When speculators talk about token performance, the first metric mentioned is usually market cap. It sounds authoritative. It sounds big. It’s how much the market is worth! Right? (Wrong..kind of)
In our view, market cap is an overhyped metric if liquidity isn’t taken into account. We acknowledge that with each market cycle exists a strong consensus for what counts as a ‘high’ or ‘low’ market cap (which is helpful for broadly sizing up how much room a token has to grow), but the consensus often breaks, especially with meme tokens. Investors are regularly caught off guard by how drastically a token can move, especially when the market cap seems ‘high’.
This is where liquidity reveals more of the truth. It shows what can happen when money flows in or flows out of a specific market. Just like we've developed instincts for reading market caps, we believe the industry needs to adopt a similar intuition around liquidity. Because if you can’t sell, was it ever really worth that much?
Let’s go through a quick example of how much market cap can move.
How a $5,000 Sell Can Drop Market Cap by Over $900,000
Let’s walk through what happens when someone sells $5,000 worth of a token in a scenario with:
- Market cap: $50 million market cap ← what everyone is looking at
- Liquidity: $1 million liquidity pool (50/50 split: $500K in tokens, $500K in USDC) ← this is a 2% liquidity-to-market-cap ratio ($1M liquidity in a $50M market cap token), which if you look at larger tokens, is not unheard of. Some may have 5% liquidity-to-market cap ratios, and many have less than 1%. If any have more than 10% that is VERY good. For this example, we’ll keep it very simple and assume 1 large pool.
- A constant AMM
- Token price: $100
Setup
- Liquidity pool: 5,000 tokens and $500,000 USDC (since token price is $100)
- Circulating supply: $50,000,000 market cap / $100 price = 500,000 tokens
- Constant product: x * y = 5,000 * 500,000 = 2,500,000,000
You sell $5,000 worth of tokens. At $100 per token, that’s 50 tokens.
After the Trade
You add 50 tokens to the pool (because when you sell tokens, you are taking UDSC from the pool, and adding tokens to the pool) → new token balance: 5,050 tokens.
To maintain the constant product:
5,050 * y = 2,500,000,000 (2.5B is the constant product)
y = 2,500,000,000 / 5,050 ≈ 495,049.50
USDC removed from pool:
500,000 - 495,049.50 = 4,950.50
You receive $4,950.50 for your $5,000 sell → slippage = 0.99%
New Token Price
New price = 495,049.50 / 5,050 ≈ $98.03
Market Cap Impact
- Before: 500,000 tokens * $100 = $50,000,000
- After: 500,000 tokens * $98.03 = $49,015,000
Market cap dropped by $985,000 from a $5,000 trade. That is nearly a 2% move from just a $5,000 sell.
Takeaways:
- Even tiny trades can punch way above their weight when liquidity is shallow relative to market cap.
- A $5,000 sell led to a $985,000 drop in market cap. This reveals how inflated market caps can be when it isn’t backed by deep liquidity.
- Always consider liquidity-to-market-cap ratio when evaluating a token. A $50M market cap looks big, but if there is only $1M of liquidity, it doesn’t mean you can sell huge amounts.
NOTE: Yes, not all pools are linear, but generally speaking these moves do happen and yes, there are many many tokens with liquidity ratios like the example above.
That’s why at Solsearch, we put liquidity and market cap side by side, and combine them into one of our favorite metrics: the Liquidity-to-Market-Cap Ratio.
Just like how the market has consensus on what a ‘good’ or ‘high’ market cap is based on the current market environment, we want to uplevel the general public's analysis of tokens by creating a consensus for ‘what is good liquidity’? Since that tells more of the true story.
So what is a ‘good’ liquidity-to-market-cap ratio?
From what we have seen so far, larger market cap should really aim to hold a 10% or high liquidity-to-market cap ratio. Is this good or not? That’s for the market to decide and create a benchmark for what is good. But in today’s market, with people not emphasizing liquidity, 5%+ would be very solid for a $500M+ market cap token, there are plenty of well known ones with less than 1% or 1-2%. Yes, this includes some of our favorite tokens…
All that to say, let’s begin prioritizing liquidity. It’s important and crucial for a stable, reliable market. Why liquidity tells the truth and market cap can be a distraction
