On July 31, 2018, a bitcoin investor logged onto a trading exchange and bet $416 million worth of bitcoin that the cryptocurrency’s value would rise – instead, the value slumped by more than 5%. The investor couldn’t cover their losses, leaving the exchange to foot the bill using other investors’ profits.
The repercussions of one investor’s actions show how wealthy individuals, known as “whales,” make big waves in turbulent cryptocurrency markets. Just as whales cause the biggest stir in the oceans, some investors trade coins in such large quantities that they influence the value of the coin itself, potentially undermining the decentralized principles upon which blockchain and cryptocurrency were founded.
We compared the wealth distribution among 140,000 nonexchange addresses from four major cryptocurrencies and the 100 richest Ethereum tokens. We found that surprisingly few accounts are needed to form majority ownership of many coins and that some currencies have more unequal distribution of wealth now than they did in 2018.
Big Whales for Big Coins
Some whales are so rich that small groups can collaborate to own a majority of a currency, which, when done maliciously, is known as a “51% attack.” Theoretically, organizations like the Chinese government could mount a 51% attack on bitcoin, although it’s highly unlikely. But smaller currencies are more vulnerable to majority owners controlling the blockchain, as Bitcoin Gold most notably discovered in 2018. So how many addresses would be needed to own a majority of the world’s major cryptocurrencies?
Before we get into the results, we should clarify that one address doesn’t translate to one individual because people often hold multiple addresses; some of the richest addresses are owned by exchanges, which hold the wealth of many people. To find a closer approximation of individuals, we removed addresses known or predicted to be owned by an exchange (read our methodology for more details).
We investigated the wealth distribution of four major cryptocurrencies – bitcoin, Ethereum, Bitcoin Cash, and Litecoin – and found that Litecoin had the most centralized wealth. Just 189 addresses are needed to own a majority of all Litecoin. The 10 richest Litecoin accounts owned a tenth of all Litecoin wealth.
Litecoin may have the most unequal distribution of wealth out of the major currencies we analyzed, but Ether – the Ethereum platform’s currency – is the only one to have seen its
wealth inequality rise since 2018. We used the Gini index, a classic measure of wealth inequality, to measure the spread of wealth across the entire distribution of each currency’s 10,000 richest addresses. What we saw was that Ethereum’s wealth inequality rose by 13% from 2018 to 2019 (0.69 vs. 0.78).
Bitcoin had the lowest wealth inequality of the four major cryptocurrencies, with a Gini index in 2019 of 0.64. While not an exact comparison, for context, the United States’ income inequality in 2018 was measured at a record high of 0.49.
Huge Fish in a Small Pond19
Ethereum ERC-20 tokens – currencies using the Ethereum platform – are a different kind of prospect to the major cryptocurrencies mentioned above. Among the 100 Ethereum tokens with the highest market capitalizations, the average number of addresses holding a majority was just 34. But the size of the majority group varied widely from token to token. Twenty-four of the 100 largest tokens were majority-owned by one address, almost always owned by the token’s founder.
This is often due to the way the availability of tokens is controlled by the founder, but having such centralized wealth brings its own risks. The initial coin offerings used to fund some tokens were identified as scams, enticing investments that boosted the token’s value, only for the founder to cash out on the large number of tokens they withheld. Even when the tokens aren’t scams, investors must negotiate an unpredictable, low regulation market.
Take the Veritaseum token, for example, which had the third-highest wealth inequality out of the 100 tokens analyzed (Gini 0.996). The founder, Reggie Middleton, was ordered to repay $8 million to investors in November of 2019 after he was judged to have illegally earned profits from the initial coin offering.
The distribution of wealth in a token or coin may mean different things depending on how the currency originated. Huobi’s tokens had the highest wealth inequality of all Ethereum tokens, according to our analysis, but Huobi token was not funded via an initial coin offering and, therefore, possibly didn’t expose investors to the same level of risk. The landscape of cryptocurrency token investment is one of wild variability.
