Where do cryptocurrencies derive their value from?

How you can be wiser with your next crypto bet?

Buy, Sell or Hodl? That’s the eternal question confronting every crypto investor! The massive price movement in crypto, often leads to gains or losses in double or triple digits in a day. Nevertheless, investing in crypto is still a lucrative opportunity, the question remains what makes these cryptocurrencies valuable?

Valuing, in its true sense, is what stock market investors do, to calculate the fair price of a stock. However, in reality, it is all theoretical. These values are used as indicators to predict the future market price. There are several different strategies used for valuing assets in the traditional market, like the P/E ratio, the Discounted Cash Flow, etc. but these do not directly apply to cryptocurrencies.

Like any currency, cryptocurrencies gain their value based on the scale of community involvement — be it the user demand, scarcity or the coin’s utility. As investors in cryptocurrency, you ought to have the ability to compare the market value (price at which it is trading) vs. its intrinsic value, in determining when to buy (if undervalued) or when to sell (if overvalued). But calculating this value is complicated and rather time consuming.

To start with, let us better understand what intrinsic value really means!

Investopedia.com says: ‘Intrinsic Value is a measure of what an asset is worth. This measure is arrived at by means of an objective calculation or complex financial model, rather than using the currently trading market price of that asset.’

In case of most cryptocurrencies (leaving aside stablecoins) — these are not backed by any gold or silver. So the value of these are based on an underlying perception of its true value. This includes factors such as market demand for the product or service, the belief in the developers and the quality of code (aka smart contracts).

According to economists, two essential characteristics are important for a commodity to have value — utility and scarcity. In case of cryptocurrencies, utility refers to the underlying value that can be derived from the said digital token. Cryptocurrencies get its utility based on how many (D)apps/merchants accept it as a form of payment. Scarcity, on the other hand, stems from the supply side of things. For example, bitcoin is limited in supply, 21 million to be precise. Analysts believe that scarcity of bitcoin increases its desirability over other assets like gold (because even though finite, we do not know the total amount of gold available). A sudden influx of gold supply will lead to a crash in the prices, but the same will never be true for Bitcoin.

A cryptocurrency derives its value through four broad aspects -

1. Utility is one of the strongest factors affecting the value of a crypto. For example — Ethereum (ETH) is used to execute commands and develop applications in the Ethereum Blockchain. ETH is converted into gas and represents the ‘fuel’ for the Ethereum ecosystem. So the more people that execute transactions and develop apps, the greater the demand for ETH and the underlying utility pushes its prices up in the market due to the network effect. The network effect is a phenomenon where increased number of participants improves the value of the service. A classic example of the network effect can be seen in social media platforms such as LinkedIn, Twitter and Facebook. The value of these platforms increases as more and more people sign up.
2. Scarcity or the finite supply of cryptocurrencies plays a vital role in driving the value. If the supply is constant, and the demand increases in the long run, the prices will go up. Apart from the classic example of Bitcoin which I mentioned earlier, some coins even employ “burning” tokenomics. This refers to the act of destroying a portion of the coin’s supply. It leads to an increase in the value of these coins as now the supply is much less.
3. Perceived value also drives the relative value of a cryptocurrency. Any cryptocurrency’s value depends on the overall viability and progress of the project. So within the community, value can increase if a project is considered invaluable based on its white paper (created by the founders and/or developers of the crypto to explain the project). Additionally, establishing partnerships or launching user-friendly software makes these tokens more valuable in the eyes of the investors.
4. Market capitalization is another traditional indicator of the coin’s value in the market. Market cap is determined by multiplying the total circulated supply by the individual price of the coin. The higher the market cap, the greater stability and belief in the market for the said token.

Apart from the above mentioned, there are some irrational and emotional factors too that play a role (which should be factored in) when it comes to the crypto markets — FUD & FOMO.

FUD is Fear, Uncertainty, and Doubt (often spread on social media). FUD can cause the price of a coin to drop, not based on fundamentals or charts, but based on bad news that spreads around social media. Many times the news isn’t substantiated in reality, and instead ends up being something silly like a popular public figure’s opinion that Bitcoin is a bubble.

FOMO is a more psychological thing. It’s the fear of missing out on something that others are enjoying (for example the fear of missing out on Bitcoin gains while others are picking out their Lambos). FOMO might drive you to buy into a coin, not take profits on a coin, or not set stop loss on a coin that has already gone up considerably. This fear of missing out is what causes people to buy at the top or hold during a dip after making profits (only to lose some or all of their profits again). People can be said to get FOMO when they act on impulse due to the fear of missing out.

Valuing a cryptocurrency is usually a lot of information overload. So much data can be intimidating, and people often lose sight of the primary objective — to invest profitably!

So why bother with all the complex calculations on your? Let the experts do their job and simply shadow invest behind them in specially curated baskets.

Presenting to you — Flippy, a platform that we are building to simplify crypto investments. Sign up now on the website and get notified when the app goes live on the play store!