Simple in appearance, it is of considerable importance when making investment decisions. What is market cap? How is it calculated, and how does it affect the crypto ecosystem?

Market cap or capitalization refers to the total monetary sum invested in a financial asset such as a cryptocurrency or stock.

It is an indicator that measures and tracks the market value of an asset. Within the cryptocurrency market, market cap is one of the indicators most closely followed by investors. It is calculated as follows:

Market cap = cryptocurrency price x number of units in circulation

For example, the Bitcoin (BTC) market cap at the time of writing is $501.88 billion:

25,761 (unit price of 1 BTC) x 19,482,197 (number of BTC outstanding)

Please note that the data used to calculate market cap is “circulation supply.” This should not be confused with “total supply,” which represents the number of tokens available over the long term (after the deduction of verifiably burned tokens). Understanding the difference between the two is vital, as the stakes and differences are considerable.

Considering the total supply method alone can present significant limitations. To cite just one example, with this method, it is not uncommon for the project behind a token issue to decide, either ab initio or during the process, on a “token unlock,” resulting in a programmed injection of tokens onto the market.

This operation can considerably distort the number of tokens in circulation. It dilutes the real value of the crypto in question and distorts the analysis based on its market cap.

It is more prudent and advisable to use the supply in circulation to calculate capitalization and monitor a crypto’s supply in circulation, not its total supply.

In this way, if you wish to calculate the capitalization of Binance’s BNB, for example, you need to take the price of the BNB and multiply it by the 153.85 million tokens in circulation (at the time of writing this article) and not by the 200 million in total supply.

The term “max supply” is also often used. It represents the total number of tokens that will come into existence and which must still, if necessary, be put into circulation. Max supply, or fully diluted market cap, predicts future capitalization if all cryptocurrency units are circulated.

The most widely used indicator for ranking cryptocurrencies

Market cap is the most widely used indicator for ranking cryptocurrencies and measuring their popularity with investors. In this respect, aggregators such as CoinGecko or CoinMarketCap are extremely useful for gaining an overview of cryptocurrency popularity.

Taking only their market cap into account, aggregators agree to define 3 categories of cryptocurrencies:

1. Large caps are those with a market capitalization in excess of $10 billion. Cryptocurrencies such as Bitcoin (BTC), Ether (ETH) and BNB fall into this category;
2. Middle-cap” or “mid-cap” are crypto-currencies with a market capitalization of between $1 and $10 billion;
3. Small-cap” cryptocurrencies have a market capitalization of less than $1 billion.

From this criterion, it is possible to derive the famous Bitcoin dominance, which measures BTC’s share of the overall market. At the time of writing (September 2023), this figure is just over 50%. The greater a currency’s market cap, the more dominant it is.

Finally, the “total market cap” calculates the capitalization of all cryptocurrencies ($1,070 billion in September 2023 versus over $3,000 billion at its peak during the last bull market in November 2021).

What is the role of the market cap?

As a general rule, investors use market cap as a gauge for a cryptocurrency’s appeal and potential for growth. It is considered safer to invest in large-cap crypto for long-term investments than small-cap crypto. This is because small-cap crypto is more susceptible to market fluctuations, while large-cap crypto is less affected by them.

Indeed, the volatility of crypto with a large market cap is often lower, although it remains higher than that of traditional assets such as equities. At the same time, the theoretical returns an investor can expect to achieve with a high-cap cryptocurrency will, for their part, be much more limited than those with a low-cap cryptocurrency.

Just as a large ship is better equipped to face rough seas, a cryptocurrency with a large market cap tends to be less volatile and more resistant to the whims of the market than one with a smaller market cap.

Generally speaking, market cap is an indicator that gives an idea of a particular cryptocurrency’s popularity. Market cap is also used to compare one crypto-currency with another, which is not true with unit price.

When carrying out a fundamental analysis of a crypto-currency, checking the supply of tokens ensures that you don’t fall into the trap of a crypto-currency with a low unit price—deciding to buy a cryptocurrency simply because its price is low and hoping for a spectacular rise is relatively dangerous.

For example, let’s examine and compare 2 cryptocurrencies, A and B. Cryptocurrency A has an outstanding supply of 500,000 tokens, and each token of this crypto is worth 2 dollars. Its capitalization is, therefore, 1 million dollars. On the other hand, Cryptocurrency B has a circulating supply of 100,000 tokens, each worth $5. Its market capitalization is therefore $500,000.

If we compare the market capitalizations of the two cryptocurrencies, we can affirm that cryptocurrency A is much more secure than cryptocurrency B. Yet cryptocurrency B is worth two and a half times more than cryptocurrency A.

Total market cap measures the health and evolution of the cryptocurrency ecosystem as a whole, although it is not the only indicator to do so. A rising total market cap demonstrates that the sector is in good shape.

Moreover, Bitcoin’s dominance over other crypto-currencies stems from the evolution of its total market cap. This important indicator enables us to observe the evolution of the Bitcoin price in relation to other cryptocurrencies, the altcoins.

In 2017, with the explosion of the Ethereum blockchain, some thought they saw a potential reversal of the hierarchy. However, this phenomenon, known as flipping, has remained purely theoretical.

A valuable but limited indicator

A cryptocurrency’s market cap considers the number of units in circulation, a value that is impossible to know. Indeed, losing the private key to one’s wallet can permanently cause the associated cryptocurrencies.

Although these lost crypto-currencies are impossible to quantify, they are still considered to be in circulation, even though they will never again be offered for sale on the market. The death of a cryptocurrency holder can also lead to this problem, although several companies are currently developing solutions to enable the transmission of such assets after death.

There is also an issue at market cap about the cryptocurrency’s price under study. Low liquidity can lead to rapid price fluctuations, making market cap analysis unreliable. If a cryptocurrency has low liquidity, its price can be easily manipulated. In such a situation, small transactions can lead to large price fluctuations, misleading the market cap.

Let’s take the example of a fictitious token: VORLD. Suppose 1,000 VORLD tokens are circulated and traded at around $50, so their capitalization is $50,000. Let’s also assume that the VORLD token order book is relatively empty and that an investor will buy $1,000 worth of VORLD tokens.

The order book empties almost completely in this scenario, and the VORLD price suddenly rises to $500. In short, the capitalization of VORLD tokens rises from $50,000 to $500,000. This figure is distorted, however, as the order book is virtually empty, and nobody wants to buy these tokens at $500 each.

This phenomenon affects many crypto-currencies with low liquidity, as their prices are easily manipulated due to a relatively empty order book.

Conclusion

Although market cap is a valuable indicator, it doesn’t give a complete picture of a cryptocurrency’s viability or financial health. For a complete assessment, it’s essential to consider other factors, such as liquidity, trading volumes, and inflation rate, and thoroughly analyze the project’s white paper. Understanding the token and its use within its ecosystem is also crucial.

Moreover, an astute investor must monitor general market trends, such as bear market phases, accumulation periods and bull runs. The intrinsic stability of the crypto-asset, as well as the investor’s financial situation, must also be taken into account before making an investment decision.