The reasons for the decline and rise of digital currencies-WWNEED.COM
You must sometimes wonder what makes a cryptocurrency so valuable despite its volatile nature. Here are the reasons and factors for the decline and rise of digital currencies.
It is not uncommon for Bitcoin to experience a price increase or decrease of 5% or even 10% in a short space of time on any given day. Smaller cryptocurrencies can have wider price fluctuations. After reading this article, you will have a better understanding of what makes a cryptocurrency valuable as well as the various reasons and factors that can lead to the rise and fall of cryptocurrencies within a single day.
Cryptocurrency value
Cryptocurrencies are not usually backed by any central authority in the same way that fiat currencies or any other government-mandated medium of exchange are. Government support can improve confidence in the currency’s value among consumers, providing a large spender and collector of the currency, but since cryptocurrencies are generally decentralized, they derive their value from other sources that include:
Supply and demand
production costs
Availability on the stock exchanges
The competition
internal governance
systems
These sources of value are at the same time the most important reasons and factors for the decline of cryptocurrencies. Let’s get to know more about it now.
Reasons and factors for the decline and rise of digital currencies
Supply and demand for cryptocurrencies
The value of a cryptocurrency is determined by supply and demand, just like any other product that people want. If demand increases faster than supply, the price goes up. For example, if a country is going through a period of drought, the price and production of grain will increase if demand does not change. The same principle of supply and demand applies to digital currencies. A digital currency gains value when demand is higher than supply.
The supply mechanism for cryptocurrencies has always been known; Every cryptocurrency publishes its own mint and burn plans. Some of them, like Bitcoin, have a fixed maximum supply as we know there will only be 21 million Bitcoins. Others, like Ethereum, do not have a maximum supply. Some cryptocurrencies have token burning mechanisms in place to prevent the circulating supply from increasing too much and to slow down the rate of inflation. Burning means copying a token and sending it to an unrecoverable address on the blockchain.
The monetary policy of each digital cryptocurrency is different, as the supply of Bitcoin increases by a fixed amount with each new block mined on the blockchain. Ethereum offers a fixed reward for each block mined, but also pays for the inclusion of “uncle blocks” in the new block, which helps facilitate the efficiency of the blockchain network. As a result, the oversupply is not constant. Some cryptocurrency supplies are dictated entirely by the team responsible for the project, who can choose to issue more tokens to the public or burn tokens to manage the money supply.
Demand can increase as awareness of the project increases or as the benefit provided increases. The widespread adoption of cryptocurrencies as an investment increases demand while effectively limiting the circulating supply. For example, when institutional investors began buying and holding Bitcoin in early 2021, the price of the coin skyrocketed as demand outpaced the pace of new coins being created, effectively reducing the total available supply of Bitcoin.
Likewise, as more Decentralized Finance (DeFi) projects are launched on the Ethereum blockchain, the demand for the effect increases. If a DeFi project takes off and continues to progress and grow, its tokens will become more useful, thus increasing demand.
production costs
New digital currencies are produced through a process called mining. Cryptocurrency mining involves using a computer to verify the next block on the blockchain. The decentralized network of miners is what allows cryptocurrencies to work as they do. In exchange, the protocol produces a reward in the form of cryptocurrency tokens, in addition to any fees paid to the miners by the trading parties.
Blockchain verification requires significant computing power. Participants invest in expensive equipment and electricity in order to mine cryptocurrency. In a proof-of-work system, such as those used by Bitcoin and Ethereum, the more competition for mining a particular cryptocurrency, the higher the difficulty of mining. This is because miners are essentially racing against each other to solve a complex mathematical problem in order to validate a new block. As such, the cost of mines increases with the need for more powerful equipment to mine successfully.
As mining costs increase, this necessitates an increase in the value of the cryptocurrency. Miners will not mine if the value of the coin they are extracting is not high enough to offset their costs. Since the two miners are necessary for the functioning of the blockchain, as long as there is demand for the use of the coin, the price will have to go up.
Listing on digital currency exchanges
Cryptocurrencies such as Bitcoin and Ethereum can be traded on multiple exchanges, with most cryptocurrency exchanges listing the most popular coins.
But some minor coins may only be available on specific exchanges, which limits access for some investors. Some wallet providers will aggregate quotes to swap any combination of cryptocurrencies across several exchanges, but they will charge a fee for doing so which increases the investment cost. If a cryptocurrency is trading poorly on a small exchange, the spread the exchange gets may be too big for some investors.
If a cryptocurrency is listed on more exchanges, it can increase the number of investors willing and able to buy it, thus increasing demand. The higher the demand, the higher the price.
The competition
There are thousands of cryptocurrencies out there with new projects and tokens being released every day. The barrier to entry is relatively low for new competitors, but creating a viable cryptocurrency also depends on building a network of cryptocurrency users.
A useful application on a blockchain network can quickly build a network, especially if it is optimized to the limitations of a competing application. If a new competitor gains momentum, it takes value from the existing competition, so the price of the existing company drops as the new competitor’s currency knows some appreciation.
Internal governance
Cryptocurrency networks rarely adhere to a fixed set of rules. Developers adapt projects based on the community that uses them. Some tokens – called governance tokens – give their owners a say in the future of the project, including how the currency is mined or used. In order for any changes to be made to the management of the currency, there must be a consensus among the stockholders.
For example, Ethereum is upgrading its network from a PoW system to a Proof of Stake system, making a lot of expensive mining equipment in data centers. This will undoubtedly have an impact on the value of ether.
In general, investors prefer stable governance. Even if there are flaws in the way cryptocurrency works, investors prefer the devil they know to the devil they don’t. As such, stable governance can be valuable by working to provide more stable prices.
On the other hand, the slow process of updating software and improving protocols could limit the upside of cryptocurrency values. If the update would unlock value for cryptocurrency holders, but takes months to implement, it hurts existing stakeholders.
regulations and legal requirements
There is some confusion about who should regulate cryptocurrency trading. The Securities and Exchange Commission (SEC) says cryptocurrencies are securities like stocks and bonds, while the CFTC says they are commodities like coffee or gold.
Both cannot claim regulatory authority over cryptocurrency trading. The specific ruling could provide more clarity and improve cryptocurrency values while opening the door to widely traded cryptocurrency related financial products.
Regulation is required to allow easier ways to trade cryptocurrencies. Products such as ETFs or futures provide more access to cryptocurrencies for investors, which increases their value. Additionally, regulation can enable investors to take short positions or bet on cryptocurrency prices using future contracts or options. This should result in better price discovery and a greater reduction of cryptocurrency price volatility.
The regulations can negatively affect the level of demand for cryptocurrencies as well. If a governing body changes the rules to dislodge investment in or use of cryptocurrency, this could lead to a drop in the price of cryptocurrencies.
Finding value in digital currency
If you understand the basic principle of supply and demand and the various factors and reasons that lead to the rise and fall of cryptocurrencies, then you can make better investment decisions. If you think that the demand will increase for certain reasons and you do not think that the supply will continue, then this cryptocurrency could be a good investment. But be aware that governments still lack knowledge on the best ways to regulate cryptocurrency, which makes it a risky and volatile investment no matter what.
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