What determines cryptocurrency prices?
The cryptocurrency price is known for its volatility and fluctuation. But what drives these changes? In this article, we’ll learn the factors influencing cryptocurrency prices and provide valuable insights for investors.
Understanding Cryptocurrency Price Dynamics
Unlike fiat currencies, such as the Euro or the US Dollar, the value of Bitcoin (BTC) is not defined by a single entity like a central bank. Instead, the price is influenced by supply and demand. Or, in simpler terms, by how much people are willing to pay for it.
The cryptocurrency price is defined by supply and demand. When there is more demand for cryptocurrency, the price goes up. When there is less demand, the price goes down.
Historically, global financial events and moments in popular culture have affected the Bitcoin price.
The process is more complicated than this, but when most coins are mined, the mining rate decreases so that the total supply is only replenished to account for lost units. If you’re aware of basic economics, you’ll know that supply and demand determine prices. For the sake of our discussion, let’s consider supply to be limited or highly restricted.
When that’s the case and demand increases, the price of that underlying asset goes up. Roughly speaking, this is the simplest way to address how the prices of cryptos fluctuate.
Could the cryptocurrency price go to zero?
Short answer: Yes. This is because the worth of a currency is based on its perceived value. There are some fiat currencies that are long out of use but are still sought after by collectors, who pay good money for a 200-year-old coin.
It’s worth nothing that currencies that are no longer used usually fail as a result of the introduction of successors or incidents like hyperinflation. Such developments tend to significantly devalue affected currencies. In the case of Bitcoin, hyperinflation is not possible as Bitcoin cannot be created arbitrarily and its production is fixed to a certain amount.
Why do cryptocurrency prices fluctuate so much?
Several external factors contribute to cryptocurrency price fluctuations:
- Fear and greed: The value of any given crypto is speculative. That means people are buying (or selling it) based on their own opinions and feelings—in particular, fear and greed.
- Regulation
- Market events
- Whales (large investors)
How do you know which cryptocurrency will go up in price?
Nobody can truly 100% predict the price of crypto; anybody who tells you they can is lying. However, there are several factors you can use to make more educated guesses on which cryptocurrencies may increase in value within a given time frame, including market sentiment, technical analysis, utility, competition, tokenomics, governance, and liquidity.
1. Market sentiment
Market sentiment has a massive impact on the value of crypto. Crypto is almost always a speculative asset, meaning it’s worth whatever people pay. In a bull run, where there’s positive market sentiment, you’ll generally see prices increasing across the market, whereas in a bear run, where there’s a negative market sentiment, you’ll generally see prices decreasing across the market.
2. Technical analysis
Technical analysis involves looking at data sets of previous market performance to understand how supply and demand have varied for a given cryptocurrency previously. While previous prices never predict future performance, technical analysis can help investors understand how a given cryptocurrency has prevailed (or otherwise) in turbulent conditions before—and there are even some patterns that may indicate a bull or bear run is coming.
3. Utility
Although cryptocurrencies are most often thought of as speculative assets, it’s not always quite so. Some coins or tokens have specific utilities, so a given purpose. For example, BNB or ETH are used for gas fees on two very popular blockchains and therefore likely in higher general demand. Understanding a token’s potential utility or utilities may help give you an indication of how in demand that token may be.
4. Competition
Like any market, competition matters in crypto. There are thousands of coins proclaiming to do the same thing—that is, become the new mainstream form of payment. In these instances, you’ll need to carefully weigh up whether to go with the market leader or take a risk on a less popular option
5. Tokenomics
An amalgamation of token and economics—tokenomics refers to the economic properties of a given token. In other words, the fundamentals that may make a cryptocurrency valuable or appealing to investors—for example, yields, burns, consensus mechanisms, token supply, and token allocations. You can usually find all this information in a token’s whitepaper. If you can’t find a whitepaper (or if that whitepaper makes no sense), you might be looking at a bad investment.
6. Governance
Governance in crypto refers to the people, or organization, running a given project or cryptocurrency. Generally, in crypto, governance is decentralized, so while specific persons may have initially developed the token, governance is then usually decentralized by allowing token holders to vote on future developments to the protocol. However, this isn’t always the case. In some instances, even when some tokens are allocated out to early investors, project developers maintain a majority by holding more tokens. You should always try to understand who holds the power.
7. Liquidity
Liquidity in this instance refers to how easily you can convert a given token into a fiat currency or even another token at its market price. For example, Bitcoin has high liquidity; you can easily sell, trade, or spend Bitcoin around the world. Meanwhile, newer projects that aren’t yet listed on centralized exchanges or with small pools on decentralized exchanges tend to have low liquidity. Illiquid tokens are prone to drastic price drops if anyone sells, as there may not be enough demand.
How does cryptocurrency make money?
Cryptocurrencies are almost always speculative assets, with the exclusion of some pegged tokens. That means investors who hold given tokens make money when demand increases, driving the price up.
Of course, buying and selling cryptocurrency isn’t the only way to make money from crypto. From mining to playing games, there are plenty of ways to earn crypto.
What backs up cryptocurrency?
Most cryptocurrencies aren’t backed by any physical asset and its value is speculative, though there are exceptions to this.
For example, pegged tokens are sometimes backed by another value, such as fiat currency or precious metals, but they may also equally be backed by another cryptocurrency or the value maintained via an algorithm.