As the cryptocurrency market continues to outgrow itself with each passing year, more and more people and investors are drawn to crypto assets as a lucrative opportunity for making money. In the past few years, both small-time investors and high-rollers like investment banks have been attracted to the growing crypto market with the belief that the future of finance is unfolding on the frontiers of crypto space. But even in the midst of unparalleled growth, certain aspects of the crypto economy remain somewhat obscure. In this article, we will tackle one of the most important questions relating to cryptocurrencies: how does cryptocurrency gain value?
Why Do Cryptocurrencies Have Value?
In order to pinpoint how cryptocurrencies gain value, we should first take a look at why cryptocurrencies have any value in the first place. As you know, fiat currencies have value because they are sanctioned by state authorities that guarantee their purchasing power. Basically, a currency has value because you can exchange it to purchase goods and services. On the other hand, stocks and securities have value because they represent the goods and services that are available for purchase on the market. Company stocks, for example, gain value because there is a demand for the products produced by the company.
Cryptocurrencies are a relatively new asset class that occupies the middle ground between regular currencies and stocks. They are not currencies in the regular sense of the term, because the purchasing power of a cryptocurrency is not guaranteed by any authority. They are also different from stocks because there may not necessarily be a product or service behind the cryptocurrency. For example Bitcoin, the most valuable cryptocurrency in the market, doesn’t represent anything but itself. It is an asset that has value because people think it is valuable.
Of course, there are thousands of cryptocurrencies in the market with different specifics so it is hard to extrapolate why cryptocurrencies gain value in general. But it is possible to make sense of why certain digital currencies gain value whereas some others are considered less valuable than penny stocks if we take into account the most basic and foundational principle underlying most modern economies: supply and demand.
What Fuels the Demand for Cryptocurrencies?
In order to understand what fuels the demand for cryptocurrencies, let’s look at two of the biggest and most developed cryptocurrencies on the market: Bitcoin and Ethereum. Bitcoin and Ethereum are good examples because they are two very different types of cryptocurrency..
Why Is Bitcoin Valuable?
Bitcoin is generally considered an asset that is akin to currencies or gold because it is considered to have both exchange value and store of value. That means that Bitcoin can be used to purchase goods and services around the globe, but it is also considered an investment that keeps its value over a long period of time without being affected by economic ups and downs that can wreck the traditional asset markets, much like gold. In other words, Bitcoin gains value because people and institutions think the digital asset is – and will continue to be – valuable as a medium of exchange and as a store of value. That is mainly because Bitcoin has characteristics that make it useful and also valuable.
Bitcoin is the first and the largest cryptocurrency, which means its network is wide enough to withstand hacks that threaten other smaller cryptocurrencies. It provides instant and fast value transfers across the globe that make it tremendously useful in a world where sending money across borders can be an economic and bureaucratic nightmare. In other words, Bitcoin has value because it emerged as an original solution to a widespread problem. Other altcoins with similar characteristics and goals as Bitcoin, on the other hand, struggle to gain as much value as Bitcoin because they are in competition with the original. Any one of these cryptocurrencies can beat Bitcoin to the top, if and when they provide better alternatives to it.
In addition, there is a limited supply of Bitcoin. There will only ever be 21 million Bitcoins, so as demand increases, the value of each Bitcoin rises.
Why Is Ethereum Valuable?
Ethereum represents another variety of cryptocurrencies because Ethereum has a different promise than Bitcoin. Whereas Bitcoin is considered as an exchange and storage method for value, Ethereum is a platform for different services. Ethereum introduced smart contracts, the concept of executing automatic and direct transactions between parties without an intermediary, giving start to a flourishing DeFi industry. In other words, people think Ethereum is valuable because it offers a product that is valuable. It is another unique solution that opens new avenues for growth.
While Bitcoin and Ethereum have different mechanisms, goals, and products, they both have something in common: these cryptocurrencies offer value to the world because they establish new ways of making things happen. They are innovative. They promise usefulness and they back it up with strong development teams and clear plans for the future, even though their roadmaps differ a lot due to their unique visions for the future. At the moment, these cryptocurrencies constitute the blueprint for many other crypto projects that try to follow in their footsteps, and luckily for us, they also provide a blueprint for us to understand why and how other cryptocurrencies gain (or lose) value.
How Does Demand Factor In?
For any cryptocurrency to gain value, there has to be a demand for that cryptocurrency. In the previous section, we explored how Bitcoin and Ethereum create such demand by offering unique methods to overcome the restraints of our current financial systems. But while vision and usefulness are the most fundamental components for a cryptocurrency to gain value, there are also other factors that play into cryptocurrency valuation.
One of the most important aspects of valuation is information. There can be no demand for a product or a cryptocurrency if the public doesn’t have the necessary information regarding the value a cryptocurrency promises. That is why educational materials and marketing play a very important role in cryptocurrency valuation. News about the cryptocurrency industry, including news about crypto hacks, new regulations, crypto-related crimes and new business partnerships between cryptocurrency projects and established companies have a direct effect on cryptocurrency valuation, i.e. the value of cryptocurrencies.
When companies like PayPal, Twitter or Tesla embrace cryptocurrencies, they signal institutional trust in these assets, increasing the reach of digital coins and increasing their value.
In short, cryptocurrencies gain value based on both general and specific considerations related to the crypto industry as well as the specific cryptocurrency. Crypto-related news, opinions of prominent figures and industry leaders, and regulations on cryptocurrencies set the broader trends regarding crypto valuation, but each specific cryptocurrency gains value based on its own real or perceived merit. While some cryptocurrencies create demand by providing unique services and products, others take advantage of hypes and other marketing tactics to promote themselves and their value.
A Few Words Before You Go…
Investing in cryptocurrencies can be risky mainly because the cryptocurrency ecosystem is still in its infancy in many ways. There are many valid cryptocurrency projects that offer valuable products, but there are also numerous others that take advantage of the FOMO mentality to create artificial demand, which can result in great economic loss for many people. Learning about cryptocurrencies with an open mind while keeping a critical outlook is a must when it comes to crypto investments.
If you are interested in cryptocurrencies, we invite you to contact our Coin IRA specialists who can help you make informed decisions about crypto ownership and investments so that you can sail ahead without worrying about scams and missed opportunities