An Entropy-Based Approach to Evaluating the Economic Efficiency of Cryptocurrencies

Blockchain technology is set to transform economics and finance by enabling secure, transparent, and decentralized transactions. Some significant examples in this sense are cryptocurrencies and decentralized finance, which leverage blockchain technology to provide fast, low-cost financial services without a central authority, as well as the tokenization of finance, already forecast by Larry Fink, CEO of BlackRock. As crypto economies and blockchain applications gain global relevance, the need to measure and assess their efficiency is becoming increasingly important. While blockchain efficiency is often evaluated in terms of transactions per second or energy consumption, cryptocurrency efficiency is implicitly assessed through various indexes, such as capitalization, price trends, average transaction value, mining profitability, and others. What is lacking is an index capable of comprehensively and coherently describing the actual functioning of a crypto economic system, accounting for its key economic characteristics – such as supply mechanisms and token distribution – and the level of user participation within the specific crypto economy. In this study, we introduce a new theoretical framework based on Shannon entropy to assess the economic efficiency of a cryptocurrency through the Entropy Balance index (EB-index). Our approach integrates on-chain parameters – sourced from Coin Metrics® – by mapping them to economic quality attributes. To illustrate how our entropy-based approach works, we apply it to two distinct sets of attributes across six leading cryptocurrencies by market capitalization and use-case diversity: Bitcoin, Ethereum, Ripple, USD Coin, Dogecoin, and Cardano. For either set of attributes, the six EB-index values provide us with a comprehensive way of comparing the considered cryptocurrencies from an economic efficiency viewpoint. Our approach is fully customizable with respect to the selection of attributes as well as their weights.