Cryptocurrency

How Cryptocurrency Price Changes and What Affects its Value

Imagine you are a doctor. One of your patients regains consciousness from a state of coma since 2017. He wakes up and tells you that Bitcoin was trading around $20,000 as per his last memory. What is its price now? So, do you save him a moment of shock by mentioning that it is still the same? Or do you tell him that it went up till $68,000 just to come back at the same price?

This doctor’s dilemma is true for most of the investors in the crypto space. One often wonders how cryptocurrency price changes so absurdly. If you HODLed strong in the current headwinds, you might wonder what affects the value of cryptocurrency. You must have come across some critics who claim that cryptocurrency has no fundamental value. Do you tend to believe them in such situations?

Well, if that’s the case, do not fear. Today, we plan to help you learn how cryptocurrency price changes and what affects its value. Let us get started.

How the value of cryptocurrency is Measured?

Time to bust some myths. A lot of people use the word value and price interchangeably. However, that is the worst way to approach any investment. Price is simply what you pay to buy an asset (cryptocurrency in our case) and the value is determined by the underlying fundamentals. It is what resides in the asset.

While price is decided by the market forces of seller/buyer, the value is determined by the overall history, revenue, growth prospects of the crypto project.

Here’s a quick example to prove this. Back in August 2020, Tesla did a 3-for-1 stock split. This means that every individual who holds 1 stock of Tesla (say at $100) would now get 3 stocks worth $33.3 each. A lot of companies do this to ensure reachability and retail participation in their shares. My question is that does it mean that Tesla’s value reduced to a third after this stock split? Hopefully your answer is a solid NO.

Now the bigger question is how to find this value? Because if you know the value of a crypto, you can compare it with market price and predict if it should go up or down.

If the market price > value, the crypto is said to be in overbought zone. In the long run, prices will match its real value.

If the market price < value, the crypto is undervalued or oversold. You can take a bet on the prices going up to match the value in a long term.

Factors Influencing the price of cryptocurrencies:

Now that we had a fair idea of determining the value of cryptocurrencies, let us dig deeper into the short term price action. How is the price of a cryptocurrency impacted on a day-to-day basis?

A. Supply and Demand:

In the short run, market forces of supply and demand impact the price of a crypto. It is economics 101. If the supply>demand, the price falls and on the flip side, if demand>supply the price jumps up.

In case of cryptocurrencies, one needs to be wary of the total supply of the tokens. Since these tokens are not dependent on any production metrics, they can be generated out of thin air. A whitepaper would give you a fair idea of how much total tokens are there and how are they distributed.

For example, Bitcoin is capped at a supply of 21M. On the other hand Ethereum has unlimited supply.

B. Availability on Exchanges:

When a new token is launched in the market, it is often made available on a decentralized exchange first. Listing on a decentralized exchange is easy and anyone can do it by adding liquidity. However, purchasing via a DEX is not as simple. There is very niched subset of super users who use DEXs to purchase crypto.

As a result, a lot of crypto projects after getting established plan their listing on Centralized exchanges or CEX. This exposes them to a newer set of audience and hence the demand pumps up pushing the price up.

C. Governance and Regulation:

Cryptocurrencies are always perceived to be the holy grail of decentralization. As a result, they (especially Bitcoin) are often considered as a threat to the monetary system established by the government.

Which is why there is a lot of uncertainty and grey area around the regulation and taxation of these assets. This impacts the prices every time a news is pushed by the media. A positive news like El-Salvador accepting Bitcoin as a legal tender would push up the prices and on the other hand rumours of Indian government banning crypto would hurt the market sentiment.

Finding Value in Cryptocurrency:

Now that you know the drill, you must be itching to find out how can you discover the underlying value of a cryptocurrency. Here’s a model that could help.

Fundamental Valuation: Crypto Asset Valuation Engine (CAVE):

A quick disclaimer before we proceed, this model is one of the many models to evaluate cryptocurrencies. A prudent investor always does his own research before investing. Coming back to this model. It tries to find the intrinsic value of the cryptocurrencies using the following metrics:

  • Revenue: It is extremely important to know the source of revenue of a crypto project. A lot of projects have dubious and shady revenue streams. One should clearly define this in their whitepaper.
  • Organization: Do you invest in the stocks where you are unaware of the founding team of the company, team size, advisor board etc.? No right? Then why should crypto be any different?
  • History: Recently, an infamous project called Terra collapsed. It resulted in a wealth destruction of $50B. Once the project went to the dust, people started digging up the past of the founder- Do Kwon. It was revealed that he was the face behind another failed, similar project. If someone had conducted this due diligence before that, it would have saved them from this mayhem.
  • Code: Cryptocurrencies are digital. There is nothing physical backing them up. Therefore, the core fundamentals of a project lie in its algorithm and code. A realm where the ‘code is law’, one needs to evaluate it before punting their money. If you aren’t equipped with the skill to audit code, there are websites that could do it on your behalf.
  • Socials: Finally, you need to check if the project has omnipresence across all social media platforms. Is the community vibrant enough? Are they talking about the project or just GMing every morning?

Fundamental and Relative Value:

We just found out how we can determine the worth of a cryptocurrency using fundamental analysis. Another key metric to approach this problem is known as relative value.

While fundamental analysis completely focuses on the asset’s intrinsic value, relative value helps us gauge its valuation as compared to its peers. This is the equivalent of comparing price to earning ratio of different stocks in the traditional finance.

In crypto parlance, you could use relative value to compare the prices of different sectors like L1s, L2s, DAOs, P2E tokens etc.

Volatile Behaviour:

Even the volatility of a crypto is a function of its price discovery. Market equilibrium is a situation where price is equal to demand. However, that is barely the reality for any financial market in the world.

This is even more relevant to cryptocurrencies which are much younger than their counterparts. Maybe mass adoption will pave the way for stability. But for now, the roller coaster rides are real.

Ethereum Push Notification System:

Despite the cryptocurrencies being extremely volatile, fortune favours the utility. And one project that is heavy on its promise is EPNS.

EPNS is a decentralized communication protocol for Web3! Using which any dApps, smart contracts, backends or protocols can send comm (starting with on-chain / off-chain / gasless notifs) tied to user wallet in an open, gasless, multichain and platform-agnostic fashion. The open comm layer allows any crypto wallet/frontend to tap into the network and get the comm across.

This post is sponsored by EPNS.

rgvdudeja
A techno manager by profession and a hardcore geek at heart. I love to poke my nose into tasks where other usually gave up on. My hobbies include, reading about Blockchain, Cryptocurrency and latest trends in tech industry, playing guitar and yes, memes!
http://pandatechiein.wordpress.com

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