suggest that Bitcoin’s true dominance score is probably above 90%.
Why Bitcoin Dominance Matters
Despite the flaws in its calculation, Dominance remains useful. Changes in this value signal whether Bitcoin is outperforming or underperforming the general crypto market, and this makes Dominance an important tool for deciding the appropriate allocation of any investor’s crypto portfolio.