Is Marketcap a good way of comparing coins?

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Adriaan Admin

Administrator
Staff member
Jan 30, 2018
225
39
28
www.bitcoinforbeginners.io
#1
The answer is: YES ánd NO!
Now that was helpful, wasn’t it? Truth is that because we don’t have much metrics to compare or measure different cryptocurrencies we are mostly stuck with marketcap, which means: the total supply of circulating coins x the coin price. Similar how market capitalization is calculated for stocks. Usually on the coin tracker websites like Coinmarketcap.com the ranking of coins is based on the marketcap, with bitcoin at #1 consistently. Circulating coins are the coins that have actually been brought in circulation for use and trading and excludes the coins that may have been locked (a team’s coin supply that have a lockup period).

Let’s answer YES first:

As we should have learned by now, the number of coins for a cryptocurrency is pretty arbitrary chosen by the coin’s developers. Even Satoshi Nakamoto did not have a specific reason for choosing the 21 million maximum supply, but it was the result of his formula of halving the block reward each 4 years. So at least we know that any coin’s price does not say ANYTHING about it’s relative value in the market or its growth potential. Many beginner crypto investors fall for the fallacy that because a (currently) sub $1 coin like XRP can still make multiple 1000x gains before it reaches the same value as Bitcoin (plus or minus $6,000 currently).

However they don’t realize that such an altcoin as XRP has a totally different coin supply (XRP 39 Billion vs. BTC 17 Million) which makes its total network value a lot higher, than the coin’s price would let you think. We suspect such developers to have consciously made that decision to fool those newbie investors in thinking they can still make those gains that they missed out on with bitcoin.* In reality the total network value of XRP is about $ 11 billion vs BTC $ 108 billion, which leaves “only” a 10x value difference between the 2.

*: In fact during the late 2017 hyper bull rally it were those “cheap” per unit coins that massively outperformed the lower supply/higher price coins JUST BECAUSE they had a low price per coin, so indeed during that period it is true you could make more money by buying the “cheaper” coins. Unfortunately the market usually corrects itself by punishing irrational price gains with deeper losses and so it did.
So in short, it is definitely important to have a notion of the total network value (= market cap) and how it ranks relative to other coins and specifically bitcoin. It kinda gives you more of a feeling of how much the coin price can realistically grow short term relative to the rest of the market (if the market as a whole stays relatively stable). If your favorite coin already has a $1 billion market cap, and the coins in the top 10 are between $2 - 28 billion, with bitcoin at $109 billion, then the short term realistic maximal upward potential of your coin’s price is 2-9x for a top 10 - top 5 position, and less realistic: 28-110x potential if you really believe it would challenge Ethereum or even Bitcoin. And that is only if indeed your coin outperforms the other top coins in the short term.

The other scenario can be that your coin won’t outperform the top 10 coins, but at least stay on track with the rest of the crypto market. In that case your coin’s price realistic longer term performance would be the same factor as you expect the total crypto market will grow.

On the other hand: if your coin has a market cap of “only” $100 million, the coin has 10x more upward potential than in the first scenario. However lower cap coins are usually regarded as higher risk, because of its lower exposure in the market, lower liquidity etc. So even though your coin maybe has more upside potential, nothing guarantees that that will actually happen and the risk for high or even total losses is even bigger.

Read more about market cap in this article on the website, which explains more about the above concept: SHOULD I BUY CHEAP CRYPTOCURRENCY COINS/TOKENS?
So the market cap certainly does have its use, but it also has some caveats and limitations that you should be aware of. This leads to the other answer to the question.

The answer is NO:

How much is the circulating supply really?
So the circulating supply that is the basis for calculating market cap is supposed to be coins that are actually in circulation and can be used for transfers or trading. But what about the addresses with Satoshi’s (Bitcoin’s founder) bitcoins: that’s about 1 million (out of the max 21 million) that have never been moved and are very likely to never be moved ever (assuming Satoshi is not alive anymore). Technically those coins are (very likely) lost forever; should they then still count as part of the real “circulating” supply.

And what about the coins of other bitcoin holders that have passed away without leaving the private keys to their heirs or those bitcoin holders that have permanently lost their private keys? And these are big numbers (and growing) but because we can’t really know how much they really are (except Satoshi’s bitcoins, but then again we don’t know for sure if he is even alive), it is kinda difficult to account for them.

