Cryptocurrency is known to be notoriously volatile. So much so that in just a span of one year, one of the largest crypto – Bitcoin, went from $64,000 to just $20,000.
Similarly, since the Ethereum merge, the prices have plunged to about $1300 from $4400 back in Nov 2021.
While these fluctuations are interesting enough, it begs the question – how does cryptocurrency gain or lose value in the first place?
The process of gaining and losing value for a digital asset is interesting. However, to understand this process better, there’s a need to understand the significance of digital currencies first.
Valuation of Digital Currencies
Currencies serve as a transactional tool. These tools allow us to get something in exchange. The more we have, the more we can afford in life.
However, as these currencies are not limited to a specific commodity or item, they could be altered. In fact, their volume could also impact the economy of the entire state or country.
Ages ago, gold was used as a transactional tool. However, since proportionating isn’t exactly convenient, then came the paper which eventually helped us distribute wealth in specific amounts.
As we progressed, we realized that it’s simple enough to just send numbers across from our phones and computers. While these numbers aren’t hard cash, these still amount to the exact same value in real life as well.
With the introduction of web 3.0, we realized that the transfer of money and value isn’t just limited to the ‘now-traditional’ methods of payments. Rather, these transactions could happen on a decentralized blockchain. In fact, their transactional volume could have the same impact on the economy of a country, one of which is Bitcoin.
How do digital currencies have a value of their own?
One of the largest cryptocurrencies, Bitcoin, is an independent project that’s not backed by any govt authorities. However, Bitcoin is still valued in billions of dollars in its entirety.
A decentralized network that consists of independent nodes allows consensus-backed transactions in this network. This means there’s no fiat authority or any other party that acts as a counterparty in between.
Being hosted on decentralized networks, these currencies gain value on the exchange platforms they exist on. The increase in value is an amalgamation of a variety of factors, some of which include:
1. The utility
With Bitcoin and Ethereum, there are more than 5000 other cryptocurrencies that exist. While these projects are constantly in development mode, there are still scenarios where they could be implemented in real life.
In this case, Bitcoin plays an important role. Even though Bitcoin is the largest cryptocurrency ever, it still fails to be a part of normal retail transactions for the most part.
Bitcoin has found its way among many payment methods over the years. But because it’s not readily accepted everywhere and is still in its infancy because of how young the entire crypto market is, there’s still time before it could be used as a primary payment method. For now, the utility isn’t crazy enough.
2. The scarcity
For a cryptocurrency like Bitcoin, the value is derived more from its scarcity than its utility. Bitcoin is like that one asset in web 3.0 that you just consider the face of the entire industry.
The cryptocurrency is limited to a quantity of 21 million, out of which most has already been mined and the rest is really hard to mine.
Due to its scarcity, if the price for any asset continues to rise, users would also be able to make transactions with the asset, even if they just hold a tiny fraction of the asset.
3. Cost of production
While it’s not evident enough, it’s a theory that the value of Bitcoin is also proportional to the marginal cost of producing it.
The amount of energy, resources, and electricity required to produce Bitcoin invites a real cost on miners.
In a competitive market where the producers are eventually making the same product, the selling price of such a product (Bitcoin in this case) tends towards its marginal cost of production.
4. The competition
When it comes to value, competition could be a pro and a con at the same time. Because how Bitcoin was the only major project to exist a few years ago, it heavily benefitted from the lack of competition in the industry.
A few years later, there are projects like Ethereum, Tether, and Binance coin that have dominated this industry and have their own fair share of value in the markets.
With the increased competition, there’s also a loss of value as the competitors are regularly improvising and providing more options to regular crypto users and investors.
In our guide on crypto pumps and dumps, we realized how celebrity endorsements can contribute to making or breaking a project.
The likes of Elon Musk, Mike Tyson, Snoop Dogg, and Jack Dorsey have played a great part in the promotions of certain projects, something that could skyrocket the popularity of a certain asset.
However, with the wide acceptance of these projects, there are also scenarios associated where certain assets start gaining or losing popularity over time. And since the popularity of a certain asset is important for its relevance and promotions, it’s almost important for these assets to get endorsements from time to time.
The changing value of the crypto assets
Cryptocurrencies gain and lose value more than usual physical assets, which is okay, considering how young this technology really is.
With so many factors into consideration, there are a lot of anomalies involved in the valuation of cryptocurrencies and digital assets.
Investing in such assets requires knowledge and you to be prepared well in advance. And talking about being prepared, it’s important to track your own personal tax report on your crypto investments as well. And what better way than to start right here at KoinX and gather all your tax reports in a single place?