Market Cap vs. Circulating Supply

The most common way to rank cryptocurrencies is by using their market capitalization. This is the value of all the coins or tokens available for purchase on the market. In other words, a market cap is not calculated by a cryptocurrency’s total supply, but by its circulating supply.

Every cryptocurrency has different circulating supplies, and some don’t limit maximum supply. Such a dynamic makes all the difference on how traders approach certain coins over others.

How To Calculate Market Cap?

Top 5 cryptocurrencies by market cap. Source: CoinMarketCap

Market cap is best viewed as cryptocurrency’s total tradeable value. We calculate it by multiplying the number of tradable coins by the price of each coin. For example, the Ethereum alternative smart contract platform, Avalanche (AVAX), has 284,926,959 tradable AVAX coins.

That is the AVAX circulating supply. Each of those AVAX coins is priced at $27.67, as of August 2022. Therefore, AVAX market cap is the following:

284,926,959 AVAX (as circulating supply) x $27.67 (price per AVAX) = $7.8 billion market cap

This ranks Avalanche (AVAX) 12th on the market cap listing.

Why Is Circulating Supply Important?

The more assets are available for trading, the less valuable they are. This is a reflection of the economic law of supply and demand. For instance, gold can be found in the Earth’s crust at 0.004 parts per million (ppm).

In contrast, aluminum is concentrated at 82,300 ppm in the Earth’s crust. Such a drastic difference in availability makes aluminum much cheaper than gold. The same logic applies to the circulating supply of cryptocurrencies.

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This is why most cryptocurrencies do not fully release all available coins. In the AVAX example, 284.9 million AVAX is only 40% of its maximum supply of 720 million AVAX. If we were to calculate that number with the price of AVAX we would arrive at a fully diluted market cap:

720 million AVAX (maximum supply) x 27.67 (price per AVAX) = $19.95 billion fully diluted market cap

In other words, the difference between market cap and fully diluted market is the difference between circulating token supply and its maximum supply. It is also where inflation control happens.

Different Cryptocurrency Inflation Controls

In the last two years, from 2020 to 2022, it has become clear what happens when central banks have to pump money into an economy.

The Fed increased its balance sheet by $4.6 trillion from March 2020 to May 2022. Source: stlouisfed.org

When the Federal Reserve injected $5T worth of stimulus to address the economic crisis wrought by the Covid-19 pandemic, the inflation rate, also known as CPI, jumped to 9.1% in July 2022, a 40-year high. That meant consumers have to pay 9.1% more (in aggregate) for products and services than the previous year.

This is why having an inflation control mechanism is so important. While the Fed uses interest rate hikes to bring inflation down, cryptocurrencies have diverse approaches.

Avalanche (AVAX)

Avalanche (AVAX) token holders can vote on the amount of staking rewards validators receive. Proof-of-Stake blockchains like Avalanche validate their network’s transactions with validators, akin to Bitcoin’s miners but using monetary power instead of computing power.

Source: AVAX staking

In return for securing the network, AVAX validators receive rewards in AVAX tokens. This is the issuance of new AVAX coins, i.e., the blockchain’s inflation rate. While the AVAX issuance is flexible, the total number of tokens is limited to 720 million.

Ethereum (ETH)

Soon-to-be Proof-of-Stake, Ethereum implemented a different inflation control. Unlike AVAX, Ethereum (ETH) doesn’t have a maximum token supply. This means that its market cap and fully diluted market cap is the same because ETH circulating supply keeps increasing with new ETH issued.

That ETH issuance works similar to AVAX. However, after introducing the EIP-1559 upgrade, Ethereum revamped its gas fee system, so that inflationary force is countered with a burning mechanic. Instead of giving miners rewards, the base ETH fee is burned, reducing ETH supply.

Stats of total ethereum burnt. Source: Watch the burn

“Burning” ETH just means that they are sent to an unretrievable wallet. This way, they are permanently removed from Ethereum’s circulating supply.

Bitcoin (BTC)

Block rewards are reduced after each halving. Source: Bitcoin.com

As the pioneering cryptocurrency with the largest market cap, Bitcoin has a halving mechanism for its inflation control. About every four years, the BTC rewards miners receive for securing the network are halved. When Bitcoin first launched, miners could receive 50 BTC per added block.

After three Bitcoin halvings, that reward is now 6.25 BTC. Bitcoin’s maximum supply is 21 million, of which 19.1 million are in circulation. With each halving epoch, bitcoins will be more difficult to mine, which mitigates the supply as the demand increases.

Impact of Circulating Supply on Investor Behavior

We have covered cryptocurrency inflation controls for the three most representative digital assets: Avalanche (AVAX), Ethereum (ETH), and Bitcoin (BTC). There are thousands of other cryptos that have tweaked their basic inflation formulas.

By managing their circulating supply, these blockchain networks manage the flow of supply and demand, which directly affects the asset’s price.

These inflation control mechanisms have an important psychological function as well. There is a big difference if cryptocurrency is valued at $0.1, $10, or $100. And this difference is not one that is measured only in decimal places. In research published by Arash Aloosh and Samuel Ouzan, dubbed “The psychology of cryptocurrency prices,” they concluded that crypto investors prefer investing in assets at low price points.

Likewise, the lower the price is, the more volatile cryptocurrency is compared to higher-priced ones. Case in point, as Bitcoin spearheaded crypto adoption and became pricier per BTC, its volatility drastically reduced over time.

Bitcoin’s volatility index. Source: BuyBitcoinWorldWide.com

Of course, the utility of each blockchain network determines the price of its native token in the end. If people decide to use the AVAX ecosystem, for lending dApps and NFT marketplaces, over Ethereum’s, the price of AVAX would jump accordingly.

What is clear is that we are in the early stage of decentralized finance (DeFi), so it is anyone’s guess which blockchain networks will make the largest DeFi portion.

Series Disclaimer:

This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.