Smart investing: what market cap and token price can(‘t) tell you

Many crypto holders wake up in the morning, grab a coffee and intuitively start checking the markets. Some do it directly from bed, others do it later. For sure, most of the people involved in crypto check it regularly out of financial interest, or just for fun. However, two of the easiest accessible information, price and market cap, hide some distortions inherent to the crypto industry.

Let’s take a look:

Market Cap

In financial markets, it’s very common to measure the size of a public company through its market cap, defined by Investopedia as:

Market capitalization refers to the total dollar market value of a company’s outstanding shares. Commonly referred to as “market cap,” it is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determine a company’s size, as opposed to using sales or total asset figures.

So we can say that: market cap = current market price x circulating supply

Public companies are those which have sold shares publicly through an IPO (Initial Public Offering) and have been listed on at least one Stock Exchange or OTC market, allowing investors to buy and sell such securities. In this case, the market cap is a good indicator, since only medium or big size companies with solid and developed businesses can afford the costs of going public. Keep in mind that they will have to meet mandatory reporting standards, comply with insider information regulations and more costly (time and money) requirements. Going public means addressing sophisticated investors and big financial institutions which receive easy access to your shares, study your company’s fundamentals, follow your actions closely, and buy & sell shares accordingly. All this contributes to a fairer price discovery that will give retail investors a more accurate market cap indicator.

In the crypto world, this concept doesn’t apply in its fullness. Why?

There is a wrong usage of the “circulating supply”-definition to calculate the market cap for all coins. For those protocols where new coins are mined over time like Bitcoin, the circulation shown and used is correct. But considering that the vast majority of projects pre-mined the total supply and offered it in an ICO (Initial Coin Offering), we need to be aware that not all coins are in the hands of the public. If not all coins are sold or some kept by the team, these coins shouldn’t be counted. Otherwise, it is very easy to inflate or manipulate the total market cap of any individual project, and unfortunately, that is exactly what is happening. Let me give you an example:

Tim wants to do an ICO to finance his new idea and pre-mines 100 million ERC20 tokens under the name of XYZ. He sets a selling price of 1 dollar and offers them to the public. If he succeeds and sells all coins, the market cap for XYZ coins would be genuinely 100 million. But it could also happen that he fails to sell the tokens and only his family and friends buy some. So let’s assume that he sells 1,000 tokens to his family and friends, raising $ 1.000, while he keeps the rest. This would mean that the market cap of his project is 100 million, and that Tim has now 99,999.00 million.

Of course, this is an extreme example, but it shows how in today’s crypto space a combination of factors inflate the overall market value and mislead investors at the moment of taking financial decisions.

Price

Looking at prices, the issue is connected to the volume of trades. Unlike what happens with shares of public companies, where trillions of dollars are traded monthly, in crypto there are more than 1.000 coins from different projects and most of them are highly illiquid for several reasons:

• The average purchaser tends to hold coins for the medium/long term, either due to the complexity inherent to trading, or based on expectations of astronomical ROI, if crypto ever becomes adopted by the mainstream.
• There are still many entry barriers for new investors not yet familiar with crypto. Buying coins for the first time stresses many non-tech people that are scared of losing their funds.
• With so many hacks lately, distrust towards centralized exchanges has grown to the point where, except for traders, people only use them to buy but immediately transfer coins to a personal wallet.

While the price of each asset is fairly formed by the natural force equilibria of supply and demand, when an asset is illiquid, a small purchase (or sale) can move the price considerably, and keep that divergence for some time, making investors pay more (or receive less) for their coins than they actually should. In addition to that, it has been suspected lately that crypto exchanges inflate and manipulate the entire market’s volume, which distorts the prices even more.

So how to compare different projects and invest smart?

In my opinion, in an extremely manipulated and distorted industry such as crypto, the best way to compare and invest in different projects is to look deeply into their fundamentals. This means that you as an investor should follow those projects closely and gather as much information as possible in order to try answering the following questions:

- Who are the people behind the project? What is their vision and mission? Have they been consistently transparent and open to their community?
- Who are their advisors? Are they actually advising the team or just showing their face on a website?
- Is there any company or foundation framing the project? Where is it located?
- Has been any development done pre-ICO, or just a white paper? If it’s not open source, has anybody reliable looked into and approved their code?
- Have the founders assumed financial risks pre-ICO? Or are they just giving a try?
- Is the token model sustainable in the long-term? Is the token really needed? Is it legal?
- How many tokens does the team keep and why? Do they have lock-up periods?
- Do you really think that the world will adopt the product or service they are trying to provide?
- How big is the market they aim to provide? Who are their competitors? How big are they?

ICOs are a great tool for startups to finance new ideas and an effective investing instrument for retail investors, as they finally give them the opportunity to participate and benefit from promising projects from an early stage. But unfortunately, not all players out there have the best intentions.

So, be smart with your money, invest carefully.