Some people wonder why the prices of bitcoin and other cryptocurrencies fluctuate. Others wonder why these digital currencies are so volatile, yet very valuable. It is not very unlikely to see Bitcoin increase in price or decrease by 5% or even 10%. Some other cryptocurrencies can even have a higher price increase.
In this article, we will look at the various factors affecting the prices of cryptocurrencies, and why they are so valuable and volatile too.
Understanding Cryptocurrency Value
Cryptocurrencies are digital currencies that do not have the backing of central authorities like fiat currencies. The government of countries backs up the fiat currencies used in the country as mediums of exchange.
The truth remains that people have more faith in the value of currencies that are backed by governmental authorities. The faith people have in fiats makes room for large collectors and spenders of the currencies.
Factors Influencing The Price Of Crypto
Cryptocurrencies on the other hand are not centralized. They are decentralized digital currencies, so they will not get their value for the governmental backing of countries primarily.
It means that cryptocurrencies will get their values from other sources, these sources are:
- Supply and Demand of Cryptocurrency
- Production Cost of Cryptocurrencies
- Number of Tradable Exchanges
- Other Cryptocurrency Competitions
Supply and Demand of Cryptocurrency
Just like every other commodity that people use, the value of cryptocurrency rests on supply and demand. If the demand increases and becomes greater than the supply, the price will increase.
On the other hand, the prices will decrease when the supply goes up and becomes higher than the demand. So, when demand is greater than supply, the price of cryptocurrencies will increase.
The mechanism of supply for new and even old cryptocurrencies is usually public. Every cryptocurrency coming into the market will show its plans of minting and burning. This plan is always in the cryptocurrency whitepaper.
Some of these cryptocurrencies have their hard cap or limited supply; for example, Bitcoin. The cryptocurrency has 21 million coins that should be in circulation after the whole mining process is completed.
Some other cryptocurrencies do not have a limited supply or hard cap. An example of a cryptocurrency without a hard cap is Ether.
Some cryptocurrencies use the burning of tokens mechanism to prevent too much circulation of the token and avoid inflation.
To burn a token, some existing amount of that token will be sent to a wallet address that cannot be recovered on the blockchain.
Production Cost of Cryptocurrencies
The only way through which new cryptocurrencies are produced is mining. Mining refers to using computer nodes for new block verification on the blockchain network. The nature of mining on the blockchain is such that miners are decentralized.
It is this decentralization of miners that powers the functioning of cryptocurrencies in a certain way.
When a miner wins the verification process slot and verifies a new block to be added to existing blocks on the blockchain network, the miner is rewarded with a freshly minted token or coin.
It takes a whole lot of computing power for miners to verify new blocks on the blockchain. The various miners have to buy very expensive computers and pay huge amounts of electricity bills to mine and verify these new blocks.
Bitcoin and Ethereum use proof of work to verify new blocks and ‘mine’ fresh cryptocurrencies.
The proof of work is the consensus mechanism of both the Bitcoin and Ethereum blockchains, and this consensus mechanism is highly competitive. For these blockchains, mining in this competitive ecosystem is very difficult.
The competition is usually miners racing against other miners to solve complex mathematical equations.
Anyone who solves the mathematical puzzle is the person who will be qualified to verify a new block, and the person that verifies the new block will be rewarded with cryptocurrencies.
Due to this high level of competition, miners spend a lot of money purchasing powerful devices so that they will increase their computational power. Now, as the process of mining increases, the value of cryptocurrencies also increases.
This directly proportional increase is because miners will not keep mining if the price of the cryptocurrency that they are rewarded with cannot take care of their mining operational expenses.
Number of Tradable Exchanges
A lot of popular cryptocurrencies can be traded on major exchanges. For example, Bitcoin and Ether are in virtually every exchange you can think of. Some cryptocurrencies that are not mainstream are not in all wallets.
Now, if cryptocurrencies are not in exchanges, they will be hidden from the eyes of investors. Now, if a cryptocurrency appears on a lot of exchanges, investors will want to buy it. The more investment going into a cryptocurrency, the more the demand.
You know what happens when the demand is high, the price usually goes up with it.
Other Cryptocurrency Competitions
In the market today, there are thousands of cryptocurrency projects and more are entering the market daily. For new competitors, the entry barriers are very low, but if you must create a cryptocurrency that people will like to invest in, then you must build a community of users.
A new cryptocurrency project with a very good application will gather a community of users faster. Most times, when a new project is built on the limitations of similar existing projects, the community members of the previous project will port to the new project.
With this migration, the new project will begin to gather a lot of traction and a user base. If this new project begins to gain momentum from the existing project, then more people will invest in the project.
More investment shows that the project is in high demand, and the high demand rate will surge the price of the cryptocurrency.
Making better choices of investment when investing in cryptocurrencies is tied to knowing the factors that affect their prices and value.
Once you know the demand and supply law and how it rules the market, you should begin to do your analysis to know which cryptocurrency will surge in value and which will decline.
Also, knowing this market demand and supply rule will help you know when to invest and when to pull out your investment from a token. Remember that no matter how much you get so good at studying these factors, there are factors like governmental regulations that you cannot control.
This factor also contributes to the value of cryptocurrencies, so you have to be smart while investing. Lastly, after all your analysis, do not forget the first rule of the crypto market, “invest what you can afford to lose because the market is a very volatile one.”