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Asset-Backed Tokens: Velocity - A Measure Of Liquidity

Amid the heart thumping excitement generated by the rallies and crashes in the crypto markets, an often overlooked aspect of the markets is the underlying liquidity of the various cryptocurrencies.  It will come as no surprise that liquidity is closely correlated with volatility – the lower the liquidity, the higher the volatility: intuitively we can imagine that if we are trying to buy something and there are few sellers, the price will be higher than if there are many sellers, and on the downside the opposite is true, as many crypto investors discovered at the beginning of 2018.  The natural corollary is that the higher the volatility, the higher the risk factor. And a surprising emerging crypto asset class, Asset-Backed Tokens, are showing some remarkable characteristics relating to their liquidity, far surpassing that of traditional securities and of other cryptocurrencies.

The crypto markets have adopted a measure called velocity to describe liquidity.  Velocity is roughly defined as total transaction (i.e. trading) value divided by total value of currency issued (i.e. market capitalization).  For the purposes of calculation, we adopt average daily trading value.

Velocity of Traditional Securities. A quick survey of traditional markets will give us some benchmarks for velocity.  U.S. Dollar cash, in the form of the US Dollar M1 money supply, has a velocity of 6.2%: in other words, 6.2% of all US Dollar cash exchanges hands every day, while the remaining 93.8% remains in people’s pockets, under the mattress, and in checking accounts.  The S&P 500 is similar with a velocity of 6.3%.  Interestingly, the popular FAANGS (Facebook, Amazon, etc.) stocks have a velocity of only 0.6%, which could in part explain their high price levels (many buyers, few sellers) and the downside risk they face in a bear market. US Treasury bonds, largely held for the long term by institutional investors and central banks, have a velocity of 0.1%.

Velocity of Cryptocurrencies. In the crypto markets the figures are not dissimilar: Bitcoin has the highest velocity of all cryptocurrencies, at about 4.1%, while Etherium is a close runner up with a velocity of 3.6%.  Third-ranking Ripple has a velocity of 1.4%, and the figures fall off quickly with other crypto currencies.  The velocity numbers for the top cryptocurrencies follow their respective market capitalizations - the higher the market cap, the higher the velocity - which intuitively makes sense as traders will be attracted to the largest cryptocurrencies listed on exchanges. 

Velocity of Asset-Backed Tokens. When we look at Asset-Backed Tokens, an anomaly quickly become evident: their velocity figures are many multiples those of traditional securities and top cryptocurrencies.  The largest Asset-Backed Token, US Dollar-backed Tether, has a staggeringly high velocity of over 100%, meaning that every Tether token gets traded every day.  While the market cap of Tether, at USD 2.4 billion, is less than 2% of Bitcoin’s USD 130 billion, is has a daily turnover of USD 2.5 billion, which is more than 50% of Bitcoin’s daily turnover of USD 4.7 billion.

Ture USD, which is also backed by US Dollars, has a velocity of 19%, while other notable tokens such as HelloGold (gold backed) and LAToken (backed by real estate, art and other assets) have significant velocities of 9% each.

Why do Asset-Backed Tokens attract so much trading activity, and thus have such high velocities?  These tokens provide less upside gains, but much more downside protection, than mainstream cryptocurrencies. Investors seem to prize their stability, giving rise to the moniker “Stable Coins” to describe Asset-Backed Tokens.  A huge contributor to this inflated level of liquidity are U.S. dollar backed tokens – the two most liquid Asset-Backed Tokens are backed by U.S. Dollars, with each token being pegged to the value of a single U.S. Dollar on a 1-to-1 ratio, which implies stability and full downside protection in all market conditions. On the flip side, there are hardly any gains to be made from an appreciation in prices of Asset-Backed Tokens, meaning there is less incentive to hold these tokens for the long term. This combination makes them effective and liquid safe havens in the turbulent crypto markets.

One footnote on cryptocurrency velocity figures: the total trading value is the sum of trading values spread over more than 200 exchanges, while securities like a FAANGS stock will trade on a single exchange.  There are active arbitrage players trading the various crypto exchanges and keeping prices in line, there would still be less liquidity than in the case of all trading occurring on a single exchange.

The crypto markets remain small relative to traditional markets, but they are showing similar liquidity characteristics.  The notable exception is the liquidity of Asset-Backed Tokens, which are many multiples those of other cryptocurrencies and traditional securities.  This hyper trading activity in Asset-Backed Tokens implies a tremendous demand for Stable Coins, which offer a haven of security in an otherwise highly volatile and risky crypto market.


Hogi Hyun is a Director at D1 Mint


The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group

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