However we should definitely assume that the real “circulating” supply is substantially lower than is shown in the coin trackers and thus the REAL marketcap should actually be lower than it currently is. So what can we do to take this knowledge into account?

Solution: the older the coin is, and the less inflation it has, assume the real supply to be lower than younger coins that have higher inflation. Only estimates can be made here though. Maybe with chain analysis tools in the future better estimates can be made based on on-chain transaction to see which coins have been moved last how long ago, which could give an estimation of how many coins are AT LEAST in circulation.


How much dilution/inflation is there midterm?
Another thing that may influence the valuation of your coin while assessing the market cap is the inflation or dilution that your coin is going to suffer under. Inflation is how many new coins will be mined in a time period and dilution is how many locked up coins will be released into the circulating supply within a time period. That can mean, in case of high inflation/dilution, that even though demand may be increasing for the coin (more money goes into buying the coin) and the market cap may be increasing, BUT because the coin supply is ALSO increasing, the value of your coin may increase slower than the market cap does.

Solution: it is wise to be aware of how much coins will be added to the circulating supply in a certain time period (depending on your investment time horizon).


Misconception: market cap is NOT how much money has actually flown into the currency!
One very important misconception that many have relating to market cap is that they think that the market cap is literally the amount of money that has gone into that currency and that the amount of money that the market cap goes up and down is the amount of money that flows in or out of that currency (bitcoin’s market cap lost 10 billion, does not mean that $10 billion has been “withdrawn” out of bitcoin). It is as I mentioned before simply the outcome of multiplying the last traded price with the circulating supply. So when they say the market cap lost $10 billion it means that all coin holders together lost that amount of value because their coins are now worth less money than before.

Example:
If a coin has a circulating supply of 1 billion tokens but there are no tokens traded (low liquidity). Now if there is 1 order in the order book that offers to sell 100 tokens for $1 each and I decide to take that order, the last traded price now becomes $1, which makes the market cap automatically $1 x 1 billion tokens = $ 1 billion. And it does that based only on an order of the size of $100. Do you think that because of this small order the total value of the coin’s supply of $1 billion is realistic? No it is not!

But this is what happens with coins and tokens that have low trading volume (low liquidity); the lower the liquidity the lower the reliability of the market cap. Lower liquidity also means that you can’t be sure that your coin is actually worth the price it is based on the market cap (latest price). If you need to sell a large amount, on low liquidity you may not be able to sell at that price because you will clear the order book all the way down and sell at much lower prices, and your order can therefore immensely make an impact on the coin’s total market cap valuation.

The rule is therefore: the higher the trading volume (liquidity), the more reliable the market cap and the more reliable that you can actually sell your coin near the latest traded price.

Solution: some stock indexes prefer to look at stocks with the highest liquidity to function as ranking, so you could take that as a consideration yourself as well. The higher the constant average trading volume, the more reliable the price and market cap truly are. But beware of “fake” volume, because nowadays many exchanges use trickery such as wash trading to pump up trading volume artificially (sites like coinmarketcap.com do try to exclude those exchanges from the volume calculations to make the numbers more representative).

A clear example of the differences of some of the aspects that we discussed in this post are clearly demonstrated here:

marketcap.png

As you can see the price per coin for Monero (89) and Ethereum Classic (13) are very different, but still their total market value (market cap) is as good as the same; this is explained by the difference in circulating supply, which is higher for Ethereum Classic, but that is purely the result of arbitrary choices by the network’s designers.

The other thing that you can see is that there is a very big difference in trading volume between the 2; Ethereum Classic has 17x more volume than Monero. The liquidity for ETC is therefore 17x higher than Monero, so the reliability of the ETC market cap is much higher.

Conclusion

In my personal opinion market cap is still a useful metric to more or less gauge the relative value of a network compared to the whole market or to other coins individually (because as you may understand by now, the coin price CLEARLY has no merit in valuating the coin’s value whatsoever!). But we need to take its imperfections into account as well and be aware of them while we make our assessments.

