“Market cap” can be misleading

Sonnie Bailey

15 July 2022

In early November 2021, Tesla hit a market capitalisation of $1.23 trillion (USD). As I type this, its market cap is just under $700 billion.

In early November 2021, Bitcoin hit a market cap of $1.263 trillion. As I write, its market cap is just under $370 billion (USD).

From a narrow perspective, Tesla’s drop represents a loss of shareholder wealth of $530 billion. Bitcoin’s drop represents the destruction of nearly $900 billion worth of wealth.

Personally, I think this sort of description misses something important.

Market cap is calculated based on the last transaction involving the asset in question. In simple terms: take the last price a bitcoin was sold/bought for, and multiply that price by the number of bitcoins in existence. Or take the last Tesla share sale/purchase price and multiply it by the number of Tesla shares in existence.

When an asset is sold, it is usually sold for the highest price that someone is willing to pay for it. If someone wanted to buy that asset for more, they would have outbid the most recent purchaser, and paid more.

Market cap implies that all of the shares (eg Tesla) or other assets (eg Bitcoin) could be sold for the same amount as the most recent transaction, even though that transaction was the highest price that someone was prepared to pay.

Let’s imagine you’re a “whale”. For instance, let’s say you’re Satoshi Nakamoto and wanted to sell the 1 million bitcoins you hold (estimated), of the approximately 19 million bitcoins in circulation. Or let’s say you’re Elon Musk and wanted to sell the ~17% of Tesla stock you hold.

If you use the market cap methodology, Satoshi would hold approximately $19.5 billion (USD) worth of bitcoin. Elon’s Tesla shares would be worth $119 billion.

But could they sell their 1 million bitcoins for $19.5 billion or 17% stake in Tesla for $119 billion in one go?

The answer is no. They would flood the market, and supply would outstrip demand at current prices. The only way that Satoshi or Elon could sell their entire interest would be by taking a significant haircut on the “value” of their investments. They would have to be prepared to sell their assets to people who are interested in buying, but only at a lower price than the market currently offers.

Assuming neither did this for a reason unknown to the rest of us, this might not necessarily reflect any change in the fundamental value of the underlying investments. But the price at which these assets trade for will be different.

It’s also worth noting that market cap doesn’t represent how much money has gone towards buying an asset in the first place.

I could create a crypto coin with a supply of 100 million coins. For shiz and giz, I could ask a friend to buy one of those coins from me for $10. If they were generous enough to do so, they’d make me a paper billionaire! $10 x 100 million = $1 billion. From a market cap perspective, I’d be a billionaire, even though only $10 has changed hands, and there’s no way I’d be able to sell the remaining 99,999,999 remaining coins for the same price (or at all, for that matter).

Similarly, especially with crypto, the “market cap” of a particular coin often bears little resemblance to what has actually been paid into the coin. Bitcoin’s market cap might be $1.263 trillion or $370 billion, or some other figure, but that is a multiple of what people have actually paid, on net, to buy bitcoins to date.

When you read about a loss of wealth or destroyed value, and it’s based on market capitalisation, be wary. It often overstates how much “wealth” has actually disappeared.


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