Market Capitalization Myths: Understanding Liquidity, Price Action, and True Value in Crypto

Key Takeaways

• Market Capitalization (Market Cap) represent the total market value of an asset.
• Market Cap does not mean total money invested.
• Market Cap does not determine price action.
• Market Price is determined by supply, demand and liquidity.

What is Market Capitalization?

Market Capitalization or Market Cap is a measure of the total market value of a single cryptocurrency, or all cryptocurrencies combined.

It is calculated as:

Market Cap = Current Price × Circulating Supply

💡Circulating supply means the amount of cryptocurrency that has been created and released and currently in circulation in a market by a certain cryptocurrency project.

For example, Bitcoin circulating supply currently is 19.83 million, price of bitcoin is currently 83,000, therefore, total market cap of bitcoins would be 19.83M x $83,000 = 1.64 trillion.

But what is the point of this concept? Actually, the main idea of this concept is to reflect the Importance, value or the size of the market for a certain asset. 

Common misconceptions about Cryptocurrency Market Cap

Market Cap = Total Money Invested ❌

Many think that market cap is equal to total money invested in a cryptocurrency. Actually, this is false. For example:

• Satoshi Nakamoto holds ~1 million BTC mined at near-zero cost.
• Early adopters bought Bitcoin for under $1000, not today's price of $83,000
• Lost coins (e.g., James Howells’ 8,000 BTC) still count toward circulating supply but represent no actual investment.

But does that mean hundreds of millions of dollars were invested in those bitcoins? Absolutely not.

🌟The key point is the above people did not acquire Bitcoin at the current market price and still have their Bitcoin existing on the blockchain. 

Therefore, if they did not buy their Bitcoins at the current market price levels, that means the current market cap does not equal the total amount of money invested. Period.

For example, if all 19 million BTC were suddenly sold at $83K, the market wouldn’t absorb that kinds sell order at that price. Sell pressure would drive prices down drastically, proving that market cap is not the real money invested.

So, what can be the total invested amount then? Actually, this is unknown, and calculating the total money invested in Bitcoin is difficult without knowing every individual purchase price. But I'm very sure it is significantly below 1.62 trillion, maybe less than 100 billion perhaps. 

Price Action is Determined by Market Cap ❌

This is funny, I have seen many so-called financial gurus talking about price action and market cap without having any idea about how market price and market cap are completely unrelated. 

For example, I saw someone posting on X saying “This certain crypto has 100 billion tokens in circulation. Its current price is $2, meaning its market cap is $200 billion. If it were to reach $50 per token, its market cap would be $5 trillion, which is bigger than the entire crypto market! That means trillions of dollars would need to flow in, which is impossible."

According to his analysis, for that crypto to go to $50 dollars, 4.8 trillion needs to flow into the market for the price to reach $50. 

This way of thinking is totaling wrong. Price action has nothing to do with market cap. The current market price of any digital asset is determined by the number of active buyers and sellers who are willing to buy and sell at a given price and the amount of liquidity, which is driven by external economic and technological factors like interest rates and technological innovations.

Let's take a simple example to understand why price cannot be determined by market cap.

Let's say we have a cryptocurrency called Troy:

• Selling at $1
• Circulating supply is 1 million
• Market Cap = 1$ x 1 million = 1 million Market Cap

 

Someone can assume looking at the market cap, if the price of Troy jumps to $2, the market cap should move to 2 million, which is correct. ($2 x 1 million = 2 million).

But he/she can also assume if price to jump from $1 to $2, another 1 million should enter into this cryptocurrency Troy based on the difference between the old and the new market cap.

This way of thinking is false. Let's see why:

How Buying Pressure Moves Prices: A Practical Example

Let's consider the aggregate supply and buying orders of all exchanges for the crypto Troy are in below amounts:

Key Points About the Order Book

Market Price = $1.00

At this price, there are 10,000 tokens available for sale (ask orders) and 10,000 tokens demanded to buy (bid orders).

This is the equilibrium point where buyers and sellers agree on the price.

Sell Orders Above $1.00

📌These are ask orders, where sellers are willing to sell at higher prices:

• $1.80 → 15,000 tokens
• $1.90 → 10,000 tokens
• $2.00 → 5,000 tokens

Buy Orders Below $1.00

📌These are bid orders, where buyers are willing to buy at lower prices:

• $0.90 → 15,000 tokens
• $0.80 → 20,000 tokens

Step-by-Step Buy Execution 

Scenario: A Buyer Wants to Push the Price Up

A trader wants to buy 15,000 tokens instantly, but the 10,000 tokens at $1.00 are already claimed by existing buy orders. To fulfill their order, the buyer must:

1️⃣ Buy from Higher Sell Orders:

• The buyer starts purchasing from the next available sell orders above $1.00.

2️⃣ Buys 15,000 tokens at $1.80:

• Clears the 15,000 tokens available at $1.80.
• The market price now moves to the next available sell order: $1.90.

⭐New Market Price = $1.90

The lowest available sell price is now $1.90.

How Much Money Was Spent?

To Move Price from $1.00 → $1.90

• The buyer spent: 15,000 tokens × $1.80 = $27,000

To Move Price from $1.90 → $2.00

• Another buyer would need to purchase 10,000 tokens at $1.90, spending: 10,000 × $1.90 = $19,000

Total Money Spent to Push Price to $2.00

• $27,000 + $19,000 = $46,000

What is Liquidity and how it plays a part in price action?

Liquidity refers to how easily an asset can be bought or sold in a market without causing significant price changes.

🔹 Highly Liquid Market:
If there are many buyers and sellers, the market is considered highly liquid. This means it can absorb large buy and sell orders without major price swings.

🔹 Illiquid Market:
If there are fewer buyers and sellers, the market is illiquid. Here, even a small amount of money entering or leaving the market can cause drastic price movements—just like in the Troy example.

🌟Key Point: Regardless of whether a market is liquid or illiquid, prices still move based on supply and demand. However, highly liquid markets offer more stability, as significant price spikes or crashes are less frequent. 

In contrast, low-liquidity markets experience sudden and extreme price changes if there aren’t enough buyers or sellers to absorb large orders. (Example: Troy)

Final Thoughts

While market cap does not determine price action, investors often use it to choose which cryptocurrencies to invest in. Those seeking high volatility for sudden gains may prefer small market cap cryptocurrencies, whereas those looking for price stability may opt for large market cap assets.

Regardless of liquidity levels, demand and supply -influenced by macroeconomic factors and technological innovations - ultimately drive the prices of digital assets.

Disclaimer: The contents of this article are for informational purposes only and are not financial advice. The views here are just the author’s opinions. The crypto market is volatile, so be sure to do your own research before investing.