How and why to use market cap
Many think that only price determines a cryptocurrency's worth, but it’s actually the market cap that paints the complete picture and represents the true worth of cryptocurrencies. It’s an important metric that can help show a cryptocurrency's growth and how it compares to competing crypto assets.
Let’s look at an example to understand this better. Consider the following scenario: There are two cryptocurrencies, A and B. Cryptocurrency A has a circulating supply of 500,000 coins, and each coin’s price is worth $2. If we use the formula mentioned above, we have:
Cryptocurrency A’s market cap = $2 x 500,000 = $1,000,000 or $1 million
Now, say cryptocurrency B has a circulating supply of 150,000 coins, but each coin is worth $5. That’s $3 more than the price of one cryptocurrency A coin. Let’s find the market cap.
Cryptocurrency B’s market cap = $5 x 150,000 = $750,000
As you can see, while a single cryptocurrency B coin may be worth more than one cryptocurrency A coin, its market cap still falls below cryptocurrency A’s overall market cap.
As a result, the formula for calculating market cap is helpful in finding out a cryptocurrency’s total global valuation. However, it’s important to consider cryptocurrencies’ volatile nature, meaning their price can drastically fall or rise depending on market conditions and other factors.
How do market caps change?
Any given cryptocurrency’s market cap is generally affected by two major variables, i.e., supply and price. Let’s see how:
Supply
The number of coins a cryptocurrency has in global circulation can affect its market price, potentially impacting its overall market cap. For example, Bitcoin has a cap on the number of coins that can exist, which is 21 million. Its mysterious creator, Satoshi Nakamoto, built a code into Bitcoin’s protocol, ensuring that no more bitcoins are mined once the total number of coins in global circulation hits 21 million.
This limits the amount of Bitcoin to exist, making it extremely valuable. Even assets like gold don’t have a fixed amount; nobody knows exactly how much gold exists on Earth and how much is available for mining and extraction. Bitcoin, however, is a known, fixed quantity. Its supply is scarce, and this scarcity drives its value up.
Price
As we saw in the above section, a cryptocurrency’s price can majorly determine its market cap. Even if there’s a small number of coins in global circulation for a given cryptocurrency, its market cap will go up if the price of each coin is high.
For example, if cryptocurrency X has 100,000 coins in global circulation and each coin’s value is $10,000, the overall market cap will be $1,000,000,000, or $1 billion (10,000 x 100,000). The circulating supply may seem low initially, but the high price of the crypto leads to a large market cap.
Conversely, if a cryptocurrency has a vast amount of coins in global circulation but each coin’s valuation is low, it may not have a large market cap. For instance, if cryptocurrency Y has 500,000,000 coins in circulation and each coin is worth only $0.00005, its overall market cap will be $25,000 (0.00005 x 500,000,000).
Several meme coins such as Dogecoin and Shiba Inu have prices that are very low due to massive supplies. Others like Bitcoin have higher unit prices because there are fewer in supply. In reality, cryptos are exceptionally divisible, meaning you can buy 1/10,000th of a Bitcoin, so the price per coin itself doesn’t matter as much.
Why does market cap matter?
Market cap provides us a lot of information on any given cryptocurrency on the market. It shows us how the world views a particular cryptocurrency and its dominance in relation to its competitors. Market cap changes in tandem with the pricing and global circulation of cryptocurrencies and tokens.
Cryptos with larger market caps often attract more investors as they're considered more appealing than other cryptocurrencies. That’s why market cap is commonly used when ranking cryptocurrencies. When determining a cryptocurrency's market position, its price alone is insufficient. Market cap, however, is a more precise metric.
Market cap can also reflect patterns and market trends. For instance, if a cryptocurrency associated with NFTs (non-fungible tokens) begins to experience fluctuations, it’s indicative of the cryptocurrency attracting or losing investors.
Crypto classification by market cap
Cryptocurrencies are bifurcated into four main classes based on their market cap:
Mega-cap
Mega-cap includes just two cryptocurrencies: BTC and Ethereum (ETH). At the time of writing, BTC has a market cap of around $470 billion, while ETH has a market cap of approximately $230 billion.
Large-cap
Large-cap cryptocurrencies have a market cap of more than $10 billion. They’re seen as low-risk investments since they have a strong risk-reward record. A few examples of large-cap cryptocurrencies are Tether (USDT), USD Coin (USDC), BNB, XRP, Cardano (ADA), Solana (SOL), and Polkadot (DOT). Many large-cap cryptocurrencies are stablecoins due to their ability to remain relatively stable in value.
Medium-cap
The medium-cap segment has cryptocurrencies ranging from $1 billion to $10 billion in market cap. Investors consider medium-cap cryptocurrencies high-risk, high-reward coins due to their untapped potential. Dogecoin (DOGE), DAI, Shiba Inu (SHIB), and Litecoin (LTC) are some of the more popular medium-cap cryptocurrencies (at the time of writing).
Small-cap
Small-cap cryptocurrencies tend to carry the highest levels of risk. They have a market cap of less than $1 billion. Many new cryptocurrency projects––such as eCash (XEC), NEO, USDD, and Bitcoin Gold (BITG)–– fall in this category.
Liquidity
When comparing different cryptocurrencies, you might have encountered the term "liquidity." It's a common finance phrase that gets tossed about, and for a good reason. Liquidity can significantly influence the market cap and investors' decisions to buy and sell coins.
But what’s liquidity? It’s a term used to measure an asset's capacity to be bought or sold at its current market value. Crypto investors aim to buy and sell at a fair value depending on a crypto's price. For example, if you own a fraction of a bitcoin and want to convert it to U.S. dollars, there must be sufficient demand from the seller's side to make a profit or sell it for a reasonable exchange rate. Therefore, higher liquidity is often better and is generally associated with lower risk.
Fully diluted market cap
We’ve discussed what market caps are for cryptocurrencies. To determine a cryptocurrency’s market cap, we need to know the crypto’s price for one coin and the number of coins in global circulation.
But what happens when a cryptocurrency’s total supply is in circulation When this happens, it’s referred to as a fully diluted market cap.
Simply put, a fully diluted market cap is the metric used to determine a cryptocurrency's market cap when all its coins release into global circulation. For example, Bitcoin. Remember the 21 million limitation? So, when Bitcoin’s global circulation reaches this figure, it’ll be called a fully diluted market cap. If we were to put this into a formula, assuming Bitcoin has all its coins in circulation, we’d have:
Bitcoin’s fully diluted market cap = Current price (at the time of writing) x 21 million = $24,450 x 21,000,000 = $513,450,000,000 or $513.45 billion
Wrapping up
Let’s go through some of the key takeaways:
- Market cap is used to determine a cryptocurrency’s dominance, popularity, and value on the market. To find a cryptocurrency’s market cap, use this simple formula:
Market cap = current price x circulating supply
- A cryptocurrency’s market cap is generally affected by two crucial variables––supply and price. If a crypto’s supply is scarce, it tends to be more valuable. A coin with a high price could still have a large market cap, even with a smaller circulating supply, and vice versa.
- Cryptocurrencies are segmented into four main market cap categories: Mega-cap, large-cap, medium-cap, and small-cap.
- Liquidity and fully diluted market caps are important factors to consider before investing in cryptocurrencies.
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