I hope this post was insightful and helps you to form a better personal opinion on how to value any coin in relation to the market. Tell me your opinion about market cap? Are there more flaws in using this metric of comparing coins? Or do you disagree and can you tell me why you think market cap is a flawless way of fairly comparing different coins on their total network value?
 

stellarowl12

Administrator
Staff member
Jan 30, 2018
80
57
18
#2
The answer is: YES ánd NO!
Now that was helpful, wasn’t it? Truth is that because we don’t have much metrics to compare or measure different cryptocurrencies we are mostly stuck with marketcap, which means: the total supply of circulating coins x the coin price. Similar how market capitalization is calculated for stocks. Usually on the coin tracker websites like Coinmarketcap.com the ranking of coins is based on the marketcap, with bitcoin at #1 consistently. Circulating coins are the coins that have actually been brought in circulation for use and trading and excludes the coins that may have been locked (a team’s coin supply that have a lockup period).

Let’s answer YES first:

As we should have learned by now, the number of coins for a cryptocurrency is pretty arbitrary chosen by the coin’s developers. Even Satoshi Nakamoto did not have a specific reason for choosing the 21 million maximum supply, but it was the result of his formula of halving the block reward each 4 years. So at least we know that any coin’s price does not say ANYTHING about it’s relative value in the market or its growth potential. Many beginner crypto investors fall for the fallacy that because a (currently) sub $1 coin like XRP can still make multiple 1000x gains before it reaches the same value as Bitcoin (plus or minus $6,000 currently).

However they don’t realize that such an altcoin as XRP has a totally different coin supply (XRP 39 Billion vs. BTC 17 Million) which makes its total network value a lot higher, than the coin’s price would let you think. We suspect such developers to have consciously made that decision to fool those newbie investors in thinking they can still make those gains that they missed out on with bitcoin.* In reality the total network value of XRP is about $ 11 billion vs BTC $ 108 billion, which leaves “only” a 10x value difference between the 2.



So in short, it is definitely important to have a notion of the total network value (= market cap) and how it ranks relative to other coins and specifically bitcoin. It kinda gives you more of a feeling of how much the coin price can realistically grow short term relative to the rest of the market (if the market as a whole stays relatively stable). If your favorite coin already has a $1 billion market cap, and the coins in the top 10 are between $2 - 28 billion, with bitcoin at $109 billion, then the short term realistic maximal upward potential of your coin’s price is 2-9x for a top 10 - top 5 position, and less realistic: 28-110x potential if you really believe it would challenge Ethereum or even Bitcoin. And that is only if indeed your coin outperforms the other top coins in the short term.

The other scenario can be that your coin won’t outperform the top 10 coins, but at least stay on track with the rest of the crypto market. In that case your coin’s price realistic longer term performance would be the same factor as you expect the total crypto market will grow.

On the other hand: if your coin has a market cap of “only” $100 million, the coin has 10x more upward potential than in the first scenario. However lower cap coins are usually regarded as higher risk, because of its lower exposure in the market, lower liquidity etc. So even though your coin maybe has more upside potential, nothing guarantees that that will actually happen and the risk for high or even total losses is even bigger.

Read more about market cap in this article on the website, which explains more about the above concept: SHOULD I BUY CHEAP CRYPTOCURRENCY COINS/TOKENS?
So the market cap certainly does have its use, but it also has some caveats and limitations that you should be aware of. This leads to the other answer to the question.

The answer is NO:

How much is the circulating supply really?
So the circulating supply that is the basis for calculating market cap is supposed to be coins that are actually in circulation and can be used for transfers or trading. But what about the addresses with Satoshi’s (Bitcoin’s founder) bitcoins: that’s about 1 million (out of the max 21 million) that have never been moved and are very likely to never be moved ever (assuming Satoshi is not alive anymore). Technically those coins are (very likely) lost forever; should they then still count as part of the real “circulating” supply.

And what about the coins of other bitcoin holders that have passed away without leaving the private keys to their heirs or those bitcoin holders that have permanently lost their private keys? And these are big numbers (and growing) but because we can’t really know how much they really are (except Satoshi’s bitcoins, but then again we don’t know for sure if he is even alive), it is kinda difficult to account for them.

However we should definitely assume that the real “circulating” supply is substantially lower than is shown in the coin trackers and thus the REAL marketcap should actually be lower than it currently is. So what can we do to take this knowledge into account?

