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People wonder what makes cryptocurrency valuable, provided that it’s notoriously volatile. It’s not unusual for crypto-currencies to increase or decrease in price on any given day. Smaller cryptocurrencies can have even broader price swings.
Today, Dennis Loos, an expert in cryptocurrencies, will give us a better insight into what makes cryptocurrency valuable and why the price might fluctuate unexpectedly within a single day.
Welcome, Dennis Loos; On the Fluctuation of Cryptocurrencies, What Determines the Value of Cryptocurrencies
It’s my pleasure to share my experience and knowledge about cryptocurrencies once again. Cryptocurrencies typically are not backed by any central authority like fiat currencies or other government-sanctioned mediums of exchange. Government backing can increase confidence in the value of a currency among consumers, and it gives a big spender and accumulator of the currency. However, since cryptocurrencies are normally decentralised, they emanate their value from various sources, including supply and demand, production cost, availability on exchanges, competition, governance, and regulations. Overall the demand and supply of cryptocurrencies set the values of cryptocurrencies.
So Dennis, What Determines the Demand and Supply of Cryptocurrencies?
Like anything else, the value of cryptocurrencies is set by demand and supply, just like other daily commodities. Cryptocurrency increases in value when demand rises higher than supply.
Each crypto announces its token minting and burning plans. Some, like the Bitcoin, have a fixed maximum supply; there will only ever be 21 million Bitcoins. Others, like Ether (CRYPTO: ETH), possess no cap on supply. Various altcoins have mechanisms that “burn” existing tokens to prevent the circulating supply from accumulating too large. Burning a token implies sending them to an unrecoverable address on the blockchain.
The monetary policy of each cryptocurrency differs. Bitcoin supply increases by a limited amount with every new block mined on the blockchain. Ethereum gives a fixed dividend per block mined, but it also pays out for involving “uncle blocks” in the new block, which helps enable the efficiency of the blockchain. Therefore, the supply increase is not as fixed. Some cryptocurrency supplies are authorised entirely by the team in charge of a project, which can opt to circulate more of a token to the public or burn tokens to regulate the money supply.
Demand can increase as project awareness grows or as utility increases. Wide acceptance of a cryptocurrency as an investment also increases demand while effectively limiting the circulating supply. For instance, when institutional investors began buying and holding Bitcoin in early 2021, the price of Bitcoin increased considerably as demand outstripped the rate at which new coins were created, effectively reducing the total available supply of Bitcoin.
Similarly, as more decentralised finance (DeFi) projects launch on the Ethereum blockchain, the demand for Ether increases. Ether is expected to conduct transactions on the blockchain regardless of what cryptocurrency you’re transacting with. Or, if a DeFi project carries itself off, its token will become more useful, increasing demand.
Dennis, How Does the Cost of Production Affect the Price and Value of Cryptocurrencies?
New cryptocurrency tokens are generated through a process called mining. Mining entails using a computer to verify the next block on the blockchain. The decentralised network of miners allows cryptocurrency to work as it works. In exchange, the protocol generates a reward in cryptocurrency tokens and fees paid by exchanging parties.
Ascertaining the blockchain requires computing power. Partakers invest in expensive equipment and electricity to mine cryptocurrency. The higher the competition for mining a certain cryptocurrency, the more difficult it is to mine. That’s because miners race each other to solve a complex math problem to verify a block. The cost to mine rises as more powerful equipment is needed to mine successfully.
As mining costs increase, it necessitates a raised value of the cryptocurrency. Miners won’t be bothered if the value of the mining currency is not outstanding enough to offset their costs. And, since miners are crucial to making the blockchain function, the price will have to go up as long as there’s demand for using the blockchain.
Dennis Loos, Do You Think Cryptocurrency Exchanges Affect Their Value and Price?
I would say that mainstream cryptocurrencies such as Bitcoin and Ether trade on numerous exchanges. Almost all cryptocurrency exchanges will list the most popular tokens.
However, some smaller tokens may only be available on distinguished exchanges, thus restricting access for some investors. Some wallet providers will put quotes for swapping any set of cryptocurrencies across several exchanges. However, they’ll take a fee, raising the investment cost. Furthermore, if a cryptocurrency is rarely traded on a small exchange, the exchange’s circulation may be too large for some investors.
If a cryptocurrency becomes listed on several exchanges, it can boost the number of investors ready and able to buy it, increasing demand. And, all else being equal, the price goes up as demand increases.
It Is Said That Competition Use and Prices of Cryptocurrencies; Dennis Is This True?
There are thousands of cryptocurrencies, with new projects and tokens being initiated every day. The boundary to entry is relatively low for new competitors, but creating a feasible cryptocurrency also relies on creating a network of users of that cryptocurrency.
A practical application on the blockchain can quickly build a network, especially if it enhances a competing application’s limitation. If a new competitor gains pace, it takes value from the prevailing competition and decreases the incumbent price. The new competitor’s token sees its price move higher.
Dennis, What Other Factors Would Contribute to the Rising and Falling of Cryptocurrencies?
Other significant factors would include Internal governance, amongst others. Cryptocurrency networks barely abide by a fixed set of rules. Creators adapt projects based on the community that uses them. Some tokens referred to as governance tokens, give their holders a say in the future of a project, including how a token is mined or utilized. To make any changes to the administration of a token, there needs to be an agreement among stakeholders.
For instance, Ethereum is working on revamping its network from a proof-of-work system to a proof-of-stake system, effectively generating much of the expensive mining equipment in data centers or people’s basements useless. That will have an effect on the value of Ether.
Generally speaking, investors like stable governance. Even if there are flaws in the way a cryptocurrency performs, investors select the devil they know to the angel they don’t. Therefore, stable governance where things are relatively hard to change can be of value by giving more stable pricing.
In addition, the slow process of revamping software to improve protocols can restrict the upside of cryptocurrency values. If an update would unlock value for cryptocurrency holders, it takes months to execute; it hurts the current stakeholders.
Thank you very much, Dennis Loos; the interview was enlightening.