Cryptocurrencies: Why are they so volatile and valuable?

Considered by many to be the first cryptocurrency, Bitcoin has skyrocketed in value since its mysterious origins in 2009.

In the decade since Bitcoin came out, other cryptocurrencies such as Ethereum and Tether have also gained mainstream attention and their prices have risen. Still, cryptocurrencies are not tangible and have nothing to do with companies like stocks, so it begs the question: why do cryptocurrencies have any value?

What makes cryptocurrencies valuable?

Simply put, cryptocurrency has value because people value it. “It comes from shared belief, it comes from consensus,” said Brock Pierce, chairman of the Bitcoin Foundation and co-founder of EOS Alliance, Block.one, Blockchain Capital, Tether and Mastercoin. “It’s hard for people to deal with cryptocurrencies because they don’t fit in any traditional bucket.”

Despite the word “currency” in the name, most cryptocurrencies these days function more like an asset. “Ultimately, you convert most cryptocurrencies back to fiat,” said Dr. Aleksandar (Sasha) Tomic, Associate Dean for Strategy, Innovation and Technology and Director of the Master of Applied Economics Program at Boston College.

Dr. Tomic, however, explained that the real value of crypto, the underlying factor driving crypto’s relevance, is its ability to be used as a currency, the same way you would use a fiat currency like USD or EUR.

Since crypto is decentralized, it offers certain advantages that government-backed currencies do not. Take this example from Dr. Tomic’s life: He lived in the Balkans in the 1990s when severe economic sanctions were imposed on Serbia-led Yugoslavia, similar to those currently imposed on Russia. “The local currency will soon become obsolete, so to speak,” explained Dr. Tomic. “Especially because of the high inflation rate.” Since crypto is decentralized, it is less affected by inflation, other government interference, or political pressure.

“The fundamental value of cryptocurrencies is the ability to trade with that currency,” Dr. Dr. said. Tomic. Cryptocurrencies are a fancy currency these days, and paying for anything in bitcoin or any other currency is generally not that common. “But if it’s common,” Dr. Tomic, “This is the real promise of crypto, it’s not just another asset.” The ability to use crypto as easily as any other currency makes crypto desirable. Because it is desirable, it is valuable.

With that in mind, it’s easier to understand why people want to acquire some digital tokens. Once this desire is in place, there are several principles that determine the value of a cryptocurrency on any given day:

1. Supply and demand

A key principle in microeconomics, the law of supply and demand, shows the relationship between buyers and sellers. Simply put, this means that when the availability of the item decreases, the price of the item increases. Conversely, if there are enough items, the price of the item drops. The value of an item increases when it is rare and coveted by many.

Many cryptocurrencies, like Bitcoin, have a limited supply. This factor is the key reason why the price of Bitcoin continues to rise. As more and more people want to buy Bitcoin, many reasons from Dr. Tomic say it’s more worthwhile. Limited supply and growing demand increase the value of individual coins.

2. Buy low, sell high

In any environment you want to invest, the key to making a profit is to sell something for more money or resources than you need to get it. This basic theory underpins the “buy the dip” strategy that some investors employ when looking at stocks or bonds, essentially buying securities for less money than they can buy later.

With cryptocurrencies, some professional or retail investors buy coins and hold them for a long time with the intention of selling them for more money in the future. This allows users to increase the price of tokens as supply essentially decreases while demand for them increases.

3. Market perception

Market perception can be described as the way consumers view a product, service or asset. “If you’re the only person in the world who thinks something has value, then it has emotional value,” Pierce said. However, market value arises when more than one person believes something has value. When you think about art, the “real” value of a painting may just be the cost of paint and canvas. However, Van Gogh’s works are considered more valuable than those of unknown painters using the same raw materials.

This example shows how people’s perception of “good” can instantly change the price of that item. This is directly related to market value because it explains how much the market is willing to pay. “When two people agree that something has value, that’s where its value comes from, and supply and demand determine the price,” Pierce explained.

Encryption is a new thing receiving a lot of media attention, and there is a potentially huge opportunity. Hearing success stories and even seeing certain cryptocurrencies rise in value can help investors see how the asset is viewed.

If a company or a particular asset has built a good reputation among investors over time, they can speculate on whether it is a good investment and may form a positive opinion that may in turn lead them to buy that asset to make a purchase.

Like many other assets, cryptocurrencies can benefit because demand increases with perceived positive value.

4. Mining

Cryptocurrency mining requires a person to solve complex mathematical equations in order to put new coins into circulation. As a reward for solving the problem, miners are rewarded with a series of coins.

This is a way to enter the crypto market through effort rather than purchase. While not all cryptocurrencies are mined, well-known coins such as Bitcoin and Ethereum have been mined and they are profitable for many participants. As more and more coins are put into circulation, mining affects both coin supply and market perception as more and more people participate in “unlocking” new coins.

Some investors also engage in yield farming, an investment strategy in which cryptocurrencies are traded over a period of time in exchange for interest and other rewards, such as money. B. More coins, “locked”. A centralized blockchain-based application will capture investors’ cryptocurrencies and lend those assets to others seeking credit. In theory, creditors pay interest, and both depositors and centralized applications keep a portion. However, this strategy may involve some specific risks.

