How do cryptocurrencies gain value?
The first time I learned about cryptocurrencies I was completely baffled.
“So are prices purely set by how much people would pay for them?” I thought.
The oversimplified answer is — pretty much.
But as we peel the layers back further, we discover that the demand dictates the price, but the following variables tend to dictate demand:
- Limited supply
- Loyal following / community
- Market speculation
To illustrate these points, I’m going to take us back to 1998 when the first Pokemon cards were released.
As many can remember, buying Pokemon cards as a child was the adult equivalent of picking up a 6 pack of beer on the way home from work. Kids were constantly scrounging up money (myself included) to buy a new pack of cards.
We were after the holographic cards. They were rare, and if you were lucky enough to find one in your pack, you’d be the ultimate hero amongst your friends for the next week.
People lusted after these rare, holographic cards because they were limited in supply.
As a result, the more rare the card was, the more value it held. Even though all the cards virtually cost the same to produce, the rare holographic ones could sell for 50x-100x the price of a standard card! This same logic can be applied to cryptocurrencies.
Cryptocurrencies by default have a fixed supply, meaning the more coins that get purchased, the rarer the coin becomes, and thus the value of the coin increases.
Parents on the other hand, had a very different outlook on these Pokemon cards. To them they were just pieces of card stock that had infiltrated their homes and kept their children occupied for hours on end. While a young Pokemon fan might spend even hundreds of dollars on a rare Pokemon card, parents likely wouldn’t buy a single one for themselves.
This leads to the next factor: A loyal following / community.
Loyal following / community
Successful cryptocurrencies often have a loyal following, with users fully invested in their reason for existence. They are likely buying into the cryptocurrency and cheering on the sidelines as it makes headway in the marketplace.
Parents of Pokemon fans did not have a personal (and thus financial) stake in the movement and Pokemon’s success. This aspect of community draws a fine line in the sand between a mere product or service, and the inertia a cryptocurrency might hold for its potential to influence products and services.
If you need to buy a USB drive, you might go to Best Buy and find a reasonably priced one that fits your needs. You aren’t purchasing a Kingston branded USB because you believe in Kingston as a company and the overall relevancy their USB’s will have in the next decade. You just need something to get the job done.
On the contrary, Pokemon fans created clubs and hosted events. They played after school. They watched the show, and discussed it amongst their friends. A strong, loyal following emerged with kids around the world that were invested in every next move.
A loyal following/community that believes in the existence of a certain crypto is arguably the primary driving force for long term sustainability — but what exactly rallies a community behind it’s existence?
Since we are still in the infant stages of blockchain and cryptocurrencies, we are just beginning to scratch the surface with it’s full potential. Even so, companies are being formed in efforts to integrate blockchain and crypto to enhance everyday lives. Some are focused on security, while others may be focused on enterprise usage, or frictionless worldwide micro-transactions. Some are also creating tokens which can be used as a form of currency specific to one application or use case.
Foresight of their full potential requires a fundamental understanding of blockchain, which may be better served in a later post. If you are new to blockchain and cryptocurrencies, just know there are massive use cases in virtually every industry worldwide, as well as many companies ready at the helm to tackle them.
It’s also important to note — just like some kids enjoyed Pokemon cards for the actual gameplay, there was also a subset of people just looking to collect the cards, and perhaps sell them when the value increased. Similarly, a cryptocurrencies community is likely comprised of a subset of users just playing the market, which leads us to our final point — Market speculation.
As with the stock market, market speculation can have a heavy influence on the demand for a cryptocurrencies. Analyst predictions, official announcements, and rumors can induce trading behavior and cause shifts in demand and price. Market speculation likely played a large role in the volatility we saw in 2016–2017 in the crypto space, but hopefully will normalize in the future as the market matures and adoption rates increase.
To recap: Limited supply, a loyal following, the underlying utility, and market speculation can influence the price of cryptocurrencies.
Head over to Devslopes if you want to learn blockchain, code your own cryptocurrency and build decentralized apps!
Thanks to Brian Leip & Team Devslopes for contributing thoughts to this