26 July 2020
What Is Market Cap And Why Is It Important?
Before you start trading or investing in cryptocurrency, it is wise to have a better understanding of market capitalization, including what it means and why it matters. The market cap of cryptocurrency provides crucial information that can impact its price and demand, making it crucial to fully understand this concept, as well as how to use the information you get.
What Is Market Cap?
In simple terms, market capitalization measures a cryptocurrency’s relative size. To calculate the market cap, you just multiply the circulating supply of the coins by the current price.
So, if a cryptocurrency’s current price is $20, and the circulating supply is 25,000,000, the market capitalization would be $500,000,000.
VARIATIONS IN CALCULATION
Although it is most common to calculate the market cap using the circulating supply of a cryptocurrency, it can also use the total supply or the max supply.
The circulating supply refers to the number of coins that are circulating and available to the general public. The total supply indicates all of the coins currently in existence, including those not sold within the public market, those that are locked, or those in reserve. The max supply is the maximum number of coins that can ever be created of the crypto.
You can use any of these figures, as long as you are consistent about using the same one for all cryptocurrencies you evaluate. However, the consensus is that the circulating supply is the most useful, hence its popularity as the default choice.
The Market Cap Does Not Show Inflows
It is important to note that the market cap does not show you money inflows, meaning that it is not a good method of seeing the amount of money in a given crypto market.
This comes from the fact that the market cap is largely dependent on price, and even the smallest price fluctuation can dramatically change the market capitalization.
The Market Cap Does Not Show Total Investment
You must also understand that the crypto market cap does not indicate the total fiat currency that has been invested. Remember that each investor likely purchased the crypto for a different price, and its value has likely risen over time.
Ranking By Market Cap
To help investors, traders, and HODLers make decisions regarding buying and selling cryptocurrency, it is common to rank cryptos by market cap. This can be as simple as classifying them as large-, mid-, or small-cap cryptocurrencies. The category a cryptocurrency falls into helps determine how risky it is as an investment and its potential for rewards.
To be a large-cap crypto, its market cap must be more than $10 billion. Just a handful of cryptocurrencies meet this requirement, including Bitcoin, Ethereum, and Ripple, although this does fluctuate.
Because of the large market cap, these cryptos are considered to be safer investments. However, they also have a lower potential for rewards due to the reduced volatility. That being said, even these cryptocurrencies tend to be more volatile than traditional investments, such as stocks, providing a larger amount of risk and potential reward.
The slightly smaller market cap of mid-cap cryptocurrencies increases the risk somewhat. They make up for this with a greater potential for growth or rewards. This comes from the fact that the cryptos may still be improving their utility or market and have not necessarily reached their full potential. To qualify as mid-cap, a crypto must have a market cap of between $1 and $10 billion.
Small-cap cryptos have caps that are less than $1 billion and are considered to have the highest risk. They can also have the highest reward. Low market capitalizations indicate that a crypto is still likely in its early stages, and it can easily fall victim to the market’s woes. In other words, they can drop in value incredibly quickly. However, if you choose the right one, it also has the potential to grow dramatically.
You Should Use Market Cap To Diversify
Ideally, you will create a diversified cryptocurrency portfolio that includes cryptocurrencies with various sizes of market caps. This will help you with risk management as the large-cap cryptos will reduce the overall risk that the small-cap ones brought. At the same time, those small-cap cryptos will increase your potential rewards, which would be smaller if you only had large-cap cryptocurrencies.
Market capitalization can help you determine the levels of risk and reward associated with a particular cryptocurrency. This should be one of the many considerations you take into account when investing in cryptocurrencies.