Diving into the fascinating world of cryptocurrency will have you notice that its value is generally considered quite “volatile” compared to its fiat counterpart. The common perception is it has less value since cryptocurrency has no physical form, or that it isn’t technically backed by any commodity to give it value.
The major difference between the two is that cryptocurrencies aren’t supported by any government due to their decentralized nature, despite the fact that money is evolving to no longer having its value backed by physical commodities or “real-world assets,” such as gold in a national bank. Regardless, fiat currencies are still supported by their issuing government body, which helps regulate their value, leaving cryptocurrencies with their volatile characteristic. To better predict their value and assess your risk, you need to know how prices are determined.
How Are Cryptocurrency Prices Determined?
The cryptocurrency market is still a nascent market, and many are still unfamiliar with how the industry works. This kind of market makes it inherently volatile, so it fluctuates quite often.
There is limited liquidity within the market compared to more established traditional economies that include foreign exchange markets. To put things into perspective, the total value of all the money in the world is around $90.4 trillion, with the total cryptocurrency market cap at around $250 billion—that’s a 36,000% difference!
Cryptocurrency trading volumes per day are around the $14 billion mark, while the daily forex trades are close to $5 trillion. This points to a thin market that naturally moves quickly, increasing the volatility of cryptocurrency prices. To help you understand how this works, here are the biggest determinants affecting the price:
1. Supply and demand
The law of supply and demand is a basic economic principle that is considered as the most important determinant of cryptocurrency prices. If a cryptocurrency has a high token supply with little demand from traders and investors, then its value will drop. Conversely, if the supply is limited and the demand is high, the value of the coin will increase.
A cryptocurrency coin must have a strong function or use-case to offer an incentive for owners to hold on to their coins since its utility is strongly correlated with its value. If you use Ether (ETH) to execute commands and develop applications on the Etherium Blockchain, it will be converted into gas and represent the “fuel” for the Ethereum ecosystem. For this reason, ETH is used as a currency within its system to fuel transactions and development. The more people who perform transactions and develop apps, the greater the demand for Ether, which will eventually push prices up.
Scarcity refers to the limited nature of the coins. In terms of economics, a fixed supply of a certain item would increase its value over time, assuming its demand also increases. This creates scarcity since there’s only a limited supply of coins in circulation and certain coins have a fixed maximum supply. Demand will undoubtedly push a coin’s value up, particularly that have great utility. Currently, we’re seeing this happen with Bitcoin, whose market supply is limited to 21 million coins.
4. Perceived value
A coin’s value is dictated by what the markets deem it to be, and how a project is valued is dependent on factors that are core to its development. Therefore, projects that consistently achieve milestones, and have collaborations and partnerships with credible companies or other projects are good signs of expansions. Other factors that can enhance the perceived value of your cryptocurrency includes a successful launch of its minimum viable product (MVP) or beta version of its protocol or software.
Why Do Cryptocurrency Prices Fluctuate (so Much)?
We’ve all been witnesses to how much cryptocurrency prices can fluctuate dramatically. Bitcoin became the poster child for price fluctuation since it was introduced and when it put cryptocurrency on the map during its price surge, hitting its peak value back in 2017.
1. Fluctuation of perceived value
There are many factors at play here, and one of the reasons is the fluctuation of cryptocurrency’s perceived store of value against fiat currency. By design, cryptocurrencies are governed by a decision from its developers of the core technology to limit its production to a fixed amount. This differs markedly from fiat currency, which is managed by governments that try to control its value in line with a country’s economic growth. As economies built with fiat currencies show signs of either strength or weakness, investors can choose to allocate more or less of their assets into cryptocurrency.
2. Security breaches
A cryptocurrency can be volatile when the community exposes security vulnerabilities in an effort to create massive open source responses in the form of security fixes. Coin developers must reveal security concerns to the public, so robust solutions are produced since hacks can drive prices down. It’s only natural that values fluctuate when news about security breaches are released to the public.
3. Bad press
Negative news events involving statements by governments that cryptocurrency is likely to be regulated, bankruptcy, or its use in criminal transactions can scare users. Incidents like these can cause public panic, driving the value of cryptocurrency down rapidly.
4. Rate of adoption
Cryptocurrency’s rate of adoption is rising, along with blockchain technologies around the globe. The market is expected to reach a staggering $2.3 billion by 2021. However, the prices of major coins are falling despite this high rate of adoption. The major reason is risk aversion among investors. The market still isn’t mature enough, and there is a growing concern relating to over-regulation.
At the end of the day, the value of cryptocurrency is dependent on speculation, and this is what’s causing a lot of trades to happen.
This is how speculation works: When someone with a lot of coins sells half his or her stash, the market is flooded with that cryptocurrency. With the supply high, it drives down prices and prompts others to ask: Why are they selling this much coins? Do they know something I don’t?
The bottom line is, the cryptocurrency market is still young and easily influenced by these factors. And with change constant in any industry, cryptocurrency prices are still expected to be unpredictable until there’s a more effective way to see how the trends can be advantageous to your investments.
Once the industry matures, all these elements that cause the prices to become volatile can be addressed. We can have a more precise way to study the trends and have the prescience to invest with less risk than what we have right now.
The good news is, with more risk comes more reward. So, if you’re ready to dive into the crypto trading world, download the BXB cryptocurrency exchange app today!