Can You Compare Cryptocurrencies by Market Cap?
Market cap is one of those industry terms that’s common enough for most people to have heard of, but is “insider” enough that the average person doesn't know what it means. I remember trying to decipher these investing terms when I was starting out and it can be difficult.
So, let’s start with a definition of what market cap does and why it’s valuable in traditional markets, and then we’ll get into looking at Bitcoin market cap and what you need to watch out for there.
The Basics of Market Cap
Market cap is short for market capitalization. This is a reference used by investors to figure out how big a company is. The way that market capitalization is figured is to multiply the number of shares available by how much the shares are selling for (source).
For example: A company that has 1 million shares that are selling for $50 each has a market cap of $50 million.
Generally speaking, the bigger the market cap of a company the more stable the investment. There are several factors that can influence an investment beyond market cap, but many investors use market capitalization as a tool to help them know where to invest and how risky the investment is.
In traditional stocks companies that have a market cap of 10 billion or more are considered large-cap companies. Market caps of between 2 billion and 10 billion are considered mid-cap companies with more room for growth. And market caps of between 300 million to 2 million are considered small-cap companies and are generally riskier investments.
With the growth of cryptocurrency, people are starting to look at market caps in crypto markets as well. But because crypto is largely unregulated at this point, there are additional considerations to take into account before considering market capitalization as a primary indicator of risk.
How Market Cap Applies to Bitcoin and Other Cryptocurrencies
Bitcoin market cap and other cryptocurrency market caps are being used to compare the value of various cryptocurrency companies.
But there are some serious problems with this approach. It’s not that market cap is not a useful tool for cryptocurrency, it can be. But it’s important to recognize that cryptocurrencies come with risk factors not associated with the traditional stock market, and to understand how to compensate for those risks.
One of the most important risk factors to look at when evaluating market cap for cryptocurrency is nonliquidity in the markets. This usually happens because certain parts of crypto are locked up or lost.
The Dangers of Locked Up Cryptocurrency
The biggest problem with using market capitalization as a measure of how strong a particular cryptocurrency is (like you would for a publicly traded company) is that there are many situations where units of the cryptocurrency are not in liquid circulation.
These locked up or lost cryptocurrency units can affect what the real market cap is of any cryptocurrency.
When you’re looking at Bitcoin market cap, for example, it’s important to take into consideration that somewhere around 4 million Bitcoins are lost on servers somewhere. That’s according to a study from Chainalysis––a blockchain analytics company.
So, when you look at standard market cap valuation of how much each Bitcoin is worth times how many Bitcoin’s there are, you really should take out the “missing” Bitcoin to see how much the company is actually worth.
Another example of this is the company Steem. Their market cap was valued at more than $400 million. But a huge portion of their value was locked up in something called Steem Power––a kind of social network (source). Which means that the market capitalization value was incredibly misleading.
Sharks can also create misleading market capitalizations. In many cases – especially with smaller cryptocurrencies – a single entity will hold on to much of the coin from the very beginning of its existence. If these sharks then dump all of that cryptocurrency onto the market at once it can devalue it really fast.
The bottom line here is that when you’re looking at market capitalization for cryptocurrency, you need to make sure that you’re looking at additional metrics as well. Especially since cryptocurrency - at this point - can still be very volatile.
Important Metrics When Comparing Cryptocurrencies
Now that we've looked at why market cap can be somewhat misleading when comparing cryptocurrencies, let's look at some important metrics you should consider when comparing and evaluating cryptocurrencies.
When it comes to comparing cryptocurrencies, the first metric that you probably should watch outside of market cap is called Metcalfe's Law. This has to do with the number of users that are actually on a crypto trading network.
When you track the number of users on the Bitcoin network (or other networks), it will mirror closely the amount of movement on that network. It seems that removing users that have not made any transactions, but have just registered can make this law even more robust. Because then you are tracking users that are actually active.
A Warning on Metcalfe's Law
Like other things, Metcalfe’s Law is not incorruptible. It can be easily gamed where there are networks that have really low transaction fees. Super low transaction fees mean that there’s less resistance to using the platform and potentially less actual trading going on, and that can screw up the law.
A second metric to watch when comparing cryptocurrencies is liquidity. I touched on this earlier in the article, but you want to make sure that you are evaluating how much trading is actually going on in any given cryptocurrency. A lack of trading could signify sharks that could dump their coins and create a drop in the market.
The final metric I recommend watching is monthly volumes. Staying away from daily volumes is a really good idea. Daily volumes can be deceiving due to their volatility.
Cryptocurrency is still a fairly volatile investment – and some people would even say it’s a gamble. Before investing in anything – especially bitcoin and cryptocurrency – it’s important to understand how bitcoin market cap and other cryptocurrency market caps actually work. You also need to know what your real risks are and be comfortable with the possibility of losing money.
Cryptocurrency is an extremely interesting and dynamic development with lots of opportunity and lots of risk. Understanding how it works is important if you’re going to invest.