If there is one thing that all cryptocurrency users agree on, it is that they are prone to volatility. The news is regularly filled with tales of people who made millions during a crypto upswing and those who lost everything during the downswings. This might have got you wondering about the variables deciding the value of cryptocurrencies.
Numerous factors contribute to the value of cryptocurrencies. Some of them are:
1. Supply and Demand
The amrket forces of supply and demand for cryptocurrencies determine their value. Price increases when demand exceeds supply. Grain and produce prices, for instance, will increase in a drought if demand remains the same. The same principles of supply and demand apply to cryptocurrencies.
This is a simplified explanation of the process; once the bulk of the coins has been mined, the mining rate slows, and the total supply is only refilled to make up for lost units. You’ll realize that prices are influenced by supply and demand if you have a rudimentary understanding of economics.
2. Production Cost
To create fresh cryptocurrency tokens, one must engage in mining. Using a computer to check the following block on the blockchain is a process known as cryptocurrency mining. A decentralized network of miners is responsible for enabling cryptocurrency to run. The protocol generates a reward from the trade in the form of cryptocurrency tokens plus any commissions paid by the trading parties to the miners.
To validate the blockchain, you need computing power. Participants must shell out for pricey hardware and electricity to mine cryptocurrency. A proof-of-work mechanism, like the ones employed by Bitcoin and Ethereum, makes mining cryptocurrencies increasingly challenging the more people to compete. This is so because miners compete to find the solution to a challenging maths problem to verify a block.
3. Political Factors
Rarely do cryptocurrency networks adhere to a strict set of regulations. In response to suggestions from the public, developers alter their projects. For instance, governance tokens allow holders to influence how a token is created or utilized in the future of a project. Before any modifications to a token’s governance are implemented, stakeholder consensus is necessary. Investors favor an efficient government.
As a result, stable governance might be advantageous in areas where it is difficult to change since it can lead to more stable pricing.
4. Crypto Exchanges
Two well-known cryptocurrencies, Bitcoin and Ether, are exchanged on several exchanges. Almost every cryptocurrency market lists the most well-known tokens. On the other hand, some smaller coins might only be accessible through a select few exchanges, restricting access for some investors.
Some wallet providers may compile prices for a given group of cryptocurrencies from many exchanges, but they will impose a fee for doing so, increasing the cost of investing.
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5. Legal Factors
The environment surrounding cryptocurrencies is mostly uncontrolled and has a reputation for being bereft of boundaries and rules. It is not subject to the same government-imposed limitations as other currencies and can be used freely across borders because of its lack of regulation.
However, it also implies that using and trading Bitcoin might lead to criminal prosecution in most financial jurisdictions. There is less liquidity and more volatility in the ecosystem due to the overwhelming majority of institutional investors’ continued reluctance to invest in the asset class.
6. Relative Competition
There are thousands of distinct cryptocurrencies, and new initiatives and tokens are introduced daily. Although there is a low entry barrier for new rivals, building a successful cryptocurrency also requires the growth of a user network. In particular, if it fixes a weakness in a rival application, a beneficial blockchain application can expand a network quickly.
When a new rival acquires popularity, the value of the incumbent is diminished, which lowers the incumbent’s price while raising the price of the new rival’s token.
7. Inflation
A fiat currency’s value would decline if the price of bitcoin increased concerning it. This is because using your Bitcoins to purchase more of that currency will be advantageous. Since the FED, ECB, and other central banks have been producing money at an increasing rate and maintaining artificially low-interest rates, this phenomenon is still present today.
8. Number of Nodes
A cryptocurrency’s value can be accurately predicted by its node count. Node count measures the number of active wallets on the network that can be found by searching the internet or a currency’s home page. One can look up a cryptocurrency’s node count and total market capitalization to determine whether or not it has a fair price. Then, compare those two metrics to those of other cryptocurrencies.
Final Thoughts
To put it in a nutshell, the two most crucial elements are supply and demand. Like any currency, community participation determines how valuable cryptocurrencies are. A cryptocurrency’s value goes up if there is a greater demand. Additional factors are politico-legal determinants and perception of the coins.
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