What Drives the Value of Cryptocurrencies?

Cryptocurrency is a new type of digital currency and like a fiat currency, it only has value because people believe it has value. Some currencies are backed by gold, some by diamonds, and some might not be backed by anything but pure believe. In this article, we will try to go through some of the most important factors affecting the value of cryptocurrencies.

Supply/Demand

Precious metals gain their value and preserve purchasing power due to their utility and limited supply. If we compare it to cryptocurrencies, their supply is also limited and is bought in at a constant rate and is unchangeable due to the conscious rules. This creates a supply that is limited, and thus people will pay more to get the coins they think have value. As Bitcoin block reward halving approached back in 2016, it  caused the price to slowly increase, because of the reduced supply of new incoming coins imminent. This might affect the price of most cryptocurrencies.

Energy Usage

The energy put into securing blockchains can be intensive. In the case of proof of work (POW) blockchains which are the most popular form, electricity usage can be intense. In the case of Bitcoin, currently the blockchain uses as much energy securing it as a small country. This reflects on the price, as on average it takes a certain amount of energy to ‘mine’ one Bitcoin. This of course goes up as difficulty increases.

Difficulty Level

The more secure the blockchain and the higher the mining difficulty, the higher the perceived value and price and the harder the coins are to get through mining. This can have an impact on price and ties in with the energy usage above, in the case of proof of work blockchains such as Bitcoin and Litecoin.

Usability

A key factor in the price of any cryptocurrency is its usability. If you cannot use it for something, whether an investment or for payments, then it would have no or little perceived value. In the case of Bitcoin, it is usable for payments on a reasonably high and ever increasing scale, meaning that its utility is high. Its high difficulty and energy usage give it a reasonably high price and as such can be used for an investment. The changes to utility can cause price volatility.

In the case of Ether, as it was designed a smart contract platform this is a practical utility, which increased the price of Ether over many other alternative cryptocurrencies.

Public Perceptions

The public perception of a cryptocurrency has big bearing on the value of the currency. In the case of Bitcoin, a driving factor can be people reacting positively to the innovations and the fact it is a thorn in the side of the mostly corrupt banking sector and gives competition which cannot be tampered with in the traditional way, but can also receive negative reactions and associations with criminality. Hacks to major cryptocurrency exchanges can also affect the reputation of Bitcoin and price in a negative way, yet innovations such as multi-signature security on wallets or innovations and payment gateways coming online can create a positive reaction. Many cryptocurrencies are reusing the Bitcoin code and just changing some of the specifications such as the coin supply, proof of work algorithm or adding other features. How much a currency has ripped off of Bitcoin with no innovation or potential utility over Bitcoin can affect its reputation.

Price of Bitcoin

Bitcoin is often seen as the ‘reserve currency’ of the cryptocurrency world. Rises and falls to the price of Bitcoin often has a knock on effect with other cryptocurrencies. Litecoin in particular often has price reactions proportional to the rise and fall of Bitcoin price, but without the difficulty increase that Bitcoin has in respect to the power used to secure both blockchains.

As Bitcoin was the first mainstream cryptocurrency and is the most supported, the price of Bitcoin can often influence the other cryptocurrencies.

Media

The medias reporting on Bitcoin in either a positive, or negative way can have influence on the public perceptions of Bitcoin, and can influence the price. This can even be used as an avenue to potentially manipulate the price, as many media outlets are owned by a few individuals and it is a major vector for potential price manipulation, as well as reporting on positive and negative aspects of the currency which can cause the price to fluctuate.

Investors

With all cryptocurrencies, especially smaller less known ones, investors can manipulate / inadvertently affect price in the following ways:

  • With a large amount of capital at their disposal, can buy a large percentage of the coin supply, then attempt to promote good stuff about the coin to ‘pump’ the price.
  • An investor making a large investment in a small coin can cause inadvertent price increases and falls.
  • People seeing investors have confidence in a cryptocurrency can encourage them to invest, and the more investors and the more demand for a currency, the higher the price.

Scams

Cryptocurrencies can sometimes be developed as a scam. This can often be associated with a coin that promises the latest and greatest technology, but is also ‘premined’ by the developers before release. This ensures they hold a good chunk of coin supply before coin release so when it is given value they dump their holdings, which crashes the value for other investors but can potentially earn the scammers a large sum of money and it is often difficult to prosecute such scams and in many jurisdictions impossible at present.

Instamining is a variant where the ability of coins to be mined is higher at the beginning after release to achieve the same goal.

Investment scams often cause people to invest in a cryptocurrency or even pay money towards the developers to develop the currency, where the only intention is to run off with the money of investors.

Due to the public nature of a blockchain, premines and instamines can easily be spotted, and when discovered often cause the value of the coin to plummet, this can happen before or after the developers did their dump of coins.

Market Dilution

This does not so much apply to Bitcoin, Litecoin, Peercoin or Ethereum which all had a unique purpose at the time of development. There is many a new cryptocurrency released every day, many rips from the Bitcoin source. Due to the number of cryptocurrencies often with no practical utility* saturating the market, alternative cryptocurrencies can find it hard to gain any sort of ground in an already diluted market.Bitcoin stood out as the first with good development, Litecoin stood out as a ‘silver to Bitcoin gold’ coin, Peercoin used an innovative POW and POS (proof of stake) combination. Ether had a practical utility for being a smart contract token to allow distributed, secure execution of smart contracts, for the price of what the ether token is, which very few cryptocurrencies can do.

Legal and governmental issues

Legal and governmental issues can influence the price, if a government beings being oppressive with tax or asset laws, it can be trivial to hide assets in a cryptocurrency, this perceived value by a country of investors can cause changes in price. Legal moves which are positive for a cryptocurrency such as making them official as currency can have a positive effect, while a country banning it could have a negative effect.

Summary

The world of cryptocurrency is here to stay, and as people give it value as a store of wealth in the case of Bitcoin, its revolutionary payment processing ability and the ability to work between borders are all reasons to continue to use cryptocurrency.

All in all, value comes from the perception of a majority, anything has value to someone because they believe it has value, for whatever reason they may have. Perception of value is what ultimately gives it value, what people are willing to put in to get a unit of cryptocurrency, be it time, faith, money or labour.

The same applies to any commodity such as food, water, shelter, technology or any other commodity. Effort put into creating/obtaining it and demand. So keeping cryptocurrency positive in the perceptions of people is key to maintaining their value.

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