If there is one thing we all know about cryptocurrencies, it is that they are volatile. The stories about people making millions during a crypto upswing make the headlines frequently – but so do the stories of people who lose everything during the downswings. Additionally, because there is no physical product or centralized organizing body, it is hard to point to anything and say “see, that good thing happened, crypto values will increase now”. So what determines cryptocurrency value?
In this article, we’ll take a look at what impacts cryptocurrency valuations and what determines cryptocurrency value.
What is Cryptocurrency?
A cryptocurrency is, most simply, a digital asset. It is called a currency because it was created to work as a medium of exchange in the same way that we use fiat currencies now.
Transactions are internet-based and are recorded in a blockchain. The blockchain shows the transaction history for each unit and is used to prove ownership. The digital assets are best visualized as virtual tokens. These tokens mean something to the internal system and can be programmed to record financial transactions and other valuable information.
Its use as a monetary system is still crypto’s most lucrative feature. It allows users to send cryptocurrencies between parties in exchange for goods and services provided. Because cryptocurrencies are not controlled by any central authority, it has unique advantages. There are usually little to no processing fees. There is less government control and regulation. This means that cryptocurrencies are portable, inflation-resistant, and transparent in their transaction history.
Cryptocurrency trading is a new, and growing, feature of the crypto world. Trading is separate from crypto’s use as a monetary system. Instead, users buy and sell cryptocurrencies as they would buy and sell shares of a company. Purchasing stock grants gives you ownership in a company, whereas purchasing a token grants you ownership of that cryptocurrency. In the U.S. tax system, cryptocurrency transactions are viewed in the same way as stock trading transactions. This reflects how most users are making money from the crypto world.
Just as the desirability of its products impacts a company’s share price, the crypto monetary system impacts the cost of crypto trading. The value of a cryptocurrency is primarily affected by its supply, the market’s demand for it, availability, and competing cryptocurrencies.
What determines cryptocurrency value?
Cryptocurrency can gain value on exchange platforms. It increases in value based on supply and demand.
The supply of a cryptocurrency depends on how many new coins are being mined and how many current owners want to sell their coins.
The demand for a cryptocurrency depends on many factors. Demand will be increased based on how useful it is to own the coins. This means if the crypto monetary system works well (i.e. fast transactions and low fees), if smart contracts become more commonplace, and if more businesses start to accept crypto, the demand for crypto will increase. Additionally, there is an increased demand for cryptocurrencies as a store of value investment.
what determines cryptocurrency value? Like any market, the value of cryptocurrencies fluctuates based on the market’s perception of its value at any given time. These fluctuations may be rooted in some of the supply and demand factors mentioned above or can happen as a result of hidden market factors.
What determines cryptocurrency value: How Users Increase Crypto Value?
There are also a few methods how users increase cryptocurrency value –
- Buy low, sell high – using the classic investment strategy, users can increase the value of crypto by buying and holding coins. The buying increases demand and hence crypto value increases.
- Mining – the act of mining Bitcoins or altcoins can be profitable. It also impacts the supply of cryptocurrencies.
- Increasing utility – as more institutions invest in crypto and accept it as a form of payment, its utility increases. As a user, you can contribute to this process. This will increase the value of cryptocurrencies over the long term.
- Media coverage – crypto prices fluctuate according to media coverage. Users can impact this through their social media accounts.
What Are the Different Types of Crypto?
There are already dozens, if not hundreds, of different cryptocurrencies, with more emerging every week. Some of the more well-known cryptocurrencies include:
That said, there are currently three broad categories of cryptocurrency:
Each of these types of crypto will discuss in more detail below.
The original cryptocurrency, Bitcoin, is a capped cryptocurrency. This means after 21 million Bitcoins will mine, no more will mine.
Having a capped currency means Bitcoin can be used as a store-of-value investment tool. Investing in a store of value currency can be compared to investing in gold. Although there is some transactional value in gold, it is mostly used as a store of value.
Bitcoin uses a Proof-of-Work mining system. This means a network of miners computes complex calculations to keep the Bitcoin blockchain running. Miners earn newly minted Bitcoins as a reward for their work. Proof-of-Work allows Bitcoin to attach a physical value to its transactional system. A Bitcoin is worth a certain amount of computing power.
