coin inflation-adjusted price
- Green area: Total network coin supply outstanding;
- Blue line: Market price of coin, in US$;
- White line: Inflation-adjusted price of coin, in US$.
coin inflation-adjusted price explained
As mentioned in the previous section, the cryptocurrency industry does use terms that typically apply to the stock market, such as market cap. This is fine. However, many have pointed out the importance of adjusting historical price due to inflation, just as the stock market does for stocks whose shares have been split by management. This is not yet typically done in the blockchain industry. We will do so here.
The concept is simple. Basically, though market caps of blockchain networks do grow by market demand, they also grow by another, quantifiable factor: inflation. Inflation here is defined by the classical definition—an increase in the money supply. Just as stocks split over time, it wouldn't be apples-to-apples to look back at a pre-split stock price history, and compare that with the post-split market prices today.
If Apple stock was worth $1,000 yesterday with 1 billion shares outstanding, but then management split its shares today to 10 billion shares outstanding worth $100 each, (a 10-for-1 split), we can no longer look back in time and make any sense of those prices when Apple stock was trading at $800, $900 or $1,000, when only 1 billion shares were outstanding. Instead, we should look back in time at theoretical, "split-adjusted" historical prices—and in this simplified (and fake) example, those prices would be $80, $90 and $100, compared with the now "real" market price today of $100 at 10 billion shares.
Due to coin supply inflation then, cryptocurrencies essentially undergo a continuous "stock split" every time a block is generated and new coins are mined. So we need to determine the "split-adjusted" historical prices—or in cryptocurrency terms—the "inflation-adjusted" historical prices, if we really want to go back in time and compare historical prices then with market price today. The formula is this:
We should understand that inflation is always a dilutive factor, just as new shares are a dilutive factor in stocks. Therefore, we should adjust the historical price downward to account for these new coins created over time.
One more very important point. If you are thinking about how to calculate your crypto investment's gross return or compound return, you should never use inflation-adjusted historical prices as your entry price. That's because unlike in the stock market—when shareholders receive proportionately more shares after a split—every time this "splitting event" occurs in the blockchain world, users are not granted new coins! In other words, with blockchains, coin inflation is a network-wide phenomenon. Therefore, the white lines above—the inflation-adjusted prices—should be viewed not according to anyone's individual investment, but more as a guide for finding "real" price trends on a network-wide level, such as all-time highs and lows.
Finally and on a related note, due to the cryptographic nature of blockchains and the law of large numbers, if someone were to lose their private key which controls their coins, this fact effectively removes their coins from the money supply. In Bitcoin's case, some have estimated that over 2 million bitcoins have been lost. We are not accounting for lost coins here, but it should be noted that if lost coins were accounted for, the white lines graphed above would be even lower.