Market Cap is a LIE! Here is why!

In articles about cryptocurrencies and in discussions about cryptocoins in general, the concept of market capitalization (abbreviated as market cap) is often used. In fact the website coinmarketcap.com, which is used as a standard for most traders, has joined the top 100 list of most popular websites on the internet according to alexa.com. In this article, we will try to explain why we think market capitalization is overused, incorrect and generally bloated. Yes, we know this is a very controversial thing to say, but we mean it: marketcap is a lie. Here is why.

Definition

The market cap is calculated by multiplying the total circulating supply of a coin with the value of one coin. For example, Bitcoin is valued right now at $10.671,40 and has a circulating supply of 16.889.750 coins, resulting in a market cap of $180.237.278.150. With circulating supply, we mean the number of coins that are circulating in the market and in the general public’s hands, dixit coinmarketcap’s FAQ. This is not taken into account the coins locked up by the owners of certain cryptocurrencies, such as Ripple (of which 60% of all coins are still owned by the team) or Stellar (a staggering 82% of all coins are still owned by the Stellar organization!). This immediately leads us to the two biggest problems with the concept of market cap.

Two major issues with the concept of market cap

First let us look at why the circulating supply is often wrong. Take Bitcoin for example. As some of you may know, 96% of all Bitcoin is owned by less than 3% of all wallets. A lot of the wallets containing a huge amount of Bitcoin have not been accessed in years. While it is possible those wallets belong to whales playing the HODL game, many of them are believed to be either:

  • Satoshi Nakamoto wallets: the inventor of bitcoin mined a staggering amount of Bitcoin at the very beginning. He did one transaction to test the concept, but all other Bitcoin have never been accessed or moved. These coins alone are estimated to come to a total of 1 million Bitcoin
  • Many early adopters of Bitcoin had what is now a staggering amount of them. Remember that in the early days of Bitcoin someone paid 000 Bitcoin for a pizza! A lot of early adopters might have thrown away or lost a wallet containing hundreds if not thousands of Bitcoin back when they were virtually worthless. It’s hard to estimate, but we’ve seen calculations ranging from several 100.000 to more than 2.500.000 Bitcoin lost this way.
  • People die, leaving behind an exchange account or hardware wallet that spouses or family don’t have access to.
  • A lot of Bitcoin dust has been collected. This refers to wallets with so little Bitcoin in it, that the value of the Bitcoin itself isn’t enough to pay the transaction cost. This is probably negligible in comparison to the previous amounts of locked up or lost Bitcoin.

And that’s just Bitcoin! When taking into account all the cryptocurrencies that currently exist, it’s very likely that over 10% of all market capitalization is locked up in coins that never can or never will be accessed again.

The second major problem is artificial pumping of cryptocurrency prices by restricting the supply. Take Raiblocks (XRB, now NANO) for example. In December of 2018 it was very difficult to acquire this token because it was hidden on a small, unsafe looking website – which turned out to be a complete scam. This allowed a small group of NANO whales to manipulate the price of NANO by washtrading: They sold and bought their own coins, steadily increasing the price. This is the same mechanism that one single person using bots used to pump Bitcoin’s value to $1000 in the 2013 bubble. In fact, some people claim tether was used to do the same thing to pump Bitcoin to almost $20.000 in the December bullrun.
More recently, on March 9th, a glitch in the supply made PACcoin climb the top three market cap! This furthers the idea that a combination of artificial price pumping and enormeous supplies of a token can inflate market cap.

The importance of fiat pairing

Some cryptocurrencies have fiat pairing. And no, we’re not taking into account USDT! Having a fiat pairing means you can directly use USD, EUR or other regular currencies to buy cryptocurrencies. The most well-known example of this is Coinbase which has fiat pairing for BTC, BCH, LTC and ETH. The importance here is that every single dollar that is invested in cryptocurrencies has to pass through one of these coins. When you use fiat to buy Bitcoin for example, the value of Bitcoin will increase. Other tokens are paired with BTC, so if Bitcoin increases the other token will increase in value as well. Let’s say you own 1 TRX which is worth 500 sats. If Bitcoin suddenly increases 10% in value versus USD, your TRX will be worth 10% more when measured in fiat, even though there was no reason whatsoever to increase in value! In fact, if the dollar value was a legit way to express cryptocurrency value, TRX should decrease in sats, to 450 sats.

The fact that most cryptocurrencies are only paired to BTC implies that trading altcoins without fiat pairing is very similar to trading Bitcoin with leverage: if Bitcoin rises, and your altcoin rises in sat-value, you have a double profit when counting in fiat. But, if Bitcoin declines in value and your coin declines in sats, you have double loss! This is one of the main reasons why expressing your portfolio in USD or EUR is not a logical thing to do: trading altcoins should always be a means to increase your Bitcoin value! This also implies that the market cap is somewhat bloated as the value of cryptocurrencies without fiat pairing should never be expressed in USD. If you own one million TRX tokens and you want to cash out, you will have to sell TRX to BTC and sell that BTC to fiat. So all money that wants to leave the cryptomarket has to pass through these same fiat-paired cryptocurrencies.

Using market cap to gauge potential

Often people try to estimate the growth potential of cryptocurrencies by looking at market cap. Small market caps (<100M) have “lots of room for growth”, and so forth. The harsh truth is most cryptocurrencies are overvalued, with a price that has been pumped by extreme speculation. Without a working product, Cardano was at a certain point valued at 17 billion USD! We are not saying there is no money to be made by speculating on these projects, but it is and will remain speculation for as long as there is no real life adoption or use case. If you want to use the word “investing”, there are three kind of crypto’s to look out for:

  • Crypto’s with fiat pairing: these are the most secure. The ultimate blue chip tokens: BTC, LTC, ETH and BCH.
  • Crypto’s providing a platform: NEO, EOS, NULS, XLM…
  • Crypto’s with a working product and real life use cases: VET, SIA, XMR, BNB

These should be a part of any portfolio and take up at least 50% to minimize risk in this extremely volatile market. We will publish an article soon(ish) about the perfect balance between blue chip tokens and altcoins for a crypto-portfolio. Stay tuned!

 

@wijcryptonairs