Don't be fooled by Cryptocurrency Market Capitalisation And Volumes - they mean absolutely nothing

In the cryptocurrency world, two words are hyper-exagerated to suck non-players into a technology that produces nothing. Market capitalisation and volumes are supposedly data to electrify the senses of something humongous. Yet the reality is, both do not mean anything.

Market capitalisation:

Market capitalisation of an asset is the quantification of an asset based on its supply and last traded price. It is a simple equation of S x P = MC. It supposedly provides an idea of the size of the asset in the market.

Price is what a willing buyer is prepared to pay for an asset. In a logical world, the buyer is willing to pay for something that is worth its value to him.

In the equities market, the worth of the shares in a company can be assessed on some bases of valuation. These would include factors like quality of products or services, product life cycle, the demand forecasts, market share, price sensitivity, competition, raw material availability, patents, regulatory changes, weather, financial status, etc. Investors have some sense of value that constrains price movement of the shares. In other words, in the equities market, capitalisation shows the asset size and reflects values.

In the case of cryptocurrencies, there is no basis for valuation. Does any investor perform any extensive fundamental and technical analysis of each crypto blockchain? Zero. The equation S x P = MC has no valuation constraint. Simply increase either variable S or P and the market cap explodes. For example, a crypto XYZ with 10m tokens has par value of $1 which all investors pay and thus market cap of $10m. If an investor can be persuaded to buy a token for $2, the market cap is immediately increased to $20m. The $20m is not the valuation of the crypto, it is a meaningless number. The crypto project with the higher number of tokens tends to have higher market cap. It deceives unwary investors into believing the token with the higher cap has more stability, whilst the lower caps have more upward price opportunities. With the high volatility of cryptos, all token prices swing wildly.

The market cap for cryptocurrencies is a metric about price, and the price has NOTHING to do with value. It is thus a deadly mistake to apply the assumption that what the market is willing to charge for a crypto asset is equal to what it’s worth. When prices of cryptos explode and market caps hit the roof, gullible investors mistake it as asset values have increased. It is a market ripe for manipulation.

A further 2 points to note on market cap:

1. Technically, crypto circulating supply numbers are always over counted. There are significant numbers of tokens that are lost in the system due to owners forgetting their private keys. Bitcoin for example, has about 20% of its supply tied up as lost tokens but they are counted in the circulation supply.

2. In both equities and cryptocurrencies, when there is a crash, media headlines are "$$$$ wiped off". This is based on the market cap. It is a silly number because not all investors had invested in at the last traded price. In the crypto XYZ example above, if the crypto crashed to zero, investors did not loose $20m which was the market cap. They lost the $10m that they invested in.

Volumes :

A similar silliness is seen in cryptocurrency volumes or market turnover.

In the Equities market, the buyer pays up with real money. Fiat enters the stock market. The total volume represents real money that went into the market. There is a relocation of economic resources aka capital aka fiat into the stock market.

In the case of Foreign exchange market, both parties pay out the currency they are selling. Again, real money or fiat enters the market. Volume is represented by real money transactions.

In the case of cryptocurrencies, where the traded currency pair does not involve a fiat, such as a bitcoin/ether (BTC/ETH) deal, no real money enters the market. The trade is simply the exchange of 2 tokens within the market. No real money is involved. No economic resource is pumped into the market. What then does the volume represent? Absolutely nothing. As blogger Bitfinex'ed described, they might as well be exchanging Pokemon cards.

Volume counts only when real money is added to the market. In cryptocurrency exchanges, this happens only when one of the currencies in the traded pair is a fiat, eg BTC/USD.

Let's see how it looks like on a typical 24 hour trading day.

The 99 highest traded pairs totaled US$69.4B. Out of this total volume, only US$8.68 involved real money ($ and Yen) entering the market, or about 12.7%. In terms of real economic resources entering the market daily, the cryptocurrency market is actually very small. The bulk of the market comprises of people exchanging Pokemon cards.

The highest trading currency pair is BTC/USDT (Bitcoin/Tether). It is also apparent Tether is the token that is most heavily traded, surpassing Bitcoin. Tether now has a very important role in the cryptocurrency ecosystem.

As the cryptocurrency market is price-driven which has nothing to do with values, it is easily open to manipulation, aided further that it operates in non-regulatory space. Has there actually been manipulation? In a follow up blog, we look at the role of Tether and the suspicious nature of its operation.