Investing and trading require many skills, whether you're putting your money on stocks, mutual funds, ETFs, bonds, or crypto. This is why knowledge is so necessary when you enter the market exchange.
Right now, there are hundreds of cryptocurrencies created and decentralized exchange projects launched. When you open an account on Binance, Coinbase, or other crypto trading platforms, you will discover unique coin names; some even got their inspirations from food and pets (Doge, Pancake, Sushi). This implies that as the crypto market lures investors, the number of options increases. And if you are to invest, you will be able to diversify your money.
Diversification is indeed a good strategy, but this isn't all. Determining how a coin is valued can also help you choose the suitable investment worth your money. Today, we're going to share some insights on how crypto price is determined so you would know precisely if the price is overvalued or not.
What determines cryptocurrency prices?
Cryptocurrency prices are not set by anyone, not an individual, not the Central Bank. Since all cryptos use blockchain, the decentralized system allows the price to be determined by factors not controlled by a single person or the government.
Five major factors determine the prices of cryptos—supply and demand, production cost, competition, regulation, and mass adoption.
Supply and Demand
Supply and demand are the primary factors that can make a crypto price go up or down. The law of supply in economics gives us the concept that when the supply is more than the demand, the cost of goods tends to go down. When demand is higher than supply, the price goes up.
You can easily observe that prices go up in the crypto market if more investors are willing to buy a coin. Prices then go down when more investors are selling their cryptocurrencies.
Let's look back at how Elon was able to pump Bitcoin and Doge's prices. Last February 2021, Tesla disclosed that it bought $1.5 million worth of Bitcoin. The rationale behind this was to become more flexible while diversifying and maximizing returns on the company's cash. Along with the purchase of Bitcoins was the announcement that it would accept Bitcoin as a payment method. Truly enough, after one or two months, Elon shared a tweet that someone just bought a Tesla car with 90 Bitcoins.
After Bitcoin, Elon shared his sentiments about Doge again through his tweet. He posted memes about Doge "going to the moon" and even shared that he bought Doge for his child as an investment. SpaceX recently told the public that it accepts Doge as payment to finance the launching of its DOGE-1 mission. And there hasn't been any news that it would halt the payment method any time soon.
These events pumped the prices of Bitcoin and Doge for months. Since Elon is a known personality, many investors followed his moves. Some were able to profit big even without using their technical knowledge. Who needs technical knowledge when you have Elon? When he showed his support in crypto, the demand for Bitcoin and Doge increased massively, pumping its price. This is a good illustration of how demand determines the price of cryptos.
Then came the news that Tesla won't accept Bitcoins anymore. This made people sell their coins, thus, decreasing the demand for Bitcoin. Obviously, the price of this crypto dropped, and as of this writing, the crypto market is crashing because of the series of news affecting its value. You can check out this news about China banning financial institutions from the crypto business.
The production cost also affects the pricing of cryptocurrencies, and it has something to do with supply as well. Cryptocurrencies require energy to be produced. This means colossal energy consumption is expected, and it's pricey.
Bitcoin, for instance, relies on a complex cryptographic math problem where miners are all competitive in solving. The first miner to solve the equation has a block of freshly minted bitcoins and any processing fees accrued from the last block.
What is peculiar regarding bitcoin mining is that the bitcoin algorithm can be located just once per 10 minutes on average compared to other products. This assumes that more participants (miners) participating in the math problem-solving competition would make it more challenging and, therefore, more costly to solve the problem to maintain that 10-minute interval.
Competition is another variable that determines how cryptos are valued. Although Bitcoin is perhaps the most popular blockchain, hundreds of other coins are aimed at investors. Bitcoin remains the dominant market capitalization alternative, but as of March 2021, based on the report of CoinMarketCap, altcoins like BNB, ETH, ADA, USDT, and DOT were among its closest competitors. In addition, fresh initial coin offerings (ICO) are always in sight because there are no substantial barriers to entry. The crowded sector is good news for stakeholders since when competition is high, it lowers prices.
The exponential increase in cryptocurrencies has led regulatory agencies to discuss how these financial commodities should be classified. The Securities and Exchange Commission (SEC) categorizes cryptocurrencies as securities. Meanwhile, the US Commodity Futures Trading Commission (CFTC) looks at cryptocurrencies as commodities. This mystery on whether the regulator would establish the rules for cryptocurrency, amid the increasing market capitalization caused ambiguity.
So, what does this mean? There are two instances where regulation affects the price. First, it gives access to investors that may not have the opportunity to buy a genuine bitcoin, thus pumping demand. Second, it will decrease market volatility by encouraging institutions that assume that cryptocurrencies', like Bitcoin's, potential values are overvalued or underestimated to make bets on the contrary.
If a cryptocurrency is adopted massively, its valuation will rocket "to the moon." The rationale behind this is because there is still a limited supply of that crypto and the rising demand contributes to a direct price increase.
But what conditions are really expected for the public to accept cryptocurrencies? One is the practical application of cryptocurrency in real life. The number of locations where specific crypto can be used for payment directly affects its price. If a coin is helpful in everyday life, like fiat currencies, the mass will indeed accept it as it is until its value rises.
These factors affect the price of crypto, and now that you know them, you'll be able to determine the "why" behind every crypto price. It's essential to learn why and how cryptos are valued to plan your investing and trading strategies. The crypto world is a huge place for small investors. But if you have enough knowledge to get the hang of what's happening, especially during pump and dump, you'll know how to protect your money and maximize your profit.