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Disclosure: I’ve lost money during Bitfinex multiple flash crashes presumably due to technical issues, so I’m not fully neutral regard Tether/Bitfinex/Ethfinex. However, my portfolio is heavily in crypto, so on a short run I’m financially incentivized not to spread any FUD about Tether, but on a long run I’m financially incentivized to warn people about projects that can corrupt the whole ecosystem.

Centralization of control is the biggest side effect of any scaling choice. (by Andreas M. Antonopoulos)‏

There is so much hate and fight going on between BTC vs BCH, while Tether threat is still undervalued and only recently got some attention due to CFTC subpoena and following huge price dip.

In this article we will not speculate if Tether is backed by U.S. dollars or not, because there are more savvy people to do that and I’ve already wrote a few articles last year about Tether/Bitfinex/Ethfinex bad business ethics.

Instead, we will talk about Tether market cap, how it’s different from all other coins, why it can potentially crash the whole crypto market if all allegations turn out to be true or governments will shut it down as a threat to real USD, and what can we do about it.

Recently Bitfinex/Tether got lots of attention again due to CFTC subpoena and following huge price dip, but many people don’t understand how market capitalization actually works, so they falsely allege that $2.2 billion market cap of Tether cannot seriously influence a $400 billion market, because it’s just 0,5% of all the money.

Biggest misconception

People with a background in finance understand that Tether market cap is nothing similar to any other coin, but we have many new investors who a not that savvy yet, so we should share our knowledge with them.

This is the most common statement I’ve seen last week.

If you think that only newbies don’t realize how huge is Tether, then here are some more examples:

Doug Polk recently said that Tether is only 0.4% of a total crypto market cap, so it seems legit. Don’t get me wrong, he contributes a lot to community by exposing scams, but that was a false assumption on the fastest growing crypto-oriented YouTube channel (150K followers).

Not only beginners, but even financially literate people like David Hay (110K followers) say that Tether is too small to cause any substantial problem.

And even early bitcoin adopters like Charlie Shrem think (or intentionally misinform) that Tether market cap is extremely small.

Which makes it vital to explain to all people in crypto how market cap works and finally destroy the myth that Tether is “just” 0,5% of all cryptocurrencies market cap and thus cannot really influence the market.

Let’s start with simple examples and then move to a bit more advanced stuff.

Apples market capitalization

Note: for simplicity let’s assume that the first trade will always be buying 1 apple for the lowest price.

Let’s say there are 3 traders and 3 apples on the market.

Current order book:

sell 1 apple for $5

for sell 1 apple for $3

for sell 1 apple for $1.

What is the market cap of all apples after the first trade? $(5+3+1) = $9?

Wrong.

The market cap is $3. ($1 price of first trade * 3 apples circulating supply)

Price aggregators calculate market cap by multiplying a current price (average last closing price among all exchanges) and circulating supply. They don’t care about the order book depth. You can try to sell your apple for $100, but that won’t change market cap unless somebody actually buys your apple for that price.

Market moves up

Now let’s say Bob came to the market and decided to buy cheap apples and sell them at the higher price.

Bob bought 1 apple for $1 and 1 apple for $3 (totally 2 apples for $4).

Then Bob started selling his apples for $5 each.

Now the order book looks like this:

sell 2 apples for $5 each (Bob)

for each (Bob) sell 1 apple for $5

What will be the market cap after the first trade?

Right, $15! (price of first trade $5 multiplied by 3 apples)

So Bob invested $4, while the market cap increased by $12 (from $3 to $15).

This is very important, so let’s repeat. Bob invested only $4, but the market cap was increased by $12.

Ponzi scheme crash

Current order book:

sell 2 apples for $5 each (Bob)

for each (Bob) sell 1 apple for $5

for Market cap: $15

Now suppose people discovered that all apples were slightly spoiled, so all traders dropped the price to $3, because nobody will buy bad apples for $5.

Now the order book looks like this:

sell 2 apples for $3 each (Bob)

for each (Bob) sell 1 apple for $3

for Market cap: $9 (after the first trade)

So the market cap lost $6 (from $15 to $9), but no fiat money were actually withdrawn from the market. That is what happened with BCC tokens after the Bitconnect scam crash.

Fake money crash

Current order book:

sell 2 apples for $3 each (Bob)

for each (Bob) sell 1 apple for $3

for Market cap: $9

Let’s say that people discovered that Bob was buying apples with fake papers to drive the price up. Immediately people reevaluated a current apples price so all traders dropped the price to $1, because they are scared to hold apples and nobody wants to buy at the high price due to FUD.

Now the order book looks like this:

sell 2 apples for $1 each (Bob)

for each (Bob) sell 1 apple for $1

for Market cap: $3 (after the first trade)

So the market cap lost $6 (from $9 to $3), but no fiat money were actually withdrawn from the market. That is what happening right now, the amount of FUD is increasing and thus price is going down, because less people want to buy and more people want to sell.