What determines the price of cryptocurrencies?
Read on to find out.
Cryptocurrency prices continue to rise and fall dramatically. Due to wild price fluctuations, the cryptocurrency market is volatile and subject to price swings. As cryptocurrency markets continue to mature over time, it’s likely these wild price swings will continue before eventually leveling off as overall market liquidity increases and becomes stable.
But before you start investing, it’s essential to understand some of the factors influencing the rise and fall of cryptocurrency prices.
1. Differences between cryptocurrency and fiat currency
Both cryptocurrencies and fiat currencies (dollar, euro, pound sterling) are used to store value and make transactions. But aside from these similarities, there are many differences.
Fiat currencies are issued, controlled, and maintained by central banks, while cryptocurrencies are created using decentralized computing networks and maintained by supporters and communities, rather than companies or governments.
2. What drives the price of cryptocurrencies?
There are many factors influencing the rise and fall of cryptocurrency prices.
- Limited supply. Due to fixed supply, cryptocurrencies are often compared with gold, which is also considered scarce.
- Supply and demand. If there is an increase in demand for digital currencies, the supply is affected. As there is a limited supply of cryptocurrencies the price of cryptocurrencies is bound to rise. Cryptocurrencies are going through the process of worldwide global adoption. Everyday more people are converting fiat to crypto and learning how to invest in new cryptocurrency systems.
- Speculation. This is one of the most influential factors that drive cryptocurrency prices. If people speculate that the price of a particular cryptocurrency will go on increasing after looking at the continuous increase in the price, cryptocurrency prices will rise. It’s a feedback loop that encourages more adoption, which in turn drives up the price, which drives more people to speculate on future values.
- Government regulations. Regulatory discussions around the world can impact price movements. Sometimes government or regulatory support of cryptocurrencies can move prices positively, while other times, regulatory ambiguity can negatively impact cryptocurrency price movements.
- Security hacks. Security breaches in cryptocurrency exchanges, wallets, and other areas result in the loss of money. Fraud and security hacks disturb those who are using and investing in the cryptocurrency market and negatively impacts the prices of cryptocurrency.
- Size of the network. The price of cryptocurrencies also depends on the size of the network. There’s more security and decentralization in the larger networks. Hence, larger networks have more value.
- New cryptocurrencies. The cryptocurrency market had only bitcoin during its early years. Now more than 2,200 cryptocurrencies are competing with bitcoin for market share. New cryptocurrencies are decreasing bitcoin’s dominance, affecting the prices of all cryptocurrencies.
- Mining difficulty. Most cryptocurrency protocols rely on the mining process to create and secure the coins that are part of their network. Overtime the computation behind mining will increase in difficulty, which makes the network more secure and also helps increase the scarcity and the number of coins in existence.
- Energy usage. Cryptocurrency mining requires a considerable amount of energy, which is used to secure the network, but also has tangible costs. Another way to say this, or to think about it, is that cryptocurrency networks are backed by the inputs of energy they consume.
- The news and media. The news and media are influential factors in cryptocurrency prices. Good news about prices, or adoption, or positive regulatory news can lead to positive price increases.
- Mass adoption. Only a small number of people have invested or traded in cryptocurrency. The more people adopt cryptocurrency, the higher the value of cryptocurrency will be. Mass adoption of cryptocurrencies drives cryptocurrency prices.
If you’re still feeling uneasy about investing in crypto assets, in the next lesson you’ll learn everything about cryptocurrency security and safety.
Upcoming Lesson: [Lesson 5] Cryptocurrency security and safety