What determines the value of crypto? The cryptocurrencies have grown in value over time and have become a hot topic for discussion.
More and more people are investing in this digital asset class every day and are making a lot of money by buying and selling them as and when the prices are favorable.
Well, these are the people who understand a lot, if not everything, about crypto and find this space absolutely exciting.
However, there are lots of people, especially the newbies, who are left wondering why exactly crypto is so volatile.
There is no doubt that this digital asset class has enough value to be considered as the right alternative to fiat money that is typically controlled by the banks.
However, it is very evident that fiat money has value because it is issued and regulated by the monetary authorities backed by the government and hence it is widely used as a medium of exchange.
But how decentralized cryptocurrency that is not used much as a payment mode in retail transactions has value may leave you surprised.
Well, this article is just right for those people who fail to understand the value of cryptocurrencies and the factors that determine its value.
Yes, there are a lot of different factors that drive the price and value of crypto coins and it is natural that you, being new to this field, may not be aware of them.
Some people however try to relate it to the basic principles of economics – the demand and supply connection but leave out other important factors such as market sentiment, public perception, mining difficulty, energy usage and others.
What Determines the Value of Cryptocurrency?
Crypto coins, whether it is the most popular Bitcoin or any other, none come with a backing from the government or any of its authorities.
It does not have any intermediary as well that facilitates a transaction.
Well, that is what makes it a decentralized network that works on blockchain technology and is dependent on independent nodes that approve transactions based on a consensus called the Proof of Work consensus.
Though the cryptocurrency shows some traits of fiat currency but it is scarce and cannot be forged unless someone double spends, a process where a user transfers the same coin to two separate networks thereby producing a duplicate record.
This, however, is prevented by blockchain technology.
Now, coming to the value factor, it is the ability of the currencies to act as a medium of exchange and as a store of value that gives it a specific value.
These currencies also come with all other primary attributes that enable them to be used in the economy.
However, with the introduction of digital currencies like Bitcoin, the definition and concept of currency value has changed completely.
The traditional physical attributes are no longer the primary determining factor of value.
Instead, other factors like velocity, demand, supply and others as mentioned hereunder are also considered along with it.
Supply and Demand:
According to the definition, supply refers to the amount of goods and services available in the market that the people can buy at any given point of time.
On the other hand, demand is the amount of goods and services that the people want to buy or are in need to buy at any given point of time.
Therefore, the supply and demand ratio is the amount of goods and services available in the market to the amount of goods and services people need.
When the supply is high in the market as compared to the demand for the same goods or services, the prices of the commodity will be lower.
On the contrary, when the supply is low but the demand for the goods and services is high, there will be a significant increase in the price of it.
This is the law of demand and supply which is inversely proportional.
In crypto, the same principle is applied to determine the price of a coin.
If the supply of the coin mined is high and the demand for it is low, the price will be low and when the demand is high while the coins are mined at a slower rate, the price will be high.
Use of Energy:
Prices of crypto coins are also determined on the amount of energy used to mine each coin.
In simple words, it depends on the energy it takes to secure a blockchain network.
When the energy used is very high, the price of the coin will be high.
On the other hand, if the energy consumption is low, it will drive the price of the coins down.
Remember, the amount of energy required to mine a new coin depends on the difficulty level in mining.
If it is high, it will use a larger amount of energy as compared to the energy usage when the difficulty level is pretty low.
Difficulty to Mine:
When a blockchain network is more secure, it will be pretty hard to mine a new coin.
This difficulty level also affects the perceived value of a crypto coin.
This difficulty level is changed from time to time by the specific network in question and is usually dependent on the time taken to produce a new coin which is commonly referred to as the block time.
This signifies the time interval between two successive blocks mined.
If this time gap is small it indicates that the coins are mined at a pretty fast rate and the mining difficulty level will be increased to regulate the time.
And, if the miners take a lot of time to mine a new block, the difficulty level will be to expedite the process and get more coins mined.
Therefore, the difficulty level in crypto mining also determines the price of the coins indirectly so to speak.
The utility of the specific type of crypto coin mined will also determine its value.
This may seem quite obvious but this factor is often ignored.
If and when a particular coin is very hard to use, which means it is not easy to sell them to others or invest or make payments, the value of it will certainly fall down to a paltry amount, if not to nothing at all.
This, however, has some relation to the demand and supply principle because a coin with low or no utility will have very low demand but the supply will be steady to reduce its value.
Perception of People:
Perhaps the perception of people of a particular crypto coin will have the biggest impact on its overall value.
