introduction
Much of the crypto world is, by definition, cryptic and obscure. But two crypto trends are crystal clear: each talent and money are flowing into the digital currency market. Almost daily there may be a brand new announcement that software developers from Google or financiers from JPMorgan are joining crypto startups which can be poised to revolutionize something.
In fact, while the overall market capitalization of cryptocurrencies has fallen from its previous highs, this continues to be the case over the $2 trillion threshold. This corresponds to the worth of the complete German stock market, which incorporates blue-chip corporations reminiscent of Siemens, BMW and Volkswagen.
It is now just as easy to take a position in cryptocurrencies because it is in stocks, but what is definitely being purchased just isn’t as clear. When investors purchase Shiba Inu – a token with a $15 billion market cap and a Shiba Inu hunting dog mascot – SHIB tokens are deposited into their digital wallets. But what do they really own? And what drives SHIB’s performance?
Theoretically, the more popular the token, the upper the worth. But does this relationship delay in practice? Let’s investigate.
Tokens vs. Coins
Before we dive into it, we first have to define some basic crypto terminology: A token is a brilliant contract built on a blockchain, and a crypto coin is the native token of a specific blockchain. For example, ETH is the coin of the Ethereum blockchain, but SHIB is an Ethereum-based token. While all coins are tokens, not all tokens are coins.
The variety of tokens has exploded lately, and the variety of tokens is now eight times larger than the variety of coins. Ethereum and Binance Smart Chain together account for about 85% of the market share of the blockchain infrastructure layer on which tokens are bought and sold. The query arises as as to whether all the currently around 1,000 coins are crucial. In the long term, that is probably not the case.
Cryptocurrencies: Number of tokens and coins
Token financing
Crypto startups are funded through equity and tokens. Raising capital through equity means issuing shares which can be privately owned by angel investors, enterprise capitalists, and the like. These shares are an ownership interest that entitles recipients to dividends and proceeds from the sale of the corporate.
Token financing is totally different: it gives investors no legal right to the underlying business. Therefore, token and stock investments aren’t really comparable.
Of course, startups looking for token funding have to persuade investors that participating within the token sale provides added value. The typical pitch is that the startup’s product requires the usage of tokens. This can create fairly complex ecosystems that resemble small economies with their various stakeholders: the startup is the equivalent of the federal government, the product is a proxy for goods, the users for consumers, and the token for the currency or medium of exchange.
Since each token represents a currency, demand and provide should determine its price. Token and coin issuers can influence supply: Bitcoin, for instance, limits the overall variety of tokens to 21 million and Ethereum has bought back and “burned” ETH tokens. Since the tokens are cryptocurrencies, their demand must be influenced by their popularity.
What is the connection between token price and token volume?
However, the connection between the start-up’s product and the underlying token just isn’t clear and subsequently difficult to judge. Shareholders would really like to own shares in a booming, revenue-generating company. However, token investors aren’t entitled to such money flows.
Worse, token investors face an information deficit as startups release little to no financial data in regards to the underlying company. This puts them at a major drawback in comparison with stock investors.
The best way for token investors to grasp the worth of their holdings is to interpret the change in token volume as an indicator of demand for the associated product. The more popular the product, the upper the demand for the token, which should reflect increasing volume of the token on the exchange.
But this relationship doesn’t arise to scrutiny. The rolling correlation between changes in token volume and token price of all tokens between 2014 and 2022, on each a monthly and annual basis, is near zero. This indicates that there is no such thing as a positive relationship between the startup’s business and the worth of its token.
Correlations between token price and token volume
But what in regards to the correlation between token volume and price for all tokens? There are numerous bad actors within the crypto space, and a few token issuers could also be more focused on scaring off under-informed investors than constructing long-term businesses.
So what if we limited our universe to only essentially the most successful tokens by market cap: the highest 1,000, the highest 100, the highest 50, and the highest 10? The last of those categories has a combined market cap of around $100 billion and includes Chainlink and Uniswap. These tokens are related to products which have amongst the most important user bases within the crypto community. If they were normal corporations, their equity can be very helpful.
Again, the correlation between volume and price is negligible regardless of the way it is measured. So perhaps the product and token within the crypto space don’t have any influence on one another.
But if product utility doesn’t increase token performance, what does? The obvious answer is theory.
In cases like Shiba Inu, that is pretty obvious. SHIB is a meme token with no underlying product. At best, it is a bet that other investors will are available and drive up the worth. This is theory in its purest form. Investors are simply playing a game of musical chairs, betting that they’ll discover a seat before the music stops.
Price and volume correlations of top tokens, 2017 to 2022
Axie Infinity provides an excellent case study of how this dynamic plays out. Axie Infinity, an internet game by which players battle one another to earn tokens called Axie Infinity Shards (AXS), became popular in 2021 as a source of income in emerging markets reminiscent of the Philippines and Venezuela. The token system, based on the Ethereum blockchain, was designed in order that players with AXS would should purchase digital pets called Axies to be able to compete.
The price of an AXS token rose from $5 in May 2021 to a high of $160 in November 2021 before declining to around $47 as of this writing. Volume increased significantly when prices surged in July 2021, but not in the course of the AXS bull market within the six months thereafter. There were periods when price and volume moved in parallel, but on average the correlation was only moderately positive at 0.5.
Axie Infinity Shard (AXS) Price vs Volume
Coin price and volume correlations
But tokens are just one side of the crypto equation. What about coins? Do they show the identical dynamics? In theory, the worth of each tokens and coins must be determined by their usage. For tokens, the worth must be determined by the corporate. But as we now have seen, this connection is difficult to confirm.
The price of coins, however, should depend upon the variety of transactions that happen on the associated blockchains. The more startups launch their tokens on Ethereum, the greater the demand and the upper the costs for ETH coins.
But here too, the correlation between coin volume and price was just as little as with tokens. This suggests that the utility of coins also doesn’t have a major impact on their prices.
Correlations between coin price and coin volume, 2014 to 2022
There could also be no connection between coins and their usage over Bitcoin (BTC) and Ethereum (ETH), the 2 coins with the most important market caps at $900 billion and $400 billion, respectively. The correlations haven’t exceeded 0.5 for any of those aspects over the past six years.
Bitcoin and Ethereum: Price and Volume Correlations
More thoughts
Of course, the correlation between stock price and trading volume can also be quite low, so the premise of this evaluation could be easily questioned. In many bear markets over the a long time, the stock prices of corporations with good fundamentals have fallen. Both tokens and stocks profit and suffer at times from investor greed and fear.
So what’s the difference between crypto and stock investing? The essential difference is that enormous corporations can distribute profits as dividends to their shareholders whatever the market environment. There isn’t any parallel to investing in cryptocurrencies. There can also be no comparable to a buyout, by which stock investors receive a premium for his or her shares.
Worse still, currency investing is a zero-sum game. For every investor who profits from a USD or BTC position, one other loses the corresponding amount.
Luckily for crypto investors, fiat currencies have been on the losing side of this trade for a while. But this trend is unlikely to last long unless blockchains provide more utility and change into greater than mere speculation tools.
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Photo credit: ©Getty Images / TERADAT SANTIVIVUT
