The growing popularity of cryptocurrencies has led many to question their long-term viability. The digital electronic currency appeared on the market relatively recently, but during its existence it has become an integral part of the global economic model. Let’s take a look at what the price of cryptocurrencies depends on.
Cryptocurrencies vs. fiat money
The prices of digital and traditional currencies are shaped by similar factors. Neither cryptocurrencies nor fiat money are backed by gold, commodities or other assets with an underlying value. The fundamental difference between cryptocurrencies and fiat currency is that the latter is backed by national governments and is legal tender.
Many countries have a fiat currency system in which the money supply is regulated by the central bank and foreign exchange reserves. Thus, these institutions can indirectly influence inflationary processes. Cryptocurrencies, on the other hand, are not under the control of national governments or other bodies. Moreover, they are not recognized as legal tender in most countries. In addition, cryptocurrencies usually have a fixed issuance volume, which makes it impossible for them to depreciate due to inflation.
In general, the principles of value creation for fiat and digital currencies are similar. Both can be used as a means of payment for the purchase of goods and services and, to some extent, as a means of accumulation.
Why are cryptocurrencies so volatile?
When talking about the cryptocurrency market, volatility is often referred to. Cryptocurrency volatility refers to the degree to which its price fluctuates. Price charts show constant ups and downs. The difference between the upper and lower price limits is an indicator of the volatility of a cryptocurrency.
Basically, the volatility of cryptocurrencies is calculated over a certain period of time. This period can be as long as you want: a week, a month, a year. But few people calculate volatility for a period shorter than a month, because during, say, a week, the price can only rise or fall. Based on the monthly volatility, you can draw conclusions, but for making predictions or trading strategies, the volatility for several months or a year is most often used.
A small-cap cryptocurrency can fall or rise 50-100% because of one news item or a few big traders. But the volatility of multibillion-dollar currencies is also high because they have a large trading volume, and that volume in turn implies a large number of traders, each trying to influence the price as much as possible.
Factors affecting the price of cryptocurrencies
Let’s take a closer look at the reasons that can influence pricing.
Supply and Demand
Supply and demand is a universal principle that determines the valuation of any potential currency or commodity that has an objective value. As more and more people have started investing in cryptocurrencies (and continue to do so), the price of the commodity has risen as it has gained more support and respect.
Supply and demand are volatile and can depend on many small factors surrounding the market as well as the parameters necessary for a cryptocurrency to function.
Not all digital money has issuance limits. For example, the next generation of proof-of-stake blockchain-based coins has no limits. There, the limits are replaced by “burning” of excess money to control inflation. If a coin’s supply is limited or demand is high, it causes prices to rise. Those willing to buy compete with each other, offering even higher prices. When interest wanes, prices fall as well.
Although bitcoin is the best-known cryptocurrency, there are hundreds of other tokens competing for money from cryptocurrency investors and speculators. While bitcoin continues to dominate trading in cryptocurrency markets, its position becomes weaker over time. Cryptocurrencies such as Etherium, Ripple, Cardano and others based on second- and third-generation blockchains have long supplanted bitcoin. Alternative cryptocurrencies are moving toward more advanced algorithms and standard integration into the smart contract ecosystem.
Cryptocurrencies have gained the status of a free currency. It is a borderless ecosystem, operating independent of central regulation. This regulatory status has its advantages and disadvantages.
For example, the lack of regulation means that cryptocurrencies can easily be traded around the world. They can be stored, for example, on a smartphone, USB drive or online wallet and never have to worry about borders and controls. But ” hidden” money can’t be easily converted into cash or transferred to a bank account without attracting the attention of tax and other authorities. Naturally, other goods and services are not available either.
The more global governments integrate the use of cryptocurrency into their economies and markets, the more likely it is that cryptocurrency will become a full-fledged investment asset class. Cryptocurrency investors and traders closely follow regulatory changes related to cryptocurrency, as they are an indicator of the liquidity of cryptocurrency markets. Such changes put pressure on prices as they affect supply and demand levels.
The influence of the major stock exchanges should be taken into account. These are the exchanges with the highest trading volume, and their prices are considered more “official. For example, if bitcoin rises on one of the major exchanges, quotes on other exchanges will surely follow. This is because most traders closely follow the prices on the major exchanges and expect smaller exchanges to follow them through arbitrage and the actions of other traders. On the WhiteBIT exchange https://whitebit.com/markets, you can follow the price fluctuations of the cryptocurrencies you are interested in and trade and buy them safely and with low commissions.
A similar principle works with exchanges all over the world, located in completely different corners of the planet. So, for example, if the price of bitcoin starts falling in China, it is likely to be followed by European and American exchanges with pairs.
Number of nodes
The number of nodes is a good indicator of the value of a cryptocurrency. The number of nodes measures the number of active wallets in the network. This information can be found, in particular, on the cryptocurrency’s website.
To analyze a currency and understand if it is fairly valued, you need to look at the number of nodes and the total market capitalization of the cryptocurrency, and then compare these two indicators with other cryptocurrencies. In this way, you can determine when a currency is overbought. The number of nodes also shows the strength of the cryptocurrency community. Accordingly, the more nodes, the stronger the community. This is an important indicator to assess the chances of a cryptocurrency to overcome crisis situations.
The direct and possible costs of producing new coins are also factors that determine the value of a cryptocurrency. For example, bitcoin has high production costs. The resources and energy invested in mining the cryptocurrency can be considered to justify the current cost of that cryptocurrency. Added to this is the huge cost of electricity required to run these systems. Studies have shown that bitcoin mining generates more than $6 billion in electricity costs annually – a colossal number.
While these cryptocurrency mining costs may seem wasteful, it is the only way to keep users safe because it is so easy for governments to ban cryptocurrencies thanks to mining.
The price of cryptocurrency rises when everyone around us starts buying it. Enthusiasm can be fueled by the media, celebrities or analysts. It’s no secret that celebrity social media posts can have a big impact on the short-term growth of cryptocurrencies. For example, the famous Elon Musk tweeted several posts about memecoins, such as Dogecoin, which led to a significant rise in the coin’s popularity.
Forecasting the value of cryptocurrencies
It is impossible to predict the future value of cryptocurrencies, as in the case of traditional markets. Expert statements often contradict what is happening in the market. It is necessary to treat predictions about the value of cryptocurrencies with some skepticism. Nevertheless, there are a number of factors worth keeping an eye on, as they almost inevitably affect the future of this or that quince and the cryptocurrency market as a whole. These include the evolving level of cryptocurrency adoption, the volume and level of regulation of the cryptocurrency market, the usefulness of tokens, the ability of the underlying technology to solve specific problems, and the development of cryptocurrency futures.
In general, the price of cryptocurrencies is influenced by a number of factors, such as supply and demand, media, competition, and others that we mentioned in this article. To get the full picture, it is necessary to comprehensively analyze the impact of these factors on the cryptocurrency market. The combination of these factors makes it difficult to accurately predict the price of cryptocurrencies, but at the same time it makes the market very interesting for traders and investors.