Understanding Circulating Supply - the XRP case study

The Circulating Supply metric is of utmost importance within the crypto asset industry and for good reason. It, along with a crypto asset’s per unit price, allows investors to better understand the relative valuation of different assets. However, the metric has been mired in controversy due to the difficulty, in some cases, of determining an accurate measure of it – this has been a particular problem for crypto assets like XRP and Bitcoin Private. This report will break down the circulating supply metric and then explain its implications with reference to XRP and the metric-related issues it has faced.

Circulating Supply Explanation

The primary utility of the circulating supply metric comes from its ability to help investors calculate the “market capitalization” of a crypto asset, that is, its total supply multiplied by its price. For stocks, the market capitalization measures the total value of a company and the same generally holds for crypto assets. The issue is that, whilst in traditional finance the float – the number of outstanding units available for trade on the market accounting for locked-up shares held by company employees and investors – can be calculated in a pre-defined way and restrictions on unit lock up are enforced by law, the same does not exist for crypto assets. While there is promise of smart contracts enforcing vesting periods in the same way legal guidelines do, this practice is not yet widespread.

Circulating supply can be defined as the total amount of crypto asset units in existence which: is not subject to any programmatic or contractual restrictions or lock-ups; is visible on the crypto asset’s public ledger; and excludes project, foundation or founder units which have not yet been soldⁱ.

Let’s begin with two working examples of the circulating supply metric: Bitcoin and Ethereum. We can break down the differences in the two crypto assets’ circulating supply schedules by appealing to Messari’s demarcation of the metric’s five inputsⁱⁱ:

• Token Generation – (i) Initial Generated Supply, and (ii) Maximum Supply
• Programmatic Inflation – (i) Defined Inflation Policy & Forecast, and (ii) Method for Amending Inflation Policy & Forecast Changes
• Programmatic Deflation – (i) Loss Estimates, and (ii) Burn Policy
• Founders’ Supply (Company & Individuals) – (i) Liquid, (ii) Vesting/Escrow Policy, and (iii) Secondary Sale Policy
• Community Supply (Investors/Partners/Third Parties) – (i) Liquid, (ii) Vesting/Escrow Policy, and (iii) Secondary Sale Policy

Bitcoin

This chart shows Bitcoin’s circulating supply since its inception. The relevant input for Bitcoin’s circulating supply is Programmatic Inflation. All bitcoin that have been created and will ever exist were produced through a block reward on a pre-defined inflation schedule. Moreover, the Token Generation input would solely define the inflation parameters decided upon during the Genesis block, such as the supply cap limit of 21 million.

Ethereum

This chart shows Ethereum’s circulating supply since its inception; in this case the supply spikes up to around 60 million ETH following the distribution to those who took part in the crowdsale and then another spike to 72 million ETH following the creation of the Ethereum development fund. Unlike Bitcoin, around 72 million ETH were created at the genesis block and distributed to stakeholders other than miners – in this case, those who had contributed to the Ethereum crowdsale and those who had helped build the crypto asset. This relevant input is Token Generation. Moreover, Ethereum has a block reward which gives its circulating supply the second input of Programmatic Inflation.

Other crypto assets have different mixes of the other circulating supply inputs. For example, Binance Coin (BNB) carries out quarterly ‘burns’ of the BNB token, therefore, reducing its overall supply. This input would be counted as Programmatic Deflation. Moreover, a crypto asset like 0x Project (ZRX) had a pre-defined vesting schedule for its founders which would count as the Founders’ Supply input.

XRP Case Study

No crypto asset highlights some of the issues with accurate circulating supply calculations better than XRP. Over the last year, two reports by Messari and Coin Metrics have called into question Ripple Labs’ reported value for XRP’s circulating supply.

The Messari Report argued that XRP’s circulating supply – and consequently market cap – could be overstated by 46% due to Ripple failing to account for, at the very least, the 6.7 billion of locked-up XRP of its co-founder, Jed McCaleb, the illiquid 5.9 billion XRP worth of donations publicly committed by co-founder Chris Larsen to RippleWorks, and the 4.1 billion XRP sold via the company’s money services business, XRP II, since 2016, which may be subject to re-selling restrictions. Messari argued that these illiquid positions of XRP equal 19.2 billion worth of XRP – which is 46% of the 41 billion XRP quoted as “in circulation” at the time of the report’s publication.

The pie chart below shows the XRP supply breakdown as reported by Ripple Labs:

Conversely, the pie chart below shows the XRP supply breakdown as estimated by Messari:

Misrepresentations of a crypto asset’s circulating supply can have large effects on its popularity and use within other financial products such as market capitalization-weighted indexes and their associated products. It is understandable, therefore, why claims such as those made by Messari present risks to XRP’s current place within the market.

More recently, Coin Metrics released a report where they conducted on-chain analysis on Ripple’s escrow system – the process by which XRP owned by Ripple Labs is placed into a “cryptographically-secured escrow account”. The research noticed several discrepancies between what was publicly reported by Ripple Labs and what was actually visible on the XRP ledger. Issues to be taken into account include:

• First, two of Ripple Labs’ quarterly reports underrepresented the number of XRP released from escrow by a total of 200 million XRP.
• Second, the escrow mechanism was implemented differently from what was publicly announced, which has led to XRP being released faster than implied by the release schedule.
• Third, other parties potentially associated with Ripple have released 55 million XRP from a previously-unknown escrow address not connected to the main Ripple escrow account.

The chart below highlights the discrepancies between the on-chain amounts released from (and returned to) Ripple’s escrow compared to the reported amounts.

The differences in the values would have an effect on XRP’s true circulating supply. For example, in Q1 2019, XRP’s circulating supply would have been understated by at least 200 million XRP.

Ripple’s CTO, Joel Katz, has since replied to the Coin Metrics report, explaining the discrepancies as a result of “timeline issues”. Whether or not his explanation is sufficiently convincing, however, does not change the fact that these issues are of the utmost importance.

Conclusion

Our research focused on XRP since it has been subject to the most controversy in relation to its reported circulating supply figures, but this issue exists for many other crypto assets, especially those which claim to hold their founders to vesting schedules. While there will continue to be issues of this nature going forward, we believe that as regulators begin to play a more active role within the space and as data analysts and researchers continue to hold crypto asset organizations to account over their reporting, the industry will move to more systematic measures of key metrics such as circulating supply.