Key Takeaways
- Until now, a standardized approach to determining the free float supply (the supply that is available to the market) of cryptoassets has not been established. This has hindered the market from developing a clear understanding of available supply and market capitalization.
- Coin Metrics’ free float supply takes many of the best practices from traditional capital markets and applies them to cryptoassets to identify supply that is highly unlikely to be available to the market in the short to mid-term. In doing so, free float supply provides a better approximation of a cryptoasset’s liquidity and market capitalization.
- Index weighting can benefit from using free float supply – free float supply reflects the liquid market more accurately and reduces potential manipulability.
- Tracking free float supply provides insight into primary token holder behavior. This can lead to more transparent reporting of foundation and team selling, increased knowledge of total market supply and behavioral analysis of stakeholders.
- Many cryptoasset valuation metrics use market capitalization which primarily utilize the on-chain visible supply. Deriving these metrics with a free float capitalization may improve the signal achieved.
Introduction
In April, Coin Metrics announced a new methodology for the determination of a cryptoasset’s supply that is ‘available’ to the market, cryptoasset free float.
Without reporting standards and regulations that require foundations and companies to accurately report holdings in a timely manner, obtaining supply data that is reflective of market trading opportunities can be a challenge.
Coin Metrics’ free float supply takes many of the best practices from traditional capital markets and applies them to cryptoassets to identify supply that is unlikely to be available to the market. In doing so, free float supply provides a better approximation of a cryptoasset’s liquidity and market capitalization. For more information on the supply that is considered restricted, please refer to the CMBI Adjusted Free Float Methodology.
While initially created to help inform CMBI design, cryptoasset free float supply can be applied in many different ways to help market participants make smarter investment decisions. Some of the areas where free float can be applied to improve market understanding include:
- Market Capitalization
- Indexes
- Valuation methods
- Foundation and Founding Team Transparency
Applying Free Float to Market Capitalization
Typically, investors expect a market size measurement to reflect the total value of assets that are available in the market. For example, to determine market capitalization in equity markets, data providers and participants exclude company and executive team owned shares, as well as shares owned by other strategic investment partners that do not provide liquidity to markets.
A standardized approach like this has not yet been consistently applied to determining the free float supply and market capitalization of cryptoassets. This has hindered the market from developing a clear understanding of available supply and market capitalization.
For determining supply and market capitalization, the CMBI Adjusted Free Float Methodology applies a standardized criteria for which units of supply to exclude from free float, including but not limited to:
- Supply owned by foundations, companies and founding teams
- Supply in addresses that have been inactive for over 5 years
- Supply staked in a smart contract to partake in governance and long-term strategic outcomes of a network without any direct monetary incentive to do so
- Supply that is vesting on-chain
- Supply that are burned or provably lost
Applying the above methodology rigorously to the top cryptoassets identifies a more comprehensive supply that is not available to the market. Utilizing the available supply to trade (free float supply) rather than either reported supply by foundations/companies or total visible on-chain supply can significantly impact investor’s understanding of the total market size of a cryptoasset and related metrics such as dominance and liquidity.
1 – Source: Price from CM Market Data on 28 June 2020
2 – Source: Free Float Supply from CM Network Data on 28 June 2020
3 – Median value of ‘Reported Supply’ from Coinmarketcap, Messari and Coin Gecko
4 – CM Tether Free Float Supply only includes USDT issued on Omni, Ethereum and Tron
Evidenced in the above, standard industry reporting of cryptoasset supply, and thus market capitalization, has traditionally been overstated. Some of the more pertinent examples of this are:
- Bitcoin – where the industry standard has been 18.4M. Coin Metrics free float calculations determine that a more accurate representation of free float supply is 14.3M (22% lower), reflecting that 4.1M Bitcoin has not been transacted in over 5 years and as such can be considered to be owned by long term strategic holders that do not provide liquidity to markets (or lost).
