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Where Do Cryptocurrencies Get Their Value?
The cryptocurrency market is experiencing another bull run, where we see various coins make incredible gains in a short amount of time. This has pushed a large number of new investors to buy bitcoins and try to take part in this financial revolution.
However, to make profits in the long term, you need to understand what gives them their value. While volatile, cryptocurrencies can be a very lucrative venture, especially if you know what to look for.
This article will go over some of the main reasons behind the value of certain coins, which should help you making more informed decisions in the markets going forward.
Short intro to the concept of cryptocurrencies
Cryptocurrencies are a digital representation of value on a decentralized distributed ledger. They can be separated into two broad categories:
- Payment coins – coins that can only be used to transfer value from one user to another. Popular such networks are Bitcoin, Litecoin, and Doge.
- Utility coins – that are used to fulfill a specific task on their blockchain, like voting, paying transaction fees, staking etc. Popular utility coins are Ethereum, BNB, and Chainlink.
Worth noting is that most coins differentiate from one another in their characteristics. For instance, some propose a capped maximum supply, while others don’t. Furthermore, some are aimed toward fast and cheap transactions while others might be a good store of value.
What gives crypto its value?
Like all open-market assets, the value of cryptocurrencies is mainly decided by the laws of supply and demand.
In a nutshell:
- As demand increases and supply lowers, the price goes up.
- As demand decreases and supply raises, the price goes down.
Having said that, there is a wide array of factors that can influence supply or demand in the cryptocurrency markets. Let’s have a more detailed look into what these are.
Scarcity
The scarcity of a cryptocurrency is defined by the total supply of a coin in the markets. As we briefly mentioned, some cryptocurrencies (like Bitcoin) have a capped maximum supply and only a limited number of coins can be put into circulation over time.
Others, on the other hand, do not have such a limit (like Dogecoin) and theoretically, an infinite number of coins can be released in the markets.
Furthermore, Bitcoin’s reward system for minting new coins is reduced by half every 4 years, This decreases the number of coins put into circulation even further.
The higher the scarcity of a coin, the better the chances will be for it to become a solid store of value over time.
Utility
The use cases of a cryptocurrency can also play a big part in its intrinsic value. Let’s compare Litecoin and Ethereum for example.
Litecoin has a single use case – to be used as a currency for exchanging value and acquiring goods and services on the internet.
Ethereum, on the other hand, can be exchanged for its value, but is also used to pay for transaction fees on its blockchain. This is an important use case, as the Ethereum network allows for the deployment of smart contracts and decentralized applications. Each time a developer wants to use the Ethereum blockchain, they need to pay the gas fees with the token.
Consequently, the more useful the cryptocurrency is, the more value it might gain.
Project quality
Another important element is the perceived value of a project. For instance, if a project’s fundamentals are solid and it provides a future-proof ecosystem, users might perceive it as more valuable.
In this day and age, to be successful, a blockchain project must bring its fair share of innovations in the ecosystem, while at the same time provide achievable and realistic goals.
A good example of such a coin is Polkadot (DOT) which shot up in the top 20 coins by market cap only a month after its release.
Hype
And last but not least, there’s the hype factor. Cryptocurrencies are a nascent technology and news and rumors can have a great impact on the market sentiment, and therefore, the price of a coin.
There are two main factors to consider:
- FOMO – or fear of missing out, where a large number of investors flock to the markets and scramble to buy in, regardless of the cryptocurrency price or its fundamentals. This can result in sharp price spikes, as we recently saw with the price rally of Dogecoin.
- FUD – or fear, uncertainty, doubt – where the market sentiment plummets due to rumors or negative news, resulting in a sell-off and price dips.
Conclusion
Cryptocurrencies are volatile by nature, and analyzing market movements can be quite challenging at times. Hopefully, our article gave you a good overview of the most important factors that give cryptocurrencies their value.
This should help you understand price movements before and after they happen, giving you a good foundation to make an informed decision when investing.