7 Factors That Affect Cryptocurrency Prices

Since cryptocurrencies are often unpredictable, you may wonder what gives them value. It is not unusual for the price of Bitcoin to fluctuate by 5% or even 10% on any given day. Smaller cryptocurrencies may see even more significant price fluctuations. But where does their value stem from? Like any other money, cryptocurrency gets value depending on the level of community engagement - user demand, scarcity, or the coin's usefulness. It is worth mentioning that, since private blockchain enterprises issue the majority of digital coins on the market, a portion of the value will also be determined by the overall efficiency of the organization behind the digital currency - project viability and perceived value. Furthermore, the value of cryptocurrency is dependent on market conditions.Before we look at the elements that influence the value of digital currencies, we must first understand the difference between cryptocurrency and fiat currencies.

How is cryptocurrency different from fiat?

To grasp this, one must first learn how a cryptocurrency differs from a fiat currency (Indian Rupee, US Dollar, etc.). The core difference is that governments issue and recognize fiat currencies as legal tender. To put it another way, its value is reliant on the confidence of the two parties involved in the transaction. Most nations use a fiat currency system, where inflation is managed indirectly by controlling the money supply via central banks and other monetary reserves.

Cryptocurrencies are not governed or controlled by any central authority. Few nations have yet recognized them as legal tender. In addition, most cryptocurrencies will have a limited supply; thus, depreciation due to inflation is quite improbable.

Aside from that difference, they're pretty similar. There is some equivalence between the two in terms of their utility as a medium of trade and their ability to hold value.

What influences cryptocurrency prices?

To compensate for their lack of central authority, the value of cryptocurrencies may be derived from other factors, some of which are:

• Supply and Demand
• Cost of production
• Value and perceived value
• Scarcity
• Regulations
• Competition
• Mass adoption

The Supply and Demand of Cryptocurrencies

Much like the value of any other commodity, cryptocurrency is subject to the laws of supply and demand. There will be a rise in price if the rate of demand exceeds that of supply. For example, if there is a drought and demand stays the same, the cost of grain and related products would rise. To put it simply, the laws of supply and demand are also applicable to cryptocurrency markets; when the demand for cryptocurrency exceeds the supply, the price increases.

A cryptocurrency's supply method is always known; each crypto discloses its token minting and burning plans. Some, like Bitcoin, have a limited quantity; there can be no more than 21,000,000 Bitcoins in circulation. Other cryptocurrencies, such as Ether, have no cap on their supply. Some cryptocurrencies "burn" current tokens to limit the issuance of new coins and so dampen inflation. Tokens may be "burned" when they are sent to an unrecoverable address on the blockchain.

Each cryptocurrency has its own monetary policy. Bitcoin supply grows by a set amount with each new block mined on the network. With Ethereum, miners are compensated not just for creating new blocks but also for incorporating previously mined blocks known as "uncle blocks" into the new block. Supply growth is, therefore, not as foreseeable. When it comes to managing the supply of certain cryptocurrencies, the decision rests solely with the project's leadership, who may choose to issue more of a token to the public or even burn tokens.

The demand for a project might rise as its visibility and usefulness grow. A growing interest in bitcoin as an investment not only boosts demand but also reduces the available supply. For instance, the price of Bitcoin spiked when large investment funds began purchasing and holding the cryptocurrency in early 2021, driving down the number of Bitcoins in circulation and driving up its price

Decentralized financial infrastructure (DeFi) initiatives on the Ethereum blockchain also drive up the price of Ether. Ether is necessary for blockchain transactions regardless of the currency being transacted with. Alternatively, if a DeFi initiative is successful, its token will gain utility and be in more demand.

Cost of production

New cryptocurrency tokens are produced via mining. When mining bitcoin, computers are used to validate the contents of the next block on the blockchain. The decentralized nature of the miners' network is crucial to the success of cryptocurrencies. In return for the work done by the protocol, miners get cryptocurrency tokens and any transaction fees paid by the exchanging parties.

