Most cryptocurrency market cap is fake

Impressive U$ dollar cryptocurrency market capitalization numbers are misleading new investors every day.

The market cap metric is used heavily by investors to estimate crypto valuation, but maybe they shouldn’t be relying on this number as much as they do.

Fake Market Cap

If you analyze a list of cryptocurrencies by market cap, you’ll find that most coins aren’t traded to and from fiat currencies.

This leads to a striking conclusion, which we present in this article.

There’s an elephant in the room and it’s cause for great controversy : the cryptocurrency market cap numbers you see are probably largely fake.

First of all, we need to discuss how these market caps are calculated, and once we do that, you’ll immediately see why most crypto market caps can’t be real.

Magic Cryptocurrency Market Capitalization

After an ICO, airdrop or a fork, new coins appear literally out of nowhere.

Some of these coins will be tokens that live inside smart contracts in the Ethereum or some other 2nd or 3rd generation blockchain.

Others are sovereign coins that run on their own blockchain, main nets and specialized wallets.

Regardless of the kind of initial coin generation process, a given number of new coins will now exist somewhere.

Seeking Initial Value

The first thing coin creators must do do after a coin is launched, is to work hard to get it listed in one of the big crypto exchanges.

Normally there’s going to be a community involved. A group that believes in the new coins and which probably have invested some amount of money in the ICO or airdrop process.

This community can be rallied to vote for the new coin to be included at the big exchanges. This usually happens via a channel on social media or chat systems like Telegram.

Once accepted on a large exchange, the coin gets listed as a trading pair with some other pre-existing currency (USD, BTC, ETH and so on).

Some examples are Tether/Bitcoin, USD/Bitcoin, Ethereum/Bitcoin, ADA/Bitcoin and so on.

As soon as the new coin is traded for any other cryptocurrency, it immediately obtains an initial converted dollar value. Note that the new coin will rarely ever be traded in a USD pair. New coins normally get listed against BTC or ETH initially, since USD processing is more expensive and prone to regulation.

Now the coin has magically obtained a US dollar value – without having ever been traded against the dollar.

This is what I call the magic cryptocurrency capitalization: the single coin that was traded against another previously existing cryptocurrency now gets its individual dollar value multiplied by the entire number of circulating coins in order to obtain its total market capitalization.

Indirect USD Valuation

This new trading pair now shows up just like stocks do in a traditional stock market trading system. Bids, asks and an order processing system which matches the highest bids against the lowest asks and performs a best possible trade for investors.

But unlike traditional stock markets, where you always trade U$ for stocks and vice-versa, in cryptocurrency trading you can trade one arbitrary crypto for another. So instead of having trading volumes measured directly in U$, you’ve got volume measured in pairs of cryptos.

As you can see, there isn’t necessarily any direct trade happening to and from U$/Euros and cryptos. Coins are indirectly given a USD value based on what the traded pair is worth.

The only cryptocurrencies that can be pegged to the U$, Euro or any other major fiat currency, are the ones being directly bought or sold in those local fiat currencies.

Which means it’s mostly Bitcoin, Ethereum and a handful of others among the top 50 ranked coins.

Crypto Lottery

To put it simply, cryptocurrency market caps are fake because it is impossible to trade most cryptos for U$.

Sounds pretty obvious, but it isn’t.

Right now Bitcoin Cash is listed with a U$ 26 billion market cap. That sounds incredible. But if you try to cash (excuse the pun) as little as 0,1% of that amount (still a lot of money), no matter how slowly you do it, its price will tend to collapse rather quickly because it’s going to be draining the market’s USD liquidity.

Suppose you generate 1 billion tokens or coins and once they are listed on a exchange, the first trade ever performed will become the unit price. Market cap trackers will then multiply this initial price for one trade by 1 billion – and that becomes the total market cap, even though a single coin was traded. It’s as if the cryptocurrency hit a jackpot of sorts, by inserting a single coin.

This is an extreme example, because none of the successful coins/tokens would survive on the first page of CoinMarketCap very long if they were this weak (and CoinMarketCap has algorithms in place to protect themselves against this sort of market stunt).

