Lecture 4.0.0. Common Terminologies You Must Know
Every industry has its language, which is used in delivering the services and goods of the industry. If you are in the Crypto Market, you should know the basic terminologies of the market.
The following are some of the basic crypto terminologies that are crucial for a successful crypto investment:
(1). Coin Supply
This refers to the number of coins or tokens that are available in a crypto project. There are three kinds of coin supply, and to effectively evaluate any crypto project, you’ll need to know the differences in the three kinds:
(a). Maximum Supply
This refers to the number of coins or tokens that the crypto project will ever have. It means the blockchain cannot mint new coins or tokens once the maximum supply is reached.
(b). Total Supply
This refers to the number of coins or tokens of the crypto project that is available after some have been burnt from the maximum supply. Therefore, the total supply gives information on the burnt activities of the crypto project.
(c). Circulating Supply
This refers to the number of coins or tokens of the crypto project that are available in the market for trading. From the total supply, some coins may be kept away by the creators of the crypto project for various reasons such as for marketing, a second airdrop, locked up in a liquidity pool, etc.
All these coins that have been kept away from the market cannot be accessed for daily trading and, hence, are not part of the circulating supply.
(2). Market Capitalisation
Market Capitalisation (often abbreviated as market cap) refers to the total value of a coin or token. As mentioned on Page xxx, Market Cap of a crypto is calculated as a product of the crypto’s market price and its circulating supply:
Market Capitalisation = Market Price x Circulating Supply
There are two kinds of Market Capitalisation:
(a). Diluted Market Capitalization
(b). Undiluted Market Capitalization
When you calculate the Market Capitalization using the Maximum Supply or Total Supply of a coin or token, it is referred to as Diluted Market Capitalization. When you calculate the Market Capitalization using the Circulating Supply of a coin or token, it is referred to as Undiluted Market Capitalization.
A good investor will pay heed to the difference between Diluted and Undiluted Market Capitalizations of a crypto.
If the Diluted Market Capitalization is quite larger than the Undiluted Market Capitalization, it is a risk to the future price of the crypto. It means a large number of the crypto are not in circulation but have been held up in wallets, mostly the owner’s wallets.
What that means is that in the future, the owner can decide to release these coins back into circulation, thereby flooding the market with the coins. This will drop the price of the crypto, causing investors to lose profits.
This was what happened to Terra Luna, one of the largest cryptocurrencies in the Crypto Market.
In April 2022, the price of Terra Luna reached an all-time high of 116 USD and its circulating supply was capped at one billion.
In May 2022, the circulating supply was increased by the developers to 5.8 trillion. This action dropped the price of Luna to as low as 0.00008 USD, thereby wiped out about 50 billion USD in valuation (CoinCodex, 2023).
What this meant was that many investors in the project lost their money. Very painful!
Therefore, what you are looking for in a good investment is the crypto coin or token whose Diluted and Undiluted Market Capitalizations are the same or at best has a minimal difference, and whose maximum supply is known
(3). Coin Scarcity
The smaller the total coin supply, the scarcer the coin is, and hence, based on the economic law of supply and demand, the greater the possibility of the price of the coin rising higher.
Remember the formula:
Market Capitalisation = Circulating Supply x Market Price
That is, Market Price = Market Capitalisation / Circulating Supply
This means that the smaller the circulating supply, the higher the price (provided all other factors, such as having a good use case, that influence the price are taken care of).
Indeed, the scarcity of a coin is one of the crucial factors that determines the future price of a crypto.
Three Mechanisms for Coin Scarcity
Three main mechanisms are utilised by developers to ensure coin scarcity. These are:
(a). Halving
Halving is a mechanism encoded into a blockchain that systematically reduces the number of coins being released into the market at periodic intervals.
For example, after every 210 000 blocks of mining, the blockchain reduces the amount of Bitcoin being released by half. Since each block of Bitcoin is released every 10 minutes, 210 000 blocks will be mined in approximately 4 years.
That means, approximately every 4 years, the halving of Bitcoin takes place, thereby making Bitcoin scarcer, hence, controlling price inflation. This is discussed extensively in the modules of Class 2 of the Secondary SOC.
(b). Coin Burning
To reduce the circulating supply of a crypto and thus ensure scarcity, the developers of crypto projects may want to permanently destroy some of the coins. This requires sending the coins to a dead wallet.
A dead wallet is a blockchain wallet that has no private key. Without a private key, it means no one can access these coins for the purpose of using them for transactions. Thus, the coins become unusable and forever removed from circulation.
In other words, it is impossible to recover coins after they have been burnt, and the proof of burn can be easily verified on a blockchain explorer. Therefore, burning transactions are public, irreversible and permanently recorded on the blockchain.
(c). Buy Back
In the stock market, companies can use cash on hand to buy back shares of common stock, thereby reducing the outstanding total shares. This process generates scarcity, which helps to improve the price of the shares in the market.
In the same manner, some crypto developers do initiate a systematic Buy Back of their coins off the trading floor of the Crypto Market.
The buy-back coins may then be locked up for future use such as for advertisement or can be sent for burning. Thus, the buy-back reduces the circulating supply, and guarantees scarcity.