Do you want to know how the value of cryptocurrencies increases? Read till the end as we explain all the factors that influence the value of cryptocurrencies.
Cryptocurrencies, often based on blockchain technology, have caused a paradigm shift in the way we perceive and interact with money. Unlike traditional currencies issued by central authorities, cryptocurrencies operate on decentralized networks, giving users more control over their financial transactions and security. Still, the question remains: how can digital businesses capture and sustain value without physical presence and support? Why are virtual currencies soaring? What causes the rise and fall of cryptocurrencies? In this guide, we will decipher how cryptocurrencies gain value.
Let’s get started.
How does the value of cryptocurrencies increase or decrease?
Let’s start with some basic factors, including the value of Bitcoin.
1. Supply and Demand
The answer to the question “What is the value of Bitcoin?” is determined by the basic economic principles of supply and demand. When the demand for a cryptocurrency exceeds the available supply, its price increases. This phenomenon is similar to traditional price increases due to raw material shortages. Each cryptocurrency describes its supply mechanism, with some having a fixed maximum supply (e.g. 21 million Bitcoins) and others being flexible. Cryptocurrencies like Ethereum use mechanisms such as token writing to maintain a manageable circulating supply.
Monetary policy differs for each virtual currency. While Bitcoin’s supply increases each time a new block is mined, Ethereum has a more differentiated reward system. Increased demand is often driven by increased awareness or utility of the project. Widespread acceptance of cryptocurrencies as investments increases demand and limits circulating supply. For example, the price of Bitcoin skyrocketed in 2021 due to institutional investment. Similarly, the growth of decentralized finance projects is increasing the demand for tokens like Ether. Fundamentally, the value of a cryptocurrency depends on the dynamic interplay of supply, demand, utility, and recognition. And current trends are focusing on the question of why cryptocurrencies are rising.
2. Production Costs
Cryptocurrency tokens are typically generated through mining, which is the process by which computers verify blockchain blocks. This decentralized network of miners is essential to the functioning of cryptocurrencies. As a reward, miners receive tokens and transaction fees. Mining requires significant computing power and cost, especially in proof-of-work systems like Bitcoin, which are increasingly competitive and complex.
Rising mining costs require higher cryptocurrency values ββto cover costs. If the reward does not exceed the cost, miners will not participate. Since miners are essential to blockchain operations, continued demand is driving up the price of cryptocurrencies.
3. Exchange Accessibility
While well-known cryptocurrencies such as Bitcoin and Ether are traded on a variety of exchanges, smaller tokens may have limited availability on certain platforms. and may have limited investor access. Certain wallet providers integrate services for exchanging different cryptocurrencies across exchanges, but they charge fees, which increases the cost of your investment. Additionally, cryptocurrencies that are less traded on smaller exchanges have larger spreads, which may deter some investors.
Listing a cryptocurrency on more exchanges widens the circle of potential buyers, increasing demand and, all things being equal, driving price appreciation.
4. Market Competition
The world of cryptocurrencies includes a variety of tokens, and new projects and tokens are emerging all the time. Although the barrier to entry for new competitors is relatively low, the success of cryptocurrencies depends on building a network of users. Blockchain-based applications with practical utility can quickly gain users, especially when considering the limitations of competing applications. As new competitors gain prestige, value is diverted away from existing competitors, causing the price of established tokens to fall as the new competitor’s token increases in value.
5. Project Management
Cryptocurrency networks rarely follow fixed rules. Instead, developers customize their projects to suit their user community. Certain tokens, called governance tokens, allow granting owners to influence the future of the project, including issues such as mining and usage of the tokens. Changing the governance of a token requires agreement between the parties involved.
For example, Ethereum is moving from proof of work to proof of stake, which eliminates the need for many mining devices. This change will inevitably affect the value of Ether. In general, investors prefer stable governance, as familiarity prevails even when cryptocurrencies have operational flaws. Sound governance adds value by promoting price stability.
However, incremental software updates to improve protocols can limit the value of cryptocurrencies, which is another aspect of how cryptocurrencies increase in value. If an update may benefit owners but takes months to implement, it may be to the detriment of current stakeholders.
