The metric of a cryptocurrency’s market capitalization, or market cap for short, is one of the most cited metrics when discussing the size of a cryptocurrency’s market. It is determined by calculating all of the tokens in circulation by the most recent price of the cryptocurrency. While the metric of market capitalization is useful as a brief snapshot of the market, it is not absolute and should be placed into the correct context. But how to make sense of the metric? Read on to find out.
Why do we need the metric of market capitalization?
Cryptocurrencies are units of digital cash that run on blockchains—decentralized ledgers that are maintained by their anonymous users, rather than central banks. This feature makes the value of most cryptocurrencies almost entirely dependent on market forces since they are not backed by centralized bodies that can implement monetary policies to alter the price of the national currency.
However, the price alone is not a reliable metric of a cryptocurrency. Each cryptocurrency has its own unique “tokenomics”; few currencies have the same total supply. This makes it tricky to analyze the crypto capital market using price alone.
For instance, some supplies of cryptocurrencies are capped and will never change. Others are unlimited and increase every year, while “deflationary” tokens decrease at a steady rate. The supply of currencies varies wildly. NFTs, or non-fungible tokens, have a supply of one—they are all unique. On the other hand, Shiba Inu token has a total supply of 550 trillion.
As such, the price of a cryptocurrency isn’t always helpful when determining the size of the market. The size of the Shiba Inu market is still worth more than ten billion dollars, even though its token is worth a fraction of a penny—there are just a lot of them. The price of stablecoins should (hopefully) stay the same; even though the market for them is huge, a US dollar stablecoin should(again, hopefully) never be worth more than Bitcoin.
Crypto market cap explained
One consistent way of determining the value of a cryptocurrency’s entire market is to multiply the size of its circulating supply by the most recent price. This approximates the size of the market. Market cap, therefore, is useful because it takes into account variances in supply and differences in tokenomics.
As of January 2022, the largest crypto by market cap is Bitcoin. Bitcoin has always been the largest coin by market cap since its creation in 2009. The next largest coin by market cap is Ethereum, the largest smart contract-enabled blockchain. The third-largest is Tether, a stablecoin pegged to the US dollar. Combined, these have market caps of about $1.3 trillion, as of January 6, 2022, although the market is highly volatile and this figure, plus the global crypto market cap, will likely have significantly changed by the time you read this.
You can see the largest coins by market capitalization on price aggregation sites like CoinGecko, CoinMarketCap, and Nomics. Many exchanges will also provide these crypto market cap charts; these display all cryptocurrency market caps. Note that the market capitalizations will vary between sites. This is because sites use different methods to track the price of a cryptocurrency. Aggregators rely on the price feeds of several major cryptocurrency exchanges, and exchanges likely only refer to their own site; a temporary skew on one of the exchanges may alter the price on the aggregation sites. In addition, aggregation sites and exchanges use different methods to determine the total supply of a coin. Supplies change all the time and not all references will be up to date.
Market capitalization, fully diluted market cap, and realized market cap
A cryptocurrency’s market capitalization is one of the most popular metrics to determine the size of a market, but it should not be confused with similar metrics.
The first is “fully diluted market cap.” This metric determines how large the market capitalization of a cryptocurrency would be if the entire supply were in circulation. When cryptocurrency developers launch their coins, they often do not put all of them into circulation straight away; instead, they often withhold some of them from the market as part of vast economic projects to incentivize people to keep using the network for decades to come.
The maximum supply of Bitcoin, for instance, is capped at 21 million, and only 18.9 million Bitcoin are in circulation. The rest must be mined into existence by powerful computers. This is because Satoshi Nakamoto, Bitcoin’s pseudonymous developer, wanted to encourage people to use their computers to keep mining Bitcoin, since mining Bitcoin is the process by which transactions are confirmed on the network.
The fully diluted market cap should not be taken at face value. If, say, you created a cryptocurrency network that had just one circulating token, and sold that token at $1 million, the network would have a market capitalization of $1 million. But if you promised the holder that they would receive a trillion tokens in 10 years, and set them aside in advance, the network would read a fully diluted value of $1 trillion and one dollar. Of course, people may dismiss the fully diluted market cap crypto’s valuation; it is highly unlikely that tokens would remain at $1 in a decade once these tokens come into circulation.