This is actually a factor that is based on the amount of money a person is willing to pay to get hold of that particular coin and this has a direct connection with the reputation of the coin in particular.
If the reputation is high, people will be interested to pay more to acquire the coin but if it is low, people will look the other way.
This is why the prices of the popular and favored crypto coins such as Bitcoin, Ether, and Litecoin for example are so high.
These coins are well known, have a high market cap, and most importantly, have a high reputation in the crypto market.
Therefore, reputation and popularity will affect the perception of the people regarding a particular coin which will, in turn, affect its price.
On the other hand, the prices of the crypto coins with a smaller cap and of the startups usually are low in reputation and therefore have a low price.
These coins may have a small following but that is not enough to build a reputation and to be known widely among the people.
Yes, media coverage plays a significant role in the public perception aspect of a crypto coin just as it does in any other kind of goods or services.
Anything negative said about a coin, even the most reputed Bitcoin, can push the price of it to nadir and when something positive is said by the media about the same crypto coin, the price may touch the zenith.
This is another significant factor that will affect the price of a crypto coin, even if it is Bitcoin, Ether or Litecoin.
With more and more new coins being launched in the market every day those particular coins that have a much smaller market cap will have to struggle to draw the necessary attraction of the investors.
With lower traction, these crypto coins will have lower effects in the market and therefore will have lower value.
You may know that there are multiples of thousands of crypto coins available in the market and out of these thousands are developed solely with an intention to scam the users.
These coins usually make tall promises and guarantee returns, features and advanced technologies that are too good to be true so that more and more people can be allured to invest in them.
More often than not, these scam crypto coins are pre-mined by the developers.
This means that they themselves hold a large amount of the total supply of the coin even before the coin hits the market.
As and when the coin gains value due to their aggressive and alluring publicity, they quickly and simply dump their holdings which cause a crash in its value.
The investors lose all the money they put in the coin and the developers gain the entire amount the investors lose which is quite significant.
It is very hard to prove such scams and therefore as of now there is literally no recourse if such a thing happens.
These pre-mined scam coins not only cause the price to fall when exposed but also affects the perception of the public in general in a negative way which further impacts the value of a coin.
The investors can affect the price of a crypto coin either intentionally or inadvertently.
This applies to all types of crypto coins but the effect of it is felt more significantly by the smaller coins especially.
The investors can affect the price of a coin in a number of ways.
When they put in a large amount of money on a particular coin they actually buy a significant chunk of the supply of the coin.
They also sometimes promote the particular crypto coin with a hope to fluff up the price of it.
In the case of smaller crypto coins, sometimes these activities of the investors can cause exceptional rise or fall in their prices.
The people will also have a changed perspective about the coin seeing that the investors have so much belief in the particular coin.
They will also start investing in these coins which will further affect the price.
Just like the investors, the users also play a significant role in determining the value and price of a crypto coin.
They usually follow a few specific methods for that such as:
Buy low and sell high – This is a classic and widely followed investment strategy in which buying and holding may increase the price and value of the coin due to an increase in its demand.
Crypto mining – This profitable way to earn more coins can impact the total supply of the coins which will in turn affect its price.
Acceptance – If merchants and institutions accept a specific crypto coin as a mode of payment it will increase its usefulness and increase the value of the coin in the long term. The users too contribute to the process.
Day trading – Day trading is a more sophisticated way of earning more crypto coins. Users simply have to look into the patterns of the trading charts every day and speculate on the rise or fall in its price.
Too much day trading by the users will also increase the price of the coins due to high demand.
The users of crypto can usually follow the standard stock market approach to trade the coins which will affect the price of it.
The value of a commodity depends largely on its scarcity. Take gold for example.
It is scarce and therefore it is so valuable. In the context of crypto coins, these are all scarce because they come with a finite supply.
For example, the total supply of Bitcoin is 21 million of which around 18 million have been mined already.
The rate at which it is mined now and the rewards halved, it will take several years from now to reach that limit.
Marginal Cost of Production:
Depending on the marginal cost of production, a coin will have intrinsic value.
For example, mining for Bitcoin will consume a lot of energy which will determine the actual cost of the coin.
There is a lot of empirical evidence available to prove this point.
Now, if you consider the economic theory behind pricing of a commodity in any competitive market (and crypto market is highly competitive because it deals with the same product – crypto coins) the price of the coin tends towards the marginal cost of production.
Sometimes the theories followed by the monetarists are followed to determine the value of a crypto coin.
Usually these monetarists use supply and velocity factors to value any good produced in any economy.
Based on their theories, most of the products of the world are valued.
