Misconceptions about Market Capitalization and Digital Currency Prices
There are multiple statistics emerging in the digital currency markets, with new ones almost daily. From coin prices, market capitalization, percentage growth, to the net worth of digital currency creators, there’s a lot.
For even the most seasoned investor, these metrics may be confusing.
As an example, the total digital currency market capitalization has reached $811 billion USD (nearly $1 trillion CAD). The implied market capitalization, which is the market capitalization if every available coin sold at current market price, is in the trillions. In market capitalization news, Ripple (XRP) this week overtook Bitcoin when compared using the market capitalization metric.
The figures, though, range from confusing to misleading. Investors with experience in traditional securities trading need to re-evaluate their strategies for the digital currency market.
Market capitalization is a tricky metric
Market capitalization is the value of all the coins of a digital currency in circulation at their current price.
When analyzing traditional stocks and shares, market capitalization is a vital statistic. In many cases, it’s more important than price. Market capitalization for stocks and shares refers to the total value of shares in a company and is the market value of that organization.
When comparing share prices, it’s easy to see that a $1 share in a company valued at $100 is very different to a $1 share in a company valued at $10 million.
For digital currencies, coins do not reflect a share in its creating company. Owning one Ripple (XRP), for instance, does not mean you own a share in Ripple’s parent firm, Ripple Labs. This shift is where digital currencies become more comparable to fiat currencies or assets such as gold.
Digital currency markets lack the detailed range of financial metrics and ratios used for analysis of stocks and bonds, so market capitalization is an important figure.
Market capitalization alone is not an indicator of a coin’s worth or ultimate return. Developers can distort digital currency market capitalizations by withhold coins, so other metrics should also be fully analyzed for a complete picture.
Look out for whales
Comparing a digital currency’s market capitalization against the total market capitalization of all digital currencies, for instance, is important. Using this comparison it’s easy to see that Bitcoin still has the lion’s share of the market. However, a lower-value digital currency with more coins in circulation could theoretically dominate the market.
Coins with lower market capitalizations are more easily influenced by “whales,” large investors who own a high proportion of one coin and can quickly crash a coin’s value by suddenly selling. Coins with larger market capitalizations, which we also know are more widely distributed across numerous investors, like Bitcoin (BTC) and Ethereum (ETH), are not as easily manipulated.
Market capitalization illustrates volatility and vulnerability. Some digital coin creators have been criticized for retaining a high proportion of the available coins, or pre-mining, which may mean they can exert more control over the market.
Investors should look to the reasons for developers retaining coins before buying. In particular, investors may want to know if there are plans to release the withheld coins. A sudden release of coins could significantly devalue the coins already held by existing investors.
Other important metrics when comparing digital currencies
Liquidity and trading volumes
Coin price and market capitalization are vital metrics but there are others to watch.
Liquidity is critical, especially for larger investors, as it refers to the ability of the market to cope with a sudden sale of assets. If there are no buyers, investors may end up with assets quickly depreciating in value.
Trading volume is a good indicator of liquidity for digital currencies. If trading volume is low, liquidity could also be low.
Changes over longer periods of time
The digital currency market is extremely fast moving, with no precedent and little historic data with so many new coins and scenarios.
It’s not so easy to study historic price changes, but for digital currencies considering performance over weeks or months as opposed to days is still important.
Transactions and coin purpose
The ultimate value and success of a digital currency will depend on how the market perceives the currency, its sustainability and its planned use.
Investors may come to perceive Bitcoin as an asset, like gold, and hold a value entirely its own.
The value of coins like Ethereum, Ripple and IOTA are influenced by if the coin reaches its purpose; the development and employment of its blockchain technology.
Other indicators of sustainability can be the number of transactions processed on a digital currencies blockchain. Ethereum is processing many more transactions than bitcoin and is an indicator of the scalability and performance of the coin.
Privacy coins, such as Monero and Zcash, which have more anonymity, have to be analyzed differently again as there is less visibility of their transaction volume and use.
Investors should look beyond financial metrics
Investors must look deeper than coin prices, market capitalizations and other financial metrics when buying or trading digital currencies.
It’s easy to understand a share is percentage ownership of an organization. A dollar can be used to purchase goods and services anywhere and gold is a tangible asset with many uses. While a dollar is more flexible in its use, gold has little chance of losing its value. Digital currencies are more complicated. Each coin has a blockchain or similar technology behind it, both coin and blockchain network have an inherently designed purpose.
Developers are launching coins to drive and fund technological developments, networks which could power the world economy or every machine we will use in a few short years. Some developers aspire to launch a currency which could one day replace fiat currencies like the dollar or yen. Other developers are in it to make a quick buck or disrupt traditional financial structures.
Understanding the motivation of digital currency developers is essential to making a digital currency investment.
Image credit: pxhere.com
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