Understanding how to calculate a fair market capitalization for Steem is a bit more complex than your traditional cryptocurrency. The value of Steem is divided among three asset classes, STEEM, VESTS, and SBD so it isn’t as simple as taking the current price-per-coin and multiplying it by the total number of coins.
If we are going to borrow concepts from the capital markets, then the best way to understand how to calculate the market capitalization of Steem is to compare it to how the market capitalization of a traditional company is calculated.
According to Investopedia, Market capitalization is just a fancy name for a straightforward concept: it is the market value of a company's outstanding shares. This figure is found by taking the stock price and multiplying it by the total number of shares outstanding.
As anyone familiar with the workings of private and public companies knows, there are often many kinds of shares circulating. Traditional cryptocurrency is most similar to common stock. On the Steem blockchain, STEEM would be analogous to common stock.
Another common form of stock is known as restricted stock.
According to Wikipedia, restricted stock, also known as letter stock or restricted securities, refers to stock of a company that is not fully transferable (from the stock-issuing company to the person receiving the stock award) until certain conditions (restrictions) have been met. Upon satisfaction of those conditions, the stock is no longer restricted, and becomes transferable to the person holding the award.
On the Steem network, VESTS, also known as Vesting STEEM, is analogous to Restricted Stock. In exchange for locking up STEEM into an indivisible bundle, VESTS are protected from most forms of dilution of the common stock, STEEM. VESTS can be transferred by updating the controlling account’s key, but an individual account cannot divide their VESTS balance.
To make a comparison to Bitcoin, imagine an unspent output that could only be transferred to another output of the same size.
According to Wikipedia, Restricted stock is generally incorporated into the equity valuation of a company by counting the restricted stock awards as shares that are issued and outstanding. This approach does not reflect the fact that restricted stock has a lower value than unrestricted stock due to the vesting conditions attached to it, and therefore the market capitalization of a company with restricted stock outstanding may be overstated.
Based upon industry convention, the market capitalization of Steem should include both liquid and divisible STEEM along with illiquid and indivisible VESTS. Some people may object that this process could over-value Steem based on the premise that VESTS are less valuable than STEEM due to the added restrictions.
Estimating the value of vesting STEEM
Assuming we are willing to go through the computational effort to arrive at a more fair market capitalization, then it is important to have a rational basis for valuing VESTS.
Perhaps the easiest way to decide the value of VESTS is to look at how people voluntarily buy or sell VESTS on the market. We know that all VESTS are created by users voluntarily converting STEEM into VESTS. This gives us a market-based indication that these users value VESTS more highly than they value STEEM.
If VESTS were worth less than the STEEM used to create them, then no one would convert voluntarily. So why does the market value VESTS more highly than it values STEEM? Because VESTS have benefits that STEEM does not. In other words, the value of the benefits outweighs the cost of the added restrictions.
So what are the extra benefits?
- Significant reduction in dilution used to fund blockchain operations.
- Voting power over allocation of funds and governance of the blockchain.
- The ability to transact on the blockchain.
Based upon this analysis one could rationally argue that valuing vesting STEEM at the same rate as liquid STEEM is underestimating market capitalization.
Should Steem Dollars be included in Market Capitalization?
In the investment world there is a more comprehensive way to value a company known as Enterprise Value.
Enterprise Value, or EV for short, is a measure of a company's total value, often used as a more comprehensive alternative to equity market capitalization. The market capitalization of a company is simply its share price multiplied by the number of shares a company has outstanding. Enterprise value is calculated as the market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents. Often times, the minority interest and preferred equity is effectively zero, although this need not be the case.
A cryptocurrency has no cash or cash equivalents which leaves EV equal to market cap plus debt. Steem is unique from most other cryptocurrencies in that it is one of the first to offer “convertible debt” backed by the blockchain. Steem Dollars are convertible to STEEM at the current price of STEEM. This means that all Steem Dollars could be converted to “common stock” in less than one week which in turn would instantly adjust the market capitalization of Steem.
Making a Fair Comparison of Blockchain Community Valuation
Websites like coinmarketcap.com attempt to rank all of the cryptocurrency projects by total valuation. This helps those interested in the space understand the relative value and invest or speculate accordingly. If we were comparing companies, then the best and most comprehensive comparison would be Enterprise Value rather than market capitalization. For almost all other blockchains, Enterprise Value and Market Capitalization are one and the same. Steem is the first of a new generation of more advances blockchains that have a significantly more sophisticated capital structure. If websites like coinmarketcap.com wish to remain fair and relevant in their comparisons and rankings of this new generation of cryptocurrency, then they will need to adopt the more sophisticated measures used by real capital markets.
