Table of Contents Hide
- Explanation of the Crypto Market Capitalization
- Market Capitalization as an Investment Instrument
- The Market Capitalization of Cryptocurrencies Determines the Volatility of Prices
- Market Capitalization as a Tool for Choosing an Investment Strategy
- Tips on Using the Market Capitalization to Determine an Investment Strategy
In the world of traditional finance, the market capitalization of a company is the most important investment criterion for determining its value. The calculation of the market capitalization is extremely simple: the number of shares released in the calculation is multiplied by the current share price. So this indicator can be quite used in analyzing and forecasting the value of shares, based on which to make a decision about investing in a promising asset.
Approximately the same approach is used in relation to cryptocurrencies. But in the cryptocurrency market, we are not talking about companies, and digital assets are not the property of a specific company or enterprise. There are some useful platforms that help investors and crypto users to monitor crypto prices, and one such platform widely used in the cryptocurrency market is CoinMarketRate. Despite both cryptocurrency and traditional markets being based on different concepts, they both need market tools that would make it easier for investors to follow exchange rates and price dynamics.
And yet there is another common feature between them: both cryptocurrencies and shares appear on the market as a result of an initial public offering: IPO for shares and ICO for cryptocurrencies (initial token offering).
Fluctuations in the current supply of cryptocurrencies do not affect the indicator of their market capitalization in any way. It, as in the case of stocks, is determined by a simple formula: the value of the token is multiplied by the number of coins issued at the moment.
So, if the current price of Bitcoin is $19,200, and 19.183 million coins are functioning on the network, then the market capitalization of Bitcoin will be $368.3 billion.
The obvious conclusion is: the MC depends on two variables:
- Coin offers;
- Their value is reduced to the US dollar.
The number of coins in circulation, in turn, depends on the monetary policy of a particular cryptocurrency, it can be different. So, for Bitcoin, the upper emission ceiling is 21 million units, and about 900 new BTC are mined daily. Fluctuations in value are stochastic in nature, which can sometimes be predicted (for example, positive news increases the price, and negative news leads to its fall), but most often not.
There are cryptocurrencies that do not have an issue ceiling, but in order to avoid an overabundance, there is a mechanism for burning coins. Thus, Ethereum, which is in the TOP 3 cryptocurrencies with a daily issue of 6400 ETH, provides a deflationary price model by burning fees under the EIP-1559 protocol. Burning cryptocurrencies is a procedure in which these coins are sent to a special wallet that does not have private keys. This means that this amount is irretrievably lost to the ecosystem.
Consequently, for some cryptocurrencies, the market capitalization also depends on how many coins are burned.
The second common way to ensure a deflationary model and guarantee the preservation of the value of the cryptocurrency is to block part of the issue. An example is an ApeCoin token (APE), launched as part of the Yuga Labs project. The initial volume of the token issue was 1 billion, but on the day of the issue (05/17/2022), only a little more than 30% of the tokens were put into circulation. The rest of the coins will be gradually unlocked over 2 years according to the schedule.
This means that the market capitalization of ApeCoin at the time of the issue was $1.88 billion. (multiply the current price of the cryptocurrency, equal to $6.13, by the number of coins equal to 306.8 million). Since the economy of ApeCoin does not involve burning tokens, the value of APE, as well as its market capitalization, in the future will depend on how useful this token will be.
And to ensure its usefulness, Yuga Labs has developed several projects that can become popular with users. For example, the Otherdeed metaverse, which is an analog of the well-known Decentraland/The Sandbox projects.
So, we have figured out what the market capitalization of coins is, and what factors influence this indicator. And there is still something to find out about how it is used.
Market Capitalization as an Investment Instrument
At its core, market capitalization is a sign of the company’s value of the company, that is, the total current value of the shares if we are talking about a company that has conducted an IPO. But shares are not always made available to investors, sometimes they remain owned only within the company and are not traded on exchanges. In this case, the MC is an estimated indicator that is not of interest to investors.