However, for the monetary products like crypto coins the same theory is applied with additional consideration of the stores of value compared to Bitcoin to calculate the projected percentage of its value.
This may be quite complicated for you to understand if you are not into finance and know the technicalities behind it.
However, an example with respect to Bitcoin will make things clear.
Since the major medium of exchange is government-backed money, focus on that and the value of Bitcoin.
Assuming that the money supply M1 in the United States is roughly more than $20 trillion at the end of last year, if Bitcoin achieves even 15% of that value with its total supply remaining the same, it will have a market cap today worth roughly $3 trillion.
Therefore, with its finite supply of 21 million coins, the value of one Bitcoin today will be nearly $143,000. Got the point?
The fundamentals of a crypto will help the users to know whether or not the coin has any intrinsic value.
While analyzing the project fundamentals, you will need to look for three specific metrics and their components. These are:
- On-Chain metrics which includes factors such as the number of transactions made within a fixed time, the value of the same, number of active wallet addresses, hash rate, transaction fees, and the staked volume.
- Project metrics that will help in determining the performance of the support team and the factors include the whitepaper, team members, and competitors.
- Token metrics is the last one that will offer a better insight about the distribution of the coin since its launch along with its prevailing market value and includes factors such as market cap, liquidity, volume, and supply mechanisms.
This means that you will be able to measure the worth of the coin and determine whether it is overvalued or undervalued, the main objective of the project fundamentals usually mentioned in the whitepaper of the token.
Coin Supply Dynamics:
How exactly the coin is released or the team behind it intends to release the coin.
Ideally, there should be a rational formula in place while issuing the coin for the public to use.
If there is no accurate coin supply dynamics the price if it will be affected negatively and the investors will suffer huge losses.
When you consider the token dynamic, once again, you will need to look into three specific metrics such as:
- Max supply – This indicates the number of coins that can exist in its entire lifetime. For example, the max supply of Bitcoin is 21 million coins.
- Total supply – This indicates the total number of coins currently circulating in the market including the locked ones but excludes those coins that are burned from its max supply. When a significant amount of coin is released it will cause the price to crash and vice versa.
- Circulating supply – This indicates only the number of coins available in the market for trading purposes excluding the locked ones.
The circulating supply helps in calculating the market cap which is the product of the circulating supply and the price of the coin.
Legal Requirements and Regulatory Authority:
Though crypto is typically an unregulated digital asset, currently the government feels the necessity of it.
However, in the US it is not clear who is supposed to regulate the exchange of crypto coins among the Securities and Exchange Commission or the SEC or the Commodity Futures Trading Commission or CFTC.
While the former considers crypto just as securities like stocks and bonds the latter considers it to be commodities just like coffee or gold.
As a result nothing fruitful has happened.
This has surely affected the price of the crypto coins because a greater clarity regarding the probable regulatory authority would have improved the value of crypto.
This is because it would have offered a more determined ruling which would have opened the doors for more financial products related to crypto that are widely traded such as futures contracts, ETFs or Exchange Traded Funds.
This would have given the investors more access to crypto which would have increased its value.
A clearly defined regulation is also required to offer easier and safer ways to trade crypto and it will also allow the investors to speculate the prices of crypto with options or futures contracts or take short positions.
As a result it will provide better price discovery and at the same time diminish the volatility of pricing crypto.
However, regulations may also have a negative impact on the price of a crypto if the demand for it is affected due to the changes in the rules made by the governing body that typically disfavors crypto use and investment.
This will send the price down.
Apart from the major factors mentioned above, there are also a few other factors that will determine the price of a crypto coin.
Competition – The level of competition among the crypto coins will determine the eventual price of the coin.
For example, when the dominance of Bitcoin waned due to rise in competition in 2017, it witnessed a sharp decline in its price.
Node count – This refers to the number of wallets of a particular crypto coin that are active and found on the homepage of the coin or on the internet. Higher the number, the higher will be its price. It will also determine whether or not the crypto can overcome the crises in the market.
Mass adoption – As and when the adoption of a particular crypto coin is adopted and liked by the masses it will affect its value in a positive manner.
Blockchain potential – Most of the sensible investors consider the prospects and security aspect of the coin to invest in.
Beginners will want to invest in those coins that are high on security. And, the professional investors will consider the future prospects of the blockchain technology. All these will affect the price of the respective coins.
Market regulation – Professional crypto investors may also regulate the market, if not manipulate it. In such situations the prices may be affected significantly.
This is typically called the work of the whales, referring to the major holders of a crypto causing the rise or fall in the price of the coin with their activities.
