When it comes to cryptocurrency comparison, people immediately look up to market capitalization as the most reliable metric as it represents currency’s core market value. However, as the cryptocurrency ecosystem is still developing and is a nascent one, their unique characteristic pave way to practices which intentionally or accidentally influence market cap to a great extent. This is exactly what Charlie Lee explained in his series of tweets on 8th February. The creator of Litecoin and Director of Engineering at Coinbase explained through these tweets how market capitalization is not a fair ground for cryptocurrency comparison. The tweets explain how few cryptocurrencies are purposefully locking up coins or destroying them to increase market cap and hence the need for a new grounds for comparison. Let’s dive deep into what Lee is suggesting as alternate:
The problem with Market Capitalization:
Lee explains that with low volumes, the volatility will remain strong and only push prices higher. This would lead to increased market cap but in reality doesn’t reflect the true value of the cryptocurrency. A good example for this would be the launch of Z-cash.
During the first few days of the launch, Z-Cash was illiquid and had a dearth of volumes which increased the volatility. The prices touched an instant high taking Z-Cash’s market cap higher than few of the already existing cryptocurrencies. While in reality this wouldn’t be a measure of the actual value as the currency is new and low on volumes. This will lead to a possibility where a coin with $ 1 Million market cap, may really be worth only $1000 as the daily volume is only $10.
The proposed solution:
To lay down the alternate for the said problem, Lee bases his idea on the fact that Bitcoin and Litecoin volumes are a bit over 1% of their market cap. Using this 1% as the benchmark, Lee has suggested Volume weighted market cap. The volume weighted market cap would reduce the market cap by how much the trading volume is less than 1% of the market cap. Hence the Volume Weighted Market cap would be Market cap times minimum of 1 or percentage volume per market cap. Basing on this method Lee posted the comparison of VWMC in descending order of various cryptocurrencies and that provided a new perspective.
VWMC = MC * Min(1,VOL*100/MC)
— Charlie Lee (@SatoshiLite) February 8, 2017
Hence Bitcoin and Litecoin’s VWMC would be the same as their market cap because their daily volumes are more than 1% of their market cap. Similarly a coin with $10 Million market cap but only $50K in daily trade volume will have its VMWC reduced to $5 Million. Hence this indeed becomes a very accurate and better way of comparing cryptocurrencies.