The actual process of “locking” is often referred to as “staking”. This strategy reduces circulation and limits supply, thereby increasing the value of the coin.

5. Utilities and underlying technologies

As Dr. Tomic explained, utility is a key factor in the value of cryptocurrencies. As more institutions accept cryptocurrencies as a form of payment, their value is also increasing. It also means that individuals can contribute to the process by using encryption.

Blockchain, the underlying technology that powers most cryptocurrencies, has also proven useful. “The blockchain is just a database,” Pierce said. “You can do a lot of things with a database.” While various real-world applications are possible, Pierce noted that it could be used to create new asset classes, modern versions of historical asset classes like gold, new utilities, and even New tools to improve stock efficiency.

Main features of money

So what does it take for a cryptocurrency to reach the threshold of being as easy to use as any other currency? Economists often categorize the different properties that money should have in order to be useful.

Acceptance: This means that the currency is widely accepted. Currently, some (but not many) sellers accept Bitcoin or other cryptocurrencies as payment methods. “With crypto, who will have the infrastructure to be accepted as a medium of exchange?” Tomic asked, noting that Bitcoin seems to be leading the way right now.
Divisibility: Another key feature of money is its ability to be divided into smaller units. Both cryptocurrencies and fiat currencies are divisible, but crypto tends to be more. For example, Bitcoin can be divided to 8 decimal places.

Durability: Currency should be reusable in order to be useful in future situations. Because of this, perishable items, while used throughout history, are not the standard form of money. Cryptocurrencies meet this requirement.

Fungibility: Fungibility means that an item has a generally accepted value and two of these items can be exchanged without devaluation by either party. If you don’t have rare coins, you can easily exchange a quarter for another. Diamonds, on the other hand, are not fungible and are not good denominations of money, as size and clarity determine their value, among other factors. For the most part, the dollar and cryptocurrencies are fungible.

Limited supply: In order to exchange money for other goods or services, it cannot be abundant enough that no one wants it. Many cryptocurrencies have a limited supply.

Portability: If you can’t easily transport currency when you need it, it’s much less useful. Physical currency is easy to transport, even more so now with debit cards. Cryptocurrencies can be transferred through investment or brokerage apps and crypto wallets that allow you to store and transfer cryptocurrencies. “You can instantly send cryptocurrency anywhere in the world,” Pierce said.

Stability: Finally, the value of a currency should remain stable or appreciate over time. Otherwise, the goods or services you can buy with money will have to be revalued over and over again. Currently, cryptocurrencies are not very stable, and what you can get with cryptocurrencies changes every day, even hourly.

To understand the core value of a cryptocurrency, “it is entirely based on its acceptance,” Dr. explained. Tomic. “It takes enough people to agree to accept cryptocurrency payments in order to use it as money.” Much of this adoption is driven by infrastructure.

Stocks and Cryptocurrencies

Cryptocurrencies can “feel” like stocks because they have many similarities on the surface. Both are intangible assets that can passively increase or decrease in value over time, and both can easily be part of an investment portfolio. But they are not as similar as they seem.

Stocks are stock securities that represent ownership of a company, and the value of each share is related to the company’s performance, supply and demand, and market perception.

Some companies also pay dividends to shareholders based on the company’s performance. While the stock of any company doesn’t grow forever, the stock market as a whole is always on an upward trend. This is because companies are always adapting or being invented to meet market demands.

On the other hand, cryptocurrencies are inherently as competitive as the US dollar, euro or Swiss franc. “The real value of cryptocurrencies will be, ‘Can you actually transact with cryptocurrencies?'” Dr. Tomic. As this “battle” unfolds, the market is showing interest in these digital currencies, and despite the limited supply, demand is increasing, increasing the value of each digital asset.

When considering where to invest, consider the differences between the two vehicles.

Crypto	Stocks
The value of a cryptocurrency is closely related to people’s perception of its value.	The value of a stock is directly related to the performance of the underlying company, which can be affected by many factors.
Some investors see cryptocurrencies, especially bitcoin, as a possible hedge against inflation. However, many experts say this type of thinking has many caveats and remains speculative.	Because stocks are backed by a company’s assets and cash flow, they are vulnerable to inflation. During times of high inflation, stocks are generally more volatile.
Cryptocurrencies are highly volatile, presenting both significant opportunities and significant risks.	While some stocks are more volatile than others, and there have been periods of high volatility in the overall market, the stock market has historically grown at an average rate of about 9% per decade.
Encryption is decentralized and not overseen by anyone. For some, that’s the appeal of digital currencies.	The stock market is regulated by the government. In the United States, this is done through the Securities and Exchange Commission, whose mission is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”

Final result

The value of a cryptocurrency is entirely derived from the public perception of its value. “We humans value what we all believe in,” Pierce said. However, as Dr. Tomic said the underlying, long-term, “true” value of cryptocurrencies has yet to be determined. “It’s still early,” he said. The reason cryptocurrencies are still volatile is that “it’s very difficult to get to this fundamental value,” said Dr. Tomic.

Ultimately, cryptocurrencies that can be used as everyday money will be the most valuable in the long run, sparking interest in owning coins that they own. “It’s probably a multi-trillion-dollar question that cryptocurrencies can reach this potential,” said Dr. Tomic.