Cryptocurrency Prices (Blockchain series — Part IV)

The price valuation and fluctuations of cryptos

Cryptocurrencies are not physical assets and some are not even backed by any business functioning element. So how do these digital coins gain value? There are several factors that determine the initial value and the current value of a given coin. Before we discuss the price determinants of tokens, however, we must note that cryptocurrency prices represent the perceived current state and future state of both an individual coin and the entire crypto-market. Just as stocks fluctuate on an individual basis (due to factors such as expected revenue growth) and an industry/market basis (due to factors such as industry outlook and countries’ economic growth projections), a cryptocurrency price depends on the profitability of an individual, blockchain company, as well as the perceived stability of the entire market. A coin can, therefore, project fantastic future revenues, but still lose value if ambiguity is associated with the state of the market. When a coin presents a positive outlook, buying increases and prices rise. When a coin presents a negative outlook, selling increases and prices fall.

The Price Determinants

As mentioned, there are numerous factors that determine the price of a cryptocurrency. We compiled the elements we deemed most important below:

1. Investors’ perceptions of the short-term price rise of a single coin.
2. Investors’ perceptions of the overall cryptocurrency market.
3. Investors’ abilities to decipher and understand the blockchain technology linked to a token.
4. The price set during a pre-sale or token sale (ICO).
5. The parent cryptocurrency (Ether, NEO) linked to a token (for altcoins).
6. The type of cryptocurrency (utility or security).
7. The projected adoption rate, revenue, and profitability of the company selling the coin.

Note: The list contains no specific order of importance.

Short-term Perceptions

Although unfortunate, this determinant most likely has the largest effect on a token’s price. Cryptocurrency investors have been characterized as incredibly short-sighted, attempting to accurately judge the next price explosion of a low-cost coin. The overly positive short-term perception of investors during 2016–2017 was a significant reason that a cryptocurrency bubble formed and eventually popped; a bubble from which the crypto-market is still experiencing declines. People are inherently greedy, thus, when they view others earning money from a certain trend, they are quick to follow that same trend without understanding crucial concepts and ideas.

Overall Market Perception

When external factors impact any financial market, prices of individual assets fluctuate congruently. Government regulation, widespread adoption, new purposes, or cost savings are just a few examples of externalities that can positively or negatively affect the entire crytpocurrency market and individual coins. Of course, this is natural. If political leaders decide that the idea of cryptocurrency will damage financial systems and chose the outlaw all types of digital coins, all tokens will decline in price. In this situation, the extent to which the technology behind a given coin will change the world does not matter. If the public is restricted access and forbidden to use such technologies, growth will be hampered and revenues will be nonexistent. On the other hand, if potential users can realize cost savings through the use of blockchain technologies in a given field such as medicine or gambling, the price of coins associated with these industries are likely to rise due to expected widespread adoption and in turn increased revenues.

Deciphering and Understanding the Technology

While this may not occur on many occasions with current cryptocurrency investors, individuals investing large sums of capital (such as large financial institutions) will only place their money and trust in coins where they can vividly predict long-term outcomes. Accurate predictions are made when individuals comprehend the basic technological processes associated with tokens. When a disconnect exists between the perceived comprehension of a coin that represents a given technology and the actual functioning of the technology, general investors are less willingly to purchase tokens due to the lack of understanding. That being said, when blockchain companies clearly state their vision, goals, purpose, and a simple representation of their platform; the ambiguity disappears, the embedded technology is understood, investors are more willingly to invest in a coin, and a token’s price increases.

Pre-sale and Token Sale

Before offered to the public in the form of an ICO (initial coin offering), tokens are commonly offered to a small number of beginning investors that provide a large sum of start-up cash in a pre-sale. A company sets the price of tokens in the pre-sale (normally at a discount). This price is directly related to the price the company intends to set for its ICO, which is determined by the expected funds needed to complete/maintain a platform to become profitable. In most occasions, a company will set a soft-cap and hard-cap to establish a lower and upper range for the sales. Even if a pre-sale does not occur, a company still sets the price of tokens for the ICO with the intention of raising a specific amount of funds. A company’s pre-sale affects the token-sale price, which in turn affects the market price when traded on exchanges. If a company can manage to sell all its allocated coins at the discounted price offered in a pre-sale, then it will probably be able to sell the ICO allocated coins at the desired price to the public, as past investors have already deemed the token investable.

If the opposite situation materializes, however, a company may need to reduce its ICO price or modify its technology and engage in another pre-sale. Furthermore, the health of the pre-sale and the ICO helps establish the market price following the listing on exchanges. When all allocated coins are sold in a pre-sale/token sale and companies reach their projected cap range (soft cap), coin prices are likely to remain stable or slightly increase in the short-term following an exchange listing. Investors will view a coin positively when a platform receives the necessary funds for development and past investors deem the coin as credible.

The Price and Technology of the Parent Coin

Any platform that is dependent on an established blockchain, such as Ethereum or Neo, to operate is also price dependent on the coin associated with that blockchain. Not only are decentralized application tokens transferable into the parent coin (for example 17,500 Bether = 1 Ether), but the well-being of the parent blockchain affects the strength of the decentralized application. In the case of Bethereum, when Ether increases or decreases, the price of Bether will increase or decrease respectively because a pre-established ratio exists.

Additionally; since Bethereum relies on Ethereum to process transactions essential to the platform’s operation, if Ethereum were to malfunction in any way or update the functionality of the blockchain to be more reliable, the price of Bether would decrease or increase respectively.

Utility Token v.s. Security Token

The type of token a company offers can substantially influence a token’s market price. A utility token is a cryptocurrency that allows holders to purchase/acquire some operational function or aspect unique to a blockchain-based platform. A security token grants holders tradeable assets for pure investment purposes and may offer ownership rights (tokens = common stock), dividends (additional coins for long-term holding), or voting rights. A utility token can be traded on exchanges, but it may not yield a long-term price increase or decline as compared to a security token. Profitability, revenue, dividends offered, voting rights, and user growth are several factors tied to the price of security tokens, while the stability of a platform is the prevalent factor tied to utility tokens. There are, therefore, more factors that can affect the price of security tokens than utility tokens; possibly causing the former to be more attractive to investors than the latter.

Projected Adoption, Revenue, and Profitability

Financial markets exist because there are individuals (investors) who assume placing their own finances in a business will not only expand that business’s opportunity to earn more money, but also more money for themselves. Investors in the cryptocurrency market act in the same manner as regular financial markets. Whether you like the system or hate it, the reality is that investors are motivated through opportunities to expand their own wealth. Any blockchain company that helps this group of individuals accomplish their goals of wealth expansion will receive funds necessary to continue their operations and an increase in token price. The rate of adoption, revenue growth, cost increases/decreases, beneficial/malicious partnerships, knowledgeable/unknowledgeable leadership teams are aspects investors use to judge the price of a cryptocurrency. This occurs for the single reason that all the aspects mentioned lead to one metric: profitability. A profitable company can remain operationally independent and can provide a return on investment to token holders. Common stock and cryptocurrencies can be compared similarly. With stocks, if no one is buying the parent company’s products or services, the company will fail to remain profitable and will not be able to guarantee a return on investment to shareholders (stock price decreases). Likewise with cryptocurrency; if the rate of adoption is predicted to be slow, revenue is predicted to be stagnant, expenses are not controlled, partnerships hamper development, and/or the team is deemed untrustworthy, profitability in the long-run will become strained and the parent company will not be able to guarantee a return on investment to token holders (coin price decreases). While in both situations the price of the stock/coin will decrease; the opposite can be true as well, resulting in a price increase of a stock/coin.

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