Market Cap is meaningless. Liquidity is KING!
OK, “meaningless” might be a slight exaggeration, but it certainly doesn’t deserve the level of significance that many attribute to it.
In this article I’m going to show you how you can create a token with a trillion dollar market cap for $1, and then I’m going to demonstrate why liquidity is so much more significant than market cap.
In a previous article about price curves and liquidity pools I used an example called “MyToken” and paired 100 MyToken with 100 BUSD in a liquidity pool. Assuming that 100 MyToken was the entire circulating supply, and the price is $1 per MyToken, we could arrive at a Market Cap of 100 MyToken * $1 per MyToken = $100 Market Cap.
This time let’s do it a little differently. Instead of placing the entire circulating supply into the liquidity pool, we only put a tiny portion of it in the pool, and we print up a huge amount of tokens that we retain in a founder’s wallet. So let’s start with one trillion tokens. We keep 999,999,999,999 MyToken and pair exactly 1 MyToken with just 1 BUSD in the liquidity pool. The price in the pool is $1 per MyToken, and there are one trillion of them in total, therefore the market cap would now be reported as $1,000,000,000,000.
Congratulations on creating one trillion dollars out of thin air! You’ve already nearly doubled the market cap of Bitcoin with your awesome financial engineering. But wait, it can’t be this easy, right?
Of course not. That value doesn’t exist anywhere but in your imagination. This is a gross exaggeration of how market cap can be inflated, but the premise holds true regardless of what numbers are used. What really matters is the liquidity, which in this case is still just a paltry $1.
Note: There are two different methods of reporting liquidity, and different sites use different methods. Be aware of which method is used so that you are making apples to apples comparisons. For more info look toward the bottom of this article.
Let’s explore that liquidity. You now have your bag of nearly one trillion MyToken valued at $1 each, and you decide to sell 100 MyToken back to the LP, eager to get $100 in BUSD so you can exchange it for fiat and go buy something. You send 100 MyToken to the LP, and then the LP uses the constant product formula of x*y=k to determine how many BUSD it needs to return to you in order to maintain the correct k value. Since the pool started off with a k value of 1 and it already has 1 MyToken and 1 BUSD, it will now have 101 MyToken and thus it must keep 1/101 BUSD in order to maintain the proper k value of 1, meaning it will emit 100/101 BUSD to you. So, you get about $0.99 instead of the $100 you were hoping for.
This leaves roughly $0.0099 in the LP. No matter how many MyToken you send to that pool, you’ll never get another full one cent out of it now. Yet what is the market cap? $0.0099*1,000,000,000,000 = 9,900,000,000. You now have an LP with less than one cent BUSD for a coin with a $9.9 billion market cap. The market cap has dropped by just over 990 billion dollars and you received less than one dollar.
Let’s do this another way. Instead of selling 100 MyToken to the pool, you instead add $1 BUSD to the pool. That same x*y=k formula would then require having only 0.5 MyToken in the pool to maintain k=1 with $2 BUSD, meaning the price per token has risen to $4/MyToken. The liquidity pool value has only doubled, but the market cap has now quadrupled. You now have a $4 trillion market cap backed by a whopping $2. You could keep adding trivial amounts of BUSD to the liquidity pool to show massive gains on the price chart and market cap.
Clearly, the more relevant figure here is the liquidity, not the market cap. Low liquidity makes it very easy to manipulate the price using relatively small amounts of capital; conversely, deep liquidity makes such manipulations cost prohibitive, meaning the price chart is more reflective of true market sentiment.
This type of trickery is used all too frequently in DeFi to help unscrupulous developers use their investors as exit liquidity. While you’re unlikely to see numbers as outlandish as in the example above, it’s not uncommon to see someone put together, for instance, $5k in liquidity against an $800,000 market cap, while holding 10% or more of the circulating supply. They might then pump in a tiny bit more capital to get the price chart looking nice and establish some momentum, then after some buyers chase after a quickly rising price they dump their bag and walk away with most of the investor’s money, far in excess of the 5k they initially invested in the LP — if that was even their own money in the first place, more likely they suckered the entire backing liquidity out of other investors.
Those who understand this game believe that they can time their exit profitably and take advantage of the false hopes of those who invest later. The problem is that after the price crashes new investors tend to be scarce and most projects like that just dwindle down to nothing, leaving the majority of investors with only a tiny fraction of the value they bought in with.
So rather than being impressed by market cap, what should you look for instead?
Liquidity and holder distribution. You want to see lots and lots of value in the liquidity pools to help absorb the price impact of sells, and you don’t want too much of the circulating supply in any one non-contract wallet where one sole individual could trigger a downward spiral in price.
ELEPHANT token is a perfect example that meets both of these standards. As of the time of this writing, it has over $37.5 million in BNB and BUSD backing the liquidity pools, the biggest human holder only has 0.8% of the circulating supply, the #2 holder about half of that, and over 67% of the circulating supply is locked into contracts which only sell the bare minimum required to fund liabilities while those same contracts just keep eating up more and more of the supply, like a big friendly whale that just wants to buy and hold as much as possible for as long as possible. Add to that some brilliant tokenomics which constantly add funds to the liquidity pool, and you’ll begin to understand why the price charts look the way they do. Indeed, even sells help feed the treasury in Elephant.money; the circulating supply gets tightened, and the treasury gets fatter on every buy and on every sell. In addition to the unique tokenomics, Elephant.money also sells yield in the form of some other offerings like Futures and NFTs which all help to feed that massive treasury.
Elephant.money sets the gold standard for liquidity and holder distribution in DeFi. As for market cap, it’s around $377 million and rising as of this writing — but keep your eyes on those wonderful, deep liquidity pools. They just keep growing and growing.
If you found this article useful a clap and a follow would really help me out. Thanks for reading and I look forward to bringing you the next one!
Disclaimer: None of this should be considered financial advice, I am not a licensed financial advisor and present this information for educational and entertainment purposes only. All crypto involves risk and typically proves most fun when you don’t invest more than you’re willing to lose. I may have a financial interest in the product(s) referenced and could benefit from your purchase.
