The values of cryptocurrencies may rise or fall with the tides, but are far from random. Learn about the changes in crypto values here.
As many memes have joked about the stock market, “Number go up, number go down.” But though it is a joke, our entire economy rests on a graph that a bunch of companies manipulates. And when that graph heads south, economies collapse.
Fortunately, currencies tend to remain relatively stable over time. But cryptocurrencies have changed that paradigm, resulting in currencies that are wildly volatile. So it begs the question, what determines crypto values?
Even though these digital currencies are not ready for everyday use, we need to figure out now how to manage cryptocurrency transactions. And that means understanding what affects their worth over time.
Keep reading for a brief guide on what makes cryptocurrency value go up and down.
Cryptocurrency vs. Fiat Currency
To understand the answer to that question, you need to understand the difference between cryptocurrency and government-backed currencies. Although both are types of currency, they’re drastically different in almost every way.
Differences between Cryptocurrency and Fiat Currency
Unlike euros or USD, there is no central bank or central authority over digital currencies. Governments and businesses do not determine their values through trade. Nor does any one entity issue cryptocurrency.
For starters, cryptocurrency runs on the blockchain ledger. This is an encrypted, publicly available ledger of all transactions since the beginning of Bitcoin’s birth. We can see transactions all the way back to when Satoshi Nakamoto’s dream became a reality.
Second, cryptocurrency self-regulates with the help of crypto miners. People pay transaction fees to use cryptocurrency, and in return, the miners get Bitcoin.
In addition to this, there is not an unlimited amount of cryptocurrency. The design of cryptocurrency makes it more scarce as time goes by. This is to reflect the extraction of gold from the earth until there is none left.
Anyone can create a new cryptocurrency at any time. There are thousands of cryptocurrencies in existence, with new ones springing up every week. This is unlike national currencies, which often have hundreds of years of history.
Why Do These Differences Matter?
Cryptocurrency has very little in common with Fiat currency. It has no government to back it and no financial institutions to regulate it. It goes without saying that what determines the value of fiat currency doesn’t determine the value of cryptocurrency.
Let’s discuss what affects the value of cryptocurrency.
Crypto Values Are Affected by Scarcity
As we mentioned above, cryptocurrency reflects the mining of gold from the earth. Gold is a finite resource, and so is cryptocurrency. Once we mine all of it, you cannot artificially create more.
Thanks to inflation, fiat currency can expand year after year indefinitely. While it is losing its value, we can keep printing more to replenish it. In theory, we could print new dollars forever.
We used to use the gold standard, but those days are long past. Cryptocurrency, on the other hand, is locked to the “gold standard” no matter what we do. There is no way to continue making cryptocurrency once it is gone.
How Scarcity Affects Value
This means that there will always be a scarce amount of cryptocurrency available. And as with anything that is scarce, demand is high, making the value high. If you’ve ever looked at the price of Bitcoin, you’ll know that a single bitcoin is worth thousands of dollars.
The value of cryptocurrency, generally speaking, will continue to go up as long as there is fiat currency. This is both a good thing and a bad thing. Good because cryptocurrency will always have relatively high value, but bad because the wealthy can hoard as much as they want.
It’s a double-edged sword, giving more potent spending power in exchange for a limited currency that does not suffer as much from inflation.
By User Usage
Similar to fiat currency, its value depends on how many people use it. The dollar is strong because businesses across the world prefer to use it for their transactions. In a similar vein, cryptocurrency depends on the people who use it.
The problem is, anyone can use any currency they like. Americans can only use USD in the United States. But imagine if, on a whim, they could choose to use euros for any transaction.
Naturally, this leads to people using the currency in response to its current value. Why bother using USD if euros are worth more? With Fiat currency, you don’t have much of a choice, but with cryptocurrency, the choice is entirely yours.
Usage patterns change in response to popularity and demand. They change in response to the news. In this way, cryptocurrency is a lot more like stocks than it is like fiat currency.
A perfect example of this is Dogecoin. It began as a joke coin but quickly exploded into a highly valuable currency. Now, it’s anything but a joke if you want to make a serious investment.
By Investment
We said that cryptocurrency has things in common with stocks. Another thing it has in common with them is the fact that people trade them. While people do trade fiat currencies via Forex trading, this is nowhere near the level that cryptocurrency is at.
A big problem with cryptocurrency is that we cannot use it for everyday transactions. Aside from a few niche stores, you can’t buy groceries or pay your bills with cryptocurrency.
Since cryptocurrency has historically had very little use, users have done the next best thing they can think of: investing. Many investment portfolios these days include cryptocurrency. Just like stocks, people sell when it’s high and buy when it’s low.
This is what causes the rampant volatility that is common with cryptocurrency. The value fluctuates in response to market demand.
Perhaps this will change in the future if cryptocurrency is more useful outside of investment. But even with obstacles such as gas fees and slippage (learn more about slippage), people continue to trade. It’s impossible to say what the future will hold for cryptocurrency beyond investment.
By Changes in the Blockchain
While cryptocurrency is decentralized in theory, it is centralized in practice in many ways. Ethereum, for example, uses a proof of stake model. This means that those who hold more of the coin have a more powerful sway in its governance.
In theory, a group of people with enough coins could make drastic changes to the blockchain. Instances like this have happened before.
In order to combat fraud (and for other reasons), stakeholders have forked the blockchain. This creates an entirely new blockchain, minus problematic transactions. This can effectively take cryptocurrency from certain wallets and put it back into the ecosystem.
When forks like this happen, it disrupts the value of the cryptocurrency. Investors lose faith, and the value dips. It can take a long time for cryptocurrency to recover after that.
Further, updates to the blockchain and algorithms can improve (or worsen) its function. This can also have an effect on the market value.
By Scams
Cryptocurrency is a truly amazing concept, but it is not without its issues. One of the biggest ones is the potential for fraud.
In recent years, cryptocurrencies have made headlines because of rampant fraud. And the most common occurrence of this fraud is known as a “pump and dump.”
A pump and dump works like this:
- A group of collaborators creates a new coin
- They pre-mine that coin, awarding themselves a portion of it before it goes live
- They hype up the new coin and convince investors to buy in
- They release the coin and experience an influx of new users
- The value of the coin skyrockets
- Investors sell their pre-mined coin, getting very rich in the process
- These investors then abandon the coin
- The coin loses most of its value
- The remaining investors now have a worthless coin
Granted, a pump and dump cannot happen with a large coin like Bitcoin. However, big Bitcoin investors can sell off all of their coins during value peaks. This can have significant effects on the overall value.
By Mining Operations
Mining is the lifeblood of every cryptocurrency. Without it, the cryptocurrency would cease to function. This means that mining efforts have a significant effect on the value of the cryptocurrency in the following ways:
- The difficulty of the mining process: more difficult proof of work cryptocurrencies may result in fewer miners, reducing the supply
- Increased competition: the more miners there are, the less cryptocurrency there is to go around
- Transaction fee prices: miners cannot subsist without transaction fees, meaning that higher fees will draw more miners
- Centralization: sometimes, large mining collectives will control production, reducing incentives for new miners to join
To be clear, mining has minimal effect. But it is an integral part that will sway how a cryptocurrency performs.
Invest in Cryptocurrency Today
Crypto values, just like fiat values, change in response to market forces and economic realities. However, cryptocurrency transactions function entirely different in comparison to fiat currency. Values will change in response to the above reasons. Check out more articles on cryptocurrency on our blog.
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