Why it's inaccurate to measure cryptocurrencies by their market caps

A
cryptocurrency’s market capitalisation isn’t necessarily an
accurate representation of its total value.
Thomson Reuters

As the price of a cryptocurrency goes up or down, its total value
is typically described with reference to its market
capitalisation.

In the case of a crypto such as Bitcoin, the market cap is
calculated as follows: The total number of coins on issue,
multiplied by their price.

But according to Julian Hosp — co-founder of cryptocurrency TenX
— the metric has some serious limitations in determining the
actual value of a digital coin.

In a commentary on the risks facing the crypto market
for CNBC, Hosp explained his
point as follows:

“If a cryptocurrency has a market cap of $1 billion, it doesn’t
mean that $1 billion has flown into that cryptocurrency,” Hosp
said.

“So, for a cryptocurrency to have a market cap of $1 billion,
maybe only $50 million actually moved into the cryptocurrency.”

“Therefore, if that coin collapsed completely, its market cap
would go from $1 billion to zero, but investors would have
actually only lost $50 million.”

So a given coin’s market capitalisation is therefore heavily
dependent on the number of coins on issue, which appears to be at
the discretion of the coin’s creators when they launch an Initial
Coin Offering (ICO).

The ICO process differs somewhat to when a company lists on a
stock exchange via an Initial Public Offering (IPO).

In that scenario, the sale of share is facilitated by an
intermediary — typically an investment bank — who underwrite the
sale.

The investment bank aims to price the shares at a level so the
float is fully subscribed – and in doing so, that process also
sets the company’s market value.

Advocates of Bitcoin argue that part of its value proposition
stems from the fact it has a finite supply of 21 million coins,
which means those in circulation aren’t just made up on a whim.

However, doubts still remain about how many of the Bitcoin mined
so far — around 16 million — are actually in circulation.

Dash Coin CEO Ryan Taylor told
Business Insider in December that the coins
held by Bitcoin founder Satoshi Nakamoto have never moved, and
part of Bitcoin’s market cap may actually be “phantom”.

In Hosp’s explanation of market cap, he also referred to the
cryptocurrency company Tether — issuer of the controversial USDT
token that’s supposed pegged to the US dollar.

More than 2.2 billion USDT tokens are supposedly in supply, which
in theory means the same amount of US dollars have flowed into
the currency to give it its value.

But the picture for Tether — which is closely linked to the
Bitfinex cryptocurrency exchange — is murky to say the least.

It was subject to a $US31 million hack in November, and amid
increasing uncertainty about the amount of US dollars backing the
USDT token, Tether
has just split with its auditors.

“Since many exchanges and other cryptocurrencies are connected to
Tether, any finding that its stated value is untrue would send
the market into a significant decline,” Hosp said.

A short time ago on coinmarketcap.com, the current combined
“market capitalisation” of the 1,498 cryptocurrencies listed on
the site amounts to almost $US560 billion – about the same as
Facebook, which has annual revenue of $US37 billion.

But based on Hosp’s assessment, the actual value of traditional
fiat currency that’s flowed into the market is likely to be
significantly less than that.

You can read more on Hosp’s summary of four key risks facing
cryptocurrencies here.

Get the latest Bitcoin price here.>>

Read the original article on Business Insider Australia. Copyright 2018. Follow Business Insider Australia on Twitter.