TLDR: If you somehow managed to buy the entire supply of a given coin B for a price of P each, it would be almost impossible to sell the coins back to the market for its “Market Cap” of B*P. Market Cap is therefore a clever fiction by spurious analogy but not an actually useful concept.
As I often do with concepts I am interested in - including ideas I have come to believe are true - I was trying to reason through from basic principles why Market Cap is a flawed concept for crypto currencies. I often hear people reasoning that it doesn’t apply to crypto since it is just the most recent unit price x outstanding units, regardless of volume. As this is essentially true for all asset classes (by definition, regardless of whether Market Cap makes sense for that asset), I thought it was worth looking further. Here are my conclusions:
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For shares/stocks, Market Cap makes sense as when you buy a share of a company you are buying a proportional share of its revenues. Let’s say you buy a share for price P and you believe the individual share will achieve R% return (actual return of RP) - that means you also believe that N shares will achieve R% (NRP in actual terms), so theoretically controlling for your available capital you would also be willing to buy N shares at NP or the whole company with C shares for C*P. Therefore your purchase price is essentially an opinion on the price of the entire company, and the price dictated by the market is essentially the aggregate of those opinions.
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For commodities, I did not hear so many discussions about Market Cap until the crypto world came along - but I’ll admit that I could have just missed it (and will be happy to hear more about how it is used in this world). In any event I do not think it is as useful a measure for commodities because these don’t give you the right to any revenues in the same way that shares do. But let’s explore it anyway. Imagine you buy an ounce of gold for price P, and the entire world stockpile of gold is G. There is a natural demand for gold since it has industrial uses as well as cultural uses in jewellery (we can ignore central bank demand as for the purposes of this argument they are just another investor trying to value gold alongside us). If you somehow managed to buy the entire world’s supply of gold for G*P without this pushing up the price (and assuming no new supply), it’s reasonably to assume you could start selling ounces of gold for at least price P since you would control the supply and you could sell at a level that ensures you achieve your buying price.
However in practice I think this reasoning is spurious as it ignores real world conditions - the ‘market cap’ is irrelevant to price or value since if the global stockpile is G but one guy owns 99%G and won’t sell no matter what, the price is dictated by the circulating supply of 1%G combined with whatever demand is. If that one guy suddenly decides to sell all, he will tank the price completely. This is different from shares as you could conceivably sell the entire company for its market cap from time to time.
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For currencies, the analogy really starts breaking down as one of the things that makes a traditional currency is having a central bank to print it, so it would be impossible to buy the entire supply anyway. However similarly to commodities, arguably it can be useful to know what the ‘Market Cap’ or total supply is as it can be useful in judging the effects of QE programs and trade imbalances (e.g.), particularly since (as with commodities), there is a natural demand for each currency - US citizens need dollars to pay their taxes for example.
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Here is where I conclude about crypto currencies. If the price of a bitcoin, say, is P and you gradually purchase all B bitcoins, can you sell them back to the market in an orderly fashion for B*P? The answer must be ‘no’ since, being generous and granting there are use cases, once there are no coins circulating, the use cases are severely undermined. Why would anybody accept bitcoin if nobody has or uses any? The analysis is the same if a lot of people have them but don’t use them (as now). There is no natural demand as even if they were widely used until such time as the supply went to zero, you can substitute them easily for other currencies or crypto, and my hypothesis is that the price would collapse entirely. Market Cap is therefore a clever fiction by spurious analogy but not an actually useful concept. This argument also (further) undermines the ‘Stock to Flow’ model. (I appreciate I have not fully accounted for tokens with no supply cap such as ETH - I need to do more thinking around those.)
Do let me know if you have any thoughts on this reasoning - I am not an economist so I am not fully versed in all these concepts. I have appreciated the reasoned discussions I’ve seen in this sub to date.
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