6. Legal Framework
The issue of regulation of virtual currency exchanges is causing confusion. The SEC classifies them as securities like stocks and bonds, while the CFTC classifies them as commodities like coffee and gold. As both authorities cannot exercise regulatory powers over crypto exchanges at the same time, the final decision could provide greater clarity, increase the value of cryptocurrencies, and expand the range of crypto-related financial products. .
Regulation is essential for smooth virtual currency transactions. Financial instruments such as ETFs and futures contracts provide easy access to investors and have the potential to increase the value of cryptocurrencies. Additionally, regulations could allow investors to use options and futures contracts to take short positions and speculate on the price of cryptocurrencies. This improves price discovery and reduces cryptocurrency price volatility.
However, regulation also has a negative impact on the demand for cryptocurrencies. If regulators unfavorably change the rules regarding the investment or use of virtual currencies, this could lead to a decline in prices in the virtual currency market.
7. Market Demand and Acceptance
Market demand and acceptance have a significant impact on the value of a cryptocurrency and answer the question of how a cryptocurrency gains value. Those with practical applications and benefits, such as enabling cross-border transactions or supporting decentralized finance, tend to be more valuable. As adoption increases, cryptocurrencies become more widely accepted, creating network effects that strengthen their value proposition. As merchants and businesses begin to accept cryptocurrencies as a means of payment, their usefulness and appeal to users increases. The value of cryptocurrencies is not just speculative. This is based on practical ease of use and the extent to which it addresses existing challenges in various industries.
8. Market Liquidity
Market liquidity in the context of cryptocurrencies refers to how easily these assets can be bought and sold without experiencing significant price fluctuations. High liquidity promotes price stability, attracts institutional investors who require large trading volumes, facilitates accurate price discovery, reduces transaction costs, increases confidence in the market as a whole, and more. It’s useful for a reason. Highly liquid cryptocurrencies are less prone to volatile price fluctuations, making them attractive to both investors looking for stability and institutions looking for an efficient trading environment. Increased liquidity increases market confidence, which can lead to broader adoption and a more stable valuation environment.
9. Media Popularity
How do cryptocurrencies increase in value? Media exposure plays a key role in determining their value. Positive coverage can increase public awareness and demand, attract more people, and increase value. However, media attention also leads to fluctuations. Rapid mood swings due to exaggerated news can lead to sudden price changes. To maintain stable value growth, it is important to find a balance between positive exposure and the volatility that can be caused by hype.
10. Price-to-Sales Ratio
This is a financial metric used to measure the valuation of cryptocurrencies and decentralized protocols. Evaluate how the value of the protocol matches its revenue and determine how the value of your cryptocurrency increases. This ratio is calculated by dividing the protocol’s fully diluted market capitalization by its annual total revenue. User payments are taken into account for using the services of protocols such as: B. Transaction Fees and Use of Decentralized Applications. This metric is valuable in assessing the sustainability and growth potential of a protocol, allowing investors to determine whether the valuation is in line with the revenue generated.
11. Price Earnings Ratio Calculated by dividing the
market capitalization (adjusted for dilution) by the protocol’s annual revenue. Annual revenue is determined by annualizing the protocol’s 30-day revenue. This ratio takes into account not only network fees, but also the rewards distributed to participants such as funders and intermediaries. It is important to note that the protocolβs revenue, i.e. the revenue allocated to token holders after deducting rewards, is only a portion of the total revenue generated. Essentially, the P/E ratio helps assess how market capitalization impacts a protocol’s returns, providing insight into the protocol’s valuation and the earning potential for token holders.
12. Market Cap to TVL
This is a metric that highlights the relationship between a protocol’s market cap and the total amount of assets held within that protocol. Market capitalization indicates the financial value of all assets included in the protocol and reflects the overall value of the project. This value is calculated based on the actual application of the protocol and is indicated by TVL. TVL represents the total value of assets locked into the protocol and provides real-world utility and use cases. The market capitalization to TVL ratio provides insight into how a project’s market value corresponds to its actual use and highlights the valuation of the project relative to its tangible assets.
