You can think of principality as the -ity ending doing its usual job on principal: it turns being first into a thing you can point at. What you point at is usually a place — the land where the first person, the prince, is in charge. Because a prince stands one step below a king, that land is usually small: one town, a river, a flag, a ruler who signs his own letters. The same root idea of standing first also names a rank in the old order of angels, and in British writing the capital-letter form settles on one country, Wales.