Computing power is required for blockchain verification. Participants invest in pricey equipment and power in order to mine bitcoin. For cryptocurrencies that employ a proof-of-work system like Bitcoin and Ethereum, mining becomes increasingly difficult as the number of miners increases. Because validating a block requires solving a difficult mathematical problem, mining is a race between computers. As such, the cost to mine grows as more powerful equipment is required to mine properly.

To compensate for the rising price of mining, the value of cryptocurrencies must rise. If the cryptocurrency being mined isn't worth enough, then miners will stop mining until its value increases beyond their operating expenses. And since miners are required for the blockchain to work, the price will have to rise as long as there is demand for utilizing the blockchain.

Value and perceived value of the project

Viability and project management are key determinants of a cryptocurrency's value. With this in mind, the issue of how to make initiatives more financially feasible emerges.

The market places a higher value on projects that consistently achieve new milestones, either via the establishment of profitable partnerships or the development of intuitive, user-friendly products. All of these things help spread the word about the project, which boosts the value of the cryptocurrency.

Scarcity of cryptocurrencies

Scarcity in cryptocurrency markets results from digital coins and currencies having a limited supply. Idealistically, there'd be more demand for digital currency than supply. However, our world is far from perfect.

Consider Bitcoin, the most well-known cryptocurrency. Bitcoins are limited to a total supply of 21 million, as has long been public knowledge. Bitcoin's skyrocketing value may be attributed to the increasing demand for the cryptocurrency as more and more bitcoins are generated and added to the blockchain. Some currencies burn coins to reduce supply. Because of this, the coins will eventually become more valuable because of their scarcity.

Regulations and legal requirements

It's not quite clear whose responsibility it is to oversee the buying and selling of cryptocurrencies. Cryptocurrencies have been classified as commodities by the Commodity Futures Trading Commission (CFTC) and as securities by the Securities and Exchange Commission (SEC).

Both parties lack the legal standing to regulate cryptocurrency trading platforms. A definitive verdict would provide much-needed clarification, potentially increasing the value of cryptocurrencies and paving the way for wider trading of financial instruments that use cryptographic tokens.

To facilitate more straightforward methods of trading cryptocurrency, regulation is necessary. Increased investor demand for cryptocurrencies is a direct result of the availability of cryptocurrency via products like ETFs and futures contracts. In addition, if cryptocurrencies are regulated, investors may be allowed to short-sell them or use futures contracts and options to speculate on a drop in value. As a result, price discovery should improve, and volatility in cryptocurrencies should decrease.

In addition, regulatory efforts could dampen consumer interest in cryptocurrencies. The value of cryptocurrencies may fall if regulatory bodies were to act in ways that discourage cryptocurrency investment or usage.

Competition

It is estimated that hundreds of distinct cryptocurrencies are now in circulation, with more constantly being created as new initiatives and tokens are introduced. While new competitors have a low barrier to entry, success in the cryptocurrency market requires building a network of users of that cryptocurrency.

If a blockchain application solves a problem that others haven't yet addressed, it might potentially gain a large user base relatively quickly. If a new rival develops traction, it devalues the existing project, causing its price of it to fall while the price of the new competitor's token rises.

Mass adoption

A cryptocurrency's value may skyrocket if a lot of people start buying it. However, widespread use of virtual currency is yet years away. Why? Because they have practical implications that must be addressed. A significant drawback is that they are not as commonly accepted as fiat currencies in making purchases. For these digital currencies to obtain widespread acceptance, their usefulness must rise, and the deal must look lucrative to the buyer.

Conclusion

You can make smarter cryptocurrency investing decisions if you grasp the fundamental supply and demand principles that underpin cryptocurrency value and the variables that influence them. If you feel demand will rise for reasons X, Y, and Z and don't believe supply will catch pace, the cryptocurrency may be a decent investment. However, keep in mind that governments still lack guiding principles for regulating cryptocurrencies, making it a slightly risky and volatile investment. Investing over the long term, as opposed to attempting to make a quick buck through fewer trades, is the safest approach.

Disclaimer: Cryptocurrencies are highly volatile and subject to market, technical, and regulatory risks. Crypto trading requires one’s own diligence, and Cryptoforce will not be responsible for any losses incurred. Any information provided here should not be regarded as Cryptoforce’s technical or financial advice.