How Do Cryptocurrencies Gain Value?
6 mins read
3 mths ago
With crypto adoption gaining traction, you have probably heard a few success stories from crypto traders and investors. More popular is bitcoin (BTC)'s price increase from $0.0008 to its current ATH of $68,0000, which has made several millionaires. While this encourages investment in cryptocurrencies, the question of how cryptocurrencies gain value and prices fluctuate is frequently posed.
Cryptocurrencies are characterised by price increases and decreases, and it is not uncommon for a cryptocurrency to record significant price changes in a matter of hours. While the price fluctuations have encouraged many to venture into cryptocurrencies, it has also created doubts.
With this article, you'll have a better understanding of how cryptocurrencies gain value, why their price might swing substantially in a single day and how these benefit you as a crypto investor or trader.
What are cryptocurrencies?
What makes cryptocurrencies valuable?
Cryptocurrencies are valuable because they can be used as an exchange for goods and services and as a store of value. Cryptocurrencies meet all the checks that make traditional currencies valuable, such as acceptability, divisibility, portability, durability, scarcity, and uniformity (protection from duplicity and counterfeiting).
In the last few years, Cryptocurrencies have enjoyed widespread acceptance. They have been integrated into the financial ecosystem such that they are used as a medium of exchange, savings, and investment. Cryptocurrencies, like traditional currencies, are divisible, which is why you can buy a fraction of cryptocurrencies. They are also designed to prevent counterfeiting (double spending), which has made them a popular medium of exchange.
In fact, unlike traditional currencies, which are prone to inflation, cryptocurrencies are considered a hedge against inflation. These qualities make cryptocurrencies valuable and have encouraged crypto adoption worldwide.
How do cryptocurrencies gain value?
The value of cryptocurrencies is determined by supply and demand. The supply and demand of a cryptocurrency at a particular time will determine if the cryptocurrency increases in value or not. When the demand for a cryptocurrency exceeds its supply, the price goes up. However, when the demand is less than the supply, the price drops.
The scarcity or limited supply of a cryptocurrency also makes it gain value, such as bitcoin’s limited supply of 21 million bitcoins. However, not all cryptocurrencies have a limited supply, e.g. ETH, which has no cap on supply. Yet, these cryptocurrencies can maintain the number of tokens in circulation by burning existing tokens.
Demand increases as crypto adoption increases and people become aware of more crypto projects. As broader adoption continues, supply decreases as people buy more cryptocurrencies, thus reducing the number of cryptocurrencies in circulation.
Factors that may affect cryptocurrencies’ value
Demand and supply primarily define how cryptocurrencies gain value; however, several factors may affect the demand and supply of cryptocurrencies. These factors include:
- Utility/ Usefulness of the crypto token
Cryptocurrencies gain value as adoption increases, and people use them as a medium of exchange, store of value, and more. Cryptocurrencies are only as valuable as their usefulness in the financial ecosystem or blockchain. This is why shit coins, e.g. Squid coin, which seems to have value at first glance, often crumble in no time.
As the crypto token improves and new features are added to address users' needs, the value increases. This explains why announcements of crypto forks and updates are often met with price gains.
- News or rumours that drive market sentiments
Market sentiments or emotions that users have towards a market can drive the value of a cryptocurrency upward or downwards. News or rumours that a well-known celebrity is or maybe investing in a cryptocurrency can drive positive market sentiments, which increases the demand for a cryptocurrency. For instance, news of Elon Musk buying Dogecoin and Bitcoin resulted in a price surge for cryptocurrencies. Crypto adoption news spurs positive market sentiments that encourage people to invest in cryptocurrencies.
At the same time, news can drive negative market sentiments that lead to sell-offs that negatively impact the price of a crypto token. For instance, news of a crypto ban or unfavourable crypto regulations in a country, a lawsuit against a cryptocurrency may lead to fear that results in investors selling off their crypto token. This reduces demand while increasing supply resulting in a decline in value.
Also, news that crypto whales would either buy or sell crypto tokens may affect the value of cryptocurrency. When a crypto whale buys more cryptocurrency, they reduce the crypto tokens in circulation, leading to price gains. However, sell-offs increase crypto tokens in circulation, thus reducing their value.
- Competing cryptocurrencies
Since the launch of bitcoin, thousands of cryptocurrencies have been created, with some crypto tokens aiming to improve the limitation of others. Like in a competitive market with several products, the poor or better performance of competing tokens can affect the price of a token.
If a crypto token proves less helpful than competing cryptocurrencies, or the competing tokens develop a new feature that attracts investors, its demand may drop. Investors will lean towards the more useful cryptocurrency, decreasing its value and vice versa.
A cryptocurrency's practical application to the blockchain and financial system should guide investment. A crypto token with no real value may crumble when faced with competition from other tokens.
- Cost of production
The cost of production, which is how easy or expensive it is to create a cryptocurrency, also increases its value. Cryptocurrencies are minted or created through a process called mining. Mining involves the use of expensive energy-consuming machines to verify blocks on the blockchain.
This is why cryptocurrencies gain value as the cost of mining cryptocurrencies increases. This is because miners won’t mine if they aren't getting the value of their actions.
- Ease of access/ availability on exchanges
The ease of access that is how easy it is to enter a crypto market can determine a cryptocurrency’s value. Cryptocurrencies that are not available on most exchanges but on select exchanges limit accessibility. As such, exchanges that offer them on their platform may not accept a direct purchase with local currencies but only with cryptocurrencies. At the same time, there may be extra fees to access these cryptocurrencies.
This may discourage investors from investing in such cryptocurrencies as it is difficult to enter the market. This is not to say that it may not work to the cryptocurrency’s advantage. That is, the difficulty in accessing such tokens may provide a sense of exclusivity that helps the token gain value.
However, most times, when a cryptocurrency is listed on more exchanges, it will be easier for investors to enter the market, and demand will increase. With increased demand comes an increase in value.
How to benefit (make money) from cryptocurrencies’ price gains
Cryptocurrencies over the years have proven to be a profitable investment, and there are several ways you can benefit from these price gains. You can make money from gains in cryptocurrencies’ value by:
- Investing or saving in cryptocurrencies: Like traditional assets, you can invest and save your funds in crypto. You buy, hodl, and sell when the price soars.
- Invest in mining: You can earn from mining cryptocurrencies. It can be expensive and involve technical skills, but you earn profits from crypto gains.
- Invest in Crypto projects: You can either stake your cryptocurrencies (lock them in a wallet and use them for verifying transactions) or lend your crypto tokens for an interest.
- Crypto trading: You can actively trade cryptocurrencies and profit from price fluctuations by buying low and selling high.
- Participate in airdrops: Participating in the blockchain by creating awareness can earn you crypto rewards through airdrops. When the crypto gains value, you can then make a profit by selling your crypto tokens.
Like any traditional asset or product, the value of cryptocurrencies is affected by the principles of demand and supply. With increased adoption and use, cryptocurrencies become more valuable and highly profitable when invested. However, several factors may affect how cryptocurrencies gain value. It is essential to consider these factors when investing in any cryptocurrency.
It also isn’t advisable to invest all your funds in cryptocurrencies without considering an emergency fund or other financial goals or needs. Understanding these factors and looking out for them will ensure that you enjoy the best benefits from cryptocurrencies price gains.
Disclaimer: This article is meant to provide general guidance and understanding of cryptocurrency and the Blockchain network. It’s not an exhaustive list and should not be taken as financial advice. Yellow Card Academy is not responsible for your investment decisions.