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What does the market cap of cryptocurrencies mean?
Letʼs be honest: We all obsessively check Bitcoinʼs price every day. Bitcoin dictates the market, and where itʼs value goes, so too go cryptocurrency prices in general.
But, what good does knowing Bitcoinʼs value do if youʼre unsure of what cryptocurrency market capitalization (or, coin market cap for short) represents? Without any further ado, letʼs discuss and clarify the ideas and principles surrounding market cap for cryptocurrencies.
The first and most important factor in understanding market capitalization is the token supply. Supply refers to:
Total supply: The maximum number of a token that exists currently or will ever exist. Some coins, such as BTC, are mineable but have a fixed supply. In this case, we know what the total possible supply is, but this number will differ from the circulating supply.
Circulating supply: The current amount of a particular token in circulation.
In order to illustrate this a bit more clearly, letʼs take a look at Zilliqaʼs token, ZIL. ZIL has a total supply of 21,000,000,000 and a circulating supply of 7,575,893,444. The Zilliqa platform uses a mineable proof-ofwork format which means that tokens are minted into the circulating supply from the total supply over a long period of time, with the total supply converted to circulating no sooner than the year 2050.
Why does supply matter for market capitalization? In order to create a rough estimate of a tokenʼs value, we can do a simple calculation using the tokenʼs last price per token and multiplying that price by the circulating supply amount. If we again take ZIL as an example, as of the time of writing its value was $.086. Multiply $.086 by 7,575,893,444 ZIL and we get a market cap of $651,526,836.
A common mistake made is multiplying the current price per coin by the total supply, coming to the conclusion that X coin is astronomically overvalued. But because those coins are not all in circulation yet, they canʼt be considered as part of the current market capitalization.
Put simply: Market Capitalization = Current Price X Circulating Supply
But Wait, Why Does Market Capitalization Matter?
Market cap is important to traders insofar as it allows them to determine, along with other fundamental and technical elements of a coin and itʼs market history, the profitable potential of buying or selling a coin at a given moment.
For instance, letʼs imagine two tokens, SUN and PWR, both of which are creating energy markets on the blockchain. SUN made it to market prior to PWR and mooned with great partnership announcements, making its way up to a $100 million market cap. PWR had its ICO and came along some months later. After releasing partnerships on a similar level to SUN and meeting a testnet milestone, PWR still sat at a $10 million market cap.
A trader might look at the market caps of both SUN and PWR and see that since PWR has only a fraction of SUNʼs market cap but similar potential, there may be significant upside in buying PWR at what seems like a low market cap in contrast to SUN.
There are of course some pitfalls in using market capitalization as an indicator for a coinʼs health. Letʼs suppose that SUN takes off one day after a surprise listing on the Korean exchange Bithumb. Itʼs $100 million market cap becomes $300 million after 24-hours of frantic trading. Does this actually mean that $200 million flowed into SUN? The short answer is no.
Because coin market cap is calculated using the last price per token, as long as there were buyers willing to pay three times the price per SUN token, the overall market cap will also accordingly show at three times higher. This makes guessing the overall health of a coin using market cap as the determinant factor tricky for smaller market cap coins since they can easily be manipulated by coordinated groups, insiders with large marketshare known as whales, and token founders holding high supplies of a given coin.
Cheap Coins Fallacy
Cryptocurrency value represented by market cap allows buyers to overcome one major fallacy that was evident in the epic bull cycle of December 2017 to January 2018. Coins that were priced low compared to others rocketed moon-wards based on the idea that money went further when buying “cheap” coins since the buyer would receive more of them than when buying a more expensive coin. PaCcoin (PAC) was a major benefactor of this belief and temporarily added on exorbitant amounts of value as a result.
Market capʼs main function is to provide traders with a ranking that goes some way in guiding decisions made in the trading environment. On December 17th, 2017, PAC had a market cap of $4.5 million. Owing to its high token supply, the price per token appeared extremely low. After several viral videos on Youtube proclaiming PAC as a “cheap coin” with the potential to be worth as much as Bitcoin, buyers rushed in and by January 7th, 2018 had pushed the PAC market cap as high as $700 million.
Had those buyers known about the power of calculating market cap, they could have figured out through simple multiplication that for PAC to be worth as much as BTC it would need a market capitalization of over $5 trillion: many, many times more than the value of the entire crypto market combined.