Inflation of fiat currency – When the price of a fiat currency decreases, usually the price of Bitcoin increases with respect to that particular fiat currency.
This means that people will get more of that currency with Bitcoin. This trend is commonly seen today because the central banks are printing more and more money to keep the interest rates low artificially.
Technology and use cases – These are also quite good factors to consider to determine the value of a crypto coin. The tech behind a crypto coin will let you know whether the coin will be worth your while.
Also, the use cases will enable you to decide whether or not the coin will be able to solve. A crypto coin with a solid tech support will attract more investors towards it which will drive up the demand and its price as a result of it.
Social media rage – The impact of the social media is also very important that will eventually determine the price of a crypto coin.
Though it is a new trend of the social media trading community especially, comments on social media can cause the price of the coins to rise by creating an artificial short squeeze that drives the price higher up. Take the comment of Elon Musk on social media for example.
Community following – A crypto coin with a strong community following will have a high reputation which affects the price of the coin significantly.
New developments – The last and perhaps the most important factor is the development factor especially of a new crypto coin that will keep it alive and kicking. Continual development and innovation are essential for a crypto to survive whether it is a privacy roll-up or a second layer scaling solution.
Internal governance – Typically, crypto networks hardly follow a fixed set of rules and the developers create projects assuming that the community will like it and use them.
Some of the tokens are called governance tokens that give the holders the right to opine on the future of the project, its usage and mining. Investors like steady and hard-to-change governance that provides more stable pricing of the coin.
Slow updating – Updating the software may be necessary to improve the protocol. If this process takes a long time then it will limit the positive aspects of the coin which will hurt the stakeholders. This will, in turn, affect its price.
Crypto exchanges – Most of the major and popular crypto coins such as Bitcoin and Ether can be traded on several crypto exchanges.
However, the smaller crypto coins will be available on a few crypto exchanges. This limits the accessibility of these coins for the investors and such thinly traded coins will usually have a higher spread and fees charged for swapping them with any set of crypto coins.
If a crypto is available on more exchanges it will have a larger number of investors willing to invest in it which will increase its demand and its price.
Celebrity touch – Love it or loathe it, stardom can affect the value of crypto coins significantly and these celebrities can be from any field such as film, music, business, or sport.
A few examples could be Elon Musk, Maisie Williams, Mark Cuban, Jack Dorsey, Mike Tyson, Snoop Dogg, Steven Seagal, Richard Branson, Kanye West, Floyd Mayweather Jr and more.
Economic and societal climate – These are the two most important factors that determine the adoption of cryptocurrencies at the institutional level. Bitcoin, especially, is considered today as a much safer digital asset in terms of inflation and market volatility.
The economic and societal climate of the world as of now has caused concerns among people who tend to hold less cash and look for a hedge against inflation.
And several companies are also following this trend which has resulted in an increased institutional adoption of crypto coins which has increased the value of the coins significantly.
PayPal involvement – In October 2020, PayPal announced that it will allow buying and selling four major crypto coins on the platform such as Bitcoin, Ether, Bitcoin Cash, Litecoin.
It also plans to allow making crypto transactions. For over 350 million users this is good news because they can use crypto in one of the 30 million merchants. Therefore PayPal support increased the demand and price of these coins.
Bitcoin halving – The halving process creates scarcity which, as said earlier, causes an increase in the value of the crypto coin. This happens after every four years in which the block reward due to mining is reduced after every 210000 blocks are mined.
Currently the reward offered is 6.25 BTC for every valid block mined. Bitcoin halving is the most critical aspect that determines the value of the coin that has a 1 million supply cap of which about 80% coins have already been mined.
Accessibility – When the crypto assets are more easily accessible, as it is now, people will be more interested in paying more for owning these coins. This will once again affect its demand and hence its price.
Historical events – These factors also result in the rise and fall of the price of a crypto coin because upgrades bring in features in it.
Therefore, determining the price of a crypto coin is not easy. There are lots of factors involved but the most important fact is that the values of the coins are typically defined by the consumers irrespective of the supply not meeting the demand or the investors causing a huge surge in its price.
The main driving force of the crypto industry is the people trading and investing in different coins available in the market for a number of reasons irrespective of a negative report that may have caused a major dent in the reputation of a specific crypto coin.
There are lots of factors that affect the value and price of a crypto coin. Through this article you have come to know almost all of the major ones.
Now, when you find the price of a coin to be too high, consider them to find out if it is really worthy.
I have special interest in crypto and intend to help common people to gain knowledge about the digital asset as well as its potential. Follow Me at Linkedin.