The reason I love cryptocurrencies is that they are decentralized and are not controlled by any central organization. Since cryptocurrencies typically have a fixed supply, devaluation via inflation is often very unlikely.
How then, is the value of a crypto largely determined? Its value is dependent on general characteristics such as the number of individuals trading, its popularity, etc.
What are the biggest determinants of the price of the cryptocurrency?
Factors such as inflation rates, monetary policy, and economic growth are not going to affect cryptocurrencies as they are not issued by any central authority or backed by a Government. The price of the cryptocurrency is determined by the following factors.
- Public and Media
Media and Public opinion have a very huge impact on the price of the cryptocurrency. The price of any particular crypto coin takes a dip if the token or the platform gets negative publicity. On the other hand, if the same coin receives good media coverage or gets support from a high-profile person — such as Elon Musk — the price of the cryptocurrency is certainly going to increase. This means the prices are heavily influenced by hype and people’s emotion.
- Supply and Demand
Being a basic economic principle, Supply and Demand is the most important factor in determining the price of the cryptocurrency. If there is a high supply of tokens and only little demand from traders, then there is a drop in the price of the cryptocurrency. Similarly, if the demand for the cryptocurrency is high and the supply is limited, then the price of the cryptocurrency increases.
The scarcity element determines the Supply and Demand cycle. It is responsible for driving up the price of cryptocurrency. The same factor was responsible for the rise in the price of Bitcoin.
- Cost of Production
Since cryptocurrencies are virtual, you may be wondering how there is a “production” cost involved. Though they are digital assets, they are nonetheless produced and incur a real cost, and electricity consumption is by far the most important contributor to this. The ‘mining’ of cryptocurrency relies on a complicated cryptographic math problem that miners all compete to solve. The first person to do so will be rewarded with a block of newly minted crypto coins.
The unique thing about cryptocurrencies is that, unlike other goods, the mining algorithm allows only a certain number of blocks/minutes to be found on an average. Therefore, the more the miners, the more difficult the problem gets to be solved, thus, making it more expensive.
While Bitcoin is one of the well-known cryptocurrencies and is still the dominant option concerning market capitalization, there are other coins such as Ethereum (ETH), Tether (USDT), etc., that are the closest competitors as of March 2021. Due to lesser entry barriers, new Initial Coin Offerings or ICOs are constantly on the horizon. The widespread competition in the crowded field of cryptocurrencies keeps the prices down.
- Availability on Exchanges
Just as equity investors trade stocks over indexes like the NYSE, Nasdaq, and the FTSE, cryptocurrency investors trade cryptocurrencies over Coinbase, Binance, CGCX and other exchanges. Similar to traditional currency exchanges, these platforms let investors trade cryptocurrency/currency pairs (e.g. BTC/USD or Bitcoin/U.S. dollar). The more popular an exchange becomes, the easier it may draw in additional participants to create a network effect. And by capitalizing on its market clout, it may set rules governing how other currencies are added.
- Regulations and Legal Concerns
Due to the increasing popularity of cryptocurrencies, regulators have started getting concerned about how to classify these digital assets. While few of them classify cryptocurrencies as securities, few other bodies consider them to be commodities. The confusion caused by these uncertainties, set by different regulatory bodies, is responsible for the change in the prices of cryptocurrencies over time.
Let me give you an example of the price of Bitcoins. If I had bought Bitcoins worth 100 euros 10 years ago and sold them in 2013, I could have made 120,000,000 euros. What is the reason for such a huge variance in the price of Bitcoins?
As I have mentioned before, the price of the cryptocurrency is determined by its sale, supply and demand, and user activity. But we can’t deny the fact that the trust of the users has marked the evolution of its value over time.
There is no single price that can be assigned to any cryptocurrency, but the multiple factors that have been mentioned have the potential either to hike up the price or bring it down. In this dynamic world that we live in, multiple factors can impact the rise and fall of the price we set to everything. This sometimes happens even though we are not aware of it, and this happens with cryptocurrencies.