Altcoins are alternative versions of Bitcoins, but with minor changes. They are often a result of a Bitcoin fork. There are many different types of altcoins.
Some major differences between Bitcoin and altcoins can find in the blockchain itself. Also, some altcoins have an uncapped supply, which changes how the coins are used. Some altcoins have made the blockchain faster, which speeds up both mining and transactions.
Altcoins also sometimes differ in the method of verification used to authenticate transactions. While some altcoins use Proof-of-Work systems, others use Proof-of-Stake consensus, which replaces miners with validators. Proof-Of-Stake mining requires a lot less energy and fewer resources than Proof-Of-Work systems since Proof-Of-Work miners have to do much more ‘work’ to mine blocks.
Altcoins can also use to create smart contracts. These smart contracts can automatically execute based upon certain conditions. There is no need for third-party involvement and so they can done immediately. Smart contracts can use in transactions as diverse as property, stock, and gas, making them a very interesting investment.
Tokens have been created to use smart contracts or tokens as a form of currency. They do not have a blockchain and are used on decentralized applications (dApps).
Crypto coins use the process of mining and the resulting blockchain as a physical measure of the currency. This is similar to how Reserve Banks used to have gold reserves that backed their fiat currencies.
Tokens, on the other hand, are not representative of any physical thing. They can use to purchase from the dApps and can use to get discounted fees and voting fees making them increasingly popular. This is similar to the decoupling of fiat currencies from the gold standard.
What determines cryptocurrency value: What Makes Cryptocurrency Go Up or Down?
Cryptocurrency supply and demand
The value of anything determined by supply and demand. If demand increases faster than supply, the price goes up. For example, if there’s a drought, the price of grain and produce increases if demand doesn’t change. The same supply and demand principle applies to cryptocurrencies.
The supply of a cryptocurrency always known. Some, such as Bitcoin, have a fixed maximum supply. Others, like Ether have no cap on supply. Some cryptocurrencies have mechanisms that “burn” existing tokens to prevent the circulating supply from growing too large and slowing inflation. Burning a token means sending them to an unrecoverable address on the blockchain.
The monetary policy of each cryptocurrency is different. Bitcoin supply increases by a fixed amount with each new block mined on the blockchain. Ethereum offers a fixed reward per block mined, but it also pays out for including “uncle blocks” in the new block, which helps facilitate the efficiency of the blockchain. As a result, the supply increase isn’t as fixed. Some cryptocurrency supplies dictated entirely by the team in charge of a project, which can opt to release more of a token to the public or burn tokens to manage the money supply.
Cryptocurrency supply and demand
Demand can increase as a project gains awareness or as utility increases. Broader adoption of a cryptocurrency as an investment also increases demand while effectively limiting the circulating supply. For example, when institutional investors started buying and holding Bitcoin in early 2021, the price increased significantly as demand outstripped the pace at which new coins created, effectively decreasing the total available supply of Bitcoin.
Likewise, as more decentralized finance (DeFi) projects launch on the Ethereum blockchain, the demand for Ether increases. Ether requires to perform transactions on the blockchain regardless of what cryptocurrency you’re transacting with. Or, if a DeFi project takes off itself, its own token will become more useful, thereby increasing demand.
Cost of production
New cryptocurrency tokens produced through a process called mining. Mining for cryptocurrency involves using a computer to verify the next block on the blockchain. The decentralized network of miners is what allows cryptocurrency to work as it does. In exchange, the protocol produces a reward in the form of cryptocurrency tokens, in addition to any fees paid by the exchanging parties to the miners.
Verifying the blockchain requires computing power. Participants invest in expensive equipment and electricity in order to mine cryptocurrency. In a proof-of-work system, like those used by Bitcoin and Ethereum, the more competition there is for mining a certain cryptocurrency, the more difficult it is to mine. That’s because miners essentially race each other to solve a complex math problem in order to verify a block. As such, the cost to mine increases as more powerful equipment needs to successfully mine.
