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What determines the value of a cryptocurrency?

The technology behind a cryptocurrency plays a very big role. Decentralised currencies are resistant to censorship but even more so, it is nearly impossible to just shut them down.

 

Thanks to the use of public ledgers, there is no need for a third party to ensure additional trustworthiness or transparency.

Another important part of the technology is its safety. The digital nature of cryptocurrencies implies that there could be bugs in the coding. For example, an ethereum-based smart contract for a democratic digital investment fund, the so-called DAO, had a bug that was ultimately exploited by a hacker who stole more than $30M worth of ether. To fix this issue, a change in the ether blockchain was discussed.  Some in the Ethereum community agreed that it would fix the problem, but others didn’t want to change the code as a matter of principle and were afraid it would affect the credibility of ether. Ethereum was then split into two versions: Ethereum (the one with the new code) and Ethereum Classic (the original code). Both can still be traded and everyone who owned ether at that point received a version of the new one and the classic one. Such an event is called fork and can have a big impact on the price if there is no consensus between the miners and other participants in the network. 

 

Node Count

Node count is a good indicator of the value of a cryptocurrency. Node count is a measurement of how many active wallets on the network exist which can be searched on the internet or the homepage of a currency.

In order to analyze whether or not a currency has a fair price, one can search for the node count and the total market capitalization of the cryptocurrency then compare those two indicators with other cryptocurrencies.

 

This is one way to find out if a coin is overbought. Node Count also shows how strong the community of a cryptocurrency is. The more nodes, the stronger the community. This is important to know in order to calculate the chances for the Currency to overcome crises.

 

Rising demand

Thanks to big online exchanges like the ones you can find in Tradimo’s list of popular cryptocurrency exchanges, the usability has increased dramatically, which is why we have seen a very big increase in the market cap over the last years. Thanks to this rise in popularity and adoption by many companies, more and more governments and countries are trying to find out how they can implement them as well. All of these reasons have been fundamental drivers for the price increase in cryptocurrencies. 

 

 

Supply and Demand is a big factor that determines the value of anything that can be traded, including all digital currencies in the market. For example, if more people are trying to buy bitcoins, while others are willing to sell them, the price will go up and vice versa. And since the supply of many cryptocurrencies is limited, the increased popularity has been driving up prices. 

 

However, if a coin faces scandals like serious hacking attacks, or a new coin becomes commonly known as a scam, then the demand for it can go down fast - very fast. As a result, a domino effect can occur: The price of a cryptocurrency could then decline even faster, as many traders and miners want to realize the profits that they have made already. Such events can also be felt beyond just one single cryptocurrency: for example, a decline of the Bitcoin price has led many times to a correction of the whole market for cryptocurrencies.

 

 

Mass Adoption

 If a currency gains mass adoption, its value can shoot through the roof. This is because the total number of most cryptocurrencies are limited, and an increase in demand leads to a direct increase in price.

But which factors are still needed for cryptocurrencies to become truly adopted by the masses? One is the applicability of cryptocurrencies in real-world situations, i.e. the number of places that accept them as a means of payment. If a cryptocurrency has a use case in everyday life like today's fiat currencies, it will be in a very good position to possibly play an important role in the future. 

Inflation of fiat currencies

If the price of a fiat currency falls, then the price of Bitcoin would go up with respect to that currency. This is because you will be able to get more of that currency with your Bitcoins. This phenomenon can be seen today, since the FED, the ECB and other central banks have been printing more and more money and keeping interest rates artificially low.


Figure 1: Sketch of the differences in the price development of a cryptocurrency (here Bitcoins) and the US Dollar

 

Production Cost

The direct costs and opportunity costs of producing a coin are also factors which determine the value of a cryptocurrency. Bitcoin, for example, has a high cost of production. The resources and energy that have been put into the mining of bitcoin can be seen as a reason why the bitcoin has value. This includes the cost of manufacturing specialized hardware like CPU's/GPU's or servers as well as the cooling systems for such hardware.

 

In addition to this, there are also significant energy costs that are necessary for these systems to operate. Research has shown that the electricity costs of Bitcoin mining range between $400 million and $6.2 billion per year.  

 

Even though it may seem that the energy used for the creation of new Bitcoins is wasteful, it is still the only way to provide safety for the users - as mining is the reason why governments can't shut down the Bitcoin blockchain easily. But there are discussions among programmers on how to make the process more efficient.

 

Regulation

The chance for regulation by governments is very high once the cryptocurrency has gone mainstream. You should also bear in mind that these regulations could lead digital money to become more centralized. This would have a big impact on the price of a cryptocurrency.

 

Critics say that transactions will be reduced and controlled because of regulations and the lack of security governments might see in cryptocurrency. Some institutions might even ban them as such attempts in Russia and China have shown.

 

Conclusion

  • The value of a cryptocurrency can change very fast, but with time one can see that the volume of transaction has gone up while the volatility has kept dropping. It remains to be seen if this trend will continue. The chance of a significant correction in price has to be kept in mind. It is up to every trader and investor to weight for themselves the significant potential of cryptocurrencies with the risks that these currencies are still exposed to.
  • The long-term value of a digital currency will be determined by many factors, such as true mass adoption and the real value that such currencies bring for our everyday lives (when compared to other traditional payment methods). Another critical factor will be whether governments and central banks embrace the new technology or fight against it. Last but not least, the usability and safety is a key component that has to evolve beyond today’s standard to allow everyone to keep their cryptocurrencies readily and safely available for use in our everyday life.  
  • All of these combined factors make it difficult to accurately predict the price of cryptocurrencies, but also make it very interesting for traders and investors in the market every day.

 

Opening a trading account

The details behind opening an account and trading will be covered in the next lessons. If meanwhile, you want to open an account with a broker feel free to do so. you can get yourself familiar with the terms and conditions, the interface and the overall services of the broker/s you choose. Remember you can start trading and practicing with a demo account.

At Tradimo we have partnered with the two most reputable brokers when it comes to cryptocurrencies. When you open an account from this page and deposit you will get offers exclusively for Tradimo learners.

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