It’s not a secret to anyone that cryptocurrencies are the most volatile assets. Actually, this is one of the reasons why any changes to the crypto market headline the news — these changes tend to be very extreme, regardless of the direction of the price movement. Many people interested in this asset class don’t really know why this happens and how values are determined, but there are some factors that might be considered during the analysis.
Before we start exploring factors influencing Bitcoin’s value, let’s make it clear that cryptocurrencies differ from common fiat money such as the U.S. dollar. Digital coins are issued not by central authorities who back this value with real reserves and economic circumstances. Nevertheless, this peculiarity doesn’t drive the demand for cryptos down, especially now, that more and more coins are being adapted across various industries.
Key valuation concepts
We all know how the values are set in the stock market, where companies have their shares with fluctuating prices, which in total provide the general market capitalization of the company. These prices depend on how well the company manages to perform as well as on the announcements about further implementations. If the analysis shows that the company’s revenue is expected to grow, the stock price will increase as well.
Basically, cryptocurrency prices are also driven by the demand for certain coins. However, when talking about these tokens, we need to understand that some projects limit their supply. This causes additional scarcity of coins and stimulates the demand to grow.
Supply isn’t the only factor that impacts the demand for cryptocurrencies because not all projects limit their supply. Ethereum is a good example of such a project. In these cases, the demand might also be driven by the acceptance of the coins across various industries. The more businesses accept a certain cryptocurrency as a payment method, the more trust it will gain from users and potential investors.
Other factors that determine the crypto value include the following:
- Uniqueness. To succeed in the rapidly growing cryptocurrency world, projects have to compete against each other and introduce something innovative. If they fail the competition, the demand will decrease, and neither developers, nor users, nor investors will be interested in them.
- Hype. There are numerous examples of cryptocurrencies that have no reasonable back for their values. In such cases, social media play a crucial role. Support from influencers or even viral memes can encourage users to buy huge amounts of coins and consequently stimulate the demand for them.
- Availability. Not all cryptocurrencies can be bought on trusted and popular crypto exchanges. In such cases, investors might feel anxious about putting their funds into such projects and that’s why they start looking for more reliable alternatives.
Developers continuously adapt projects to meet current and future needs, but the implementation of changes in governance tokens requires consensus from stakeholders.
The stability of governance is a desirable trait for investors, highlighting a perceived flaw in the cryptocurrency realm. Cryptocurrencies are prone to significant price volatility, leading to substantial fluctuations. The last-year crash of Bitcoin is a good example of this.
The regulatory landscape surrounding cryptocurrencies remains uncertain. Regulatory measures could potentially instill a sense of security among investors, positively impacting cryptocurrency adoption as an investment vehicle. However, such regulations may also have adverse effects, including reduced demand for cryptocurrencies and altered investment rules, ultimately impacting their value.
The effect of economic changes and financial events
Although cryptocurrency is thought to be a completely independent asset class that does not suffer from inflation and economic downturns, in fact, its relation to serious economic changes is quite obvious these days.
Again, the recent crypto winter is a good example of how the expected recession can affect the world of what was thought to be completely virtual. That winter started as the talks about a potential economic downturn started. As a result of that bearish trend, the entire cryptocurrency market was devalued from $3 trillion to $993 billion.
Why is it so if the majority of cryptocurrencies aren’t backed by any reserves of other assets that can actually suffer from an economic downturn? The anxiety and uncertainty of investors are the most considerable reasons. In fact, when these talks started, the majority of investors started looking for safe havens. Cryptocurrency didn’t manage to prove its reputation as a safe haven, so many holders started selling their digital assets and buying more reliable ones that are expected to hedge such risks as inflation, growing interest rates, and so on.
So, the world of cryptocurrency remains a thing we will be exploring for the following decades. Nevertheless, understanding its basic valuation concepts is a good thing for beginning investors who are attracted by the possibility to take advantage of the “money of the future” right now.