Why You Should Be Cautious About Using Market Cap To Guess Future Prices

A distinct feature that bitcoin maxis are quick to remind critics when the agelong argument arises is the fact that, unlike fiat currencies, the value of cryptocurrencies is not dependent on government policies or economic factors. While this striking feature has attracted many to the fascinating world of digital assets, this begs the question of what backs cryptocurrency?

Crypto Trading and Markets

In a bid to cash in on the volatility of cryptocurrencies, expert traders have devised various means to analyze price charts to base their investment and trading decisions. Fundamental analysis, technical analysis, and market sentiments are by far the most used equipment in their toolbox. While fundamental analysis entails a deep-dive into the fundamentals of an asset, technical analysis deals with the use of technical trading tools to analyze the price chart to speculate on the future price direction.

What is Market Capitalization?

As part of fundamental analysis, one of the foremost metrics traders consider when making trading decisions is market capitalization. The market capitalization of a cryptocurrency is simply the product of its price and the circulating supply.

Market Capitalization = Price * Circulating supply

For instance, if Bitcoin’s current price is $35000, and its circulating supply is 18 million, then its market cap is $630 billion. A variation of the market capitalization is the “Fully Diluted Market Cap” which represents the product of the price and total supply (where total supply does not equal circulating supply).

Fully Diluted Market Capitalization = Price * Total supply

For instance, if bitcoin’s current price is $35000, and its circulating supply is 21 million, then its the fully diluted market cap is $735 billion.

Is Market Capitalization a Significant Metric?

Market capitalization is a significant and relevant metric to traders because it measures the relative value, size, and popularity of a cryptocurrency. Generally, traders believe that cryptocurrencies with large market capitalization are more established, less volatile, and subsequently, a less risky choice.

Often, they target long-term growth when trading this category of crypto. Coins and tokens with mid-sized market capitalization are considered slightly riskier and more volatile while low market cap cryptocurrencies are regarded as very risky and very volatile, though they may present short-term growth potential.

Is Trading with Market Capitalization Advisable?

It is important to note that cryptocurrencies are highly speculative assets and that analysis based on market capitalization is not foolproof. For context, when new tokens are minted, their starting price is usually determined by the issuers until it trades publicly. This means that they have a direct impact on market capitalization at the early stages.

Traders who enter positions on account of the market capitalization must remember that such cryptocurrencies may be highly overpriced, or in some cases, underpriced.

Predicting the future price based on market capitalization is highly flawed since it does not account for lost tokens. Financial advisory firm Cane Island Alternative Advisors explained in its report that about 1500 bitcoins are lost every day and 4% of the available supply, is lost annually.

Taking this into account, only about 14 million bitcoins are currently in circulation, a significantly lower figure than the publicized 18.3 million. This hints that at every point in time, bitcoin’s market capitalization is far less than the touted figure. The same applies to every cryptocurrency in existence.

Finally, as a rule of thumb in trading, combining at least two analysis methods or trading tools is advisable to increase the likelihood of being profitable. While the market capitalization of a digital asset may tell a lot about the fundamentals of the asset, it is often not enough to speculate on its future price, hence, traders must tread with caution.

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