What Drives the Price of Cryptocurrencies?
With increased awareness about cryptocurrency trading and regulatory relaxations, trading in cryptos has increased manifold. At this juncture, it will be beneficial to know what drives the price of cryptocurrencies.
May 22, 2010, was the day the world witnessed its first Bitcoin transaction. A Florida-based resident, Laszlo Hanyecz, traded 10,000 bitcoins to purchase two pizzas worth $40! The value of Bitcoin was only a few cents back then. Little would he have imagined that one Bitcoin would reach over $60,000 a little after a decade, and what he had spent would be worth millions! Bitcoin and other cryptocurrency prices keep fluctuating every second. There could be many reasons for it. Countless people storing, depositing, borrowing, or lending a particular cryptocurrency on crypto-saving platforms like Pokket, as if in a savings bank account, and contributing to the increasing trustworthiness of the cryptocurrency project can also be a reason for the continuously soaring price of a cryptocurrency. This blog post examines each factor responsible for cryptocurrency price changes and fluctuations.
The price of Bitcoin, or any cryptocurrency for that matter, can go up and down at any time. It is similar to how fiat currencies or the values of stocks fluctuate. The chart below shows how the prices have progressed over the last year. So, what drives the price of cryptocurrencies?
What Drives the Price of Cryptocurrencies?
One of the defining points of cryptocurrencies is that most are unregulated and do not have a central governing authority. However, its pricing depends on various factors, as listed below:
- The Demand and Supply Situation
When it comes to analyzing and determining the price of any commodity, the principles of economics come into play. Every economist worth their salt knows that the pricing of any item depends on its demand and supply position. When trying to find an answer to what determines the price of bitcoin, you must also consider this same rule of economics.
However, each cryptocurrency has its set of rules and protocols. For instance, Bitcoin has decided on a supply cap of 21 million, whereas Ethereum does not have any. The Bitcoin supply increases by a fixed amount for each block mined on the blockchain, whereas Ethereum offers a fixed reward for each block mined.
New bitcoins can be created at a fixed rate. However, the design is such that the value slows down over time. As a result, the Bitcoin supply decreases, corresponding to a price jump. That explains the Bitcoin halving phenomenon that occurs roughly once in four years to increase its corresponding demand, affecting its pricing. Thus, the demand and supply position is a significant price determinant in the cryptocurrency universe.
- Trustworthiness and Transactional Benefits
How does cryptocurrency value increase or decrease other than supply and demand fluctuations? The trustworthiness and transactional benefits of the blockchain can be significant factors. Trustworthiness directly links to the computing power, and the transactional benefits depend on the size of the blockchain network.
The better the computing power, the higher the trustworthiness factor is, resulting in a more increased transactional flow and greater acceptability of the crypto as an exchange medium. Automatically, it enhances its liquidity and affects its pricing accordingly.
- Cost of Production
Similar to other commodities, the cost of production also ranks among the top drivers of cryptocurrency prices. New crypto tokens are created through mining, which involves verifying blocks on the blockchain network. It requires computing power, which means that miners invest in expensive equipment and electrical resources to mine cryptos.
Bitcoin and Ethereum (currently) work on the Proof-of-Work concept, where the mining competition is directly proportional to its difficulty. It involves employing more resources, thereby increasing the mining cost. Automatically, it increases the cryptocurrency’s value.
- Influencer intervention
“What is the real value of cryptocurrencies?” is one question that has been asked time and again. That is because even so much as a tweet posted by a high-profile investor like Elon Musk, Bill Gates, etc., can influence prices to fluctuate either way. For instance, Dogecoin, a cryptocurrency created in two hours, enjoyed a 25% boost in its value with a single-word tweet “Literally” by Elon Musk. At the same time, a mere suggestion from Musk that he was breaking up with Bitcoin pulled down its prices by 15%.
- Competition Can Swing Prices
Once, Bitcoin used to rule the crypto exchanges. In 2017, Bitcoin had a massive share of up to 80%. Today, it has reduced to around 50% because of the competition from alternative coins. Ether (ETH) is the prime competitor because of the DeFi boom. Similarly, other cryptos like XRP (Ripple), BNB (Binance Coin), and ADA (Cardano) have become popular, providing investors with more choices. While these currencies have captured a significant portion of the market, Bitcoin has its benefits being a pioneer. Therefore, its prices have surged despite the reduction in the market share.
- Internal Governance
Generally, cryptocurrency networks are community-driven and do not follow a static set of rules. However, they comply with a robust internal governance system. Concepts like governance tokens give more authority to holders that have a more significant say in their stability. Thus, you find Ethereum shifting from a Proof-of-Work model to a Proof-of-Stake system. While it can render miners’ expensive equipment and investments useless, it will affect Ether’s value considerably. An instance such as this is what causes cryptocurrency to rise and fall internally in the absence of external government regulations.
- Regulatory Developments
Only one country (El Salvador) has accepted cryptocurrency (Bitcoin) as legal tender. The crypto markets are primarily unregulated. It has its benefits because it allows for free use across geographical borders and is not subjected to the government-imposed restrictions that fiat currencies have. At the same time, criminals can use it anonymously for transactions, which could scare away institutional and individual investors. The volatility and lack of liquidity can affect its pricing. However, if the regulations change, the pricing can gain stability. Thus, regulatory developments have a significant say in cryptocurrency pricing.
Final Words
Even though cryptocurrencies have been active in the financial sphere for more than a decade, it is still considered a nascent asset class by investors globally. Though cryptocurrencies like Bitcoin have very high values compared to the dollar, the various factors discussed above can alter their fate drastically in no time. In cryptocurrency pricing, especially heavily-traded crypto assets, huge fluctuations must always be expected.
Knowing what drives the price of cryptocurrencies can help you make informed decisions concerning your crypto investments. In other words, those who can answer the question, ‘How is cryptocurrency price determined?’ and analyze the parameters listed in the above discussion will be able to make better crypto investment or trading decisions. Platforms such as Pokket allows people to deposit their bitcoin or other cryptocurrencies with a ‘Crypto Savings Account’ like a bank and earn high yield without any extra fees. These types of platforms could also be one of the reasons that contribute to the stability of a coin. So next time, before you think of investing in cryptocurrency, you may want to have a quick look to see if it’s listed at Pokket.
References
- McCall, M. (2020, December 2). A $200 Million Pizza! Here’s How Bitcoin Made That Possible. Nasdaq
- Adeyanju, O. (2020, May 11). Bitcoin Halving: Experts Think You Should Buy Only If You’re ‘Hodling’ For The Long Haul. Forbes.
- Bloomenthal, A. (2021, December 16). What Determines the Price of 1 Bitcoin? Investopedia.
