Understanding Token-Based Cryptocurrencies Market Cap Variation

Some very important concepts to understand about how your cryptocurrency, typically an ERC-20 based token, is actually doing; and why to ignore the USD market cap figure and focus on the fundamentals.

Walter White, after opening a car wash with his crypto winnings


#1: There is a fundamental disconnect between your crypto currency -> BTC; and BTC -> USD rate

Its USD market cap variation doesn’t tell the full picture whether it moved due to fundamentals with that currency or due to completely unrelated events tied to Bitcoin or Ether against fiat such as USD!

The USD market cap of your cryptocurrency doesn’t by itself tell you how that cryptocurrency is doing, if there is something fundamentally awesome or wrong with it, or some news which came about in relation to it or not. Why — because it is pegged to the performance of Bitcoin or Ether, which are themselves pegged directly against fiat such as USD, and trade independently of your token.

Such tokens are priced in either Bitcoin (BTC) or Ether (ETH). That means, on most exchanges where these are available you can *only* buy these in either BTC or ETH.

Example

A hypothetical scenario with a cryptocurrency called Kin

Lets say for a token cryptocurrency called CCY. Based on the trading activity and supply/demand, a price in both BTC and ETH is established, where 1 CCY = X amount of BTC; and 1 CCY = Y amount of ETH.

Completely independent of this, BTC is also traded against USD (where 1 BTC = Z1 amount of USD). Further completely independent of that, ETH is also traded against USD (where 1 ETH = Z2 amount of USD).

The market cap in USD figure represents if you were to sell your crypto for BTC, and then that BTC to USD at that moment in time.

How to actually view your cryptocurrency’s market cap:

Any fluctuation in BTC ->USD based on factors relating to either or both of those will fluctuate your cryptocurrency’s market cap in USD, without there being any material change in your cryptocurrency’s underlying fundamentals!

If BTC goes to $0 for any reason, so does your cryptocurrency, as it is pegged against BTC to start with. Which means even if you trade your crypto for BTC, you can’t really sell that BTC for USD in the market anymore. The same holds for ETH — USD fluctuations as well.

In its self-contained unit your cryptocurrency might have done exceptionally well, but its valuation is dependent entirely on the currency it is bought in. So if Bitcoin and Ether sink, so does your cryptocurrency.

Amplification factor

This becomes worse and amplified if your crypto falls in value against BTC; and BTC also falls in value against the USD. Alternatively, if your crypto rises in value against BTC, and BTC rises in value against the USD, then your gain gets amplified as well.

So being a holder of a cryptocurrency guarantees to you that your fortune is fundamentally tied to the exchange rate between BTC-> USD and ETH -> USD. By getting additional tokens, you are not diversifying your portfolio, the underpinnings of your portfolio are still BTC and ETH. You need to care what happens to these and sing a little prayer for them each night before you sleep. Your cryptocurrency is increasingly worthless if BTC and ETH are sinking.

You would also need to think about minimizing your exchange risk here. In the above example screenshot, it was clearly beneficial to sell in ETH and convert that to USD.

#2. Yuuge fakeness in market cap: very small volume traded influences market cap due to ICO giveaways

Market cap = circulating supply X price
This circulating supply excludes the locked up supply (reserved for the firm, backers, etc). Trade 1 token, and the price gets set. Since most of these ICOs are creating trillions of tokens (hey, it is just a variable value and free for them to create) — this market cap in USD is smoke and mirrors. For a $1 billion plus dogecoin or dentacoin, there isn’t really a market which will pay $1 billion to the holder.

Here’s an experiment which will make you a billionaire on paper.

  • Create a token, and lets call it NUTMEG
  • In the ERC-20 token creation step, choose total supply as 10 trillion
  • 90% of this you specify as reserve/belonging to a “non-profit”/etc
  • Give away 1 trillion tokens for free to random people

(In a real ICO you would do something like: Price ICO as: 1 NUTMEG= 0.0000001 ETH ;Promote/market/spend money on ads; Lets say you sell 100 billion NUTMEG. At this point you proceed to cash out your 10,000 ETH (convert your ETH to USD) for your business development. At ETH’s current rate, that is about $100MM!)

  • List your token on an exchange.
  • Now you buy/sell just 10,000 NUTMEG tokens on that exchange. Lets say based on that trading price initially gets set 1 NUTMEG = 0.0000001 ETH, similar to the ICO price.
  • You submit a request to a site like Coin Market Cap to list your token as well based on that trading data availability.
  • Here’s the problem: Even though only 10,000 tokens got traded on the exchange out of the 1 trillion which were given away and not locked up, the circulating supply is still considered as the entire 1 trillion here.
  • Market cap = circulating supply X price => 1 trillion X 0.0000001 ETH = $100 million
  • Trade few million NUTMEGS, the price increases marginally to 0.0000004 ETH. The market cap now, though is $400 million!
  • Trade another few million NUTMEGS the price increases marginally to 0.000001 ETH. The market cap now is $1 billion!
  • Can you cash out that $1 billion though ? No. Because the earliest participants got it for such a reduced price that they can’t be considered willing market participants who would buy it at that increased price later on. After selling out a few million, which was the effective worth of the market/what the market had an appetite for, your token is racing towards $0. More you try to sell your significant holdings, the more the market crashes for your token. The billion is a figment of your imagination.
It just happens that the small quantity traded, combined with the massive circulating supply (which is often a function of cheap initial giveaways) times the price gives the illusion of a massive market cap. Fuzzy math!

How to really win here

Look at the fundamentals behind an ICO — the team and the product; not the whitepaper, which any high schooler can write. Understand that the USD market cap is a fuzzy number, while it provides sense of the trend, in absolute numbers, it is meaningless.

The best bet here is a cryptocurrency which can gain against either BTC or ETH; and if BTC or ETH gain against the USD as well, then you are compounding your gain here. What this means is that instead of holding BTC or ETH directly, if there emerges a strong performing cryptocurrency with strong fundamentals, holding value in that would be a better bet instead of BTC/ETH.

The next logical step for such a strong cryptocurrency has to be to break free of the dependence on the price of BTC and ETH and to be tradable directly against the USD and other fiat currencies.


Appendix: 1000 people own about 40% of all bitcoin

These whales can drive the price of bitcoin up or down — as they want, and make money in both cases.

Disclaimer: I am just a blogger with an opinion who can and will be wrong. Don’t take this as investment advice. These are just my observations for myself which I have decided to share.