The second alternative market cap metric is “realised” market cap, made popular by metrics sites like Coin Metrics and Messari. Realized market cap recognizes that, just like with “fully diluted market cap,” the total market cap of a coin ignores the full picture. It does not take into account coins that have been lost, forgotten about, owned by the deceased or withheld from their owners (who may be, for instance, in prison). Realized market cap attempts to address this by only taking into account coins that have recently moved from the network. For this reason, the realized market cap is smaller than the actual one. On Coin Metrics, Bitcoin has a total crypto market cap of $823 billion, it has a realized market capitalization of $462 billion.
How helpful is digital currency market cap, really?
There is reason to cast doubt on the significance of a coin’s market capitalization. One main reason, aside from the issue with lost or “dead” coins that sparked the idea of realized market cap (see above), is that the metric only reflects the last price at which a cryptocurrency sold, rather than detailing the health of a market. If you sold a Bitcoin for $10 million, its market cap would, until someone places another trade, be larger than the entire global economy.
Such problems are not exclusive to cryptocurrencies. The price of art, an illiquid asset, only reflects the most recent sale. Accordingly, spuriously high prices for NFT art can artificially lift the market cap of a project, making a project’s market cap an unreliable metric. So, some crypto market cap calculators, even those by those sites for the top crypto market caps for NFTs are suspect.
Another reason to doubt the crypto market cap ranking is that, unlike stocks, it is very easy for cryptocurrency protocols to create or destroy tokens, which may cause volatility in their prices if markets lag behind. The factors that influence the creation or destruction of new tokens are manifold. Some algorithmic “stablecoins,” like Ampleforth, destroy and create tokens in period “rebases” to try and fix the price.
Most native cryptocurrencies of base layer blockchains, like Bitcoin or Ethereum, create new tokens to the miners that validate the transactions on their network. Some projects, like Yearn Finance, create tokens at will to satisfy the demands of investors. Some projects, like Polkadot, redenominate tokens to reflect higher prices—in 2020, it converted each DOT coin into 100 coins. So, although market caps are still better than prices at proving the overall size of a market, they do not reflect the full picture of a project’s economic structure.
Alternative metrics to determine the size of a cryptocurrency project
Total Value Locked
Some coins do not fare particularly well when considering their market cap, but they are part of important projects nonetheless. A great example of this is the numerous governance tokens that power various decentralized finance protocols.
Take UNI, the native token of the most popular Ethereum-based decentralized exchange, Uniswap. UNI was gifted to all users of Uniswap in late 2020, but despite being the token of the largest decentralized exchanges on Ethereum and one of the backbones of decentralized finance on Ethereum, UNI only has a market capitalization of $10 billion, making it the 19th largest coin by market capitalization. Other metrics within the decentralized finance industry tell a different story. Uniswap, the protocol, has $3.29 billion locked up within its smart contracts, and the exchange processes volumes of $2.85 billion a day–the largest out of any decentralized exchange. It just so happens that $1.35 billion of ETH, the native coin of the Ethereum network, forms the bulk of that $3.29 billion, not the UNI token.
This does not mean that the UNI token is not important: far from it! The token can be used as a voting chip within Uniswap’s governance protocol, and huge bagholders can shape the future of upgrades, allocate money to developers and artists, and vote on how to fix bugs. So, squarely focusing on UNI’s market cap would undermine the importance of the coin in controlling the protocol it supports.
The metric that forms the $3.29 billion is called “total value locked,” and it is a common metric used to determine how much money is held within the coffers of decentralized finance protocols. You can see the top protocols by TVL on sites like DeFi Pulse or DeFi Llama. The reason why a protocol’s TVL could be larger than the market cap of its native token is that the TVL may be formed of hundreds of different tokens.
Some people dismiss TVL, too, because the calculations that define it are not standardized across the industry, and certain protocols, like lending protocols, look larger than decentralized exchanges, since some calculations of TVL can “double count” tokens held within lending protocols.
Volumes
Alternatively, a token’s trading volume can help determine how popular a coin is. Trading volumes are calculated by determining the worth of all coins traded in a given timeframe, like a day, week, or year. Volumes do not indicate the health of a market; a coin may have high volumes if lots of people want to sell the token at once, like in the event of a market crash. That said, volumes do a decent job at indicating the popularity of that token or coin (not taking into account wash trading, the practice whereby the same party, usually an exchange or a coin creator, buys and sells lots of the same coin to inflate volumes).
Stablecoins like Tether, Binance USD, and USDC often have some of the largest daily volumes because they are used as stable assets when trading in and out of more volatile currencies. Stablecoin volumes usually rise in times of market panic, as investors will use them as hedges against volatility. Bitcoin and Ethereum also have high volumes. These currencies are far from stable, but their huge market capitalizations make them slightly more resilient to market forces.
