What is bitcoin dominance and how does it affect investor portfolios?

[TL; DR]

🔹 Since bitcoin is the most popular cryptocurrency most traders base their strategies on its price performance.

🔹 We calculate bitcoin dominance by dividing the bitcoin market cap by the total crypto market capitalization.

🔹 During an altcoin season prices of most cryptocurrencies rise resulting in a lower bitcoin dominance index than before.

🔹 During a bear run the bitcoin dominance rises.


Introduction

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The crypto market is different from the stock market because of the high volatility of cryptocurrencies. Due to the risks arising from price instabilities, experts in the crypto sector have devised various technical analysis tools to track changes in prices of cryptocurrencies and the overall market direction. bitcoin dominance is one of the tools we use to analyse trends in the crypto market. In this post, we discuss factors that affect bitcoin dominance as well as how investors can use it.




What is bitcoin dominance?

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bitcoin dominance is a ratio of bitcoin market capitalization to the total crypto market capitalization. It gives us the relative value of bitcoin in the entire cryptocurrency market. People give much significance to bitcoin because it was the first cryptocurrency and it is the number one digital coin in the sector. As a result, many investors include BTC in their crypto investment portfolios.

Due to its dominance in the market, many investors base their trading strategies on its price performance. This is because the performance of other cryptocurrencies is related to that of bitcoin, a reason why the entire crypto market gets into a bull market if BTC rallies for a long period. Conversely, if BTC gets into a prolonged bear run the entire crypto market follows suit.


How to calculate bitcoin dominance?

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In order to calculate bitcoin dominance one should have the BTC market capitalization and the total crypto market capitalization. To get the BTC market capitalization, we simply multiply its current supply by its market price. On the other hand, we get the total crypto market capitalization by adding the individual cryptocurrency’s market capitalization. However, people rely on special software to calculate it.
Once the market capitalization of BTC and the total crypto market capitalization are available, we use the following formula to calculate the bitcoin dominance index.

bitcoin dominance = bitcoin market cap/ Total cryptocurrency market cap.





Why does the market put more significance on BTC than any other cryptocurrency?

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As a result of its popularity, novice crypto traders buy, hold and sell BTC. Interestingly many people are more aware of BTC than any other cryptocurrency. This is because many individuals and institutions invest in it.

The other reason for its popularity is that it exists on every crypto exchange which increases its exposure. In addition, it has the largest market capitalization, something which lures investors to it as they believe that a cryptocurrency with a large market capitalization is less risky than the ones with lower market caps. Also, due to its finite supply and halving mechanism, BTC is deflationary in nature.


Factors that influence the value of bitcoin dominance

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When BTC was the only cryptocurrency in 2009 its bitcoin dominance was 100%. However, as more cryptocurrencies were introduced into the market, the value of the index has decreased over the years. In 2017, bitcoin dominance reached a high of 95%. However, in 2018 the bitcoin dominance fell to 37.64% because of the ICO boom and the increasing popularity of major altcoins such as ETH and Solana.


Factors that influence the bitcoin dominance index

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There are several factors that influence the value of the bitcoin dominance index. These include the greater adoption of stablecoins and the emergence of new cryptocurrencies.


Increase in adoption of stablecoins

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Since the inception of stablecoins, their popularity has been increasing as they hedge against falling prices of other cryptocurrencies. For example, during bear markets, investors purchase stablecoins to maintain the networth of their investments. As such, they do not convert their crypto holdings to fiat money. On the other hand, the investors convert their stablecoins to BTC or other altcoins during bull markets.


The introduction of new cryptocurrencies

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Many organizations introduced new cryptocurrencies over the years.Therefore, as more new coins and tokens come onto the market the value of the bitcoin dominance index decreases. Nevertheless, if some of these cryptocurrencies lose their popularity or if they collapse the value of the bitcoin dominance index increases.


Change in the price of BTC

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Since the supply of BTC does not significantly change, the rise or fall of its price affects the value of the bitcoin dominance index. For instance, if the value of BTC falls while that of major cryptocurrencies remain constant or rise, the bitcoin dominance index decreases. In contrast, if the price of BTC increases while that of major cryptocurrencies remain constant or decrease, the bitcoin dominance index increases.


How to use the bitcoin dominance in trading

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As an indicator, bitcoin dominance serves several purposes.

Changes in bitcoin dominance can indicate the onset of an altcoin season. During the altcoin season prices of most alternative cryptocurrencies rise. We denote this by a fall in bitcoin dominance. When this happens investors tend to invest more in altcoins rather than BTC. Thus, the bitcoin dominance index helps traders to adjust their investment portfolios.

Traders can use bitcoin dominance extremes to trade. Currently, the extremes are 75% on the upper side and 35% on the lower side. These limits were established during the periods 2017 to 2021. If the bitcoin dominance is closer to 75% it is an indication that the price of BTC could fall at any time. Therefore, traders look for selling signals.

On the other hand, if it is closer to 35% we expect the price of BTC to rise at any time. Thus, traders look out for buying signals.
The bitcoin dominance also helps us to spot the onset of bear run and bull markets. This is because during bull markets the demand and popularity of altcoins increase leading to a decrease of the bitcoin dominance index. As a result, investors reduce their BTC holding and increase the amount of altcoins they own.

The opposite is true, during a bear run the bitcoin dominance index rises.This is because investors purchase more BTC than before due to the decrease in prices of most altcoins. Therefore, investors would rather hold BTC than altcoins.


Conclusion

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The bitcoin dominance index helps to predict changes in market trends which helps investors to adjust their investment strategies. Basically, the bitcoin dominance index falls during bull markets and rises during bear ones.



Author: Mashell C., Gate.io Researcher
This article represents only the views of the researcher and does not constitute any investment suggestions.
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