The basic definition
Market capitalization, usually shortened to market cap, is a common way to describe the size of a cryptocurrency. The calculation is simple:
market cap = price per coin x circulating supply
Circulating supply is the number of coins currently available to trade, as estimated by data providers. It is usually lower than the total supply that exists, and lower again than the maximum supply that may ever exist. The differences are explained in the article on circulating supply.
A worked illustration
Suppose a made-up coin has 1,000,000 coins in circulation and trades at $2.
- Market cap = 1,000,000 x $2 = $2,000,000.
If the price rises to $3 with the same supply, the market cap becomes 1,000,000 x $3 = $3,000,000. If instead 500,000 more coins enter circulation and the price stays at $2, the market cap becomes 1,500,000 x $2 = $3,000,000. The two paths reach the same figure for different reasons, which shows why the number alone does not say what changed.
Why price per coin is a poor size guide
A coin trading at a very low price is not necessarily “cheap”, and a coin trading at a high price is not necessarily large. The price per unit depends on how many units exist. A coin with a huge supply can have a tiny price and still have a large market cap, while one with few units can have a high price and a small market cap.
Take two invented coins. Coin A has 100,000,000 units at $0.50, giving 100,000,000 x $0.50 = $50,000,000. Coin B has 1,000,000 units at $20, giving 1,000,000 x $20 = $20,000,000. Coin A has the lower price but the larger market cap. Comparing market caps is therefore more informative than comparing unit prices when you want to compare size.
Market cap is not money invested
One of the most common misunderstandings is to read market cap as the total amount of money that has flowed into a coin. It is not.
The price is set by the most recent trades, which typically involve only a small part of the supply. Market cap simply multiplies that last price by every coin in circulation, including coins that have not traded for years. If a coin trades at $2 and someone sells a small amount at $1.90, the calculation falls by 5% for the whole supply, though no one sold the whole supply at that price.
For the same reason, market cap does not mean that the stated amount could be withdrawn. If many holders tried to sell at once, the price would likely fall well below the last traded price, especially for coins with thin market liquidity. The figure is an estimate of value at the margin, not a pool of cash.
Another illustration: suppose a new coin has 100,000,000 units and a buyer pays $1 each for just 1,000 units. The reported market cap becomes 100,000,000 x $1 = $100,000,000, although only $1,000 changed hands. Small, thinly traded markets can therefore show impressive market caps that rest on very little real trading.
Other things market cap hides
- Circulating supply is an estimate. Different data sites can report different supplies, particularly for coins with locked, lost or unreleased tokens. The effect of lost coins on effective supply is one example.
- Locked and future tokens. Many projects hold or schedule large amounts of tokens that are not yet circulating. The fully diluted valuation multiplies the price by the maximum supply instead, which can be far higher. The related issue of token unlocks matters as new coins reach the market.
- Concentrated ownership. If a handful of wallets hold much of the supply, market cap overstates how freely tradable the asset is.
- Prices on different venues. Aggregators combine prices from several exchanges, and the method affects the final figure.
How market cap relates to price movements
Market cap does not drive prices; it is a result of price and supply. Even so, size is often discussed as a rough guide to behavior.
- Larger market caps are generally associated with deeper trading and smaller price impact from a given order. This is a tendency, not a rule.
- Smaller market caps are often more volatile and easier to move, and they may be more exposed to manipulation, which is a risk worth keeping in mind.
- Because market cap rises when new coins are issued at the same price, supply changes matter. A higher number on its own does not mean there has been new demand.
Market cap is also used to rank coins, for example in lists of “top 10” assets. Rankings change over time, and a rank is not a recommendation or a measure of quality or safety.
A cautious way to use the number
Market cap is a useful summary, but it is best read alongside other information: trading volume, how the supply is distributed, and how the supply will change in future. Treat very large reported figures for thinly traded assets with scepticism.
Cryptocurrency prices are volatile and any asset can lose most of its value. Past performance does not predict future results, and nothing here is financial, tax or legal advice.