The way cryptocurrencies are priced seems hard to understand at first. Once you know it, though, it becomes possible to find coins and tokens worth your while. The ChangeHero team has written this guide in simple English to help you understand how cryptocurrency gains value.
Key Takeaways
- Cryptocurrency is a special kind of virtual currency. It works without a middleman such as the government or a company.
- Cryptocurrencies are usually not backed by any real-world asset or currency. It makes their value more dependent on the law of supply and demand.
- In addition, other factors shape the value of a cryptocurrency. They include tokenomics, team and community, cost of production, speculation, and legal status.
What is Cryptocurrency? Definition and Features
Is it your first guide on the topic? Before you continue, we suggest you read our guide with definitions for beginners: Crypto Basics in Plain English: Blockchain, Crypto- and Digital Currencies.
If you know something about cryptocurrencies, let us briefly refresh the definitions anyway. A cryptocurrency is a unit of exchange, or a currency, in a cryptographic database called a blockchain. The blockchain’s key feature is the lack of control from a single point. This is what we mean when we say it is decentralized.
Cryptocurrencies these days can use other types of ledger than blockchain. Nevertheless, any decentralized digital currency is referred to by this name.
Cryptocurrency vs. Fiat currencies
Fiat currencies like the dollar and euro are not at all like cryptocurrencies. The most obvious difference is that they are issued and overseen by the government. Cryptocurrencies are issued through running software on millions of computers worldwide.
There are digital assets that use the blockchain but have the same value as real currencies. They are called stablecoins and are different from other cryptocurrencies. You can think of them as crypto tokens that represent a fiat currency.
Read more: Crypto Basics in Plain English: Bitcoin and Mining, Altcoins, Ether (ETH), Stablecoins
Fiat and cryptocurrencies have one thing in common. They are usually not backed by physical valuables like gold. The value of fiat currencies depends on the monetary policies of a government. An example of monetary policy is the total amount of money at a moment. Cryptocurrencies also have these policies but the users can accept or change them.
Cryptocurrency vs. Virtual & Digital Currency
Any digital form of money is a digital currency. Out of the three, this is the broadest term. Cryptocurrencies are also a kind of such currency.
Virtual currencies can exist only electronically. Not all digital currencies are virtual because some types can be turned into cash. Your cell phone balance is an example of virtual currency. It is controlled by the cell operator.
Cryptocurrency is a type of digital and virtual currency but not the other way around. Not any digital or virtual currency works the same as crypto. It does not need a middleman to be sent and received. It also works worldwide unlike national currencies. This is why its value is not fixed to any real currency.
How Does Cryptocurrency Gain Value?
The perceived value of cryptocurrencies is a sum of many parts. It is not tied to a single real-world currency because it works worldwide. This causes its value to change a lot.
Some people use this to their advantage. One can hold a cryptocurrency token until it becomes more expensive. Others buy them when the price is low and sell when it is high. But how do you know when you have this chance?
Supply and Demand
In economics, the main mechanism that forms prices is supply and demand. Supply means how many units are there on the market. Demand means how many people want to buy them.
Generally, if there is a lot of something, it is cheap. Rare things cost more to prevent them from running out. This is the influence of supply.
If a lot of people need something cheap, its price rises. If something is expensive but no one is buying, the price goes down until people start to buy. This is the influence of demand.
The supply of cryptocurrencies is always known. It can be checked through its blockchain. But what drives the demand for cryptocurrencies?
Firstly, people get them if they know how their supply will work. People use Bitcoin (BTC) as a store of value because there are never going to be more than 21 million bitcoins. Crypto projects call their monetary policies token economics, or simply tokenomics.
Secondly, people use these cryptocurrencies to send money abroad or buy goods and services. This is the original use case of Bitcoin but since then, the list has grown.
Thirdly, most cryptocurrency tokens come with utility or a use case of some sort. For example, there are gas tokens that pay the transaction fees on the blockchain.
Cost of Production
There is also a floor price or the lowest possible value for most cryptocurrencies. Despite being virtual, they need real-world resources like electricity or hardware. These resources almost always have a cost themselves. The people who produce cryptocurrencies have to sell them for more than they spend on these resources.
