How is Cryptocurrency Valuable?
You may wonder what makes cryptocurrency valuable, given that it’s notoriously volatile. Smaller cryptocurrencies can have even wider price swings. After reading this article, you’ll have a better understanding.
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- 1 The value of a cryptocurrency
The value of a cryptocurrency
Cryptocurrencies usually aren’t governed or backed by any central authority. Government backing can improve faith in the value of a currency among consumers, and it provides a big spender and collector of the currency. But since cryptocurrencies are generally decentralized, they derive their value from other sources, including:
- Supply and demand
- Cost of production
- Availability on exchanges
Cryptocurrency Supply and demand
The value of anything is determined by supply and demand. If demand increases faster than supply, the price goes up. The monetary policy of each cryptocurrency is different. Bitcoin supply increases by a fixed amount with each new block mined on the blockchain. Ethereum offers a fixed reward per block mined, but it also pays out for including “uncle blocks” in the new block, which helps facilitate the efficiency of the blockchain. As a result, the supply increase isn’t as fixed. Some cryptocurrency supplies are dictated entirely by the team in charge of a project, which can opt to release more of a token to the public or burn tokens to manage the money supply. Demand can increase as a project gains awareness or as utility increases. Broader adoption of a cryptocurrency as an investment also increases demand while effectively limiting the circulating supply.
Cryptocurrency Cost of Production
Verifying the blockchain requires computing power. Participants invest in expensive equipment and electricity in order to mine cryptocurrency. In a proof-of-work system, like those used by Bitcoin and Ethereum, the more competition there is for mining a certain cryptocurrency, the more difficult it is to mine. That’s because miners essentially race each other to solve a complex math problem in order to verify a block. As such, the cost to mine increases as more powerful equipment is needed to successfully mine.
Some smaller tokens may only be available on select exchanges, thus limiting access for some investors. Some wallet providers will aggregate quotes for swapping any set of cryptocurrencies across several exchanges, but they’ll take a fee for doing so, increasing the cost of investing. Furthermore, if a cryptocurrency is thinly traded on a small exchange, the spread the exchange may be too big for some investors. If a cryptocurrency becomes listed on more exchanges, it can increase the number of investors willing and able to buy it, thus increasing demand.
The barrier to entry is relatively low for new competitors, but creating a viable cryptocurrency also relies on building a network of users of that cryptocurrency. A useful application on the blockchain can quickly build a network, especially if it improves upon a limitation of a competing application. If a new competitor gains momentum, it takes value from the existing competition, thus sending the price of the incumbent down as the new competitor’s token sees its price move higher.
Developers adapt projects based on the community that uses them. Some tokens called governance tokens give their holders a say in the future of a project, including how a token is mined or used. In order to make any changes to the governance of a token, there needs to be consensus among stakeholders. Generally speaking, investors like stable governance. Even if there are flaws in the way a cryptocurrency operates, investors prefer them . As such, stable governance where things are relatively hard to change can be of value by providing more stable pricing. On the other hand, the slow process of updating software to improve protocols can limit the upside of cryptocurrency values.
Regulations and legal requirements
Regulation are require to allow for easier ways to trade cryptocurrency. Products such as ETFs or futures contracts provide more access to cryptocurrency for investors, increasing its value. Additionally, regulation could enable investors to take short positions or bet against the price of cryptocurrencies with futures contracts or options. That should produce better price discovery and reduce the volatility of cryptocurrency pricing. Regulations could also negatively impact demand for cryptocurrency. If a governing body changes the rules to disfavor cryptocurrency investment or use, it could send the price of cryptocurrencies lower.
How is Cryptocurrency Valuable?
If you understand the core principle of supply and demand behind what gives cryptocurrency value and the factors influencing them, you can make better cryptocurrency investment decisions. If you believe demand is going to increase for reasons, and don’t think supply will keep up, that cryptocurrency could be a good investment. But be aware that governments still don’t have best practices for regulating cryptocurrency, which makes it a particularly risky and volatile investment no matter what. Always remember to do your own research before investing and you should be fine. Regardless, you must have a plan and a strategy. Always with Crypto is important to watch the latest news and check daily price chart likely we offer that.
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