Fortunately, Steem already provides a simple approximation known as the virtual STEEM supply which is calculated by adding up the total vesting STEEM, liquid STEEM, and the STEEM that would exist if all Steem Dollars (SBD) were to be instantly converted to STEEM. This metric multiplied by the current price of STEEM will produce a “market capitalization” or “enterprise value” that is closer to the true value of STEEM. It should be recognized, that so long as people are still voluntarily converting STEEM to VESTS this all inclusive metric is likely an underestimation.
Available Supply vs Total Supply
coinmarketcap.com makes a distinction between available supply and total supply. The distinction between available supply and total supply was originally introduced in response to Ripple which created 100 billion XRP but only distributed 34 billion to people outside of Ripple Labs. To better understand the rationale behind this it is useful to look to analogies in the equity markets.
The best analogy is the difference between Issued and Outstanding shares.
Issued Shares are the shares of stock that are sold to and held by shareholders of the company. These can be held by people within the company, investors or the general public. Issued shares also refer to the shares of stock that are available for sale. Essentially, this is stock that has been formally issued by the company to generate revenue.
Outstanding Shares are the shares of stock that are owned by people within and outside the company. They do not include shares that are retired, in treasury, or for sale. These are only shares that are currently held by a person or entity. This figure is placed on the balance sheet of the company, and is used to help calculate key metrics that help determine the risk level of the investment.
Here is a video that explains these different kinds of shares.
In this case, 100 billion XRP is like issued shares whereas the 34 billion XRP is like outstanding shares. The 66 billion XRP is reserved shares that can be sold to generate revenue for Ripple Labs. If it is sold then they become outstanding shares.
Because cryptocurrencies are not shares in companies, the analogies are not a perfect fit. If the blockchain is viewed as an independent entity then the closest thing to reserved shares or issued shares are future mining rewards or the reserve pool for BitShares. These are shares that are not in control of any individual market participants, but allocated entirely at the discretion of the blockchain.
From this perspective, coinmarketcap.com is grossly inconstant in its application of Issued vs Outstanding shares. Bitcoin has “issued” 21 million BTC, but only has 15 million outstanding. Where as BitShares has issued about 3.7 billion BTS and has about 2.5 billion outstanding.
Ripple Labs, on the other hand, is a private entity with respect to the Ripple blockchain. All 100 billion XRP are outstanding. This is no different than any other company that issues shares to its founders. Coinmarketcap doesn’t exclude Satoshi’s BTC from outstanding supply simply because he is a “founder” and has opted “not to sell”.
Steem is authorized to issue unlimited STEEM at a deterministic schedule defined by the blockchain’s rules. All initial STEEM was issued and became “outstanding” via the process of paying miners to produce blocks. Much of this outstanding STEEM was converted into vesting STEEM but still retains the property of being outstanding.
The founders / creators of Steem mined their STEEM much like how Satoshi mined over 1 million BTC while the total supply of BTC was less than 2.6 million. From this perspective, the percent of STEEM mined by Steemit, Inc is the same order of magnitude as the Steem mined by Satoshi.
The only difference between Bitcoin and Steem is that there is some ambiguity over exactly how much Satoshi mined, where as Steemit,Inc has been incredibly transparent regarding how much it has mined. The other difference is the timescale over which the tokens were mined.
Is a founder’s balance considered issued or outstanding?
The determining factor of whether or not a token should be included in the outstanding supply is whether or not the blockchain is viewed as an independent unincorporated organization or whether the blockchain is just an extension of its founders. This hinges on a single question: do the founders have an obligation to use their balance for the benefit of the entire currency, or are the tokens held by the founders considered their private property.
If a founder buy’s or mines a token, does that convert it to “treasury shares”? The answer depends on whether the tokens held as “treasury shares” must be used for the benefit of all other shareholders.
The founders of Steem have stated from the beginning that they consider all of their STEEM to be private property. Any profits earned from the sale of their Steem can be used without obligation or consideration of any other party. This distinction is a necessary precondition to avoid rendering STEEM a security to be regulated. That said, the founders are free to use their profits to build businesses that in turn grow the value of STEEM. It may even be in their best interest to do so, but this is also true of all large shareholders of any company.
This is very similar to how many bitcoin miners used the profits they earned by selling their Bitcoin to fund businesses and build infrastructure that in turn give Bitcoin value. Steem is no different in this respect.
Conclusion
In the spirit of transparency, fairness, and objectivity coinmarketcap.com and similar sites should adopt a more consistent and rational application of valuation metrics used in the equity markets. A simple set of guidelines should be created that when answered objectively determines how various smart-contract instruments map to traditional equity market analogs. Once the mappings are made, the resulting market capitalization and/or enterprise value is trivial to derive.