written by @thevladcostea
Market capitalization is an often misunderstood and somewhat flawed metric that can easily distort the magnitude and importance of cryptocurrencies when observed alone.
To get a coin’s market cap, you take the price per coin (determined by the market grappling with current supply vs demand), multiply it by the number of tokens that exist in circulation, and get a total valuation that should provide a sense of scale. Yet most of the time, this metric ends up misleading uninformed investors.
The two variables involved can be problematic, especially if only a small number of exchanges list the coin, and the total supply cannot be easily verified with full nodes. This means that a small number of exchanges could feasibly coordinate to disproportionately pump the price of an asset in order to boost the cryptocurrency’s ranking on popular websites. Furthermore, if determining the total supply also requires the involvement of oracles and trusted third parties, then the accuracy of the metric is dubious at best.
Not All Is What It Seems
In the case of Bitcoin, the market cap makes much more sense: the project has a predictable supply, is listed on every cryptocurrency exchange in the world, gets traded in very high daily volumes, and has been included in traditional markets for years. Anyone running a $100 Raspberry Pi node can participate in the supply validation process, and the price difference between exchanges is insignificant. Therefore, calculating the BTC market cap does make sense in order to provide a better understanding of the coin’s importance in international trade.
On the other hand, many altcoins (particularly ones with few listings and low market caps) are very much like penny stocks: they can get easily pumped with relatively low amounts of money, but the magnitude in terms of market cap is going to look deceptively significant.
As of August 2020, there are 18.4 million bitcoins in circulation, and the price tends to fluctuate within the range of $11000 and $12000. Therefore, the market cap is going to be somewhere between $202 billion and $220 billion (roughly a 9.1 percent difference). The daily volume today is twice as high as it was in December 2017 at an all-time high, and it represents more than 10% of the market cap.
If we look at smaller assets though, we can see issues with putting too much value on the market cap calculation. Here’s just a single example:
In the case of HedgeTrade (an Ethereum token whose price has increased almost 20 times since its January 2019 launch), there is a circulating supply of approximately 301 million HEDG coins and a price that currently gets determined by trading on only a dozen exchanges. The project’s market cap is slightly higher than $570 million, but the daily trading volume is usually lower than $1.5 million (0.26% of the total supply). The gap between these metrics is stark, yet HEDG has achieved a top 50 asset listing on CoinMarketCap because liquidity is not accounted for.
(It should be noted: this is not intended to be a commentary on the validity or function of the asset, but rather a simple observation of the contrast between market cap and liquidity as compared to Bitcoin).
A Hypothetical Coin
Let’s say someone creates a token with a supply of 1 billion units and gets it listed on a couple of exchanges. Not all If the limited supply of coins on those few exchanges bid up the price to $1, we’re going to observe a new asset with a billion-dollar market cap. However, the ways through which the coin has acquired this status can be completely opaque and unfair. Just because a coin has a high market cap doesn’t mean that there is great interest in it. The metric completely disregards volume across multiple exchanges, which is objectively better to measure the amount of trading. By looking at the volume, transaction sizes, and order books, you can also tell to which extent the market is manipulated, observe patterns, and estimate the real number of users. Small-cap altcoins gain eyeballs when price movement affects market cap, but traders often make the mistake of rarely checking volume on exchanges.
When considering investing in any coin, market cap metrics should be taken with a grain of salt. It’s very easy to game and manipulate this metric. It’s best to pair this information with other metrics, including the number of exchanges listing the asset and overall liquidity. This gives a better overall view of genuine market demand.
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