Cryptocurrency capitalization - we understand the nuances
We have all heard about the exciting billions of cryptocurrency market capitalization. Also, many of you probably paid attention to the flashy headlines from the category “Bitcoin lost 10% of capitalization in a day”, and you probably came up with the idea of the importance of this factor. But is it ?
The secret is that cryptocurrency capitalization has its own characteristics. What is its difference and how to correctly use capitalization indicators in trade and investment - we will understand.
The essence and features of cryptocurrency market capitalization
Formally, the cryptocurrency capitalization is calculated by multiplying the total number of tokens by the rate of one coin (for example, to the US dollar). Then the capitalization of the token, which was issued in the amount of 1 billion, and costs $ 1 on the exchange, will be $ 1 billion. The capitalization of companies whose shares are traded on the stock market or other securities is calculated in a similar way. However, in fact, these indicators differ, and this is due, to a large extent, to the specifics of the cryptocurrency market.
A specific number of stocks are always traded on a stock exchange. In addition, it is almost always known who owns the remaining shares. The asset is liquid and controlled, and the possibilities of manipulation are limited. Therefore, the company's capitalization calculated through stocks can be considered as objective as possible. If the share price drops sharply, which leads to a decrease in capitalization, there are always reports on the assets owned by the company (real estate, capital goods, etc.).
As soon as it becomes clear that the market capitalization of the company is lower than the total estimated value of all assets owned by the company, the price of the shares will skyrocket, as it becomes clear that they are "underestimated."
A similar strategy is not applicable to cryptocurrency. This is because most cryptocurrencies do not have any tangible additional value. Even in the case when the cryptocurrency is supported by a valuable and popular product (for example, smart contracts and the whole Ethereum system), it is impossible to give an objective assessment of it. As a result, the only way to calculate market capitalization is to multiply the price of the token by their total number.
There are several reasons why such capitalization will not be objective enough and it is illogical to build a trading strategy on it.
Firstly, most companies “hold” a certain share of tokens (sometimes more than 50%) for their own purposes, releasing only a part of them for public sale. Of this amount, far from all tokens can be sold out, and some more will be put aside by positional investors in the "long box".
As a result, after the ICO, only 5-10% of tokens (maybe less) will be traded on exchanges. Capitalization, calculated on the basis of trading with the twentieth share of tokens, cannot be objective - after all, any large investor entering the market can easily collapse the course several times.
Secondly, the cryptocurrency mechanism itself assumes that most of the assets will not be traded on exchanges, but will remain “in the hands” of investors as a long-term investment. A similar situation exists with the STEEM cryptocurrency of the blog service with financial support for Steemit content and the GOLOS token of the Russian-language analog service. With the help of these tokens, users vote for the best content, distributing the award, and it takes several months to bring these tokens to the exchange and sell.
As a result, it turns out that focusing on standard indications of cryptocurrency market capitalization on sites like coinmarketcap.com is not only pointless, but it can also be dangerous for a wallet. However, you can try to evaluate capitalization in an alternative way.
Ways to evaluate the real cryptocurrency capitalization
In order to assess the real capitalization of the token, you can try to analyze additional factors. According to most analysts, the most objective is the number of network users and the number of transactions in cryptocurrency. By tracking the dynamics of these indicators over a specific period of time, you can determine the increase or decrease in the liquidity of the coin and interest in it. As a rule, the price moves proportionally.
Until the summer of 2017, the price of Bitcoin grew in direct proportion to the increase in the number of network users. Then there was a price jump up, and the dependence was interrupted. However, the growth of the cryptocurrency rate was accompanied by another objective factor - the growth of volumes.
Trading volumes began to grow in July 2017, and at the end of the year they increased another 10 times - in proportion to the increase in the exchange rate. In this situation, the price spike, no matter how phenomenal it may be, can be called fair, as it was backed by liquidity. If the price rose at low trading volumes, this would only indicate that some “whale” is pushing it up, manipulating the market and taking advantage of the absence of other major players.
However, volume analysis itself is a little more complicated than it might seem. The increase in volumes does not always coincide with the increase in prices, and a sharp increase in trading volumes should not be taken as a buy signal. Volumes indicate that the price change was supported by a large number of tokens, regardless of whether the price rose or fell.
If you build on this trading strategy, then it makes more sense to look for divergences between price and volume and to make deals in such situations.
Analysis of capitalization charts, prices and volumes
Before drawing the final conclusions, we’ll take a look at the charts of several altcoins according to coinmarketcap.com.
On the chart of Ethereum, it can be seen that the chart of the capitalization of the coin moves almost identically to its price. On the other hand, price hikes were far from always accompanied by an increase in trading volumes. In the selected areas, both times some time after the price increase at high trading volumes, there was another jump, but without volume support.
The situation is similar on the Ripple charts, only here the volumes were accompanied by both growth and fall of the cryptocurrency. Capitalization, as in the case of Ethereum, is 100% correlated with the price chart.
Litecoin was no exception - a complete correlation of price and capitalization and chart jumps, sometimes supported by volumes, sometimes not.
The examples discussed above confirm the fact that the market capitalization of cryptocurrencies is not only not always reliable, but also completely useless in predicting further price movements. If its 1: 1 chart repeats the price movement, then capitalization cannot become a leading indicator.
Of the other indicators, the most promising for use in fundamental analysis are volumes. By comparing the dynamics of prices and volumes, it is possible to identify moments of discrepancy, for example, when the price went up sharply without volume support. In such a situation, it makes sense to take a short position - after all, when large players enter the market, such an “overbought” will be quickly compensated, as was seen in the screenshots above.