The Pitfalls of Using CoinMarketCap’s Prices as a Novice Crypto Investor
Originally published on: BTCMANAGER
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March 13, 2019
The cryptoasset price data platform CoinMarketCap is not only the go-to platform for digital asset prices but remains one of the most visited websites on the Internet.
While CoinMarketCap (CMC) has managed to play a vital role in introducing cryptocurrencies to new investors since the early days of the altcoin market, the platform has increasingly come under scrutiny for its lack of professionalism and questionable business practices.
A Problematic Pricing Methodology
Those who have been in crypto for longer than five minutes know not to trust CoinMarketCap’s prices. The main reason for this is its problematic pricing methodology.
To calculate the asset prices you see on its platform, CoinMarketCap takes “a volume-weighted average of market pair prices. […] The rationale for using a weighted average is because in general, markets with higher volume have higher liquidity and are less prone to price fluctuations.”
While CMC does state that it excludes exchanges “if [the exchange’s] price does not seem indicative of a free market price,” the platform seems to happily accept all exchange data fees as they come seemingly without conducting due diligence on the legitimacy of the trading platforms’ data sources. Several exchanges that CoinMarketCap includes for its data feed are small, unregulated exchanges whose data integrity is more than questionable.
“The volume of any cryptocurrency is the total spot trading volume reported by all exchanges over the last 24 hours for that cryptocurrency,” the company states on its website.
CoinMarketCap does mention though that it refrains from using volume data if an exchange “does not enforce a trading fee or otherwise offers significant incentives to trade on the market pair.” However, this does not even come close to filtering out all exchanges that engage in wash trading. Hence, CMC’s volume data is far from representative of an asset’s available liquidity.
It has been reported on numerous occasions that many digital asset exchange volumes are not representative of an asset’s real trading activity and, thus, its actual liquidity. The Blockchain Transparency Insitute has recently published a report highlighting this issue.
Therefore, since CMC puts more weight on prices from exchanges with the highest trading volumes, which are often falsified, the prices on the platform cannot give an accurate representation of the price level a cryptoasset is actually trading.
An Unfortunate History of Promoting Scams
While CoinMarketCap’s history of promoting cryptocurrency scams through banner ads may not have many implications on the quality of its data feed, it would suggest that the company’s leadership ethics are questionable.
As Castle Island Ventures partner, Nic Carter, highlighted in a blog post, CoinMarketCap has run ads for cryptocurrency scams BitConnect, ETHConnect, and BitPetite for which the company has been paid handsomely at the expense of unwitting investors who eventually lost money.
Moreover, CoinMarketCap ranked BitConnect in its top ten cryptocurrencies in July 2017 when the market value of the BCC coin merited an entry. The issue, however, was that the data used to calculate BCC’s market capitalization came predominantly from the Ponzi scheme’s own exchange data feed.
Despite warnings from notable community members, CoinMarketCap did not delist BCC and continued to rank it among the most valuable coins in the market. Additionally, even after BitConnect collapsed, its fraudulent coin was still being priced on CoinMarketCap for another six months.
A Lack of Coin Due Diligence
The CoinMarketCap BitConnect story also highlights the issue of the platform’s complete lack of due diligence for the digital currencies and tokens it lists.
While one may argue that the cryptoasset markets are the pinnacle of free markets and that any tradable asset deserves to have its price listed, the reality is that retail investors – often with little to no investment knowledge – go onto CoinMarketCap to discover new investment opportunities.
By listing effectively every tradable digital asset regardless of how dubious it may be, CoinMarketCap is facilitating potentially fraudulent cryptocurrency projects by introducing them to potential investors.
The number of scam coins that have come and gone, and have been listed on CMC, are in the dozens, if not hundreds. CMC has seemingly made little to no effort to filter out assets that have a high potential of turning out to be scams.
Use CoinMarketCap With Care
CoinMarketCap is an excellent platform if you want a “quick-and-dirty” snapshot of where the market roughly is. However, using CoinMarketCap prices to make trading decisions or, worse, to price financial instruments or value portfolios means opening yourself up to an added layer of risk.
CoinMarketCap’s shortcomings are perhaps most pronounced when it comes to small-cap cryptoassets, where the price listed on CMC is regularly far away from where you can actually trade the asset, especially if you are looking to trade more than a few hundred dollars.
The current pricing methodology deployed by CoinMarketCap combined with its lack of due diligence makes the platform unusable for serious investors. Hence, it is not surprising that a range of new cryptoasset price data platforms have launched in the last few years as financial institutions are searching for trustworthy pricing to build new cryptocurrency-based financial products and solutions.
CoinMarketCap remains the go-to crypto pricing source for retail investors, and this is unlikely to change soon. The platform’s first-mover advantage has enabled it to establish itself as an authority despite its evident shortcomings. For the sake of new investors entering the space, commentators can only hope that CMC cleans up its act and improves the quality of the data it provides on its platform.
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