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“Market cap” is a common term thrown around in the world of cryptocurrency. Market cap (or market capitalization) is an important metric you’ll need to learn to understand the crypto-market landscape.

You may think price alone is a solid way to measure the value of a cryptocurrency. Let’s dive into why that is not true, and why you should use the market cap to value a token.

What Is Cryptocurrency Market Cap?

Market capitalization (market cap) is a metric that indicates the market value and size of a cryptocurrency. Cryptocurrency market cap is represented by this handy equation:

current market price x circulating supply (total # of coins in the market) = crypto market cap

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The market cap is to identify the value of a cryptocurrency and accurately compare it against other cryptos.

Does the term “market cap” sound familiar? This concept is borrowed from the stock market, where stock market capitalization is the current share price multiplied by the total number of existing shares.

So…

company stock market cap = total number of shares x current price

cryptocurrency market cap = total number of circulating coins x current price

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In the traditional financial world, this calculation is a way of representing the total value of a company. If each share is one slice of the company pie, then the share price multiplied by the total number of shares gives the total company value.

Why is this important to consider? The price of a share alone can give an inaccurate measure of the size of the company. Likewise, the price of a cryptocurrency can give an inaccurate measure of the total value of the cryptocurrency.

This is why stock market analysts and crypto analysts use market capitalization to make informed investment decisions.

How to Calculate Crypto Market Cap

Imagine that XRP currently costs $0.50 per coin and has a total circulating supply of 40 billion.

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This gives XRP a market cap of 20 billion.

XRP total market cap: $0.5 (price per coin)

x 40,000,000,000 (total number of coins)

= $20,000,000,000 (market cap)

Now, imagine that Litecoin currently costs $50 per coin and has a total circulating supply of 84 million. This gives Litecoin a total market cap of $4,200,000,000.

Litecoin total market cap = $50 (price per coin) x 50,000,0000,0000 (total number of coins)

So, even though the price of Litecoin is higher, XRP has a much larger circulating supply. This makes the total value of XRP higher in terms of market cap.

Is it possible for Litecoin to overtake XRP in market cap? In order to do so:

The price of an individual Litecoin would have to increase, or

The total supply would have to increase without the price reducing

Circulating Supply, Total Supply, and Max Supply

There are three metrics used for calculating cryptocurrency market cap: circulating supply, total supply, and max supply.

Circulating supply is the most commonly used metric. Circulating supply is the number of coins currently circulating in the market available to the general public.

Other methods of measuring market cap use total supply, which represents the total number of coins in existence. This might include coins that are locked, reserved, or not sold on the public market.

Max supply is the total number of coins that could ever be created in the lifetime of the cryptocurrency.

Circulating supply is thought to give the most accurate measure of market cap because it doesn’t include coins that are not in public circulation.

Crypto Market Cap ≠ Total Fiat Investment

New cryptocurrency investors often make the mistake of thinking that the market cap reflects the total amount of fiat currency invested in a coin. This is false for a number of reasons.

When the cryptocurrency is first created, not all of the coins will necessarily be purchased. If only one person buys a coin, for $1, and the total number of coins is 20,000,000, then the total market cap would still be $20,000,000.

If demand increases for the cryptocurrency and people start to aggressively buy, then the bidding will drive up the price. This increases the value of other people’s tokens accordingly – raising the total market cap even further.

Then, if everybody suddenly decided to sell the cryptocurrency when the market cap reached $200 billion, the price would rapidly fall due to shrinking demand. The total amount of fiat currency investors would be able to withdraw would be less than $200 billion.

This creates a large difference between the market cap and the total amount of money invested.

A 2017 estimate from JP Morgan found that the cumulative amount invested in Bitcoin up to 2009 was $6 billion, which is significantly lower than the market cap at the time of $300 billion. This means that for every dollar invested in Bitcoin, the market cap increased by 50 dollars.

Michelle O’Connor, Twitter @Mq2oco