With the explosion in the number of cryptocurrencies on the market to choose from as investment tools, traders are constantly looking for tools and ways to determine trends in the crypto world. The Bitcoin dominance ratio is one tool that can help traders determine the market conditions for Bitcoin and other coins. When used correctly, Bitcoin dominance can help you determine whether trading altcoins is a better trend than trading Bitcoin. In this article, we will discuss what Bitcoin dominance is, what affects this metric’s ratio, and strategies that you can implement in crypto investing using the Bitcoin dominance ratio.
What is Bitcoin Dominance?
Bitcoin dominance is the ratio of Bitcoin’s market cap to the market capitalization of the entire cryptocurrency market. When we compare this ratio to Bitcoin itself, we can learn about the many possibilities in the current market situation. To understand the concept of Bitcoin’s dominance, traders must understand what market capitalization is and why it is so important.
What is Crypto Market Capitalization?
With cryptocurrencies like Bitcoin, market capitalization is the total value of all coins currently mined and circulating in the market. Market capitalization is calculated by multiplying the number of coins circulating by the current price of a coin in the market. For example, in November 2021, the number of Bitcoins on the market reached approximately 18,881,000. At that time, the market price of Bitcoin was US$60,000 . Therefore, the market capitalization is 18,881,000 x 60,000 = 1,133,000,000,000. Thus the total value of Bitcoin on the market is US$1,133,000,000,000.
The total market value of Bitcoin is meaningless until you compare it to the market capitalization value of other coins. For example, the total value of gold in the market is US$10 trillion. So we can say that the value of gold is 11% of the value of Bitcoin. From there, investors can determine whether investing in Bitcoin will be more profitable or detrimental in the future.
One of the advantages of cryptocurrencies is how easily we can determine how many coins are on the market, and their current price. As a result, determining the market capitalization of the entire crypto market is very simple, and we can visualize it through a graph.
Relationship Between Bitcoin Dominance and Market Capitalization
Bitcoin dominance uses the market capitalization of BTC coins and the total number of coins on the market for its calculation formula. Here is the Bitcoin dominance ratio calculation: Bitcoin Market Capitalization/Overall Cryptocurrency Market Capitalization.
In general, the shape and direction of the total capitalization of the crypto market will follow Bitcoin. This is due to Bitcoin’s strong influence on the overall market as the largest cryptocurrency and the first to be created. As investors and traders, we know that the general public understands only a fraction of the knowledge of the crypto market. That’s why most are familiar with Bitcoin as the only cryptocurrency on the market. As a result, when crypto market demand increases, the overall asset value of Bitcoin and other coins tends to increase, driving the market capitalization higher. When the crypto market is risk-averse, the largest cryptocurrencies are liquidated, reducing the overall market capitalization.
Below is an overview of Bitcoin’s market capitalization, the overall crypto market capitalization, and the Bitcoin dominance ratio.
Factors affecting Bitcoin dominance (chart)
In the early days of cryptocurrencies, Bitcoin’s dominance reached 95% or more, as there was little market interest in other available coins. However, Bitcoin’s dominance diminished once other coins began to attract market attention.
For example, when the initial coin offering (ICO) trend began to increase in 2017, investment in other coins grew, and Bitcoin’s dominance dropped to 35%. In early 2018, Bitcoin’s dominance increased again to 70% as many other coins in the market declined. In early 2021, Bitcoin’s dominance decreased again because investment in other coins increased based on negative sentiment towards Bitcoin’s network energy usage. And China’s decision to ban Bitcoin mining caused it to decrease even further.
Let’s look closely at the formula that produces the Bitcoin dominance ratio figure. We will see that there are two variables in the calculation: Bitcoin’s market capitalization and the total market capitalization of other coins. These two things affect the movement of Bitcoin’s dominance in the market.
Bitcoin Price Fluctuations
Bitcoin’s market capitalization is a major factor in its dominance in the crypto market. Since the amount of Bitcoin rotating in the market tends to be stable and does not grow on a large scale, the biggest influence on Bitcoin’s market capitalization is its price.
The relationship between the Bitcoin price and market capitalization can be seen in the figure above. Notice that the market capitalization moves with the price of Bitcoin. As the price increases, its market capitalization increases accordingly.
