Recently, a lot of very-low-quality cryptocurrency tokens have been seeing enormous “market caps”. I think a lot of people are getting confused by that, and are resolving the confusion incorrectly. If you see a claim that a coin named $JUNK has a market cap of $10B, there are three possibilities. Either: (1) The claim is entirely false, (2) there are far more fools with more money than expected, or (3) the $10B number is real, but doesn’t mean what you’re meant to think it means.
The first possibility, that the number is simply made up, is pretty easy to cross off; you can check with a third party. Most people settle on the second possibility: that there are surprisingly many fools throwing away their money. The correct answer is option 3: “market cap” is a tricky concept. And, it turns out that fixing the misconception here also resolves several confusions elsewhere.
(This is sort-of vagueblogging a current event, but the same current event has been recurring every week with different names on it for over a year now. So I’m explaining the pattern, and deliberately avoiding mention of any specific memecoin.)
Suppose I autograph a hat, then offer to sell you one-trillionth of that hat for $1. You accept. This hat now has a “market cap” of $1T. Of course, it would be silly (or deceptive) if people then started calling me a trillionaire.
Meme-coins work similarly, but with extra steps. The trick is that while they superficially look like a market of people trading with each other, in reality almost all trades have the coin’s creator on one side of the transaction, they control the price, and they optimize the price for generating hype.
Suppose I autograph a hat, call it HatCoin, and start advertising it. Initially there are 1000 HatCoins, and I own all of them. I get 4 people, arriving one at a time, each of whom decides to spend $10 on HatCoin. They might be thinking of it as an investment, or they might be thinking of it as a form of gambling, or they might be using it as a tipping mechanism, because I have entertained them with a livestream about my hat. The two key elements at this stage are (1) I’m the only seller, and (2) the buyers aren’t paying much attention to what fraction of the HatCoin supply they’re getting. As each buyer arrives and spends their $10, I decide how many HatCoins to give them, and that decision sets the “price” and “market cap” of HatCoin. If I give the first buyer 10 coins, the second buyer 5 coins, the third buyer 2 coins, and the fourth buyer 1 coin then the “price per coin” went from $1 to $2 to $5 to $10, and since there are 1000 coins in existence, the “market cap” went from $1k to $2k to $5k to $10k. But only $40 has actually changed hands.
At this stage, where no one else has started selling yet, so I fully control the price graph. I choose a shape that is optimized for a combination of generating hype (so, big numbers), and convincing people that if they buy they’ll have time left before the bubble bursts (so, not too big).
Now suppose the third buyer, who has 2 coins that are supposedly worth $20, decides to sell them. One of three things happens. Option 1 is that I buy them back for $20 (half of my profit so far), and retain control of the price. Option 2 is that I don’t buy them, in which case the price goes to zero and I exit with $40.
If a news article is written about this, the article will say that I made off with $10k (the “market cap” of the coin at its peak). However, I only have $40. The honest version of the story, the one that says I made off with $40, isn’t newsworthy, so it doesn’t get published or shared.
Recently, a lot of very-low-quality cryptocurrency tokens have been seeing enormous “market caps”. I think a lot of people are getting confused by that, and are resolving the confusion incorrectly. If you see a claim that a coin named $JUNK has a market cap of $10B, there are three possibilities. Either: (1) The claim is entirely false, (2) there are far more fools with more money than expected, or (3) the $10B number is real, but doesn’t mean what you’re meant to think it means.
The first possibility, that the number is simply made up, is pretty easy to cross off; you can check with a third party. Most people settle on the second possibility: that there are surprisingly many fools throwing away their money. The correct answer is option 3: “market cap” is a tricky concept. And, it turns out that fixing the misconception here also resolves several confusions elsewhere.
(This is sort-of vagueblogging a current event, but the same current event has been recurring every week with different names on it for over a year now. So I’m explaining the pattern, and deliberately avoiding mention of any specific memecoin.)
Suppose I autograph a hat, then offer to sell you one-trillionth of that hat for $1. You accept. This hat now has a “market cap” of $1T. Of course, it would be silly (or deceptive) if people then started calling me a trillionaire.
Meme-coins work similarly, but with extra steps. The trick is that while they superficially look like a market of people trading with each other, in reality almost all trades have the coin’s creator on one side of the transaction, they control the price, and they optimize the price for generating hype.
Suppose I autograph a hat, call it HatCoin, and start advertising it. Initially there are 1000 HatCoins, and I own all of them. I get 4 people, arriving one at a time, each of whom decides to spend $10 on HatCoin. They might be thinking of it as an investment, or they might be thinking of it as a form of gambling, or they might be using it as a tipping mechanism, because I have entertained them with a livestream about my hat. The two key elements at this stage are (1) I’m the only seller, and (2) the buyers aren’t paying much attention to what fraction of the HatCoin supply they’re getting. As each buyer arrives and spends their $10, I decide how many HatCoins to give them, and that decision sets the “price” and “market cap” of HatCoin. If I give the first buyer 10 coins, the second buyer 5 coins, the third buyer 2 coins, and the fourth buyer 1 coin then the “price per coin” went from $1 to $2 to $5 to $10, and since there are 1000 coins in existence, the “market cap” went from $1k to $2k to $5k to $10k. But only $40 has actually changed hands.
At this stage, where no one else has started selling yet, so I fully control the price graph. I choose a shape that is optimized for a combination of generating hype (so, big numbers), and convincing people that if they buy they’ll have time left before the bubble bursts (so, not too big).
Now suppose the third buyer, who has 2 coins that are supposedly worth $20, decides to sell them. One of three things happens. Option 1 is that I buy them back for $20 (half of my profit so far), and retain control of the price. Option 2 is that I don’t buy them, in which case the price goes to zero and I exit with $40.
If a news article is written about this, the article will say that I made off with $10k (the “market cap” of the coin at its peak). However, I only have $40. The honest version of the story, the one that says I made off with $40, isn’t newsworthy, so it doesn’t get published or shared.
Related: youtuber becomes the world’s richest person by making a fictional company with 10B shares and selling one share for 50 GBP