You have probably seen the stories of the volatility of cryptocurrencies, as the rollercoaster of massive gains and losses often make headlines. In 2021, Solana gained 11,000% in value. Conversely, Bitcoin has fallen by 50% over a very short period. What causes these gains and declining values?
Cryptocurrencies are not issued by a central bank or backed by a government. Because crypto does not follow the same rules as investing in a traditional currency, factors like monetary policy, inflation, and economic growth measurements that typically influence currency value do not apply in the cryptocurrency sphere.
Whether you are new to crypto, or a Lambo-driving pro, everyone needs to understand the basic principles. The key to being successful at cryptocurrency investing is knowing the answer to “How does cryptocurrency gain value?” Once you know the factors, you can improve your ability to anticipate and react, refining and improving your crypto game.
Despite its differences from traditional currency, several elements can contribute to fluctuations in cryptocurrency values. Here are eight factors to consider when valuing crypto and determining where to invest.
If you have ever collected anything, from coins or stamps to Pokémon cards, you know how scarcity drives up the value of a collectible. The same thing applies to crypto. When there are fewer coins available for purchase, it becomes more valuable.
Let’s use the world’s most famous cryptocurrency, Bitcoin, as an example. The number of Bitcoins that will ever be produced is finite. The rate of increase in supply is also decreasing until the final total number of Bitcoin reaches 21 million coins, which is expected around the year 2140.
This limited supply causes any new release to have more demand than supply, pushing up the value.
Some cryptocurrencies use a burning mechanism to destroy part of the coin supply, creating scarcity and limiting the number of coins available on the market.
Cryptocurrency transactions are recorded in multiple nodes, not on a single server. A node is a computer connected to the blockchain network. This computer automatically downloads a copy of the blockchain upon joining the network. The more nodes there are, the more secure the network.
The node count is how many active wallets exist in the same network. It is a marker of the strength of a community. The higher the node count, the stronger the community. A stronger community can protect against a crisis or dramatic decline to zero.
The cost of production plays a role in determining the price of a coin. Cryptocurrency production is called “mining.” Crypto mining involves a group of users utilizing their computing power to solve a complex math problem. The first miner to solve the problem wins a reward of newly minted coins.
The network of miners allows the decentralized cryptocurrency to keep working. If the cost of mining rises, the cryptocurrency’s value may also increase. Miners want to cover the expenses of mining and make a profit. They will not mine if the rewards are not big enough. Since miners are essential to making the blockchain function, the price will have to go up if there’s demand for using the blockchain.
Cryptocurrency exchanges are websites that facilitate buying, selling, or exchanging cryptocurrencies for other digital currency or traditional currency. Having a cryptocurrency available on many crypto exchanges increases the number of people buying that currency, driving up the demand.
New tokens and coins are launched every day. This competition amongst currencies and the growing acceptance of crypto have attracted investors. With this growth in investment and available cryptos, demand and awareness have increased.
The barrier to entry is low; however, it needs to build a network of users for a cryptocurrency to be viable. If the application is useful, improving upon competitors can yield growth, causing its price to rise.
Cryptocurrency is decentralized and unregulated, and some governments do not see these characteristics favourably. Some governments have banned popular cryptocurrencies within their borders, which could negatively impact the value of these coins if there are many crypto users in that country.
Conversely, the more governments incorporate crypto into their economies and markets, the greater the demand. Many investors and traders closely follow regulatory developments as an indicator of acceptance, safety and growth, and, hence, investment.
As a decentralized and unregulated space, trust is an essential factor in determining the value of a cryptocurrency. If a coin faces threats, including hacking attacks or the perception that it is a scam, demand for it can decline sharply. This decline could cause traders and miners to try to recoup as much value as possible and sell, further decreasing the price.
Public perception of cryptocurrency can significantly influence a coin’s value. Positive news, such as a country adopting cryptocurrency, a business like PayPal accepting crypto, or even a tweet from Elon Musk, can all lead to a cryptocurrency’s growth. On the other hand, negative news or perception can cause the value to tumble just as quickly.
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