- Bitcoin Cash and Bitcoin SV – the industry standard has been to utilize their on-chain supply of ~18.5M native units to determine market capitalization. Through understanding how many BCH and BSV have been moved since the fork, Coin Metrics has determined that a more accurate representation of supply for BCH and BSV is 12.0M (36% lower) and 9.9M (45% lower) respectively.
- XRP and Stellar – both of these foundations report their own holdings to data distributors. Due to an absence of regulatory standards and the irregularity of reporting, not all addresses may be disclosed and the reported values may not be maintained. Coin Metrics has identified additional supply that can be traced to the foundations and team members, which is reflected by XRP and Stellar having a free float supply of 30.4B and 16.5B, lower than is typically reported.
Applying Free Float to Indexes
Most multi asset indexes are weighted by each constituent asset’s market capitalization. Thus, redefining a cryptoasset market capitalization to reflect free float will impact the construction of indexes.
The key benefits of weighting an index using the free float market capitalization as opposed to the reported market capitalization include: reflecting the liquid market more accurately, maintaining more timely supply data to weight indexes, reducing potential manipulability of index weightings, and reducing index rebalancing costs.
Cryptoassets have varying levels of auditability and transparency when it comes to foundation and team holdings. For this reason, Coin Metrics applies a free float supply banding approach when weighting CMBI Indexes. The banding methodology reflects that supply determination is currently not a perfect science. For example if Coin Metrics identify 53% of cryptoassets as the free float supply, but the ‘true’ value is 56% (or 50%), the asset will ultimately fall into the 50-60% band. Such an approach helps to overcome nuances in supply determination and varying levels of transparency, reporting and auditability.
Simply, after determining the ratio of free float to on-chain available supply, each asset’s ratio is rounded up to the closest 10%. This value is then applied for the purpose of weighting assets in the CMBI Market Cap Weighted Asset Index Series. For example:
- Bitcoin’s free float ratio is 77.8% (free float supply of 14.3M of a total on-chain supply of 18.4M).
- Rounded up to the nearest 10%, Bitcoin’s band would be 80%
- Applied to the total supply of Bitcoin, 18.4M, Bitcoin’s in weight in the index would be derived using a supply of 14.7M (18.4M * 80%)
Increasing Market Transparency
As part of Coin Metrics’ new free float supply metric identification process, addresses in the following categories have been tagged by Coin Metrics and are considered to be restricted:
- Owned by foundations/companies
- Owned by founding team members
- Governance contracts where there is no direct financial benefit
- Provably lost
Doing so can provide timely and transparent reporting of the movements and actions of each category of stakeholder on a cryptoasset’s network. This can lead to more transparent reporting of foundation and team selling, increased knowledge of total market supply and behavioral analysis of stakeholders.
Without transparency, market participants are left uninformed on the actions of foundations and teams, making it impossible to understand the holistic market dynamics.
Case Study 1: Tether (USDT)
Many market spectators monitor and observe the printing and burning of USDT as significant market events that can impact the price of Bitcoin and crypto markets. Speculation to the impacts of Tether activity has been so high that many academics and regulators have investigated this activity during significant market events.
However, observing the on-chain activity of USDT can be misleading as Tether has historically printed USDT in large batches in anticipation of future demand and distributions. Thus, on-chain supply does not necessarily mean new supply in public markets. Coin Metrics’ free float supply excludes USDT held by the Tether Treasury to provide a more accurate indication of the supply that is currently in public markets.
As can be observed below, particularly through 2018 and the first half of 2019, the USDT issued does not necessarily represent the USDT in markets. Particularly interesting is the USDT activity in early 2019. Market participants observing the on-chain supply would not have noticed significant change as Bitcoin rose from $4,000 to $12,000. However, by observing free float supply, the correlation between free float USDT and Bitcoin’s price becomes clearer.
