An Intro to Cryptocurrency Market Capitalization
Cryptocurrency market capitalization constitutes a mathematical technique for determining the value of a cryptocurrency. While some people think price represents value, reality says otherwise. For example, a particular ham sandwich tastes no better when you spend $30.00 on it rather than $10.00. In fact, the added cost for no added value might well give you a stomach ache.
Prices fluctuate for a variety of reasons. Favorable or unfavorable news stories create price jumps. Government actions play a part. And, exchanges sometimes create dramatic effects in price.
Investor psychology also plays a role in short-term price variations. Bitcoin benefited from something known as the Thanksgiving Effect in 2017. People go home, enjoy a good meal, feel optimistic, talk to their friends and relatives about their investments, then invest their own money accordingly. Bitcoin enjoyed a good ride prior to the holiday and enjoyed continued success as a result.
Instead, you should be focusing on cryptocurrency market capitalization.
Cryptocurrency Market Capitalization Defined
Stock market analysts use the market capitalization of companies to make informed investment decisions. Market capitalization (market cap) simply defines the current share price multiplied by the total number of existing shares. In cryptocurrency terms, this means the current price of a coin times the total number of coins in the market, often referred to as circulating supply.
Company Market Cap = Total Existing Shares * Current Price
Cryptocurrency Market Cap = Total Current Coins * Current Price
Cryptocurrency Market Capitalization: An Example
Assume the fictitious TickleCoin currently sells for $1,000.00 a coin.
And the fictitious ScratchCoin currently sells for $1.00 a coin.
1,000,000 TickleCoin currently exist.
1,000,000,000 ScratchCoin currently exist.
TickleCoin Market Cap = 1,000,000 * $1,000.00 = $1,000,000,000
ScratchCoin Market Cap = 1,000,000,000 * $1.00 = $1,000,000,000
Consequently, TickleCoin and ScratchCoin share equal value as total entities.
Assume TickleCoin mints coins to where the supply now contains 2,000,000 without any change in price. And the price of ScratchCoin falls to $0.50 without any change in circulating supply.
TickleCoin Market Cap = 2,000,000 * $1,000.00 = $2,000,000,000
ScratchCoin Market Cap = 1,000,000,000 * $0.50 = $500,000,000
TickleCoin now ranks four times more valuable than ScratchCoin.
What Does This Information Tell Us?
As a general rule, this shows us the amount of investment risk involved. Stocks categorize broadly as small cap, mid cap, and large cap as the market cap increases.
Large cap companies like Apple, Amazon, Walmart, or Home Depot present less risk to the investor. But growing to a certain size limits a company’s growth potential.
Small cap companies inherently present more risk because of potential company failure. However, they yield tremendous reward to early investors when they succeed.
You can also use market cap to take snapshots of company or cryptocurrency groupings. For instance, take all the companies in a given sector (technology, retail, manufacturing) and calculate each company’s market cap, then add them all together. That gives you the market cap for that sector.
Similarly, do the same for a group of cryptocurrencies. Take the privacy coins, for instance, calculate their market caps, and add them all together. That number gives you a picture of the value of the privacy coin space.
Bitcoin Size Versus Altcoin Risk
Bitcoin boasts the largest cryptocurrency market capitalization, with a circulating supply at a little over 17,000,000 Bitcoins and price around $8,000.00 at the time of this writing.
Bitcoin Market Cap, approximately = 17,000,000 * $8,000.00 = $136,000,000,000
Looking down the list of crypto coins, those ranked around the 100 mark on the list generally have a market cap of around $55,000,000.
Although one of these coins may sell at a lower price than Bitcoin, you’re buying into less value. However, these cryptocurrencies also potentially have more room for growth. Your challenge is to determine which of these low-cap coins could bring as much value to the world (or close to as much value) as Bitcoin has.
Another aspect of cryptocurrency market capitalization to consider involves market manipulation. Small market caps lend themselves to price manipulation more readily than large caps. Bad actors exploit small market cap coins by controlling enough of the total supply to create large price movements in one direction or another. In the early, shady days of the stock market, operators made an art of this practice, as documented in Edwin Lefevre’s book Reminiscences of a Stock Operator, first published in 1923.
What Doesn’t This Information Tell Us?
Cryptocurrency market capitalization provides no information regarding the future direction the price will take. Bitcoin’s large market cap provides no immunity against price drops.
No part of the equation determines the future coin supply. Instead, the code defines whether the system will mint future coins. And If so, at what pace.
Some cryptocurrencies cap the total supply of coins while others create an infinite supply. The Bitcoin network caps the total number of bitcoins at 21 million. As for Ethereum, Vitalik Buterin speaks favorably of a system where existing Ether gets burned out of the available supply to avoid inflation.
Don’t overvalue a fixed supply, though. Although inflation reduces the value of a currency, scarcity doesn’t necessarily equate to value. Not all rare books command a high price. A capped supply guarantees one thing: all the variation in the market cap comes from price since supply remains fixed.
Market cap in and of itself tells us nothing about the velocity or direction of the coin, whether explosive growth or gradual decline. But, calculating market cap over a period of time could reveal trends.
For crypto, the number of dead coins is a unique factor that also influences the market cap. Some people lose their wallet. And some users lose the seed to recover a wallet that’s crashed. Bugs in the code also cause lost coins. Hackers steal crypto, and in some cases may not be able to redeem the coins.
So the more accurate cryptocurrency market capitalization equation goes something like this:
Cryptocurrency Market Cap = (Total Circulating Coins – Dead Coins) * Current Price
Unfortunately, no good way exists to determine the number of dead coins to discount.
The market cap approach belongs to the fundamental analysis field of stock market investing. Fundamental analysis seeks to calculate the value of a company to determine future rewards. This strategy involves long-term thinking and looks for growth in value over time.
On the other end of the spectrum, technical analysis focuses on short-term trends, and price fluctuations play a more important role than long-term valuation. If an investor using technical analysis believes the price of a stock or cryptocurrency will skyrocket over the next week, that constitutes a good short-term investment regardless of market cap. The value could sink to zero next year, but a short-term investor would not care.
Limitations to using traditional stock market analysis like market cap arise when you realize these techniques serve to analyze companies. Bitcoin exists as a software system to enact financial transactions in a decentralized context, not as a company. Similarly, Ethereum provides developers with a platform to create decentralized applications and organizations. Ethereum helps to create companies, but its own central mission does not involve seeking profit and increasing its revenue.
When people invest in Bitcoin, to a large extent, they bet on a particular vision of the future. They believe the world will move to crypto, and Bitcoin appears to hold the strongest claim on that version of the future. But no one truly knows.
Fiat Currency Trading
While stock market analysis applied to cryptocurrency shows limitations, analysis techniques used in fiat currency trading also exist. Do they prove useful when transposed to crypto trading? Unfortunately, just as stock analysis focuses on company data, analysis for fiat currency trading focuses on nations. Nations produce fiat currency. How a nation fares in terms of trade agreements, employment, and military conflicts factor into fiat currency analysis.
Fiat (Wikimedia Commons)
So fiat currency trading techniques prove largely irrelevant to crypto trading.
A multitude of tools exists to arm investors with information. Cryptocurrency market capitalization resides in the arsenal of those tools. It provides a long-term perspective as price alone fluctuates in the short term. Prices of the entire market have risen and fallen, but Bitcoin’s dominant market cap tells us that it still remains the most valuable cryptocurrency.