Ask someone how cryptocurrency prices work. You’ll probably get an answer like “it’s supply and demand”.
That’s absolutely true: at the core of cryptocurrency prices – or the price of any asset – lies supply and demand.
However, there’s much more to crypto prices than just paying one price and selling at another. Chrisjan Pauw decided to explore the issue last week in a piece titled,
“How Cryptocurrency Prices Work, Explained.”
In that piece, Pauw provides a great overview of the economics behind crypto prices, including how they’re different from the prices of traditional assets.
“The biggest difference between cryptocurrency values and fiat money is that fiat currencies are backed by central governments and declared as legal tender. Its value is basically derived from the fact that the central government has stated that it has value and two parties in a transaction put their trust in that value.”
Cryptocurrencies, meanwhile, lie outside the control of a central government or authority and are not accepted as legal tender in most places. With that in mind, let’s look at some of the basic facts behind how cryptocurrency prices work, as explained by Pauw:
Cryptocurrencies Vs Fiat Currency
Cryptocurrency gets its value from supply and demand. Fiat currency sort of derives its value from supply and demand, but it’s more insulated from market pressures.
- Generated by computers
- Decentralized and outside the control of any one person
- Digital medium of exchange
- Limited supply
- Issued by governments
- Centralized and monitored by governments
- Physical medium of exchange
- Unlimited supply
Why Do Cryptocurrency Prices Fluctuate So Much?
Pauw’s answer to the question above is simple. “It’s still a nascent market.”
“The cryptocurrency market is still considered very new and, beyond hearing the term “cryptocurrency,” most people are still very much unfamiliar with the industry. Nascent markets have a number of qualities that make them inherently volatile.”
Some of those inherent qualities include a lack of liquidity, including a lack of activity in foreign exchange markets. Bitcoin trading, for example, is dominated by US Dollar, Japanese Yen, and Korean Won trading. Forex markets, where fiat currencies are traded, are much more diverse:
“Daily cryptocurrency trading volumes are around the $14 billion mark, while daily forex trades are closer to $5 trillion. The spread — the difference between the buy and sell price — on foreign currency trades will be a few pennies at the most, while spreads on cryptocurrency trades can be as high as a few dollars.”
Today, crypto trading is dominated by a few centralized crypto exchanges. These exchanges provide a centralized point of failure.
The Factors Behind Crypto Prices
“Supply and demand is the most important determinant of cryptocurrency prices,”
explains Pauw. This is a basic economic principle. Tokens with little demand from traders and users will drop in price, assuming all else remains equal.
This is the same reason why scarcity drives up the price of bitcoin. As media attention and the technology grows, demand for the currency rises. Supply, however, hardly increases.
Other factors that affect demand include token utility (the usefulness of a token) and the usefulness of its underlying blockchain platform.
Mining difficulty also factors into the system. It’s harder to increase the supply of a coin with a higher mining difficulty.
Cryptocurrency Prices Over the Last 18 Months
Finally, Pauw explores the price of cryptoassets over the past 18 months.
“Tracking the price of bitcoin gives us a good indication of the overall cryptocurrency market in the past 18 months.”
Bitcoin began the year 2017 at a price of $1,000, then traded to lows of around $775 when China started investigating crypto exchanges. The SEC rejected a bitcoin ETF in March 2017, dropping the price further, and then Japan declared bitcoin a legal currency and the bull run continued past $3,000.
There was the BCH/BTC split, when the price of bitcoin dropped to $2,000 in the leadup to the split, and then there was the bull run in August, when the price of bitcoin surged after the split. The bull run continued all the way to December 2017, when BTC peaked at $20,000 (with BCH at a peak of around $3500).
2018 has been more tumultuous. We’ve been in a bear market since December. Google, Facebook, and Twitter banned crypto ads earlier in the year, causing crypto markets to sink even further. As late as July 2018, bitcoin was hovering around the $6,000 mark. Today, it sits over $8,000.
What can we learn from these price movements? Well, we can learn that the price of bitcoin is affected by a number of different things – from governmental policies to media attention to hacks. By studying bitcoin’s price history, you can make reasonable predictions about its price future.
How Accurate Are Bitcoin Price Predictions?
What about bitcoin price predictions? Are there actually people, algorithms, or platforms that can predict the price of cryptoassets in the future?
“Like with traditional markets, there are no guarantees when it comes to future price predictions for the cryptocurrency market,”
Some have predicted bitcoin will break $1 million, for example. Others believe bitcoin will be worth $0 in the near future. One of these could be right – or neither.
How Cryptocurrency Prices Work Conclusion
Ultimately, cryptoassets and fiat assets have varied widely in price – both for widely different reasons. By studying the past price history of cryptoassets, we may be able to make reasonable assumptions about the future – or the future might completely rewrite every price prediction algorithm as we know it.