Wealth Inequality Is Most Variable Among Smaller Tokens
To help understand which tokens are most likely to have very unequal distributions of wealth, a sign that a market could potentially be easily dominated by few individuals or manipulated by its founder, we related the “top-heaviness” of tokens’ wealth distribution to the tokens’ market capitalization. A top-heavy wealth distribution would be one where large amounts of wealth were held by a small number of addresses – defined here by the log ratio of the mean address wealth to the median address wealth.
The more a token’s market was worth, the more likely the distribution of wealth was evenly spread (that is, compared to other tokens). In other words, the tokens that showed the greatest concentration of wealth in the fewest addresses were all tokens that have relatively small market capitalization – $100 million or less, in fact.
If centralized wealth worries you as a cryptocurrency investor, then it may help to avoid buying tokens with a market capitalization of less than $100 million. Mature tokens, such as Binance and Tether, are likely to show similar distributions of wealth to major coins like bitcoin. Why might this be? Perhaps successful tokens attract more investors, splitting the wealth among more addresses. It’s possible that tokens with smaller market caps are younger, and the wealth distribution may even out over time.
The fact that a few whales hold as much wealth as many small fry is true of all financial realms. It’s a hot topic among cryptocurrency enthusiasts because the lower liquidity and higher volatility in cryptomarkets mean whales can make bigger waves.
Concentrated ownership of wealth creates serious points of failure in a system designed to be robust through decentralization. This is perhaps most true for centralized exchanges, the singular custodians of many people’s wealth. Such failure can and does happen. The bigger the whale, the bigger the target – hackers and scammers hunt with big harpoons.
We found that Litecoin is more vulnerable to the influence of whales than bitcoin, Ethereum, or Bitcoin Cash, but Ethereum was the only coin to see rising wealth inequality among its richest addresses in 2019. The concentration of wealth can be far more extreme when considering tokens instead of coins. Almost 1 in 4 Ethereum tokens had a majority owned by the project founder. These smaller token projects are lucrative investments for some because the returns can be monumental, but potential rewards reflect the risk.
Investors should do their research and consider many factors before buying any cryptocurrency. Just make sure one of the things you consider is how big the whales are in your sea – either you can swim in the current, or you’ll be swept along in their wake.
Methodology and Limitations
We collected the balances in the wealthiest 10,000 addresses in bitcoin, Ethereum, Bitcoin Cash, and Litecoin, from bitinfocharts.com and the wealthiest 1,000 addresses in the top 100 Ethereum ERC-20 tokens from etherscan.io (in terms of market capitalization). We collected address balances on Aug. 16, 2018, and Nov. 4, 2019, and analyzed the annual change in wealth distribution among those addresses. The two dates at which the data were collected represent snapshots of market fluctuations rather than continuous trends.
Previous studies of cryptocurrency whales acknowledged that one address does not equal one investor but failed to tackle the issue. The anonymity of addresses is a pillar of the cryptocurrency ecosystem, but one that creates problems when studying the distribution of wealth. We dealt with the most troubling aspect of this problem when studying whales: that exchanges own some of the richest addresses, leading the wealth of many to be mistaken for the wealth of one person. Although it could be argued that exchanges shouldn’t be ignored (because most are custodial owners of coins held in their accounts), we decided to omit exchange addresses to make the results more interpretable.
We identified addresses that belonged to 41 exchanges using wallet nicknames associated with each address. We predicted which anonymous addresses were owned by exchanges by cross-referencing address names across currencies. Addresses that held more than two currencies were assumed to be exchange addresses and omitted from our analysis. Just over 6% of addresses in our data set held more than two currencies. Addresses that held more than two currencies typically held three times more coins (Two or fewer currencies, average balance = 0.06% of supply; more than two currencies, average balance = 0.28% of supply).
We calculated the percentage of coins owned by the richest addresses and the number of addresses needed to own the majority of coins in each currency. After omitting exchange addresses, we identified addresses that had an unusually large balance, given the rank-size distribution of wealth on the log-log scale. To study the relationship between currency size and wealth distribution, we estimated the 50%, 75%, and 90% quantiles as a function of market capitalization using quantile regression.
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