As mining costs increase, it necessitates an increased value of the cryptocurrency. Miners won’t mine if the value of the currency they’re mining isn’t high enough to offset their costs. And, since miners are essential to making the blockchain function, as long as there’s demand for using the blockchain, the price will have to go up.
Mainstream cryptocurrencies such as Bitcoin and Ether trade on multiple exchanges. Just about any cryptocurrency exchange will list the most popular tokens.
But some smaller tokens may only be available on select exchanges, thus limiting access for some investors. Some wallet providers will aggregate quotes for swapping any set of cryptocurrencies across several exchanges, but they’ll take a fee for doing so, increasing the cost of investing. Furthermore, if a cryptocurrency thinly trade on a small exchange, the spread the exchange takes may be too big for some investors.
If a cryptocurrency becomes listed on more exchanges, it can increase the number of investors willing and able to buy it, thus increasing demand. And, all else being equal, as demand increases, the price goes up.
There are thousands of different cryptocurrencies in existence, with new projects and tokens launching every day. The barrier to entry is relatively low for new competitors, but creating a viable cryptocurrency also relies on building a network of users of that cryptocurrency.
A useful application on the blockchain can quickly build a network, especially if it improves upon a limitation of a competing application. If a new competitor gains momentum, it takes value from the existing competition, thus sending the price of the incumbent down as the new competitor’s token sees its price move higher.
Cryptocurrency networks rarely abide by a static set of rules. Developers adapt projects based on the community that uses them. Some tokens — governance tokens — give their holders a say in the future of a project, including how a token mined or used. In order to make any changes to the governance of a token, there needs to be consensus among stakeholders.
For example, Ethereum is working to update its network from a proof-of-work system to a proof-of-stake system, effectively rendering much of the expensive mining equipment in data centers or people’s basements useless. That will undoubtedly have an impact on the value of Ether.
Generally speaking, investors like stable governance. Even if there are flaws in the way a cryptocurrency operates, investors prefer the devil they know to the devil they don’t. As such, stable governance where things are relatively hard to change can be of value by providing more stable pricing.
On the other hand, the slow process of updating software to improve protocols can limit the upside of cryptocurrency values. If an update would unlock value for cryptocurrency holders but takes months to execute, it hurts the current stakeholders.
Regulations and legal requirements
There’s some confusion about who should regulate the exchange of cryptocurrencies. The Securities and Exchange Commission (SEC) says cryptocurrencies are securities like stocks and bonds, while the Commodity Futures Trading Commission (CFTC) says they’re commodities like coffee or gold.
Both can’t claim regulatory authority over cryptocurrency exchanges. A determining ruling could provide greater clarity and improve cryptocurrency values while opening the door for more widely traded crypto-related financial products.
Regulation requires to allow for easier ways to trade cryptocurrency. Products such as ETFs or futures contracts provide more access to cryptocurrency for investors, increasing its value. Additionally, regulation could enable investors to take short positions or bet against the price of cryptocurrencies with futures contracts or options. That should produce better price discovery and reduce the volatility of cryptocurrency pricing.
Regulations could also negatively impact demand for cryptocurrency. If a governing body changes the rules to disfavor cryptocurrency investment or use, it could send the price of cryptocurrencies lower.
What determines cryptocurrency value: Finding value in cryptocurrency?
If you understand the core principle of supply and demand behind what gives cryptocurrency value and the factors influencing them, you can make better cryptocurrency investment decisions. If you believe demand is going to increase for reasons X, Y, and Z and don’t think supply will keep up, that cryptocurrency could be a good investment. But be aware that governments still don’t have best practices for regulating cryptocurrency, which makes it a particularly risky and volatile investment no matter what.
The Bitcoin network introduced to the world in 2009 by an unknown individual or group called Satoshi Nakamoto. In 2021, there are more than 10,000 different projects in the field of cryptocurrencies. Each of them have its role in building the future of money.
The market value of cryptocurrencies reached $ 1 trillion for the first time in January 2021. It passed $ 2.5 trillion in less than three months later. It shows that this market is one of the growing markets in the favor of its investors.
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