The problem of cryptocurrency market capitalizations

  • “Once the speculative fervor has worn off, market capitalizations often tend to decline in a big way,” a cryptocurrency executive told Blockworks.
  • Developer activity, dApp usage, user growth, and the number of active wallets are better indicators of strength

Market capitalization in the cryptocurrency world can be misleading indicators of value, and industry watchers say metrics like user growth and developer activity should carry more weight.

The market capitalization of a crypto-asset is calculated by multiplying the number of tokens or coins in circulation by the current market price of a single unit. The metric is widely, but perhaps incorrectly, used to gauge a cryptocurrency’s performance and value.

It is true that the higher the price, the greater the market capitalization of the corresponding cryptocurrency, but they do not take into account the token blocking periods or the supplies held by the company’s insiders.

In the world of traditional finance, market capitalizations certainly have a lot of importance. This is simply because they represent the dollar market value of equity, which allows investors to gauge a company’s profitability rather than relying on its sales figures.

One problem with cryptocurrency unique metrics is that lost tokens end up being counted into market value, rather than stolen from the supply. For example, about 20% of the current bitcoin supply, or $ 140 billion, is lost or stuck in neglected wallets. Should lost tokens be accounted for in terms of the present value of the remainder?

The growth, the use of the protocol are better indicators of the cryptocurrency market

According to Oskari Tempakka, Token Terminal’s growth leader, looking more specifically at circulating market caps, rather than fully diluted ones, can be deceptive.

“This is a metric that many investors look at without taking into account blocked tokens, vesting programs etc. So there could be a big difference between current and fully diluted effective market capitalization,” he told Blockworks.

Tempakka believes digging into developer documents and white papers to estimate token unlocking could have a big effect on the price of a single token. He added that many investors, recklessly, don’t even bother checking market caps and instead make decisions based on the price of a single token.

More valuable indicators, he says, are the service a particular project has made available, the amount of usage it’s seeing, and the amount of revenue the service generates.

“The most important indicator of value in your protocol, for me, is a fundamental analysis of what is happening under the hood from a business perspective,” said Tempakka. “The more organic growth and utilization you have, and the greater the growth of active users, the greater the evaluation of a protocol should be from a fundamental perspective.”

Volatility during market cycles

Market cap data can also fluctuate enormously during bearish and bullish cycles, due to changing market sentiment, and does not reflect deeper information such as transaction volume, number of users or activity on the network.

“In bull markets, protocols are often seen exploding in value due to speculation. But once the speculative fervor subsides, market capitalizations often tend to decline in a big way, “Daryl Kelly, founder of the NFT LTD.INC platform, told Blockworks. So this metric says very little about whether people like it. use whatever cryptographic protocol is in question, including a particular DeFi or metaverse project, he added.

Blockchain developer numbers are another good metric

Kelly thinks developer activity is a more useful indicator of the strength of a cryptocurrency or project.

“Just look at Ethereum and Solana. The amount of developer activity on these networks is immense and is only growing, “he said, adding that this criterion suggests enough user demand on these blockchains to build more applications for anything from DeFi and NFT to crypto games. .

A report on the state of cryptocurrencies released by a16z in May shows that Ethereum has managed to attract 4,000 monthly active developers, easily beating those of other protocols.

Santiago Portela, CEO of FITCHIN, agreed that market capitalizations are an imperfect metric, noting that Solana’s does not reflect the strength of the blockchain.

From a pricing point of view, Solana could be perceived as a negative performance. But that’s a different story when you consider the volume of NFTs traded on the blockchain. This month, trading volumes on Solana-based markets such as Magic Eden and Metaplex hit their highest level since May.

“It tells me that adoption is on the rise in that network and that there are builders behind it, in fact, these are the key aspects to truly understanding the strength and resilience of the ecosystem,” he said.

But not everyone believes that market caps are a weak measure. Nischal Shetty, CEO of Indian cryptocurrency exchange WazirX, said they can be a useful tool for assessing the strength of various protocols. But he agrees that the hype during bull markets can blow up market caps for obscure protocols beyond the usefulness they offer.

More reliable metrics, in addition to developer numbers, include user growth, the number of active wallets, and the use of dApps (decentralized apps), according to Shetty.

“One reason behind Ethereum’s success is that it has a large number of applications built on top of it which in turn attract users. And this user growth also attracts more developers. So, in this case, there is a virtuous circle in which developer activity and user growth feed each other. That’s why I think it’s important to look beyond the hype, including market cap, “he said.

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  • Shalini Nagarajan

    Shalini is a cryptocurrency journalist from Bangalore, India covering market developments, regulation, market structure and institutional expert advice. Prior to Blockworks, she worked as a market reporter for Insider and a correspondent for Reuters News. You are holding bitcoin and ether. Reach her at [email protected]

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