What is market capitalization? Its use in crypto

¿Qué es capitalización de mercado? Su uso en cripto
4 min read

Market capitalization, also called market cap or market capitalization, is a concept widely used in economics and finance, and is especially important in the world of cryptocurrencies.

The traditional use of the term refers to the public’s opinion of a company’s equity value. Market capitalization is measured as the total number of shares multiplied by the price of each share at a given time. If we have a company with 10 million shares and the price per share is €1, its market capitalization will be €10 million. 

Capitalización de Mercado

Its use in the stock exchange

In capitalism, the ownership of a company is represented in shares or participations (assets known as equities in Anglo-Saxon terminology). Therefore, the market cap is useful for comparing the size of companies and stock exchanges.

As mentioned above, this metric reflects the public valuation of a company’s equity, and its valuation may be undervalued or overvalued. This valuation reflects future expectations and can be far from the real value of that company. There are even investment strategies such as value investment that are based on the search for undervalued companies in the hope that in the long term the market will be rational.

Market Cap of Gold and Bitcoin

But market capitalization applies not only to companies but also to commodities such as gold and cryptocurrencies. To calculate the market cap of gold, the amount of gold on the market, for example measured in ounces, is multiplied by the price of each unit. In other words, how much all the gold in the world is worth. 

In the same way, to calculate the market capitalization of Bitcoin, we multiply all existing bitcoins by their price. In the case of gold, it is difficult to know precisely the stock, so its market cap may vary depending on the estimate. Unlike gold, in Bitcoin the exact supply circulating at any given moment is known. 

These two cases are illustrative because both are real assets, that is, they are not debt, their value is not based on the creditworthiness, or ability to repay the debt, of an entity (as is the case with fiat money). Both compete in the real asset market as good stores of value

Therefore it makes sense to compare them using market cap. Gold’s market cap is around $10 trillion while Bitcoin’s is about $700 billion at the time of writing. In other words, Bitcoin is more than 10 times smaller than gold.

Market cap

Problems or disadvantages

One of the problems with this metric, especially in the context of cryptocurrencies, is that it can yield a value that is highly inflated and far from reality.  

Suppose there is a new coin that is not listed in almost any exchange. If there are 1 billion coins in circulation and someone buys 1 unit for 10€, taking that price as a reference, this coin would have a capitalization of 10 billion, entering the top 10 cryptocurrencies with the highest capitalization. If there is little liquidity in this asset, it is very possible that the metric gives unrealistic results.

Compare cryptocurrencies

One of the biggest mistakes made in cryptocurrencies is to take the price of each coin to make comparisons and even assess whether it is cheap or expensive. The price of a coin by itself is actually irrelevant as it provides no information about that market. 

For example, one unit of a coin could cost 1 million dollars but only 100 units exist. If we only look at the price we will think it is very expensive but in reality it is a very small coin. Its market capitalization would be 100 million against the 700 billion in Bitcoin.

Conclusion

Market capitalization is a good way to compare the size of companies, commodities and cryptocurrencies. It is a metric that any investor should be aware of and use to base their financial decisions. But its problems and limitations should also be taken into account.