Market capitalization is one of those common concepts that most people have heard of, but the average person doesn’t really know what it means. I remember trying to decipher these investment terms when I was first starting out, and it can be difficult.
Let’s start with a definition of what a market cap does and why it’s valuable in traditional markets, then let’s take a look at the bitcoin market cap and what to look for there.
- Because cryptocurrencies have risk factors not associated with traditional stock markets, market valuations may not accurately account for risk in crypto.
- When evaluating the market price of cryptocurrencies, consider illiquidity, which is caused by a portion of the cryptocurrency being locked up or lost.
- Sharks can also create a misleading market cap for cryptocurrencies by grabbing large chunks of coins and dumping them into the market all at once.
- Other metrics for assessing cryptocurrency risk include the number of users on the network, liquidity, and monthly volume.
Fundamentals of Market Cap
Market value is short for market value. This is a reference that investors use to determine how big a company is. The way to calculate the market capitalization is to multiply the number of shares outstanding by the amount they are selling for.
For example, a company selling 1 million shares for $50 has a market capitalization of $50 million.
In general, the larger the company’s market capitalization, the more stable the investment. Investments can be influenced by a number of factors beyond market capitalization, but many investors use market capitalization as a tool to help them know where to invest and how risky an investment is.
For traditional stocks, companies with a market capitalization of $10 billion or more are considered large companies. A market capitalization of $3 billion to $10 billion is considered a mid-cap company with more room for growth. And those with market capitalizations between $300 million and $3 billion are considered small companies and are generally risky investments.
With the rise of cryptocurrency, people are starting to see market caps in the crypto market as well. But since crypto is largely unregulated at this point, there are additional things to consider before looking at the market cap as a primary indicator of risk.
How Does Market Cap Apply to Bitcoin and Other Cryptocurrencies?
Bitcoin market cap and other cryptocurrency market caps are used to compare the value of various cryptocurrency companies.
But there are some serious problems with this approach. That’s not to say that market capitalization isn’t a useful tool for cryptocurrencies, it can be. But it’s important to recognize that cryptocurrencies have risk factors not associated with traditional stock markets and understand how to offset those risks.
One of the most important risk factors to consider when evaluating cryptocurrency market capitalization is market illiquidity. This is usually because some part of the crypto is locked or leaked.
The Dangers of Locked Cryptocurrencies
The biggest problem with using market capitalization as a measure of how strong a particular cryptocurrency is (like a publicly traded company) is that there are many situations where cryptocurrency units are not in liquid circulation.
These locked or lost cryptocurrency units may affect the actual market value of any cryptocurrency.
For example, when you look at the market cap of Bitcoin, it’s important to note that somewhere around 4 million Bitcoins have been lost on a server. This is according to research by blockchain analytics company Chainalysis.
So when you look at the standard market cap estimate of how many bitcoins each bitcoin is worth, you need to take out the “missing” bitcoins to see how much the company is worth.
Another example is Steem. In 2018, its market capitalization exceeded $400 million. But a huge chunk of their value was locked up in a kind of social network called Steem Power, which meant that market valuations were very misleading.
And sharks can mislead market valuations. In most cases, especially with smaller cryptocurrencies, one entity will hold most of the coin from its inception. If these sharks dump all that cryptocurrency into the market at once, it could devalue it very quickly.
As it turns out, there are additional metrics to consider when looking at the cryptocurrency market cap, especially since cryptocurrencies are still very volatile at this point.
Important Metrics for Comparing Cryptocurrencies
Now that we’ve seen why market valuations can be somewhat confusing when comparing cryptocurrencies, let’s take a look at some important metrics to consider when comparing and valuing cryptocurrencies.
When it comes to comparing cryptocurrencies, the first metric to consider outside of market capitalization is Metcalfe’s Law. This is due to the number of users in the crypto trading network.
When you track the number of users on the Bitcoin network (or any other network), it will accurately reflect the amount of traffic on that network. It seems that this law could be made stronger by excluding users who have just signed up without making any transactions. Because you follow users who are active.
A Note on Metcalfe’s Law
Like anything else, Metcalfe’s Law is not incorruptible. It can easily be played where there are networks with low transaction fees. Too low transaction fees mean there is little resistance to using the platform and no real trades taking place, which could undermine the law.
The second metric to consider when comparing cryptocurrencies is liquidity. I touched on this at the beginning of the article, but I want to make sure you appreciate how much trading is going on in any cryptocurrency. A lack of trading means that sharks can dump their coins and cause a market crash.
The final metric I recommend looking at is monthly numbers. Staying away from everyday books is a really good idea. Daily amounts can be deceiving due to their volatility.
Cryptocurrencies are still fairly volatile investments, and some might say it’s a form of gambling. Before investing in anything, especially Bitcoin and cryptocurrencies, it is important to understand how Bitcoin market caps and other cryptocurrency market caps work. You also need to know what your real risk is and how likely you are to lose money.
Cryptocurrency is a very interesting and dynamic development with a lot of opportunities and risks. If you’re going to invest, it’s important to understand how it works.