What Determines the Value of a Cryptocurrency?
When Bitcoin launched in 2009, it wasn’t worth much. In fact, apocryphal stories permeate the internet of early coders spending hundreds or even thousands of Bitcoin on a single pizza.
Fast forward to today, however, and it’s worth thousands of dollars — and it continues to establish its value in the cryptocurrency market.
What is Crypto Valuation?
The cryptocurrency market is notoriously volatile. While the value of traditional financial assets is largely determined by performance drivers such as interest rates, inflation, operating profits, and monetary and fiscal policies, crypto assets are a whole different beast.
Crypto valuation is the process of determining the value of a cryptocurrency asset based on its fundamentals (and other factors that I will discuss below). It also involves determining whether the fair value of a given cryptocurrency asset is overvalued or undervalued by the market.
In an in-depth study of cryptocurrency valuation, S&P Global found that cryptocurrencies rely on a different set of key performance drivers compared to fiat. And the differences between crypto and traditional finance become even more pronounced when crypto valuation is compared to traditional asset valuation.
When thinking about how to determine the value of a cryptocurrency, for example, an analyst must consider a host of factors that mathematical models cannot necessarily measure:
- The technology used to build the cryptocurrency project.
- The coin or token’s regulatory framework.
- Market confidence and adoption.
What Decides the Price of Crypto?
Another burning question relating to cryptocurrency is ‘What determines the price of cryptocurrencies?’ One moment a new cryptocurrency’s price can skyrocket, only to be rapidly followed by a significant dip. So, what decides the price of crypto?
1. Supply and Demand
The fundamental economic principle of supply and demand holds true for cryptocurrencies. If token supply is high but there is little interest or demand in a certain cryptocurrency, then its value will drop.
Conversely, if token quantity is limited but traders and users place it in high demand, then prices shoot up accordingly.
2. Production Cost
Like any other commodity, production costs are key in determining a cryptocurrency’s market value. Studies show that the price of most crypto assets is highly correlated with marginal cost of production.
In the case of Bitcoin, for example, this cost is the sum of fixed costs, such as mining infrastructure and utilities, and the indirect cost related to the algorithm’s difficulty level. The complexities of Bitcoin’s algorithms can speed up or slow down production rates, thereby affecting the cryptocurrency’s overall supply and, by extension, its price.
While it is widely known that only 21 million Bitcoin can ever be mined, it is less widely understood that Bitcoin becomes more energy and time-intensive to mine, the more Bitcoins are created. This serves to both restrict supply and create a long-term deflationary effect on the cryptocurrency.
3. Market Capitalization
The market capitalization of a cryptocurrency is an estimate of its total value, calculated by multiplying the number of coins in circulation by one coin’s current price. Market cap indicates the popularity and dominance of a particular cryptocurrency, making it a key driver of its price.
For example, many crypto users expect the market cap of Ethereum to overtake Bitcoin — ‘the flippening’ — before 2030. This is partially because even though each ETHER token is worth far less than a BTC, there are far more ETHER tokens in circulation.
4. Node Count
The node count indicates the number of active wallets in a network and is an essential indicator of how strong a community is. A larger number of nodes implies greater decentralization and strength – two key qualities that make up successful cryptocurrencies.
Node location is both a blessing and a curse from a regulatory standpoint. Globalised node networks make regulating a cryptocurrency from one jurisdiction almost impossible — so investors should understand that for better or worse, there is currently little regulation in the crypto space.
5. Cryptocurrency Exchanges
Exchanges typically list the most popular cryptocurrencies in the market. If a cryptocurrency is listed on more exchanges, more investors can buy it, thereby typicaly increasing demand (and its price).
Conversely, delisting from an exchange can lower the price of a cryptocurrency. However, altcoins can experience price spikes when listed on their first exchange, as traders seek to capitalize on entry opportunities.
6. Inflation of Fiat Currencies
The long-term effect of inflation in fiat currencies can also affect the prices of cryptocurrencies. When fiat loses its value due to rising costs and falling purchasing power, analysts have theorized that investors will flock towards assets such as Bitcoin to hedge against inflation.
However, Bitcoin’s price has suffered in the high-inflation era of 2022, meaning the alternative investment remains hostage to tightening fiat monetary policy.
Regulation is another major factor that affects the prices of cryptocurrencies. Regulatory uncertainty, for example, can cause investors to become wary and drive prices down.
Similarly, positive news or developments around a particular cryptocurrency may push its price up.
How Do Cryptos Gain Value?
Aside from its price, it’s also worth looking at how a cryptocurrency gains value. A newly launched token, for example, will be worth little initially. It will, however, start to increase in value once it gains traction among users and investors.
Let’s take a brief look at what determines the value of a cryptocurrency:
Miners help to maintain a network and process its transactions by producing new tokens. They are rewarded with crypto for their efforts. However, miners will only continue mining if there’s a desirable return on investment. So as mining costs grow, the value of cryptocurrencies must also increase to offset these costs effectively.
The cost of tokens is significantly affected by their utility, or how well they can be used for solving real-life problems. The more useful a cryptocurrency is, the greater its demand and value.
Competition is also an important factor in the value of a cryptocurrency. A token’s worth often depends on how well it stands out among its peers and whether investors view it as a viable alternative to existing cryptocurrencies.
The media can also play a major role in affecting the prices of cryptocurrencies. Positive media coverage will attract more investors, increasing its value, while negative press can achieve the opposite.
Finally, the availability of a token is also critical to its success. Cryptocurrencies that are easy to access and use will be more attractive to potential investors, further driving up their demand and value. If it’s hard to find or purchase a token, fewer people will buy into it, leading to lower prices.
Regulation can also drive an asset’s value, given that greater regulatory guidance might help reduce speculation among cryptocurrency assets. As a result, this can lead to higher investor confidence and attract more long-term investors. Regulation injects stability, making assets more appealing to those previously averse to these highly volatile and speculative assets.
It’s important to consider all the above factors when discussing how to determine the value of a cryptocurrency. As mentioned, unique factors differentiate crypto valuation from traditional asset valuation.
Of course, certain aspects, such as token liquidity, supply, and demand, can still be likened to those of traditional finance. However, a crypto asset’s value is ultimately determined by its fundamentals and the overall market sentiment about it — something that no mathematical model can accurately predict consistently.
- How do you calculate the real value of a cryptocurrency?It is difficult to accurately predict the exact value of a crypto asset since there are many variables at play. Still, you can roughly calculate a cryptocurrency’s value with its market capitalization.
- How does cryptocurrency lose value?Cryptocurrencies can lose value due to negative news, lack of utility, increased competition, market manipulation, or regulatory uncertainty.
- Does mining a crypto increase its value?Yes, mining a crypto may increase its value – based on supply and demand, the more miners working on a blockchain network, the greater the demand for crypto tokens and, thus, the higher their value can be.
- Can cryptocurrencies be overbought or oversold?Yes, cryptocurrencies can be overbought or oversold based on market sentiment, news, and hype.