A common example of this is Bitcoin mining. This process is called mining because, like gold, Bitcoin is scarce and gets harder to produce. In BTC mining, computers crack difficult codes. These days there are a lot of computers doing this. The problems can only be solved by purpose-built machines, which cost money. The more machines are on, the higher the chances of mining bitcoins but electricity costs money. To prevent them from breaking, they need to be cooled, which sometimes costs money.
The expenses add up, so any mined Bitcoin has to be sold for a price that will cover the costs. A lot of miners end up losing money.
Most cryptocurrencies these days are produced with less effort. However, they still require things like hardware and an Internet connection. The floor price of such cryptocurrency tokens is lower. Other factors, though, have a higher influence on their perceived value.
Crypto Trading
Even in a traditional stock market, speculation drives the prices. Its main idea is buying and selling an asset to get a profit. Cryptocurrencies are traded on special cryptocurrency exchanges every day round the clock.
Arguably, speculation in crypto is what has more effect in the short term. The use case, utility, team, and tokenomics play a more important role in the long term.
Two conditions can help the value of a crypto asset grow. One is trading volume, or how much money goes through the market. High volume makes it easier to move the price. Another is liquidity, or how easy it is to fill orders. If there are not enough offers to cover a large order, the price will move abruptly.
If a cryptocurrency gets listings on exchanges, its liquidity and volume improve. Which is why its perceived value grows. Together with it, grows the price.
Competition
Today, there are over 2 million cryptocurrencies in the market (source). They often overlap in use cases, utility, and tokenomics. There can be two cryptocurrencies with the same idea. The execution of this idea is usually different. Users are free to choose one that they think is better.
For example, smart contracts were invented for Ethereum (ETH). As time passed, other smart contract platforms appeared. They improved things like transaction costs, speed, and tokenomics. As a result, their market capitalization is estimated to be millions. Why is Ethereum still the most valuable one? It has the technology and reputation that seem more reliable.
Governance
Fiat currencies change according to how the government decides. However, cryptocurrencies lack this kind of control. Users have to communicate and vote to make any changes (or not).
There have been cases when a new cryptocurrency branched off because users disagreed. One of these is Bitcoin Cash (BCH). Originally, it was Bitcoin but some developers proposed to change its rules. The majority accepted and continued on the updated blockchain. A minority chose not to update and split into a branch with old rules.
Usually, it does not lead to a new coin. In the case of BCH, the minority was large enough to make it happen.
There has to be a middle ground between team control and the lack of it. It is not seen as positive when a team has too much influence on a cryptocurrency. However, if there is no work put into a project, holders lose confidence and dump coins.
Legal requirements and regulations
By 2024, the crypto market has been around for a while. It has been long enough to establish some internal rules. And it was not long enough for the real-world law to fully catch up with it.
Some countries treat crypto tokens as property. Other places treat it as commodities or even like stocks. All approaches show some benefits and drawbacks. It is not common at all to treat crypto like a special class of assets.
Not to mention, cryptocurrencies are illegal in many countries. More uniform and accepting legal norms could greatly improve the value of cryptocurrencies. The opposite is true, too. If a cryptocurrency is found to break laws, holders are likely to dump it.
Conclusion
Now you too can look for the factors we listed above! They can help you find a cryptocurrency that should gain value. Feel free to use this guide as the first step to navigating the crypto market.
By the way, you can learn even more from our blog. To get updates about new articles and more information, subscribe to ChangeHero on social media: Telegram | X | Facebook | Reddit
Frequently Asked Questions
How does crypto get its value?
Crypto users who produce new coins and tokens sell them for how much it costs them to produce it or more. Then, on the open market, speculators trade it for profit. In the longer term, users get a better idea of the cryptocurrency’s value. The balance between supply and demand finds an equilibrium price.
What causes an increase in the value of a cryptocurrency?
The value of a cryptocurrency can increase or decrease under the influence of many factors. Some examples of them are exchange listings, legal status, competitive advantage, etc.
What is сryptocurrency backed by?
Most cryptocurrencies are not backed by any real-world asset. In that regard, they are not too different from real currencies. Their value depends on the circulating and total supply, inflation rate, liquidity, etc.
