There are many differences between traditional investment vehicles and digital assets, but one aspect I see most beginners fail to grasp is the understanding of supply and market capitalization. The only changes that an investor has to worry about in traditional finances are adjustments to monetary policy done by the governing body of that asset or commodity. With the development of Blockchain systems, governments are not the only entities that can affect economies. This allows for each token to have an individual economy and because of this we have to treat each token completely different. With the purpose of explaining these ideas at their most basic level, I will use Bitcoin (BTC) currently priced at 48,414 USD (2/15/2020) and Ripple (XRP) priced at .57 USD (2/15/2020) as my examples throughout this article. First, let’s clarify what supply and market capitalization (market cap) are in reference to digital assets.
The supply of a digital asset is referring to the total number of coins or tokens that are in circulation. This is the most basic definition. There are many subsets of supply that must also be understood.
Maximum supply is referring to the total number of coins or tokens that will ever be produced by a specific blockchain. This number is usually created at the inception of a blockchain system and cannot be edited unless stated in the source code of the system. The maximum supply of BTC is 21 million and the maximum supply of XRP is 100 billion tokens. That means XRP will have 4,761x more tokens in existence than bitcoin. The purpose of this explanation is simple; I have heard many neophyte crypto investors say “these are cheap and maybe someday these will equal bitcoin (48,414 USD).” For this to be true each XRP would only be to equal 9.18 USD, which shows that 100 dollar XRP would be extremely hard to achieve.
Another term that is a subset to supply is total supply. While similar to maximum supply, total supply is the current supply including burned or lost tokens. Over the years as BTC developed, early holders of bitcoin were careless with their access keys and an estimated 3.7 million BTC 1 is believed to be unrecoverable. When taking this into account the scarcity of BTC is actually increased and could increase its’ value further in the future.
Supply may seem like an easy enough concept to understand, but many blockchain projects use supply to affect the price of their token to confuse potential investors.
The market capitalization (market cap) is one of the best metrics for digital assets. Market cap of a coin is calculated using this formula: Market cap = Total Supply * Price of each coin. So for our examples, The current cap for BTC is roughly 928 billion (928,290,155,526 USD) and the cap for XRP is 23 billion (23,833,367,218 USD). The purpose of this calculation is to show how a token’s price is relatively meaningless without taking into account it’s supply.
Another metric I use frequently is Fully Diluted Market Capitalization. This calculation takes into account the maximum supply instead of the total supply and gives you a better picture of what the market cap will be when all tokens (including tokens not yet mined) are distributed. Again, it is important to take this into account as many blockchain companies hold large percentages of tokens to give the appearance of scarcity. This metric has little affect on well distributed tokens such as BTC which computes its’ price to 44,204 instead of 48,414, which is only a 8.6% difference . While using XRP’s fully diluted market cap the price calculates to .23 USD down from .57 USD, which is a 54.1% difference. These differences are staggering and is one of the reasons you should be doing research on all tokens you are looking to invest in.
That’s a Wrap
Digital assets are a different animal when compared to traditional finance. As a green investor, fully understanding the basics of supply and market capitalization allows for you to rein in expectations and portray realistic price goals for your potential investments. One of the best places for crypto research and analytics is on the website Messari that I use constantly when doing research on a potential new investment. What are some useful crypto analytics that you use?
-Dr. Austin Fortner