Successful investing requires us to equip ourselves with information. Laws and regulations require essential information about traditional investments (stocks, bonds, ETFs, and mutual funds) to be made available to investors. While crypto's decentralized nature makes the same data hard to come by, here are some basic metrics that we can use when comparing cryptocurrencies to invest.
Crypto market capitalization
A crypto's market capitalization represents its total value in terms of another currency, such as US dollars.
We can use a crypto's market capitalization to give us a sense of its adoption and growth. For this use case, market capitalization is better than price because price alone can be misleading. One cryptocurrency may have a higher per-coin price but a lower market cap than another cryptocurrency due to differences in supply.
In general, cryptos with smaller market caps tend to be riskier but have higher growth potential than larger market caps. We can diversify some of the risks by holding various cryptos with a range of market caps.
A crypto's supply, the total number of coins or tokens, directly impacts its value as seen above in the market capitalization calculations. Keeping market capitalization the same, increasing the supply will theoretically lower the value of the coin or token.
Some coins are similar to cash and other fiat currencies because they are minted, or created, indefinitely. There is an unlimited supply that grows in an inflationary fashion so its value will erode over time.
Other cryptos, like Bitcoin, are the opposite. The supply is a fixed amount that can be mined, much like the amount of gold in the ground. We call these cryptos deflationary.
Similar to gold, the fixed supply means that it will increase in value relative to inflationary cryptos and cash over time. The imbalance between the supply causes a gradual increase in value. For instance, the number of Bitcoin is flat, so it will take more US dollars to buy one Bitcoin as the government creates more dollars over time.
A crypto's volume shows us how much of it is actively traded and reflects its liquidity. Volume helps act as tie-breakers for us in the case two cryptocurrencies can have the same market capitalization. It's likely one may have more utility and a larger community using it, which are signs of better growth potential. The increased usage is shown in how much volume is traded daily.
Higher volumes tend to lead to more stable prices because there are plenty of buyers and sellers, making it easy for us to transact at the market price. When the volume increases, the price will generally move in the same direction. As more people are buying a crypto (increasing the volume), its price will rise, attracting more folks to buy, and the cycle continues.
However, major news or events can create a sharp spike in volume and destabilize prices when investors are frantically trying to buy or sell. Many exchanges or data services aggregate 24-hour trading volume in fiat denominations, like the US dollar, as shown in the image below.
We need to know as much as we can about a cryptocurrency before investing. Using this information to identify the differences between cryptocurrencies will prevent us from losing money in case we mistakenly invested in a riskier one than we thought.
As a general rule of thumb, higher market caps, higher volume, and deflationary crypto will have more stable prices and relatively less risk. Lower market caps, lower volume, and inflationary coins are riskier but could also have more potential growth for better returns.
Check out the short video below for a deeper dive into how to invest in crypto using market cap: