Bitcoin, Education, Investing

How Does Cryptocurrency Gain Value?

Throughout 2021, Bitcoin rose above $65,000 three separate times: February 2021, April 2021, and November 2021.

These milestones are incredible considering that Bitcoin was worth less than $1,000 in 2017.

Many other cryptocurrencies reached all-time highs in 2021 as well.

This fast-paced market and price fluctuations can spur anyone new to crypto to wonder how cryptocurrency gains value and what impacts the price. 

Our guide highlights some of the most significant factors that could drive up the value of cryptocurrency this year and beyond.

Understanding the Role of Liquidity Plays in Price

Liquidity is the ability to buy and sell an asset, without impacting its market price.  Cryptocurrencies with higher market caps are usually more liquid, so large buy and sell orders are less likely to impact price movements compared to those with lower market caps. 

As cryptocurrencies gain more liquidity over time, their prices become relatively less volatile. Bitcoin is the most liquid cryptocurrency on the market. It has the highest market cap of any cryptocurrency and almost every major exchange lists it. 

In contrast, many mid-cap altcoins are listed only on a couple of exchanges and don’t see nearly as much trading activity. 

As a result, the values of these cryptocurrencies tend to move up and down more for each large buy order or sell order.

5 Factors That Impact How Crypto Gains Value

Now liquidity is clear, let’s examine the major factors that determine how does cryptocurrency gain value.

1. Supply and Demand

In 2021, the global adoption of cryptocurrency surged 880%. Every day more people are converting fiat to crypto and learning how to purchase crypto.

As with any other financial market, supply and demand is the foundation of price movement. 

Bitcoin, for instance, has a finite capped supply and high demand. Only 21 million BTC will ever be produced. This means that it doesn’t take much of an increase in demand to drive value up.

Other coins like Dogecoin (DOGE) have a nearly infinite supply. This means that it will take many, many more buyers (very high demand) to drive up the per-unit value of DOGE.

2. Speculation

Crypto has an array of important use cases in technology, but it is subject to speculation like with any other financial market.

Speculation is the market’s anticipation of what will happen to an asset’s price in the future.

If enough people speculate that the price will increase after looking at the continuous increase in the price and make large crypto purchases, prices will rise. It’s a feedback loop that encourages more adoption, which in turn drives up the price. 

Fear of missing out (FOMO) plays a big part in the crypto market. If prices rise quickly, FOMO often brings in new users who will purchase crypto because they don’t want to miss out on the opportunity. Users often refer to this as an “overbought market,” meaning that a price drop is a realistic scenario.

It’s critical to understand that speculation is also a double-edged sword. If the market starts to trend downward, a snowball effect may lead to price declines that seemingly defy rationale. Users often refer to this as an “oversold market,”  meaning that a price bounce is a realistic scenario.

3. Programmable Money

The crypto market tends to move in a uniform direction. However, fundamentals like technology and use cases help explain why one cryptocurrency gains more value over time relative to another.

For example, many people have predicted that the ETH market cap will surpass the BTC market cap. Many regard the Ethereum network’s capabilities to support programmable money as a vital foundation for the future of digital currency. The Ethereum network allows developers to develop their own DeFi apps, launch their own NFT collections, and more. 

Anyone who makes a transaction on the Ethereum blockchain needs ETH to pay for network fees. It’s possible that the value of ETH will rise as demand for the network grows. Likewise, other DeFi tokens like ADA, AVAX, and MATIC play a similar role on their respective blockchain networks. 

4. Government Regulations

Regulations, or rumors about new regulations, can have an impact on the crypto market. Negative news such as national trading bans or crypto mining restrictions can lead to price decreases. Positive news, such as the adoption of crypto as legal tender by certain countries, can lead to price increases.

With regard to new crypto regulations, U.S. President Joe Biden signed an executive order on cryptocurrency in March 2022. This policy direction appears favorable for the crypto sector and underscores that the U.S. government is willing to see the crypto market continue to innovate.

5. Macroeconomic Events

The overall state of the economy and the perceived state have led to rapid price swings for cryptocurrencies, especially during times of extreme market uncertainty. 

For example, in March 2020, the price of Bitcoin and other cryptocurrencies decreased at the onset of the COVID-19 pandemic. However, as stimulus money flowed into the global economy and economic conditions improved, crypto prices quickly rebounded to reach new all-time highs by November 2021

As another example, the Russia-Ukraine conflict sent crypto prices plummeting in February 2022. Days later the market experienced a major comeback. On February 28, 2022, the price of Bitcoin went up 14% — the largest single-day rally in more than a year.

Understand Market Volatility

Understanding the crypto market and what leads to price trends is certainly a complex endeavor.

While the stock market may only rise or fall a few decimal places each day, crypto is known for days of double-digit ups and downs.

The market is unpredictable. Crypto buyers must learn to exercise patience and realize that market volatility is the norm.

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