The technology of cryptocurrency has been making it to the headlines ever since it was first envisioned and developed. It has already transformed several industries. However, it is easy to misunderstand the similarities and differences between cryptocurrencies and fiat currencies like US dollars. Above all, what makes one form of cryptocurrency more (or less) valuable than another? And what determines the price or value of a cryptocurrency?
The simplest answer to these questions is that cryptocurrency has the value that people are willing to ascribe to it. This attribute makes it similar to any other kind of currency or unit of exchange. But within this, just as with other currencies, you’ll find that a number of factors come into play when determining the value of cryptocurrencies. Some of these are:
Supply and Demand
What makes a metal like gold so valuable is its perceived value and limited supply. There isn’t much of it, and so it’s a good replacement for things which you want to stay valuable. This is the purpose of currencies, to make the value of goods and services portable. However, this also means that its value can fluctuate. Naturally, the value of gold goes up when people perceive it as a valuable metal and believe that its supply is limited. Supply and demand also effects the value of cryptocurrency. Since the supply of a particular kind of cryptocurrency is constant and limited, people pay more to obtain the currencies which others are investing in as well. The more invested in a currency becomes, the better bet it looks, and the more people are willing to invest in it.
The Difficulty Involved in Mining
It takes quite a lot of energy to ‘mine’ one unit of cryptocurrency. In the case of Bitcoin, for example, the energy used annually is almost equal to the electricity that the country of Denmark uses in a year. It’s costly, and the hardware and coding required is complex. When there’s a higher level of difficulty involved in mining a coin, the coins are harder to get, and consequently, its perceived value increases.
Investors can affect the value through hype in the case of most cryptocurrencies. This is especially true when it comes to the lesser-known options. When investors with a large amount of capital at their disposal invest considerably in a particular form of cryptocurrency, the value of that currency will go up. In some cases, when an investor with clout attempts to promote the cryptocurrency he invested in, it can drive the value of that currency upwards. Though creating hype for a cryptocurrency like this is common, it can lead to short-term bubbles that often burst.
Perception of the public
How the general public perceives cryptocurrencies can influence their value a lot. The public reputation of a particular cryptocurrency can be quite volatile. Currency values can fluctuate when people react positively to an innovation. Values can also change when positive or negative news regarding cryptocurrency reinforces the belief that cryptocurrency offers some unbeatable competition which cannot be tampered with. Public focus moves on quickly.
The utility factor
The utility factor of any unit of exchange is about whether it can be used for some useful purpose. The more a currency is used, the more its utility is demonstrated, and so the more valuable it becomes.
Aside from these factors, there are a number of other forces in play that makes cryptocurrencies valuable. These include legal and governmental issues, the price of Bitcoin (which is still seen as the ‘reserve currency’ of the cryptocurrency world), and the level of confidence in traditional institutions like banking. Ultimately, it isn’t one single force that makes cryptocurrencies valuable, but a range of factors.