How does the cryptocurrency market work?

The market for cryptocurrencies, whilst almost a decade old, is still nascent in relative terms. There is a lot of uncertainty surrounding the value and stability of various tokens, which is largely responsible for keeping the mainstream out of the crypto-space. In this article, we will try to explain some of the factors that influence market volatility.

What is the difference between crypto and fiat currency?

At face value, there is very little difference to be gleaned between fiat and cryptocurrencies. After all, what is fiat money but a number on a screen? Fiat money used to be backed by gold, but the gold standard has long been a thing of the past. The only thing that backs the value of fiat money now is the government that has issued it. In other words, fiat money is backed by trust in the government. Finally, the central bank of a country controls the supply of fiat money, which means there is a risk of inflation. Cryptocurrencies, on the other hand, are not considered a legal tender, are on a decentralized ledger, and come in limited supply. Their value is also determined by trust between trading parties, which we shall get into below.

Why is the cryptocurrency market so volatile?

Several journalists and academics have tried to figure out exactly why the price of Bitcoin and other tokens fluctuate so much and so frequently. It largely comes down to the trust described above. When cryptocurrency exchanges are hacked, for example, trust goes down and so does the value of various cryptocurrency tokens. Another factor that affects volatility is the fact that the cryptocurrency market is still nascent. New and emerging markets have a tendency towards instability that plateaus over time. Finally, there is the factor of limited liquidity, which also affect volatility. In part due to the limited supply of tokens, the total value of cryptocurrency is much lower than that of fiat money.

What determines cryptocurrency prices?

As with many other markets, the prices of cryptocurrency tokens are determined by supply and demand. Given that most cryptocurrencies, apart from Ethereum, come in limited supply, it means that there will always be an element of scarcity. Bitcoin, for example, has a maximum cap of 21 million BTC. However, as discussed above, there are other factors that influence the price of a token. Trust is a big factor, but so is the utility of a given cryptocurrency. Ethereum, for example, has a high utility. This means that the value is quite high despite the lack of supply cap.

How reliable are the predictions?

Although experts will always make predictions as to what will happen in the future, no one can truly predict anything with absolute certainty. What is interesting with the cryptocurrency space is that most of the predictions being made can be quite extreme. Some have predicted that the value of Bitcoin will rise to a million dollar per coin. Given that it is currently just under $7,000, this seems a bit unlikely. Others have been more modest and predicted the value will go up to $25,000 per BTC. Last year saw Bitcoin hit almost $20,000, so a few thousand more is not unlikely.

 

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