The one thing we can all agree on about cryptocurrencies is that they are volatile, with dramatic price fluctuations sometimes occurring within a short period. We frequently read about people who made millions during a cryptocurrency upswing - but we also read about people who lost everything during crypto downswings.
Furthermore, since there is no physical product or centralized organizing body, it is hard to point to anything and say "See, that good thing just happened, crypto values have increased now".
In this article, we'll take a look at what impacts cryptocurrency valuations and how does cryptocurrency gain value.
What is Cryptocurrency?
In simple terms, a cryptocurrency is a digital currency that is designed to work as a medium of exchange over a computer network and is not controlled by any central authority, such as a government or bank.
It is a tradable digital asset or digital form of money, built on blockchain technology that only exists online.
An individual's coin ownership records are stored in a digital ledger, which is a computerized database that uses strong cryptography to protect transaction records, control the creation of additional coins, and verify that ownership has been transferred which is also known as a blockchain.
Transactions are internet-based and are recorded in the 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.
Cryptocurrencies, despite their name, are not necessarily considered currencies in the traditional sense, and while they have been classified in varying ways, including as commodities, securities, and currencies in the past, cryptocurrencies are viewed to be distinct assets in practice.
The value of a cryptocurrency is primarily affected by its supply, the market's demand for it, availability, and competing cryptocurrencies.
Why Traditional Currencies Have Value?
There are six key attributes to a useful currency: scarcity, divisibility, acceptability, portability, durability, and resistance to counterfeiting (uniformity). These qualities allow a currency to find widespread use in an economy. They also limit monetary inflation and ensure that the currencies are secure and safe to use.
Currency is useful if it works as a store of value or, to put it differently, if it can reliably maintain its relative value over time. Throughout history, many societies used commodities or precious metals as methods of payment because they were considered to have a relatively stable value.
How Does Cryptocurrency Gain 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. Supply is fundamental to determining an asset's price. Something scarce will likely have a much greater value than something widely available.
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.
El Salvador became the first country to make Bitcoin legal tender on September 7, 2021.7 The cryptocurrency can be used for any transaction where the business can accept it. The U.S. dollar continues to be El Salvador's primary currency.
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.
Many cryptocurrencies gain value as a result of new developments or technological improvements to pre-existing infrastructure. Hard and soft forks, for example, can create buzz around a coin, altering traders' perceptions. In August 2017, the forking of Bitcoin's blockchain into Bitcoin Cash resulted in significant volatility, but also new highs for the valuation of both coins.
Similarly, in August 2021 the price of Ether jumped before and after the London fork, which was one of the biggest upgrades to Ethereum's blockchain in its six-year history. Bullish traders buoyed the value of Ether in the weeks leading up to the London hard fork, while its value surged 8% following the network upgrade.
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.
One of the biggest issues is cryptocurrency's status as a store of value. Cryptocurrency's utility as a store of value depends on how well it works as a medium of exchange. If cryptocurrency does not achieve success as a medium of exchange, it will not be useful as a store of value.
Throughout much of its history, speculative interest has been the primary driver of cryptocurrency's value. Cryptocurrency has exhibited the characteristics of a bubble with drastic price run-ups and a craze of media attention. This is likely to decline as cryptocurrency continues to see greater mainstream adoption, but the future is uncertain.
Conclusion
In the ever-changing world of crypto, assets can rise and fall with striking alacrity. Many factors influence the extent to which any given cryptocurrency gains value, from supply and demand, cost of production, availability on exchanges, competition, governance and regulation, celebrity endorsements, and the ripple effects of anonymous whales. And then there are always unforeseen intangibles, which can yield unexpected surges.
If crypto's volume of transactions continues to increase, while volatility settles, keep an eye on long-term value and mass adoption, which could have a lasting impact on the future of both cryptocurrencies and fiat currencies.