#PaperWealth #Fragility #Bitcoin #MarketCapitalization #Hodling
Is paper wealth more fragile? 🤔
In a world where digital currencies like bitcoin are gaining popularity and creating massive amounts of paper wealth, it’s natural to question the stability of this wealth. Let’s explore the concept of paper wealth and its fragility in the context of bitcoin and other assets.
### What is paper wealth?
Paper wealth refers to the value of assets on paper, such as stocks, bonds, or digital currencies, that have not been realized through a sale. It is the theoretical value of an asset based on its market price, and can fluctuate based on market conditions.
### Fragility of paper wealth
1. **Volatility of markets**: Paper wealth is subject to the volatility of markets, where prices can fluctuate rapidly based on supply and demand. This can make paper wealth more fragile, as sudden market shifts can erode value quickly.
2. **Illiquidity of assets**: Just like in the example of the illiquid penny stock, assets that are not easily tradable can create paper wealth that is difficult to realize. This can increase the fragility of paper wealth, as it may be hard to convert it into cash when needed.
3. **Realized vs. unrealized gains**: The fragility of paper wealth also depends on whether gains have been realized or remain unrealized. Unrealized gains are vulnerable to market fluctuations, while realized gains are more stable as they are locked in.
4. **Market capitalization**: The market capitalization of an asset, such as bitcoin, plays a role in determining the fragility of paper wealth. A large market capitalization can provide stability, but rapid increases in paper wealth can create fragility if the market is not able to support it.
### Bitcoin and paper wealth
When it comes to bitcoin, the concept of paper wealth takes on a new dimension due to its digital nature and decentralized trading. Here are some factors to consider in relation to the fragility of paper wealth in bitcoin:
1. **Hodling philosophy**: Many bitcoin investors subscribe to the hodling philosophy, which involves holding onto their bitcoin for the long term. This can create a large amount of unrealized paper wealth that may be susceptible to market shifts.
2. **Market capitalization**: Bitcoin’s market capitalization has grown significantly over the years, creating substantial paper wealth for investors. However, the question remains whether this wealth is sustainable in the face of market volatility and potential selling pressure.
3. **Realization of gains**: As more investors start to realize their gains in bitcoin, the fragility of paper wealth may come into play. If a large number of investors decide to sell at the same time, it could lead to a sharp drop in prices and erode paper wealth quickly.
### Conclusion
In conclusion, paper wealth can indeed be fragile, especially in the context of illiquid assets like penny stocks and volatile markets like bitcoin. While paper wealth represents the value of assets on paper, its stability depends on various factors such as market conditions, asset liquidity, and investor behavior.
As investors navigate the world of paper wealth, it is important to consider the potential fragility of their investments and diversify their portfolios to mitigate risk. Whether it’s bitcoin or traditional assets, understanding the nature of paper wealth and its vulnerability to market forces is crucial for long-term financial success.
This is a problem with simple market capitalization calculations.
Market caps of large companies are somewhat lies, but all valuations are somewhat lies too. However, this is a well-known phenomena and is well studied.
For this reason, often prices especially for less liquid securities are corrected by how much actual money exchanged hands at that price (VWAP for instance).
What you are looking at for bitcoin is somewhat akin to a liquidity event, where so many people are looking to cash in on their assets that it affects the price negatively.
TLDR: This is a well known phenomena, generally one should correct paper wealth by the liquidity behind the wealth. However, liquidity events do happen and are well studied.
The market cap is the total liquid equity for the company, including the total value of stock. You didn’t create $670,000, you bought 250 shares of common stock.
What you did do is buy $30 worth of stock from the company or another shareholder for $50.
A $1,000,000 market cap company offering shares worth $0.12 could offer in the region of 8,300,000 shares.
So you likely bought roughly a 0.00003% stake in the company with your $50, nobody made $670,000.
It’s more fragile in the sense that market capitalization is a bad way of estimating total value in the first place, for precisely the reason you’ve shown. A better estimate of value is what all of the shares would actually sell for if they were all put up for auction simultaneously. Unfortunately we can’t estimate that without a lot more knowledge about everybody’s demand curves — and so we use market cap instead, because it’s easier to compute. But wrong.
Think about the situation with housing. You want to sell your house so you can move to a different city. You put it on the market for $300K, because that’s the price that the last house on the street sold for. After several viewings you have no buyers, but you need to move out. So, you cut the price, then cut it again. Eventually you sell for $250K. Now, let’s say that all your neighbours live in similar houses of similar size. They will notice, this. Can they be confident that their houses are worth $300K? No, of course not. Let’s say that you calculate the “market capitalization of the street”. There are 25 houses. At the start it was 25 x 300 = $7.5M. After your sale it has dropped to $6.25M. Your sale has cut $1.25M off the market capitalization of your street. So, the same thing can happen to *physical assets*!
The problem here is that market capitalization depends on the current price, and the price depends on the marginal buyer and marginal seller. We don’t get to see what is “inframarginal”. That is, we can’t see the whole supply curve or the whole demand curve – so we have nothing better than market capitalization.