Amid increasing hype about blockchains and distributed ledgers, the value of global cryptocurrency markets has risen rapidly so far in 2016.
As of mid-June, the value of all blockchain-based currencies in circulation was $14.37bn, and the price of bitcoin was, as it has been historically, a leading driver of this growth. At June's highs of $700, the price of bitcoin had risen almost $300 since the end of May.
As the value of bitcoin continues to surge, many have looked at bitcoin's market capitalization as an indication of bitcoin's value. With a total value of all bitcoins in existence at $10bn, the bitcoin market is currently more valuable than one of the largest social media companies in the world, Twitter.
Some have argued, however, that it's unclear exactly where exactly the bitcoin market cap stands now, asserting it's impossible to determine with any sense of accuracy the value of all usable or spendable bitcoins.
Due to factors - including the notion of "zombie" bitcoins and the number of bitcoins stored by long-term, buy-and-hold investors - these market observers believe it's difficult to make summary statements about the vitality of the market or its current trajectory.
While this may be a minor thing, this difficulty in profiling the size and character of the bitcoin market is telling of the challenges the digital currency has in defining itself to the broader public. In addition, it points to pitfalls bitcoin will likely have to clear in its near-future.
More importantly, the discussion of how to capitalize a finite, virtual currency speaks to the debate of what the future of digital commerce may look like.
To understand the significance of a capitalization to a market, one must understand what a market capitalization is and how it is calculated.
Market capitalization is defined traditionally as the price per share for the commodity at the time of the capitalization, multiplied by the current number of outstanding shares in the market. For most publicly-traded companies and securities, the capitalization is an simple way to ascertain the health of the market in comparison to where it was previously and comparative to other securities being traded.
The problem with the bitcoin market, however, lies in the definition of "outstanding shares."
Most analysts use the traditional definition of "number of tradeable units that were active in the last two weeks" to determine market cap. While this is a perfectly acceptable for most securities, this definition has two unavoidable holes when it comes to bitcoins.
First, if bitcoins are a digital currency, the outstanding shares definition fails to adequately account for dormant coins.
In 2014, NVIDIA engineer John Ratcliff theorized that approximately 30% of the current bitcoin supply is made up of "zombie bitcoins" that have been inactive for more than a year. This number includes bitcoins connected to inaccessible wallets, government-seized bitcoins, "burned" bitcoins and bitcoins abandoned during the early days of bitcoins - including Nakamoto's mythical stash of over a million bitcoins.
Due to bitcoin's security and lack of centralized authority, any attempt to access these lost coins - short of brute-forcing their wallets' passwords - is impossible. As such, these coins exist, but they are effectively unusable by anyone except those in possession of the related private keys.
These bitcoins, combined with those that are intentionally dormant - as either commercial reserves or as personal savings - account for coins that were used in good faith, but are currently not "active" in the market.
Today, intentionally or unintentionally dormant coins are not reflected in most calculations of the bitcoin market cap.
Second, if bitcoins are a commodity, then the bitcoin market capitalization - as it is calculated today - is a reflection of trade volume of newly mined and short-term traded coins, and not long-term investments. As previously argued, this would exclude intentional dormancy, making the bitcoin market cap a reflection of the current fluidity of the market and not its overall worth.
Still, Stephen Holmes, CTO of the Digital Banking Lab at IT consulting firm VirtusaPolaris, argues that using the market capitalization to estimate the bitcoin market's worth is missing the point.
"Bitcoin is a store of wealth. The advantage is that it is a finite currency so it cannot be deflated because of the printing of additional bitcoins, unlike today's flat currency," said Holmes, adding:
"Scarcity is the real value of bitcoin... exchange rates will by definition fluctuate over time."
One of the characteristics that directly affects the value and capitalization of cryptocurrencies is that they are scarce, meaning that they are goods that exist in a finite quality.
If one was to say that a cryptocurrency is a commodity in the traditional sense, one would expect to be able to trace a cryptocurrency's units to an actual physical entity that would confirm the unit's uniqueness and ownership. What prevents this from happening is the blockchain, an openly shared register that stores and verifies the transactions of every cryptocurrency unit. The blockchain makes the notion of simply copying a bitcoin meaningless.
This reinforces the notion of an electronically-assured digital good, but it also creates a situation that may not be friendly to newcomers.
For example, a novice user who has lost their wallet's password or a casual user who has had their laptop stolen will also lose access to his or her bitcoins. Though there are storage solutions available, this feeds fears that investors who buy into the market could lose custody of funds, something they may not have with more traditional assets.
"It's a double-edged sword," said Chris McAlary, chief executive officer of Coin Cloud, a bitcoin trading and ATM company.
"People are drawn to bitcoin because it empowers them to take on the advantages that come with existing outside of the traditional banking system. With that come some risks which novice users may not be ready for. Successful bitcoin companies will build products that minimize that risk."
Zombies and the future
The question of "zombie" bitcoins is also important because of what it represents about this emerging technology. It is theoretically possible for digital goods, such as downloadable videos, music and games, to be digitally protected using a blockchain.
Such a scheme could make media ripping and non-authorized sharing - such as peer-to-peer downloading - pointless.
This, however, opens up the possibility that assets are lost. If a product is expected to be sold digitally, many would agree that there must be a mechanism in place to facilitate recovery - something a blockchain in its present form cannot do.
"With any asset there is a risk of losing it. Bitcoin is no different," said Holmes, adding:
"The only real difference is that with bitcoin you have to carefully secure the bitcoins and that means putting them in a wallet and best practice is to hold them offline. Key management has been an ongoing challenge in the IT industry so it could be argued that this is one of the potential weaknesses of any cryptocurrency."
In considering the true value of the bitcoin market, one must take seriously the question of lost wealth and the validity of the efforts to recover it. Due to the fact that the market has not embraced wealth recovery as a requirement, it may ultimately be impossible to truly quantify the size of the market.
To some bitcoin enthusiasts, this is a perfectly acceptable situation.
"A few years ago, I lost my key to my home safe," Holmes said. "After carrying the heavy safe to a number of locksmiths and getting nowhere I finally visited one and literally within two minutes he had opened the safe. Locksmiths and wallet crackers are actually a healthy development, providing that the cracking is done with consent."
He added that these concerns, as with bitcoin's market cap question, are simply issues that will be solved over time, concluding:
"As it did at the beginning of the dot-com boom, the market will provide what it needs to survive."
Market graph image via Shutterstock