For public companies, market capitalization in combination with other factors is a criterion for determining the feasibility of investing. Simply put – whether the shares are overvalued or, conversely, undervalued.
These factors include:
- Profitability of the stock (the ratio of price to profit);
- Money turnover;
- The amount of the company’s serviced debt;
- Management portfolio analysis;
- Characteristics of the products (services offered);
- The level of competition in this area.
If the company’s shares are traded on the stock market, the RK indicator allows it to be classified into one of three categories: small/medium/large capitalization. It is clear that the shares of each category will be of interest to the corresponding groups of investors, who also have their own classification by trading volume.
It is believed that the smaller the market capitalization, the more risky investments in such a company will be, but with a successful combination of circumstances, the profitability will be much higher. Investors who prefer stability rely on investing in companies with large market capitalization, where profitability will depend more on the amount of investment, rather than luck.
Approximately the same strategy should be followed with respect to investments in crypto assets. The current value of cryptocurrencies, like the value of shares, is considered one of the determining factors when making an investment decision, but in general, does not reflect the degree of risk. But market capitalization is a more objective criterion. It is no coincidence that beginners are recommended to invest in bitcoin and Ethereum as the two most stable and expensive cryptocurrencies, but stability is a relative concept here.
The volatility in the world of digital money is an order of magnitude higher than in the traditional financial sector, so another tip for novice investors is that the share of cryptocurrencies in the investment portfolio should not be high.
The Market Capitalization of Cryptocurrencies Determines the Volatility of Prices
Although the very concept of cryptocurrency, inextricably linked to the blockchain, implies complete decentralization, it must be understood that the word “full” is not interpreted quite correctly here. Many coins, if not the majority, are associated with specific people standing at the origins of the project. So, Vitalik Buterin’s name is definitely associated with the Ethereum project, and, say, the mention of Charles Hoskins evokes associations with Cardano.
Any public statement of such people concerning the crypto market almost always causes jumps in the value of the corresponding coins. Sometimes – not too noticeable, sometimes – quite tangible. Such volatility for tokens, whose market capitalization is high, can cause both rapid enrichment and an equally significant loss of money.
For cryptocurrencies, whose MC is small (up to $3 billion), price fluctuations may have an even greater relative spread, and here the degree of risk will depend on the price.
Market Capitalization as a Tool for Choosing an Investment Strategy
Following the value of cryptocurrencies, the market capitalization of coins is the second most important factor chosen by investors as an assessment of the degree of investment risk. Using this indicator, you can perform a preliminary assessment of the project status. If the level of the RK is large, it can be concluded that other investors have already completed a comprehensive assessment of the project and invested in it. In other words, market capitalization can be used as a form of crowdsourcing.
But this is an estimate in the first approximation, because the current state of the crypto asset may not reflect its prospects. In any case, when assessing the feasibility of investing, the factors described above should also be carefully studied.
Tips on Using the Market Capitalization to Determine an Investment Strategy
Many experts recommend using a methodology for evaluating the weighted market capitalization of crypto assets. It will be useful even in cases when the investment portfolio includes only two assets, BTC and ETH.
The essence of this strategy is that you need to try to invest proportionally in several cryptocurrencies, guided by the cryptocurrency capitalization schedule.
In the case of the example above, you need to sum up the RC values for bitcoin and Ethereum and calculate the percentage ratio for each of the coins (you will get about 71% for BTC and 29% for ETH). It is recommended to invest in these two leading cryptocurrencies by total capitalization accordingly: out of every hundred dollars, $71 to buy bitcoins, and $29 to buy Ethereum.
Approximately the same strategy should be used if you focus on cryptocurrencies belonging to the medium and small categories by capitalization.
It is important to understand that the market capitalization of bitcoin, as well as any other cryptocurrency, is subject to constant changes, and in order to get a more or less complete picture of the dynamics, you should study the corresponding charts several time ranges – daily, weekly, monthly and longer, if it is useful.
The second important conclusion is that the ROK will be the main criterion for investors who prefer the use of cautious tactics. Those who prefer risk need to focus on the value of cryptocurrency.