Crypto Shilling

There is also a lot of market self regulation in cryptos where information flows quickly and the markets adapt in real time. If a worthless coin were pumped like this, anyone who owned it would simply dump their coins and their price would drop immediately. And there’s a fairly new (and initially popular) Bitcoin fork where precisely this scenario happened.

Bitcoin “Gold” (BTG)

Bitcoin Gold is a good example of fake market cap. As soon as it was forked, it was traded for U$ 479 a piece. Since there automatically existed 16+ million BTG – because it was a fork of the main Bitcoin blockchain – multiply U$ 479 by 16+ million and you get more than U$ 8 billion market cap, even though not a single U$ was traded for BTG, ever. If so much as a tiny percentage of BTG owners attempted to convert their coins to U$, they would be in for a bad surprise.

October 2018 Update: Since we published this article, Bitcoin Gold price has “fallen” to U$ 25. But in reality it was never really worth U$ 480.

Bubble Bobble

The reference between fiat currency valuation and cryptocurrencies is absolutely worthless, unless you are trading between fiat and crypto. And, for 99,9% of all trading volume, that means only Bitcoin can have a fairly accurate fiat market cap.

Many analysts and market gurus are calling it a bubble.

But it’s not exactly a bubble, because there is no fiat currency at all involved in most of this fictitious market cap. A bubble assumes people are depositing real money into something that is not worth that money. That is not the case with most cryptos – since the money never got there at all. It simply does not exist.

Granted, some ICOs have raised tens of millions of U$ in cash, therefore a fraction of their valuation can be measured in fiat. But for most cryptocurrencies there has never been a single unit traded between themselves and fiat.

Crypto Triangulation

It is impossible to trade most, or any in some cases, of this market cap for fiat. To do that you would have to trade 99% of alt coins into Bitcoin and from Bitcoin into fiat. And by the time you did that the altcoin’s price would tend to zero.

It’s as if the same U$ had been counted twice, once for Bitcoin and once for the altcoin, but that U$ amount only exists for Bitcoin. Repeat this process for N altcoins and you’ve got the same U$ amount counted N times, when it only really exists for Bitcoin.

In other words, you would only know the total U$ valuation for any of the alt coins if you were able to test how much of it could be effectively traded for U$, which is impossible for 99% of altcoins. As soon as you attempted any such test, Bitcoin valuation would skyrocket and the altcoin valuation would drop towards zero.

Suggested Solution(s)?

No 100% accurate solution exists unless all cryptos were freely traded for fiat, which isn’t bound to happen any time soon.

Therefore, it would only be possible to estimate precise U$ market caps for the cryptoassets being traded for U$. In all other cases, an approximation must be made. Especially for altcoins that are not at all traded in fiat. Estimates should be clearly labeled as such, not as actual market cap.

The algorithm being used today is inappropriate. Most of them simply multiply the unit price by total supply which, as we’ve seen, is wrong.

In fact, CoinMarketCap.com has been listing new coins with zero market cap for a grace period in order to avoid such distortions and marketing stunts (like pumping a new coin with a tiny amount of volume just to get it listed on the first page).

Secondly, only coins with U$, Euro or other official fiat exchanges, with reasonable trading volume, should be listed with a U$ or equivalent fiat market cap. All other market caps are 100% fake. If there is no trade between a crypto and fiat, then it is impossible to list it with any fiat market cap whatsoever.

Cryptocurrency Market Cap is not Transitive!

The fact that you can trade altcoins for Bitcoin, and that Bitcoin itself has a price in U$, does not imply that these altcoins magically acquire the equivalent U$ valuation. As we’ve seen, this implies the same U$ being counted twice, once for the altcoin and a second time for Bitcoin or whatever crypto is actually traded for fiat.

This is clearly reflected in Bitcoin’s market dominance. There’s a reason why Bitcoin hovers around 50% market dominance, and that is because most fiat is being counted twice – once for Bitcoin and again for the altcoin.

Economists and mathematicians can probably develop more accurate models for estimated cryptocurrency market cap, based on how much actual value flows in and out of cryptos, but certainly the way it’s done today is completely flawed.

See Also: Fake cryptocurrency market caps, Part II – A striking graphical coincidence

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