How do you take your daily news? Through the TV? Through the newspaper? Through mobile phone apps? Well, whatever medium you choose, you always come across some article or headline or news about cryptocurrency or bitcoin.
Cryptocurrency has become such a buzzword nowadays. Cryptocurrencies are wildly volatile, and we all are aware of it. Well, how can we not be? Our news feeds are always alerting us about the crypto-markets highs and lows. It sure makes up a general impression that cryptocurrencies are interesting but tricky business.
In today's article, we will discuss how and where do cryptocurrencies get their value? This article follows our previous articles on bitcoin basics, mining game, and bitcoin myth-busting.
Let's get started.
Valuation of cryptocurrency
Like any other currency, cryptocurrencies get their value on the basis of the scale of community involvement – demands of the users, scarcity, or the coin's utility. It is worth noting that since most of the digital coins in the market are issued by private blockchain-related companies, some of the value of cryptocurrencies will also stem from such a company's image efficiency – project viability and perceived value. In the points to come, we will discuss what makes up the value of cryptocurrencies.
The utility of the coins
To make a cryptocurrency valuable, one needs to enhance its utility. Cryptocurrencies are essentially a manifestation of using decentralized digital ledger known as blockchain technology. Therefore, to improve the utility of cryptocurrency, one needs to make it usable within a blockchain environment.
To understand this, let's take the example of Ethereum. You cannot start using Ethereum platforms without Ether. Ether is a coin that is specifically designed and tailored to run the transactions within the Ethereum blockchain platform. So, the value of Ethereum is dependent on the demand for the Ethereum platform services.
Other key factors driving the value of cryptocurrency from the utility point of view are payments of dividends, modes of exchange within the blockchain environment, voting rights, etc.
Scarcity of cryptocurrencies
The scarcity of cryptocurrencies refers to the finite nature of digital coins and currency. In an ideal world, the demand for digital coins should exceed the supply of digital coins. But the world is not perfect, right?
Take the example of the most famous cryptocurrency of all – Bitcoin. It is a known fact that bitcoins are finite in number, i.e., 21 million coins. As more and more bitcoins are mined and brought into the blockchain circulation, the demand for the same increases pushing their values to soar highs. Some currencies deploy a burning mechanism that destroys a part of the coin supply. This causes the coins to become scarcer and raises their value as a consequence.
Value and perceived value of the project
The overall viability and progress of project management are two essential drivers of the value of cryptocurrency. Now the question that arises is how do projects become more viable?
Projects that continually keep developing one milestone after another through lucrative partnerships or those that produce user-friendly software become valuable and feasible in the market's eyes. Essentially, these factors contribute to the positive chatter around the project and the company and, consequently, affect its cryptocurrency value.
Market capitalization – An important factor of value than individual coin price
Market capitalization, or market cap as it is usually called, is the most straightforward indicator of the value of a coin in the market. Market cap is calculated by multiplying the total supply of the coins with the price of each coin:
Market Capitalization = Total Circulating Supply Of The Coins x Price of Each Coin.
Let us try to understand this with the help of an example:
Coins in circulation = 2,00,000
Coins in circulation = 1,00,000
Price of each coin = Rs. 3
Price of each coin = Rs. 4
Market Cap = Rs. 6,00,000
Market Cap = Rs. 4,00,000
As you can see, even though Coin B is priced more individually, Coin A takes the lead in terms of market cap value. Therefore, we can say that the market cap index is a better technique to indicate the true price or value of a cryptocurrency.
Adoption by masses
The value of a currency can shoot through the roof if the masses adopt it. Because of the limited number of cryptocurrencies units available, the demand increases, increasing its prices. But if they start getting accepted as a medium of exchange in transactions, the demand will rise even further, and the price rise will know no bounds.
Costs of production
Another factor contributing to the value of cryptocurrencies is the direct cost and the opportunity cost of producing them. We know that the production cost (or mining as it is called) of bitcoins is significantly high. You need specialized hardware systems that eat up vast amounts of energy to mine bitcoins. (Research shows that in a year, about $400 million to $6.2 billion go into energy costs in relation to bitcoins).
Even though the energy used in the mining of bitcoins might appear wasteful, it is still the only way to ensure safety for the users. This is because the governments cannot shut down the bitcoin blockchain so quickly.
As bitcoins and other cryptocurrencies are poised to become more mainstream, the chances of them coming under some form of government regulation are relatively high. The imposition of regulations would lead to digital money becoming more centralized, causing a considerable impact on a cryptocurrency price.
Increasing node count
Another good indicator of cryptocurrency value is node count. Node count refers to the measurement of the number of active wallets on the blockchain network, which can be easily searched on the internet or the homepage of the respective currency—the more the nodes, the stronger the community.
To analyze if a currency is reasonably priced, you can search for the node count and the total market cap of the cryptocurrency and compare with the same parameters of other cryptocurrencies. This is one of the ways to know if a particular cryptocurrency is overbought.
Bitcoins and other cryptocurrencies are regarded as highly volatile, with wild fluctuations all around. But as the tech giant and people of influence continue to show their interest in blockchain technology and digital ledgers, coupled with governments' attempts to bring cryptocurrencies under regulation, cryptocurrency is one term that is here to stay! Or, dare we say, is the future of all currencies and transactions.
Stay positive, test negative.