Its been a decade since a programmer (or, possibly, a group of programmers) under the pseudonym Satoshi Nakamoto released a whitepaper outlining the technological structure Bitcoin which over the past decade has ushered in a new age of blockchain technology and decentralized digital currencies. But for the most part of this period Bitcoin was the only currency that was in existence. It was after the birth of Ethereum, which gave a platform for other projects to release their coins and this slowly started demising the contribution of Bitcoin urging a need to Bitcoin Dominance Index.
The Rise of Altcoin and Origin of Bitcoin Dominance Index
For the greatest number of years since 2009, Bitcoin has been the most dominant cryptocurrency and its dominance level was nearly 100%. But with the introduction of Ethereum, a lot of projects got a platform to release their coins. This led to the birth of a plethora of coins aiming to solve different existent issues which Bitcoin couldn’t solve. The rise of these altcoins slowly started challenging the dominance of Bitcoin and led to the formation of the Bitcoin Dominance Index.
Bitcoin Dominance Index originally was created to illustrate how much importance Bitcoin, the first digital currency to scale, had in the overall crypto economy. The Index stands as a ratio between the market cap of Bitcoin to the rest of the cryptocurrency markets.
Uses and Significance of Bitcoin Dominance Index
While fundamentally the ratio only states the dominance of Bitcoin over other altcoins in crypto markets, over last few years or since the trading is cryptocurrencies has picked up, traders have used this ratio/index for a variety of purposes.
Some Traders have found it useful to gain insight into the market and more specifically, the sentiment of traders if it is tilted towards the main Bitcoin or towards the other alternative coins (altcoins). Considering the dominance index as a market sentiment indicator, some traders have created successful strategies to move their money from altcoins to bitcoin and vice versa considering what the Dominance Indicator is indicating.
A lot of traders have again has part of their assessment strategy, used this index to effectively measures demand for Bitcoin relative to the demand for altcoins trying to get at the right price of bitcoin. As crypto markets have fairly justified that cryptos prices are a pure function of demand and supply, these indicative strategies have been helpful for them. Its pretty simple for a commoner to gauge that if the value of altcoins starts to plunge and Bitcoin does a far better job of holding its value it’s clear that the investors are buying up Bitcoin.
For some traders, they could also use the index to infer the market’s risk aversion. At some points, Bitcoin has functioned as a safe-haven asset, serving as a strong store of value during macroeconomic turmoil. By functioning like digital gold, Bitcoin has drawn many investors during these difficult times.
The Dominance Index is also used by a lot of researchers and fundamental analyst to gauge how much innovation is going on in the market overall, and specifically, where that innovation is taking place. To explain with an example, in the late-2016 and early-2017 period, Bitcoin’s market dominance fell to an all-time low. This is because Ethereum, with what was back then a first-of-its-kind smart Blockchain with token making factories, was becoming all the rage. In this period, it is very obvious to see that there was a high level of innovation; specifically, coming from Ethereum:
Criticism Of The Dominance Index
While there has been a lot of traders and consumers happy with the Bitcoin Index, there has been another group of people who are not really in favor of the Index. One major criticism of the Bitcoin Dominance Index is that market participants could easily reduce this particular measure by creating their own coins and also holding airdrops, which is when members of the cryptocurrency and blockchain community receive free units of digital currency.
Another reason that people believe that Dominance Index is not a true indicator is that they believe a lot of altcoins market caps have been manipulated. According to Jimmy Song Ripple, here stands the best example. He clearly states in his blog that Ripple – XRP is the coin where all coins have created a forehand and only released them to the public a bit at a time. He adds that there a huge number of Ripples that are being held in reserve so that the actual float (that is, the amount available to the public to trade) remains relatively small. Many pre-mined coins do the exact same thing to manipulate not just price but for their market caps. Only a small portion of the coins actually are traded while a big reserve sits on the side owned by their creators to keep the market cap of the coins high. With so much of XRP in hands of few can definitely can result in market cap manipulation.
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Also, to add to market cap manipulation point, many of the altcoins have ultra-low liquidity and actually don’t have that much money invested in them, despite the large market cap. These altcoins aren’t taking anything away from Bitcoin as much as they are pumping themselves up.
Another point that makes people believe that the Dominance index is less reliant as many of these Altcoins are actually subcoins of Ethereum and much of the market cap may be double-counted unless segregated into other MainNet coins.
With all the points tabled from viewpoints, Bitcoin Dominance Index is still a very crude metric and one that’s unfortunately very easy to manipulate. While it does give a fair bit of indication about how Bitcoin is behaving compared to other altcoins, it definitely needs some more time and stringency to become a loyal tool of the traders.
Nilesh Maurya has been associated for past 8 years as an Investment Banker with Omega Capital, a bespoke Investment Banking outfit having offices in Mumbai, New York, Singapore, and Dubai. He has been a regular contributor to business publications such as Business India and Market Express and has been a mentor to many start-up companies. Nilesh Maurya has been associated for past 8 years as an Investment Banker with Omega Capital, a bespoke Investment Banking outfit having offices in Mumbai, New York, Singapore, and Dubai. He has been a regular contributor to business publications such as Business India and Market Express and has been a mentor to many start-up companies. Follow him on Twitter at @KoinKing1 or connect with me on linkedin.