Why “Market Cap” doesn’t mean what you think it does
So the crypto market is in a bit of a tail spin, with traders guessing at what “the bottom” will be. I have my own assumption, but this isn’t the time nor place for that.
Aw!
Oh right, there’s my conceit, a person I talk to who emulates you, the reader, to make everything more engaging
Hahaha conceit, you used it wrong stupid
Oh. Gosh, that’s embarrassing.
Well, you’re not just learning about crypto here. You can learn anything!
¿Even Spanish?
Maybe I’ll just begin the article now. So, the crypto industry is still going through some teething. I’ve written about some of the teething issues with the main stable coin.
I’m going to look at one of these here, the market cap, because it’s a shame that people are getting ideas crypto that are wrong.
So… start yet? Man, if this was youtube i’d comment “video begins at 1:34”
… My therapist is not doing a good job. Ahem. Point one is the market cap of crypto: market caps can be found here.
They’re really simple — take the circulating supply, multiply by the last traded price, get the market cap. This seems fair — it is how market caps in a stock market work, anyway, so why is this a problem?
There are two problems, actually. The first is that there might well be 17.5 million bitcoins around, but there aren’t 17.5 million bitcoins available.
Is this, like, a dating thing? Like how I keep seeing beautiful people on tinder but none of them ever match with me?
No. … Maybe. idk, look, the point is estimates are that as much as 3.8 million could be lost. So already, the market cap of bitcoin is lower than that stated amount. A fair bit lower, actually.
Oh, interesting. Market cap is like, the value of a company?
In stocks, market cap reflects the company size (~small, medium, large cap). It’s a comparison tool. You wouldn’t use it to value the company — that’s the enterprise value, which is a different number altogether and requires some thoughtful analysis and comparing the company to other similar companies.
Wait, but if Amazon has a market cap of 1 trillion, I can buy the company for 1 trillion right?
Uh, slow down there Crassus. No, because once people realise what you’re doing they’ll charge more for it. In a similar vein, if everyone tries to sell Amazon stock that stock price isn’t going to hold, and its market cap will drop.
Oh, right. So comparison tool. Hey! what’s the market cap of the USD?
Hey! indeed. That’s… not really a thing, but here is an interesting article on various “market caps”, and to answer your question I’d guess that M2 — the measure of money in banking accounts and cash — would be a good indicator. That’s sitting at around 14.3 trillion USD. But honestly, it’s hard to say, because one thing people in crypto *hate* is the idea of fractional reserves (which M2 very much uses) so you’re not really comparing the same thing. The other reason it’s hard to say is because buying up all the USD makes no sense. What… what would you do with it? Would anyone want it anymore?
Aw. Things are never easy. Is that it about market caps?
No. The real problem is that they make no sense in crypto at all.
Oh! Intriguing! But I have ADHD still. Are there… cats?
Ok, happy?
SO SO HAPPY
Cool. So here’s the deal, most coins in crypto cannot be bought with USD, but rather, you first buy Bitcoin (or in a pinch, Ethereum), and then you trade *that* for the coin you actually wanted. That’s really the whole conceit…
Oooh I learnt something from earlier!
Yes, that’s really the whole conceit of Ethereum — buy that coin, use it to trade for other coins in an ICO. For example, the biggest US exchange CoinBase, at the beginning of 2018, only supported Bitcoin, Ethereum, LiteCoin and Bitcoin Cash. Only two of them are in the earlier image listing the largest coins by market cap. (As an aside, CoinBase has been busy adding new coins all this year — mostly coinciding with the collapse of the entire market.)
It’s easy to work with Binance (the largest exchange) when it comes to depositing cryptocurrency. But it’s not possible to buy anything directly there with cash. So again, everyone generally arrives via a small handful —generally Bitcoin or Ethereum.
Well, what’s the problem? I was at a coffee shop earlier, and I’ll swear they didn’t want my cash either the length of time it took to get served.
Well, if you first need to buy Bitcoin for cash, then exchange the Bitcoin for, say, Ripple…
Oh right. Ok, so I buy a Euro for a USD. And then I change the Euro for a British Pound, so that makes the market cap of a pound…
Stop, no, stop. Look, look it’s like this — imagine there are two coins, Bitcoin and Ethereum. But you can only buy Bitcoin with cash, and you can only get Ethereum by exchanging with Bitcoin…
Right, so I buy a cow for a peso, and if I exchange that for a cup, then the cup is worth…
Stop. Say there are only two types of coin, and that there is only one Bitcoin coin in existence, and only one Ethereum coin too. You exchange a dollar for a Bitcoin, so it has a market cap of 1USD (only one bitcoin exists, it’s worth a dollar). You then exchange the Bitcoin for an Ethereum coin, Ethereum has a market cap of 1USD too now (one Ethereum coin exists, it’s worth a dollar).
Got it.
Now the total market cap of Bitcoin is…
1 USD!
And the total market cap of Ethereum is…
1 USD!
And the market cap of both coins is…
2 USD! Obvious!
But the total amount of USD put into the crypto system was…
2… no, wait. It was only 1USD!
Right. You end up double counting the USD. If there is another coin, and you change the Ethereum for that coin, then you could have a total market cap of 3 USD, but again, only 1 USD in the system.
What if I change the Ethereum back to Bitcoin for less Bitcoin?
Exactly. You can literally increase the market cap of Bitcoin by exchanging your Ethereum coin for 0.5 Bitcoin (market cap of Bitcoin now at 2 USD!) and then change that 0.5 Bitcoin back for 0.5 Ethereuem (market cap of Ethereum now also 2 USD!) and suddenly the total market cap of the two coins is 4 USD, and
and there was only ever 1 USD in the system… oh.
So that’s a bit of a problem. Similar to the fractional reserve of M2 in a way, really.
Because the market only really ever had a few coins you could buy in with, then there is a lot of double counting. And because the coins themselves can increase their value without additional USD (or any other cash) flowing into the system, the market cap doesn’t really reflect anything tethered to the value of any existing currency.
So Bitcoin doesn’t represent 59 billion in stored value at all. I’m not sure what it represents, only that it isn’t 59 billion, rather a fraction of that number.
Stored value?
We’ll talk about that another time. But right now just note that:
- the market cap of a currency is a weird thing to use as a comparison tool
- the market cap of Bitcoin and all the other coins is grossly inflated, because of double-counting currency and because coins can trade back and forth between each other.