Solution: the older the coin is, and the less inflation it has, assume the real supply to be lower than younger coins that have higher inflation. Only estimates can be made here though. Maybe with chain analysis tools in the future better estimates can be made based on on-chain transaction to see which coins have been moved last how long ago, which could give an estimation of how many coins are AT LEAST in circulation.


How much dilution/inflation is there midterm?
Another thing that may influence the valuation of your coin while assessing the market cap is the inflation or dilution that your coin is going to suffer under. Inflation is how many new coins will be mined in a time period and dilution is how many locked up coins will be released into the circulating supply within a time period. That can mean, in case of high inflation/dilution, that even though demand may be increasing for the coin (more money goes into buying the coin) and the market cap may be increasing, BUT because the coin supply is ALSO increasing, the value of your coin may increase slower than the market cap does.

Solution: it is wise to be aware of how much coins will be added to the circulating supply in a certain time period (depending on your investment time horizon).


Misconception: market cap is NOT how much money has actually flown into the currency!
One very important misconception that many have relating to market cap is that they think that the market cap is literally the amount of money that has gone into that currency and that the amount of money that the market cap goes up and down is the amount of money that flows in or out of that currency (bitcoin’s market cap lost 10 billion, does not mean that $10 billion has been “withdrawn” out of bitcoin). It is as I mentioned before simply the outcome of multiplying the last traded price with the circulating supply. So when they say the market cap lost $10 billion it means that all coin holders together lost that amount of value because their coins are now worth less money than before.

Example:
If a coin has a circulating supply of 1 billion tokens but there are no tokens traded (low liquidity). Now if there is 1 order in the order book that offers to sell 100 tokens for $1 each and I decide to take that order, the last traded price now becomes $1, which makes the market cap automatically $1 x 1 billion tokens = $ 1 billion. And it does that based only on an order of the size of $100. Do you think that because of this small order the total value of the coin’s supply of $1 billion is realistic? No it is not!

But this is what happens with coins and tokens that have low trading volume (low liquidity); the lower the liquidity the lower the reliability of the market cap. Lower liquidity also means that you can’t be sure that your coin is actually worth the price it is based on the market cap (latest price). If you need to sell a large amount, on low liquidity you may not be able to sell at that price because you will clear the order book all the way down and sell at much lower prices, and your order can therefore immensely make an impact on the coin’s total market cap valuation.

The rule is therefore: the higher the trading volume (liquidity), the more reliable the market cap and the more reliable that you can actually sell your coin near the latest traded price.

Solution: some stock indexes prefer to look at stocks with the highest liquidity to function as ranking, so you could take that as a consideration yourself as well. The higher the constant average trading volume, the more reliable the price and market cap truly are. But beware of “fake” volume, because nowadays many exchanges use trickery such as wash trading to pump up trading volume artificially (sites like coinmarketcap.com do try to exclude those exchanges from the volume calculations to make the numbers more representative).

A clear example of the differences of some of the aspects that we discussed in this post are clearly demonstrated here:

View attachment 29

As you can see the price per coin for Monero (89) and Ethereum Classic (13) are very different, but still their total market value (market cap) is as good as the same; this is explained by the difference in circulating supply, which is higher for Ethereum Classic, but that is purely the result of arbitrary choices by the network’s designers.

The other thing that you can see is that there is a very big difference in trading volume between the 2; Ethereum Classic has 17x more volume than Monero. The liquidity for ETC is therefore 17x higher than Monero, so the reliability of the ETC market cap is much higher.

Conclusion

In my personal opinion market cap is still a useful metric to more or less gauge the relative value of a network compared to the whole market or to other coins individually (because as you may understand by now, the coin price CLEARLY has no merit in valuating the coin’s value whatsoever!). But we need to take its imperfections into account as well and be aware of them while we make our assessments.

I hope this post was insightful and helps you to form a better personal opinion on how to value any coin in relation to the market. Tell me your opinion about market cap? Are there more flaws in using this metric of comparing coins? Or do you disagree and can you tell me why you think market cap is a flawless way of fairly comparing different coins on their total network value?
Such an informative post, always enjoy your explainer posts!
 
Likes: Adriaan Admin