Modeling of emission and the value of cryptocurrencies based on signal theory

From the recent tweets of the founders of Ethereum it is clear that they are seriously concerned about not always justified the hype around the market value of the cryptocurrency. Work Vitalik Buterin devoted to attempts to clarify the situation.

It’s not the easiest read, however, in the quite in detail the author’s views on the situation. The following is a translation of the article, however, it should be noted that not only she, but also the subsequent discussion in the comments is of independent interest, and if the problem seems interesting, familiarity with the discussion (see source) will be very useful.

The text is often found such a thing as «burning a transactional commissions». It is not that other, as an indirect dividend, the coins taken out of circulation, causing the rate of the token increases, and benefit all community members.

The most common explanation of the situation «Why crypto-currencies can maintain their value, even if the income from transaction fees are burned?», remains the concept of cryptocurrencies as a «store of value». The value of the token, reads the argument, comes from the fact that people use it to store their values, so that the price is solely supported by self-sustaining inductive argument: people see that the token had the value from the time of Genesis until the time T-1 that it has a value at the time T, and that, most likely, at the moment T+1 it will also be of value; based on these expectations, people buy a token (or refrain from selling it), thus making the prediction true.

In General, it is NOT equal to saying that the cryptocurrency is a bubble, because, unlike the bladder, the above argument remains valid when rational expectations – it does not require market participants ‘ irrational behavior, the wrong conclusions, or outright deception, that is, the factors that create the bubble (hence originate the popular memes of the type «bagholder» or «greater fool Theory»).

In order for the argument to work, it must achieve a balance in which cryptocurrency is growing at the same pace with the global economy (or perhaps a couple lower rate), and besides, has such properties, which benefit its holders, for example, the lack of correlation of risks with the stock market, which is useful for diversification, or inherent to cryptocurrencies reliability (resistance to censorship).

The latter property is valued; in a sense, the blockchain can be likened to a company that provides secure storage of the gold (however, not all risk) and annual fee for storage is it the income from which is derived and market capitalization is enough to replace gold as a secure asset, the shares of the company.

Now consider the following question: what cryptocurrencies gain special status as a store of value and which are not? After all, anyone can download the code on github Bitcoin to start your coin and wait until the market determines its value, however, it is unlikely any way will be close to the value of bitcoins.

Theoretically, there are a large number of possible options: Bitcoin only has value only Bitcoin Cash, Bitcoin and Ethereum, only the IOTA, but at least only the top 1000 Coinmarketcap, where the Sha256 from the number list, Prime number, etc. the Set of cryptocurrency with a non-zero value is not fixed, it can join new players. However, if anyone can join the club, there is a problem: everyone wants to create a cryptocurrency and sell the tokens at a profit, as a result, the price of all cryptocurrencies will tend to zero (or at least their custom value to something based on future discounted transactional fees). Is there a balance somewhere in the middle?

The answer to this question is Yes. Consider a scenario with a set of entrepreneurs who can afford to spend capital in order to create a «signal» associated with their token. Expenditure $M capital creates a signal power of M*R () where R () is a random distribution with an average value of 1. Balance: cryptocurrency with a signal power of M is the initial market capitalization M*k, where k is reduced if the ratio of the sum of the capitalization of all cryptocurrencies to global GDP is growing (in addition, k>1 if cryptocurrency is not, and k<1 if cryptocurrency is 100% of global wealth).

The full market capitalization of all cryptocurrencies in any given time is at the point where k slightly greater than 1, so the entrepreneur brings some profit. If world GDP grows, for example, 3% per year, it can be assumed that the existing cryptocurrencies grow on average by 2% per year, and each year they added a new cryptocurrency with an initial value of 1% of the cost of existing. This is a situation of long-term stability; market share of cryptocurrencies as an asset remains constant in the long run.

Next question: what are the signals to which entrepreneurs spend capital? In theory, it could be anything. Even if the developer of the cryptocurrency is building a sand pyramid in Egypt, people may want to purchase cryptocurrency with the most impressive pyramids and the model continues to work. However, in practice, human psychology demands that the signal did not look quite ridiculous, or at least claim to seriousness; as well as to study in detail the cryptocurrency prevents people from a number of information barriers, the signal activity is manifested in two primary forms:

  • Technical development

  • Marketing, and its share is significantly higher than the cost of p. 1. This includes social media marketing, advertising, listing on the popular exchanges, the costs can reach several million dollars.

  • Total to join the club of currencies with the label «store values», the entrepreneur need some technical know-how and marketing sufficient to build the community.

    This shows that the market is internally useless digital asset does not necessarily collapses to zero in the foreseeable future, if you allocate and manage costs to create balance through well-chosen signals.

    Start a new cryptocurrency are now virtually free of charge, however, the new cryptocurrency, which is interested in sufficient numbers, requires ever-increasing costs of «marketing as a Proof of Work».

    Of course, the signaling theory is only one of the methods. An alternative theory of the valuation of cryptocurrency, more familiar to specialists in the field of classical Economics, described in early work, one in which cryptocurrency is presented in the form of corporations, and estimates of their cost derived from the expected discounted sum of coins – part transactional commissions, withdrawn from circulation (burned).

    Currently, only a small number of blockchains can be accurately represented by this theory; despite the fact that the Commission Bitcoins at some point reached $20 million per day, which corresponds to rather decent looking ratio P/E of 30 (P/E – ratio market value per share to the earnings per share), and the Ethereum gave a fifth of this amount (however, they are now $600K for BTC and $550K for the ETH in the day), the Commission can only be seen as income; they are paid directly to miners so that they can be considered the cost of the security; the profit for the blockchain remains.

    In pure PoS, even if the coins are taken out of circulation, this theory works, even in a weakened form: the coin is a tool that you can use: if you make the effort, you can claim a share of transaction commissions through virtual mining. As long as the effort is less than the award, the tool has value.

    It is reasonable to assume that the cryptocurrency world, in which the price of tokens is determined by the proportion burned of future commissions, or the value of the instrument to access these commissions will look healthier than current systems. If you display the brackets outright fraud, the only way to earn will be building (or investing in tokens as financial support) of the blockchain, which people really use.

    Given that the P/E ratio below 100 seems achievable (for example, in 2009, this ratio for the S&P was over 120), such a world can be built. In fact, even now it may be that tokens that have a wider application, have priority over tokens that do not possess such properties.

    The reason is simple: assume that all cryptocurrencies grow in average by 2% per year, but one of them burns every year 0.5% of the coins from transaction fees. Accordingly, the rate will rise to 2.5%, so it will be more willing to include in large investment portfolios. Therefore, in the long term, we believe that the best store of value becomes a system that contains properties that are useful primarily for other reasons, and the properties of the storage values will remain only in second place.

    Finally, with regard to the current situation in which cryptocurrencies can rise and fall dozens of times during the year: of course, the difference between 2% and 2.5% can not be detected. This means that to achieve the equilibrium state takes time – the ecosystem needs to move to the next state.

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