Bitcoin Dominance Index: Is It a Misleading Crypto Market Cap Metric?
Bitcoin Dominance Index – And Why It's A Truly Misleading Metric
Bitcoin, from the metrics of value, market capitalization, and performance lead a lot of its ardent supporters to profess the underlying dominance of it as a cryptocurrency compared to its rivals.
This remains the case when anyone brings up the dominance index, one that has been treating Bitcoin well, especially with the recent developments in the market and the third correction that has taken place. While values have slid, the market dominance of Bitcoin has crept up and past 50% this week.
As a result of this news, the reveling congregation of Bitcoin supporters flocked to social media such as Twitter and Reddit to rejoice in the unparalleled supremacy of it compared to other coins.
It's pretty remarkable to see just how fickle these same supporters can be whenever it comes to a bull vs bearish market for Bitcoin and cryptos, especially when it comes to clinging to specific statistics. Fundamentals certainly haven’t changed in a week nor has adoption budged by any relevant metric.
One of the ways in which analysts will point to the ‘strengths' of Bitcoin when compared to its rivals is the ‘Bitcoin Dominance Index‘ (BDI). The reason they use this statistic is that whenever the BDI declines, it serves as an indicator that investors are pulling their money out of Bitcoin and taking it to any number of other crypto-assets.
In contrast, whenever this Dominance Index rises, analysts theorize that this indicates that investors are pulling money out of rival cryptocurrencies and alt-coins, and pouring it into Bitcoin. Now, while this is an interesting theory to bring out in order to indicate dominance or a waning in influence, the Bitcoin Dominance Index is based on unfounded thinking, making many of the theories unfounded as well.
At the moment, there are over 1,843 various cryptocurrencies of varying values and popularity, according to the site CoinMarketCap. And there are continually more crypto-assets that are being added to the site's lexicon over the course of this quarter alone.
One of the interesting facts about any new crypto asset that is introduced to the cryptocurrency pool, is that its immediate and later values are added to the total market capitalization pool as well. Adding new crypto assets to the market does not signify money is flowing away from Bitcoin. Still, it affects Bitcoin’s dominance negatively.
So, by this logic, the addition of any new crypto asset to the collective market cap would serve to erode this ‘Dominance Index', leaving Bitcoin to continually pull itself back up to its initial position. While new altcoins don't indicate a movement of investments away from Bitcoin, it does negatively influence Bitcoin as a whole.
One of the other elements that erodes the underlying validity of using Bitcoin Dominance index as a metric is the constant presence of premines. For a cryptocurrency like Ripple (XRP), one that is extensively premined, one that also only boasts a market cap of 10% Bitcoins, only roughly 40% of XRP's total token supply is available to the public and in circulation. meanwhile, the remaining 60% of XRP tokens are retained by Ripple themselves.
What does this mean? It means that only those tokens that exist within the circulating supply of tokens are counted in an overall market capitalization. This also means that the current value of Ripple (which stands at $0.34) is based only on the number of its tokens that are in this circulation too. So what would happen if all the XRP was released into circulation? What is the release schedule? Can we trust it? Where Bitcoin’s supply growth is predictable, Ripple’s is at the discretion of Ripple itself.
It must also be taken into consideration that a large number of listed as BDI's are ICOs, while also taking into consideration that the vast majority of Initial Coin Offerings fail by some margin, we begin to understand that the value these crypto assets add to the total market capitalization is trivial.
Both crypto assets and ICOs have the potential to profoundly affect this BDI, negatively and positively. This fact, in itself, demonstrates some of the serious logical holes that BDI has whenever it's used to assess the relative success of cryptocurrencies.
Using this same fact, if 100 new ICOs were to be introduced to the market tomorrow, this would adversely impact on the underlying Bitcoin Dominance Index of Bitcoin, whether these new crypto assets were held at the same price, or fluctuated to some extent. When dominance falls, it’s no indication money is moving away from Bitcoin. That said, using BDI to determine the current state of Bitcoin is arbitrary.
With this same issue in mind, most of these coins attached to ICOs or otherwise, have no underlying liquidity to them, at least not a substantial amount. You can see this with a large number of the smaller altcoins that CoinMarketCap has listed on its database; some of them are worth millions in terms of market capitalization, all the while, there are other crypto assets that only boast a market cap of hundreds of thousands, and sometimes just hundreds of dollars.
Hypothetically, if someone were to create a cryptocurrency, with a total token supply . of 1 billion, which was then sold to only one person, that token would, in perpetuity, have a total market cap valuation of $1 billion based on that one sale. This, in itself, would be enough to shift the total Bitcoin Dominance Index by 1%, even though there have been no funds moved out of Bitcoin to any other asset. There are plenty of coins like this, hundreds in fact. As such, it’s clear that the way valuation is packaged into the BDI is improper and perhaps an unwise way to determine much at all.
Taking into consideration these hypotheticals based around the logic upon which the BDI is used, it goes to show that it is fundamentally flawed in terms of theory and practical application within the market.