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Why Cryptocurrencies Should Not Be Valued By Market Capitalization (Article and Video)

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Why Cryptocurrencies Should Not Be Valued By Market Capitalization



Why cryptocurrencies should not be valued by market capitalization

Kyle Torpey has been writing about Bitcoin since 2014. In this article, he explains why you shouldn't value cryptocurrencies based only on their market capitalization.

Although Bitcoin was conceived as the only cryptocurrency today, thousands of alternatives are traded on exchanges.

Market capitalization is most often the key metric for comparison. It is fundamentally the wrong approach, and there are several alternative indicators that you can use to evaluate cryptocurrency.

What's wrong with market capitalization?

Capitalization is a term taken from traditional economics. The market capitalization of corporations is determined by many indicators, up to its managers' decisions, and the result partially based on analysts' forecasts for stock prices. Things are easier in the cryptocurrency space. Cryptocurrency capitalization is the total value of the tokens present on the market. It is calculated by multiplying the number of issued tokens by the cost of one coin. Depends, respectively, on two parameters are the price of one token and their quantity. However, it should bear in mind that not all issued coins are available for real trading. We also recommend reading Binance Is The Fastest Growing And Most Profitable In History.

Consider the Icelandic token Auroracoin, issued in 2014. Its market capitalization was over $ 1 billion, but most of the tokens were locked and unavailable for trading. It turns out that in reality, the market capitalization of Auroracoin was then just over $ 10 million.

On top of that, it happens that one organization holds a large number of coins from the beginning. If such savings are held outside the stock exchange, there is a pointlessly high market cap, and there is no activity around the coin.

A study by blockchain analyst firm Chainalysis found that nearly 4 million bitcoins are likely lost forever. It means that Bitcoin's market capitalization can also be misleading.

Or another example. Imagine that Forbes created 1 trillion ForbesCoins out of nothing and then sold one ForbesCoin to someone for $ 1. This would mean that ForbesCoin has a market capitalization of $ 1 trillion. But such an estimate is completely useless because the market would crash when all the other ForbesCoins listed on the exchange.

Put: it's silly when the market only relies on market capitalization. For a more accurate assessment of the cryptocurrency, other indicators should take into account.

Metcalfe's Law

FundStrat co-founder Tom Lee believes that the increased number of network users has driven the 94% rise in Bitcoin's price over the past four years. FundStrat's method for tracking the number of users combines the number of unique addresses and the volume of transactions in USD. It is a method based on Metcalfe's Law, which states that a network's cost is proportional to the square of the number of users on it.

It is unclear if FundStrat considers the presence of bitcoins on the registered addresses a necessary condition. No money is required to create a new address, but there is a commission for the transaction. Another possible problem with this method is that new addresses are not always created when you buy Bitcoin on the exchange.

Another metric that is once used to evaluate cryptocurrency networks is the number of transactions per day. The price of Bitcoin has been rising along with the number of daily transactions. However, in 2017, the price of cryptocurrency skyrocketed, and the number of transactions per day has significantly decreased. Based on all of the above, the correct approach is to consider the transaction volume expressed in USD, not the number.

More metrics to evaluate

Assess cryptocurrency; it is better to use additional indicators that are difficult to manipulate. At this point, you can account for some combination of trading volume on exchanges (excluding exchanges without commissions), the total transaction volume expressed in US dollars, and the average transaction fees paid to miners.

The easiest way to determine if something "unclean" with the market capitalization of a chosen currency is to look at the trading volume on the exchanges. Lack of liquidity on exchanges means that a whale with many coins can come at any time and crash the market.

Accounting for the volume of transactions, expressed in US dollars, will allow you to see the real activity around the token. If we take into account the average commission to miners, you can get real data on traffic in the network.

The amount of money collected by miners for transactions is an interesting metric for analyzing cryptocurrency. It can be considered the most striking indicator of data in terms of the demand for a particular network. It is the total amount of money people are willing to pay to use the network daily.

It should be noted that some of the considered methods for evaluating cryptocurrency networks are not useful for networks where strong confidentiality guarantees are implemented.

Article and video on the topic: Why Cryptocurrencies Should Not Be Valued By Market Capitalization.

Author: Jonathan Burroughs

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