A Practical Guide to How Cryptocurrency Prices are Determined and Market Capitalization

Introduction: Why Market Capitalization is Key to Investment Decisions

When comparing cryptocurrencies in the market, simply looking at token prices does not allow for a comprehensive understanding of the overall market. Among a variety of assets, from large projects like Bitcoin and Ethereum to emerging small tokens, market capitalization is the metric that measures true value.

Market capitalization is a fundamental indicator that represents the total value of a cryptocurrency project, calculated by multiplying the current price by the number of tokens in circulation in the market. This formula is simple, but it is an important factor that significantly impacts investors' portfolio construction and risk management.

Understanding the Relationship Between Price Determination and Market Capitalization

Basic calculation method for market capitalization

To understand how the price of cryptocurrencies is determined, the concept of market capitalization is essential.

market capitalization = current price × circulating supply

For example, if a token is priced at 1 dollar and there are 10 million units circulating in the market, the market capitalization will be 10 million dollars. By using a weighted average price obtained from multiple exchanges, a fair valuation of the entire market can be achieved.

balance of price and token supply

The price of cryptocurrency is influenced by the balance of supply and demand, but simply looking at the price alone is not enough to assess the scale of an asset. Let's take a look at the following comparison example:

• Project A: 500,000 tokens × 2 dollars = 1 million dollars in market capitalization
• Project B: 1 million tokens × 1 dollar = 1 million dollars in market capitalization

At first glance, the price of Project A seems high, but in fact, both have the same market scale. In other words, to understand the overall value of the network, the indicator of market capitalization becomes important.

Practical Benefits Brought by Market Capitalization

1. Fairly compare projects of different scales.

By market capitalization, it becomes possible to evaluate projects ranging from large-scale to small-scale side by side. For example, by comparing a project with a market capitalization of 10 billion dollars to one with 1 billion dollars, you can objectively grasp the differences in maturity and recognition in the market.

Large-scale projects generally suggest that they have a more established foundation and receive support from a wide range of users and investors.

2. Guidelines for investment risk management.

Projects like Bitcoin and Ethereum, which are at the top of the market capitalization, are recognized in the market as “stable assets”. Due to their high liquidity and long track record, they are considered to have relatively low risk.

On the other hand, new tokens with a small market capitalization have limited liquidity and are at risk of large price fluctuations even with slight selling pressure. When investors consider the risk-return balance, market capitalization becomes an important factor in their decision-making.

3. Tracking the overall performance of the market.

In line with practices in the financial industry, market indices that group specific asset classes have also been established in the cryptocurrency market. These indices are composed mainly of assets with high market capitalization and serve as a reference for investors seeking overall market trends and diversified investment strategies.

Understand the Difference Between Circulating Supply and Maximum Supply

The “circulating supply” used in the calculation of market capitalization refers only to the number of tokens currently available for trading. It does not include tokens locked in smart contracts, tokens held by the team for future purposes, or tokens that have been burned.

This definition allows market capitalization to more accurately reflect the actual market value of cryptocurrencies.

Assessing Future Risks with Fully Diluted Valuation (FDV)

Alongside market capitalization, another indicator to watch closely is the fully diluted valuation (FDV).

FDV = Current Price × Maximum Supply

Many projects release their tokens gradually over several months to years, rather than immediately flooding the market. Even a project with a market capitalization of $50 million could see its FDV reach $500 million if the total supply is circulated in the future.

In this case, there is a risk of token dilution due to additional supply. If the supply exceeds market demand, it could lead to downward pressure on prices.

By checking both market capitalization and FDV, you can balance the evaluation of the project's current status and future supply risks.

Combine with other indicators for a comprehensive assessment

Market capitalization is useful, but it is not sufficient on its own. By considering additional indicators such as trading volume, total value locked (TVL), and the number of active users, one can more accurately assess the fundamentals and long-term prospects of a project.

By combining multiple indicators, you can avoid the trap of relying on a single number for investment decisions.

Summary: Properly Utilizing Market Capitalization

To understand how prices are determined in the cryptocurrency market, a multifaceted valuation metric known as market capitalization is essential. This metric is the most widely used criterion for assessing the scale of a project, its position in the market, and investment risks.

Market capitalization is not a perfect indicator, but when combined with other market data, it provides investors with deeper insights and more reliable judgments. Understanding such basic indicators is an essential foundation for making appropriate decisions in the cryptocurrency market.