However, just because Bitcoin’s market capitalization is higher, it does not mean that its dominance in the market has increased. Bitcoin’s market capitalization is just one of the factors of Bitcoin’s dominance.
Altcoin Fluctuations in Market Capitalization
Another factor of Bitcoin’s dominance is the capitalization of all cryptocurrencies in the market. This factor is a little more difficult to account for with the sheer number of cryptocurrency assets in the market. There are currently over 12,000 cryptocurrency assets, which is quite a large number to keep track of easily. Fortunately, some websites have this metric automatically built in.
There was a time when as the Bitcoin price trend increased, there was a significant increase in the Bitcoin market capitalization. But, there are times when the market capitalization of all other cryptocurrencies increases faster than Bitcoin.
In the image above, you can notice how the first trend looks bigger and stronger than Bitcoin’s market capitalization growth on the right. This shows that the collective evaluation of altcoins is increasing faster than the valuation of Bitcoin, implying that altcoins strongly influence the total market capitalization. Then after the correction, the trend on the left (the blue one) continues to increase rapidly compared to Bitcoin’s market capitalization (the graph on the right). As a result, the proportion of the total crypto market valuation attributable to Bitcoin has been diluted and become smaller.
How to Trade Crypto Using BTC Dominance
There are several ways to use the Bitcoin dominance index for profit. We can use this ratio to determine which assets are stronger and more profitable to trade. We can also anticipate extreme readings and trade the pivots of the ups and downs.
Strategy 1: Using BTC dominance to Determine the Strongest Trend (table)
Traders can use the Bitcoin dominance ratio to determine if the Bitcoin trend is stronger or if investing in other coins is a better decision. Bitcoin dominance identifies which trends will perform better than others so that traders can make an informed decision. Here are the steps that can be taken:
- Determine the trend of the Bitcoin dominance ratio.
- Determine the trend of the Bitcoin market at the same time.
- Use the factor table to determine the right strategy.
Strategy 2: Trading Extreme High and Low Readings
Between 2018 and 2021, Bitcoin’s dominance fluctuated from 35% to 74%. With the crypto world constantly evolving, there is a chance that this index number will not increase more than 74%. On the other hand, a Bitcoin dominance ratio below 35% illustrates that the total value of other coins is growing compared to Bitcoin.
Another strategy that can be considered is to trade the corresponding market when the ratio reaches extremes. When existing ratios reach extremes, there is a risk of changes in the direction of the ratios. Thus, when the ratio reaches a reading that is too high, the market ratio is at risk of declining. On the other hand, a very low reading may increase Bitcoin’s dominance.
The simple reason is that investors will measure the value of a cryptocurrency based on its peers. Bitcoin’s potential appreciation and value may be higher if investments have been flowing into altcoins for some time.
Traders can use the table below to determine which markets to focus on when BTC dominance is at risk of reversal.
By definition, it is very rare for Bitcoin dominance to reach these historical highs and lows. However, it can offer some good trading opportunities when the ratio reaches extreme levels. Still, it’s important that you manage your risk, as the ratio has been known to break through these historical levels.
Is Bitcoin Dominance a Reliable Indicator?
The crypto market is a complex ecosystem. No system can be simplified and used as a single indicator. Bitcoin dominance is one possible benchmark in describing the current state of the market environment. As a result, relying solely on the Bitcoin dominance index will result in inconsistent assessments.
One drawback is that the number of altcoins has recently proliferated, dragging the dominance ratio lower. Therefore, we cannot have a large amount of historical data to identify recurring trends. Moreover, if the number of altcoins continues to grow,, the ratio will become smaller and smaller, reaching a new low. If this happens, the Bitcoin dominance index may no longer be applicable.
The Bitcoin dominance ratio is a good tool to help you understand trends in the crypto market. Depending on the Bitcoin dominance ratio trend, and the Bitcoin price, a trader can determine whether the stronger trend is with altcoins or Bitcoin. Bitcoin dominance is not without its limitations. Since the crypto market is still very new, many more altcoins will likely come in the next few years, making the index obsolete. But at least for now, it can help traders better understand the state of the crypto market.