13. Network Value Transaction Ratio (NVT)
A metric that evaluates the relationship between the market capitalization of a digital asset and trading activity on the network. This ratio, calculated by dividing a token’s market capitalization by its 24-hour trading volume, is called the NVT ratio. This ratio allows you to compare different digital assets based on their trading activity compared to their market value. Essentially, the NVT ratio acts as a measure of relative value, indicating how much transaction activity is associated with the network value of a particular digital asset.
14. Realization Cap
A specific segment of market valuation that assesses the value of each unused transaction. Instead of using the current value, the calculation is based on the value of the last transfer. This approach differs from tracking the sum of the market values ββof all coins in the network, as it reflects the actual realized value. A realized cap values ββcoins based on their actual presence in the chain’s economy, thereby mitigating the impact of dormant or lost currencies. Each time a coin that was previously trading at a significantly lower price is used, it increases by a certain amount.
15. Market Value by Realized Value
This is a cryptocurrency metric calculated by dividing the market capitalization of a digital asset by its realized value. This ratio, known as the MVRV ratio, serves as a tool to assess whether a cryptocurrency’s price is currently below or above its “fair value.” By using MVRV and analyzing these cryptocurrency metrics, traders and investors can identify potential market highs and lows and make informed decisions about market trends and price movements. You can do it. This ratio helps estimate the relative valuation of a digital asset compared to its historical realized value, thereby contributing to more accurate insight into market dynamics.
Recessions and Cryptocurrencies
A recession is defined as a widespread decline in economic activity lasting more than a few months. During this period, economic output, employment, and consumer spending will decline, which will also impact cryptocurrencies due to lower consumer demand.
In 2021, cryptocurrencies reached an all-time high of approximately $3 trillion. However, as talk of economic downturn emerged, the value of cryptocurrencies began to decline. The most significant drop saw the value of the two largest digital currencies fall by almost 75%. By January 2023, the cryptocurrency market’s valuation had fallen to approximately $993 billion.
Anticipation of an impending recession has made the public anxious and turned away from risky assets such as stocks, shares, and cryptocurrencies. Consumer confidence has declined due to concerns about economic recession. The value of cryptocurrencies depends on consumer demand, and rising costs of living could limit disposable income, which could make people less inclined to invest in cryptocurrencies.
The impact of a prolonged recession on the value of cryptocurrencies remains uncertain due to the lack of historical precedent, but cryptocurrencies, like other risky investments, may suffer from recession-related fears. expensive. The above is a rough summary of how virtual currencies acquire value.
Important Principles to Consider When Evaluating Cryptocurrencies
1. Liquidity Risk Considerations
To know what causes a cryptocurrency to rise or fall, it is important to consider liquidity risk. Liquidity determines how easily an asset can be bought and sold without experiencing significant price fluctuations. Cryptocurrencies with higher liquidity are more stable and offer investors better entry and exit points.
2. Consistency of Evaluation Models
Consistency of evaluation models is essential. Valuing cryptocurrencies using standardized methods ensures that comparisons between different assets are accurate and meaningful. This helps you make informed investment decisions based on reliable data.
3. Prioritize intrinsic value over short-term volatility
Focus on the intrinsic value of a cryptocurrency rather than being influenced by short-term price fluctuations. Analyze the underlying technology, real-world applications, and deployment possibilities. This approach provides a more comprehensive understanding of the long-term value and utility of cryptocurrencies.
Final Thoughts on How Cryptocurrencies Gain Value
The value of Bitcoin is a complex phenomenon formed by the interaction of dynamic factors. The advantages and innovative features of cryptocurrencies are: Other features such as transaction speed, security, and smart contract capabilities may increase its appeal and demand. Market sentiment, regulatory developments, and economic conditions further influence the ups and downs in the value of cryptocurrencies.
Disclaimer: This material has been prepared for informational purposes only and is not intended as tax, legal, or financial advice. You should consult your own tax, legal and accounting advisors before entering into any transaction.