Within crypto assets, only some can be valued with methods applicable to companies (discounted cash flows, etc.), but when we leave this subcategory, the issue becomes much more difficult.
Cryptocurrencies are an asset class unlike any other available in the markets for investors. One characteristic that makes virtual assets stand out is their rapidly changing values. These digital currencies have a penchant for recording gains of up to 30% of their valuations within a day, making them a favorite for daring investors.
The opportunity to make 30% gains under 24 hours means the odds of losing the equivalent are high. The markets enjoyed a stellar bull run in 2021, with the assets like Bitcoin (BTC), Ethereum (ETH), and Shiba Inu (SHIB) gaining over 100% within the year, but the recent turn of events has led to a massive fall of up to -70% from all-time highs.
Cryptocurrency prices do not swing arbitrarily. There is actual science behind the volatility as several factors cause it. This piece seeks to shed light on the various factors that determine prices to understand cryptocurrency prices better.
Since prices are inherently chaotic among digital assets, market investors should use a coin price tracker such as CoinStats to keep tabs on changing prices automatically. CoinStats is a leading portfolio manager in the space that allows investors to monitor all their crypto holdings from one dashboard.
Let's jump in and understand the reasons behind cryptocurrency's wild swings.
Utility of crypto assets
A massive chunk of digital currency's value comes from the use of the asset. Although blockchain technology is still relatively new, several use cases have been created in a short period. The crypto assets with the most value are those with the most utility.
A keen example is Ethereum, market capitalization's second-largest digital currency. Since its launch, Ethereum has found utility primarily because of its smart contracts that have made it the de facto home of Non-fungible tokens (NFTs), decentralized applications (DApps), and decentralized finance (DeFi).
The various utilities have increased Ethereum's prices by over 20,000% since its creation. If a virtual currency loses its utility, prices are bound to fall. Several cryptocurrencies have slid down the charts because their use has become obsolete in a fast-paced industry due to competition from rival blockchains or their lack of innovation.
The interplay of demand and supply factors plays an essential role in the volatility of cryptocurrency assets. Generally, the scarcer a commodity is, the sharper the value rises. The same is true for digital assets in the virtual currency markets today.
Following the above, most crypto projects have created systems to ensure the scarcity of their tokens. Bitcoin, for example, limits the inflow of new tickets per block and employs a halving mechanism every four years. Using a hard cap of 21 million BTC is another brilliant strategy to create scarcity for the project, creating value for the asset.
The proliferation of tokens without any recipe for control leads to a sharp fall in asset prices. For projects without a hard cap or a halving mechanism, token burning is employed as a deflationary strategy to keep prices in check. Ethereum and Shiba Inu are some of the projects that have used burning tokens to record a measure of success.
One key factor that influences cryptocurrency price is the activity of whales. Whales are addresses that hold a sizable number of tokens, usually up to $1 billion worth. When whales sell their holdings, it often leads to a fall in prices as retail investors and those with smaller holdings follow suit. The interplay between buying and selling pressure leads to intense bouts of volatility as whales, and retail traders surf the markets.
The impact of whales on crypto prices is most seen in smaller cap cryptocurrencies. Small cap coins are those whose market capitalizations are below the $1 billion mark. Their on-chain data indicates that their volatility is typically higher than mid-cap and large-cap coins like BTC, ADA, and ETH.
Risk-averse investors are advised to stick with cryptocurrencies with large market caps as their price swings are not as extreme as other coins at the bottom of the list. However, those with a large appetite for risk may consider taking their chances with small cap virtual assets.
Often underrated, the activities of regulators play a role in crypto's wild swings. Since the inflow and exit of capital influences prices in the markets, one bold stroke from regulators can send prices soaring to new highs or crashing to previously unseen lows.
Ripple Labs, creators of the XRP token, has been entangled in a protracted legal battle with the U.S. Securities and Exchange Commission (SEC) over the sale of "unregistered securities to the public." The case has harmed the XRP prices as it currently sits at -80% of its all-time high.
Conversely, actions like the SEC approving a bitcoin futures ETF were integral in BTC's march to a new all-time high. The move was reminiscent of the Office of the Comptroller of the currency's (OCC) decision to allow banks and financial institutions to use crypto for settlements.
Cryptocurrency prices may appear to move on their whims and caprices, but behind every wild swing, a factor determines the price. This list is far from exhaustive as there are other factors like the effect of exchanges and liquidity on virtual currency prices.
To recap, prices are determined by the level of scarcity of the crypto asset, buying and selling of whales, regulatory decisions around the world, and the utility of projects.
Before going ahead to invest in a virtual asset, an understanding of the factors that influence the price is critical. This knowledge will be handy in trading decisions that could lead to great success.