From time to time, due to various external factors, fiat currencies gain or lose in value. Although some of the reasons behind their price volatility are exclusive to the cryptocurrency market, as a store of value, cryptocurrency is no exception to price fluctuations.
The valuation factors are numerous, ranging from the coins’ scarcity, user demand, utility, etc. Plus, most of these assets are launched by individual startups which means that part of their success lies in the delivery and efficiency of these projects.
Today, we’ll outline the crucial factors that cause the value of a cryptocurrency to change and demonstrate these ups and downs using Bitcoin’s price history.
Factors Affecting Crypto Prices
Unlike the unlimited supply of fiat currencies, most cryptocurrencies are hard-capped, i.e. their total supply is limited. For example, Bitcoin is capped at 21 million BTC, with over 18.5 million BTC already mined.
Bitcoin founder Satoshi Nakamoto set this limit for two reasons: to prevent inflation scenarios and create scarcity.
However, contrary to what you might think, we won’t run out of bitcoins to mine in the next couple of years. This has to do with the increased Bitcoin mining difficulty and halvening. Every four years, the Bitcoin network slashes the mining reward in half. People refer to this phenomenon as halvening.
Even though experts predict we won’t run out of new BTC before 2140, the supply inelasticity and shortage in supply has created buying pressure and drives the price of hard-capped cryptocurrencies.
It’s really that simple – the more use cases people find for cryptocurrency, the more popular they’ll be and the increased demand will pump their prices up. Right now, cryptocurrency is an attractive alternative to traditional digital or contactless payments because it allows for faster, cheaper, and more secure money transfers.
An increasing number of merchants and online retailers let their customers pay with Bitcoin and a couple of other reliable altcoins. Big players like Visa and Mastercard have already shown support for these assets, and only last month, PayPal started offering crypto services too. As a result, Bitcoin skyrocketed in price.
Central banks around the world have also acknowledged the potential of cryptocurrency. This is evident by the fact that a number of banks and leading institutional investors have partnered with Ripple (XRP), an altcoin that provides sophisticated cross-border payments.
Cryptocurrencies are revolutionizing the DeFi industry too. Decentralized finance tokens are gaining traction as research shows that an increasing amount of institutional money is flowing via on-chain transactions.
Fiat Currency Inflation
Usually, the government chooses the currency that will be used as legal tender. This currency has no intrinsic value other than the one the government assigns to it.
In this system, it’s mostly central banks and monetary reserves who are in charge of the fiat money supply and control inflation to some extent. Inflation occurs when the purchasing power of a fiat currency – the U.S. dollar, let’s say – decreases significantly. When this thing happens, cryptocurrency will increase in value against the US dollar.
Contrary to fiat currencies, authorities don’t consider crypto as legal tender but it can still be used as a medium of exchange. You can legally buy, sell, trade, or pay with digital assets using cryptocurrency exchanges, your bank account, or credit card.
However, most countries lack a regulatory framework to control cryptocurrency money transfers. Countries such as the US, the UK, Canada, and Australia have attempted to regulate these digital currencies. They treat crypto as property and crypto profits are subject to capital gains tax.
For some economists, a more rigorous crypto regulation can increase the costs of these transactions which then affects cryptocurrency prices.
Competition and ICOs
Another factor that can cause price rallies is the rising competition among digital currencies. Although it’s highly unlikely that another cryptocurrency will be able to take Bitcoin down, there are some very profitable altcoins that might be competing against one another for mainstream adoption.
Both the market capitalization and liquidity of assets like Ethereum (ETH), Ripple (XRP), Bitcoin Cash (BCH), EOS, and Litecoin (LTC) are very impressive. On top of that, new crypto projects keep emerging on the Initial Coin Offerings (ICOs) market. If an asset lacks purpose and real-life use case, another fully-fledged virtual currency will win the investors’ attention.
Blockchain Consensus Mechanisms
Research shows that the cost of altcoin production has an impact on crypto prices. Blockchain is the technology that underpins cryptocurrencies and their peer-to-peer networks. To keep the blockchain ecosystem secure, miners solve complex algorithms and mine new coins. This algorithm is also known as a consensus mechanism.
Bitcoin, for example, uses the Proof of Work mechanism which requires a vast amount of computing power, i.e. consumes a lot of electricity. Therefore, in order for mining Bitcoin to pay off, the mining reward has to be higher than the mining costs.
Milestones in the Price of Bitcoin
During the first couple of years after its 2009 launch, Bitcoin was worth just a few US dollars. Its price picked up around 2013 when the first Bitcoin exchanges (later on cryptocurrency exchanges) emerged on the market. Bitcoin experienced several price increases and arrived at 1,000 USD for 1 BTC by the end of the year.
In 2014, China entered the crypto market and created a number of mining pools. This was a volatile year for Bitcoin, especially after the notorious hacking attack of Mt. Gox, a popular crypto exchange that operated with over 70% of the BTC in circulation.
By mid-2015, Bitcoin’s price plummeted down to $300 and remained unstable until 2017. This had a lot to do with the negative media press. People considered Bitcoin as a black market currency as a number of countries, including China, investigated criminal activity associated with crypto exchanges.
Things were looking pretty grim for Bitcoin until 2017 when Japan declared it a legal currency. All of a sudden, the number of altcoins doubled. This kept driving Bitcoin’s price to new heights, hitting $20,000 in December 2017.
Unfortunately, this unprecedented cryptocurrency growth was followed by a heavy fall as Bitcoin reached $3,500 in November 2018. Bitcoin has had a steady price growth since then. In the wake of the COVID pandemic, more people are seeking contactless and decentralized payments. From the looks of it, Bitcoin might even break its record by the end of the year.
Now that you know the factors that cause cryptocurrency to gain value (or lose it in some cases), you can make well-informed decisions when investing in the crypto market.
Final words of advice: always check the reliability, market cap, and liquidity of the crypto asset you want to invest in. Look for information on the coin’s team the project’s goal and philosophy.
You should also decide in advance what you want to do with your cryptocurrency once you purchase it. Do you fancy betting against its price or do you want to use it for purchasing online services as a more secure payment method?
If you’re curious about DeFi and want your institution to incorporate smart contracts as part of its business model, look for decentralized finance tokens that offer these services. Don’t just blindly follow the hype and choose an asset that caters to your needs.