How are Cryptocurrencies Valued?
One of the most common questions in our industry is in regard to how cryptocurrencies are valued. The perception is that somehow they have less value because they cannot be held in physical form, despite the fact that cash is becoming obsolete regardless. Or that they are not “backed” by anything despite the fact that fiat currencies are no longer backed by physical commodities either.
The main difference between cryptocurrencies and fiat currencies is in that they are not supported by governments in the same way fiat currencies are. Despite the nature of money evolving to no longer having its value backed by physical commodities, like gold in a national bank, they are still supported by the government that issued them. As a result, the value of fiat currencies is generally based on the stability of the government that issued that currencies.
The value of cryptocurrencies derives from the network upon which they are built. This is further influenced by a variety of factors, such as:
- Supply and demand: For example, there will only ever be 21 million Bitcoins, released at a steady rate, meaning inflation should not affect the value of the currency, assuming a consistent demand exists. Although such a system is not employed by all cryptocurrencies.
- Price of Bitcoin: all other cryptocurrencies are based on and pinned to the price of Bitcoin, meaning changes in Bitcoin price can affect other currencies.
- Energy/electricity required to validate transactions and mine coins: Proof-of-Work, the consensus protocol used by Bitcoin, consumes a lot of electricity, whereas Delegated-Proof-of-Stake, used by Lisk, consumes considerably less, which has a factor on the price.
- Difficulty level: Similarly to the electricity required, the difficulty level faced by miners in securing a cryptocurrencies network can affect the price of each token.
- Public perception: how investors perceive the blockchain space as well as each individual currency will directly affect its price. For example, if media reports positively on the blockchain space then prices can increase. Similarly, if a cryptocurrency is a caught up in a scandal, the price of that token will fall.
- Large investors: an investor holding a considerable amount of a cryptocurrency and deciding to sell it all at a low price will result in the price of that currency dropping considerably. Such investors are sometimes referred to as “whales” as their investments have ripple effects on the rest of the market.
- Utility of the currency or product: what product is the company that issued the currency providing and is it useful? Where can the currency can be spent? What does the currency allow you to do? All of these factors affect the price of a currency.
Due to all of these factors the price of cryptocurrencies can be volatile, which is why some investors regard them as opportunities to make money. Whereas the value of a dollar or euro generally tends to remain relatively stable this is not the case with cryptocurrencies.
For example, the value of the Lisk token went up from $2 in August 2017 to almost $8 in September 2017, before returning to $4 in November 2017 and up to well over $20 before January 2018. Such fluctuations are completely normal in cryptocurrencies which is why some people argue that they are not suited to being used for regular transactions. However, with greater adoption cryptocurrencies will begin to stabilize more. Until then, the rush to uncover tokens that grow rapidly has led to a huge growth in the the cryptoasset market.
Whether cryptocurrencies are a good storage of value is an idea that is often heavily debated. Some people argue that they are not good representations of value because they are not backed by any physical commodity, despite the fact that most currencies today are not either.
Cryptocurrencies derive their value from the network upon which they are built and as a result what people are willing to pay for them. This, in combination with the fact that cryptocurrency is still a relatively young concept, inevitably causes some volatility.
However, the notion that all cryptocurrencies are not a safe storage of value is a false and arguably outdated one. As long as the cryptocurrency held is that of a solid, respectable project and they are stored securely, they are as good a storage of value as any other investment.
How to Trade Cryptocurrencies?
One of the most widely discussed and appealing aspects about cryptocurrencies is the combination of volatile prices and the fact that they can easily be traded, meaning that money can be made in doing so. However, cryptocurrencies can be high risk investments and it is important to have a solid awareness about how to safely invest as well as an understanding of what you are investing in. In this segment we will examine the fundamentals of cryptocurrency trading.