Case Study 2: Chainlink (LINK)
As per the ‘reported supply’ on all data distributors, the supply of LINK is 350M. However, since genesis in late 2017, the founding team has moved 31M LINK worth almost $50M at the time of wallets’ activity. This represents a 3.5% rate of inflation that investors may not be considering when developing valuation models.
Applying Free Float to Valuation Methods
Many cryptoasset valuation methodologies use market capitalization in the derivation of indicator metrics. Two of the more popular valuation methods utilized for Bitcoin are:
- Willy Woo and Dmitry Kalichkin’s Network Value to Transaction (NVT) Ratio – which measures the total value of Bitcoin to the value transmitted through its network.
- Murad Mahmudov and David Puell’s Market-Value-to-Realized-Value (MVRV) Ratio – which measures the relationship between the current market value of Bitcoin and its realized value (aggregate value of all BTC priced at the time they last moved).
Both of these relative measures of Bitcoin’s performance use the market value of Bitcoin. For Bitcoin at least, market value naturally appreciates over time due to its programmatic inflation schedule. However, current measures do not account for inactivity or holders that might restrict supply from markets, thus reducing the ‘accessible’ value of the network.
In redefining what market value is by adjusting for free float, new and more clear insights and signals can be observed for both these measures.
NVT Signal (NVTS)
Often referred to as the “crypto PE ratio”, NVT was first introduced by Willy Woo as a proxy measurement for the underlying utility of Bitcoin’s network. Such an approach to valuing cryptoassets had not previously been undertaken and the result proved valuable in detecting over and undervaluation. Dmitry Kalichkin later proposed NVT Signal (NVTS) which increases the emphasis on predictive signaling through utilizing a 90-day average for the daily transaction volume.
However, in the last few years, NVTS has often over-signaled bearish and failed to signal bullish as strongly as it previously has. By adjusting the numerator to reflect the free float market capitalization (network value), it can be argued that more distinct and more accurate bearish and bullish signals can be achieved.
The current NVTS measurement (green line) has largely remained in overvalued territory since the start of 2019, whereas the free float NVTS (blue line) has provided less frequent but more precise overvalued signals. Further, free float NVTS has identified stronger undervalued signals than NVTS in both late 2018 and March 2020.
The definition of Free Float Network Value to Transaction Ratio (FF NVTS) is:
Market-Value-to-Realized-Value (MVRV) Ratio
In their announcement of MVRV, Murad and David indicated that such a measure provided insight into an interesting market dichotomy that can be described as follows:
“The booms seem to expand the network via an exuberant viral gossip mechanism that broadcasts the existence of Bitcoin to the world population; while the busts, in the long-run, seem to reward individuals who chose to delay short-term financial gratification in the search for sound money.”
Such a dichotomy can suggest that at times there is a fracture in the price discovery from short term traders and the ‘sounder’ and more steady long term investors.
In their initial medium post, thresholds were identified as follows:
- Above 3.7 indicated overvaluation
- Below 1.0 indicates undervaluation
Potentially suffering from the same issue mentioned above, the numerator of MVRV incurs a natural increase from the programmatic inflation of Bitcoin. In recent history, MVRV has remained closer to the bottom of it’s ‘fair value’ range, which implies that if the natural level of inflation is impacting MVRV negatively, traders are missing potential buy opportunities (i.e. if MV was lower, MVRV may dip below 1.0).
This issue is overcome by adjusting the MVRV numerator for free float supply as evidenced below. Such an approach has shown some additional buying opportunities that have empirically proven to optimize the signal from MVRV.
The definition of Free Float Market-Value-to-Realized-Value (FF MVRV) is:
Conclusion
Measuring and understanding the Free Float Supply of cryptoassets has a broad host of applications that can improve market participants’ understanding of ‘real’ market capitalization, optimize the signal from network valuation metrics, improve construction of indexes to better reflect the market’s liquidity profile, and increase the transparency of large cryptoasset interest group behaviors.
