Hi there. In our previous post, we discussed what Cryptocurrency Market Cap was. This time, we’ll tell you how differently market cap works for stocks and crypto.
Stock market cap vs Cryptocurrency market cap
The term market capitalization originally comes from the stock market. To understand how differently market cap works for stocks and crypto, you need to have a basic understanding of how stocks work. Let’s give you a simple overview.
Owning stock in a company will give you a share of its ownership. Ownership broadly means two things:
- Having the right to a portion of the company’s future income distributed in the form of dividends.
- Receive a proportionate amount of proceeds in case the company is sold
The total value of all the shares is the market cap of the company. The company’s market cap is an estimate of its current ability to produce revenue and its potential for growth. A significant percentage of a company’s stock is held by the founders and other big shareholders.
Now, in the case of cryptocurrencies, a large portion of the tokens is held by the company behind the project and by whales who just eat up the tokens and keep them dormant in their wallets.
How are these two approaches different?
Most of these stocks pay dividends. So, the stocks that the owners will have will earn them dividends, which in turn is going to dilute the stocks owned by the other shareholders. However, this is not the case with cryptocurrencies. When a whale hoards up tokens in their wallets, it just lies there. How many stories have you heard about folks having hundreds of bitcoins in their pen drive and then completely forgetting about it?
So why is this a problem?
If a big portion of the supply is locked up, then this seriously affects the liquidity of cryptocurrency and the coins get spent more often. To understand why this is a problem, let’s do a thought experiment.
Suppose there is a hypothetical crypto called A Coin which has a total supply of 100 million coins. Now, imagine that some whales have bought and stored away 50 million A coins. So, now we only have 50 million coins available for trading. Imagine that A Coin really goes off and people start trading more and more, they will only have 50 million coins to trade with instead of 100 million As such those 50 million coins are going to be spent more often.
Overspending leads to high token velocity. Token velocity increases when people are selling off their tokens at a faster rate. High token velocity means low network value. Since these tokens have low liquidation, the velocity invariable increases.
Let’s quantify token velocity (TV):
TV = Total Trading Volume / Average Network Value.
So, more the trading volume aka more that coin is traded more the velocity. Consequently, less the network value, more the velocity.
How is it relevant to market cap?
What all of this basically means is that market cap may not be the best metric to judge the value of a cryptocurrency. Like we have stated above, there is a critical difference between the market cap for stocks and the market cap for cryptos.
In the case of stocks, the total number of shares available is a far more accurate figure and it truly defines the distribution of a company’s ownership. In that case, the market cap is a pretty accurate metric.
However, in cryptocurrencies, just by knowing the market cap, we can’t make an accurate judgment about the company’s value. We don’t know how many of those coins are just locked up in dormant wallets and what is the true velocity of these tokens. Without all these metrics, market cap is not really the best method to judge the actual value of a cryptocurrency.
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