Does Market Capitalization Even Matter for Cryptocurrencies?
The volatile nature of the crypto-scene currently can’t be understated and has left many professional investors in a state of confusion. How do they apply traditional economic principles to this highly lucrative, yet very unpredictable new area?
Liquidity, Crypto Whales, and Due Diligence
The most obvious, and simple, part of this question that most turn to is the market capitalization. Data can be collected from two primary sources: Coinmarketcap or CoinGecko. The latter offers a few more metrics to assess a token’s reception in the community and by developers at large. Ultimately, both services provide information on the supply in circulation multiplied by the price per unit of the cryptocurrency.
This seems relatively straightforward, and it is somewhat accurate when you’re dealing with longstanding currencies. The amount in circulation and their value doesn’t change that much, especially in fiat. This stability is deliberate to avoid the kind of volatility seen here in the crypto-scene.
However, it’s not that great at predicting the value of a nascent virtual currency.
Take Dentacoin, for example. It currently, has a market cap of $545 million. Not that bad considering the scope of the project. Only 4.5 percent of Dentacoin’s tokens are in circulation. Put another way, 8 Trillion Dentacoin Tokens exist, but only 325 billion are currently liquid.
Beyond that, a good chunk of them are held in smart contracts that are held for distribution when specific goals are reached. From 2018 – 2044, about 80 percent of the total tokens will be unfrozen and sold, with 2018 alone having 1.9 percent of that unfrozen increase the supply by another 152 billion.
This mechanism allows crypto-based companies to release a small amount of a currency, and when a large purchase occurs, they sell more of their tokens. By keeping their tokens out of circulation, even a relatively small investment can cause a massive spike in the percentage value of a single token. When one sees a single coin raise in value by a considerable amount in a single day, this is usually the case.
On the other hand, for investors, it means the coin can drop a large amount in a single day as well. Just because someone bought a ton in a single day, doesn’t mean that they could be sold back for the same amount due to a surplus amount that isn’t liquid yet. In fact, the market could drop tremendously if those funds do become liquid.
Luckily, most cryptos do not do this. They don’t abuse this kind of sound faith the market has currently.
Still, it’s worthwhile to thoroughly investigate potential investments beyond just the number of a coins total supply. The market cap is useful, but it’s critical to keep in mind the myriad other factors that could affect a cryptocurrency. These are still early days, and even the highest capped coins are still subject to the artificial movement of whales in the ecosystem.