Circulating Supply vs Total Supply: Beware Dilution Risk

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Summary:

  • Circulating supply (the number of coins in circulation) and total supply (the maximum number of coins that can exist) are key determinants of a coin’s price.
  • If a coin’s circulating supply is very far off from its total supply, there is a real dilution risk, because the moment more coins are added to circulation, its value will decrease, especially if fresh demand doesn’t come in to prop up the price.
  • The rule of thumb: Ensure that the project you’ve invested in does not have less than 50% of the supply in circulation, otherwise you face dilution risk and a price drop. circulating supply

Investing in crypto successfully requires due diligence that starts with fundamental research. One of the fundamental analysis components that all traders should look at is the circulating supply and the total supply of a coin.

What happens if you buy a coin with a circulating supply of one million, only to see the supply increase to five million, diluting your share by 500%? The tokenomics can make or break a crypto project because they are directly tied to market cap.

If the circulating supply increases, there has to be an influx in cash to retain the market cap. The more coins are added to circulation, the more the value decreases. Conversely, the more coins are burned or removed from circulation, the more the value increases.

This guide will analyze how circulating supply affects crypto prices and what to research in a project. We will also break down examples of the world’s biggest cryptos. By the end of this article, you will know exactly what to look out for in your next crypto investment–at least in regards to circulating supply and total supply.

What Is Circulating Supply?

The circulating supply is the current number of coins that circulate on the blockchain. For Bitcoin, the circulating supply is 19 million and for Ethereum the circulating supply is 121 million.

The circulating supply is always a percentage of the total supply – the higher the percentage, the better. For example, Bitcoin has a circulating supply of 19 million, which is about 90% of the maximum supply of 21 million. This means that Bitcoin’s value can’t be significantly diluted by a deluge of new bitcoins coming into the market.

If the circulating supply is five million and the total supply is 100 million, this means the circulating supply is effectively 5%. This is risky; a holder could be looking at a dilution rate of 95% if they fail to do their research prior to investing.

How to Calculate Circulating Supply?

The circulating supply can be calculated by dividing the market cap by the coin price. The formula is the following:

  • Market Cap / Price = Circulating Supply

For Bitcoin, the $380 billion market cap can be divided by the $20,000 price, producing a result of 19 million BTC.

How to Calculate Market Cap?

The opposite applies if we want to calculate the market cap (total value) by multiplying the circulating supply by the coin price.

  • Bitcoin’s circulating supply is 19 million; multiplied by $20,000, the market cap is roughly $380 billion.
  • Ethereum’s circulating supply is 121 million; multiplied by $1,150 the market cap is roughly $140 billion.
  • Dogecoin’s circulating supply is 132 billion; multiplied by $0.07 the market cap is roughly $9 billion.
  • Chainlink’s circulating supply is 470 million; multiplied by $6.4 the market cap is roughly $3 billion.

Using a market cap and circulating supply calculator such as CoinMarketCap, the market cap calculation is processed automatically.

How Does Circulating Supply Affect Cryptocurrency Price?

Many novice traders assume that just because the price of a crypto is high, it must mean that the project is superior. This may not be the case; it could just mean that the circulating supply is low for now.

Ethereum’s circulating supply is nearly six times higher than that of Bitcoin’s, which is why the price is lower at $1,200 per ETH while Bitcoin is trading at $20,000 per BTC.

The converse is true; just because the price of a crypto is low, it does not automatically mean it’s an inferior project, because the supply might be high. In fact, it may well be a top 20 crypto by market cap.

A great example is Shiba Inu. With a circulating supply of 550 billion, it has a price of $0.0001 per coin. Despite that, the market cap is still relatively high at $6 billion.

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What Is The Total Supply?

The total supply is the maximum amount of coins and represents a limit that cannot be exceeded. The total supply of any crypto is hard-coded in the code, and further mining is not allowed.

For example, Bitcoin’s total supply is 21 million. Bitcoin inflates at a rate of 6 BTC per block at the moment (every 10 minutes), but as the rewards decrease with halvings, the total supply is expected to be only fully mined in 100 years.

Circulating Supply vs Total Supply

Circulating supply is different from total supply because it calculates all coins that are active on the blockchain. Bitcoin’s founder, Satoshi Nakamoto, holds over 1 million BTC, equivalent to $20 billion at the current market. Those coins haven’t been moved in over 10 years, but they are still considered part of the circulating supply.

A sudden increase in total supply can cause significant damage to a project.

The Terra (LUNA) collapse is one example. To re-peg the algorithmic stablecoin UST, the Terra team had to mint new LUNA to back the liquidity of the UST stablecoin. The total supply of LUNA increased from 300 million up to 6.5 trillion in a matter of days. The price went down from $80 down to $0.0001–a fraction of a cent due to the rapid increase in supply, devaluing the project.

This risk is not likely in the case of Bitcoin, as the inflation rate is spread out over 100+ years. The risk of inflation is higher for DeFi coins powered by smart contracts, especially with minting bugs causing the majority of hacks in the DeFi scene.

How Does Burning Decrease Circulating Supply?

Coin burning can cause a jump in price for existing coins because fewer coins are in circulation. The act of burning represents the removal of coins from circulation by sending them to the burn address.

The “burn address” is the first genesis address on a blockchain. The burn address is where coins are sent if they want to be removed from circulation because no one has the private keys and they can’t be retrieved.

Upon sending to a burn address, block explorers such as Etherscan detect a decrease in supply, which is then typically reflected in a price increase. This is how projects such as Shiba Inu decreased their supply significantly and made their project successful.

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What Happens When Circulating Supply Reaches Max Supply?

If the circulating supply and the max supply are equal, this means all coins were released in circulation. The crypto price could go up or down depending on market conditions, but nothing drastic will happen.

For example, the Litecoin circulating supply and maximum supply are identical at 84 million, meaning all LTC were mined. The price of Litecoin fluctuates based on market conditions. During the bull market in 2021, LTC reached an all-time high of $386 and then gradually decreased to $50 in the bear market.

How To Make Investment Decisions Based On Circulating Supply?

To successfully invest in crypto, one must research the ratio between the circulating and total supply. If more than 80% of coins are released in circulation, there is limited dilution coming down the pipeline. If less than 50% of coins are released in circulation, an investor risks dilution and a price drop.

If the circulating supply increases, the market cap doesn’t always follow. Let’s say we double the Bitcoin supply to 42 million. The market cap might remain the same at $380 billion, but the price of Bitcoin could decrease to $10,000 unless there is 2x the amount of cash injected to retain the current market cap.

The rule of thumb: Ensure that the project you’ve invested in does not have less than 50% of the supply in circulation. While the price might appreciate in the short-term, dilution can slash potential gains over the next few years.

Conclusion

The circulating supply and the total supply of a crypto are key determinants of a crypto’s price. These metrics inform investors about the possibility of dilution risk and price appreciation. As such, knowing how to make investment decisions based on circulating supply can be one of the most rewarding early lessons for novice traders to learn.


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