What affects and determines cryptocurrency prices?
The price of cryptocurrencies is mainly influenced by two factors: public interest (demand) and the available supply.
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Have you ever wondered why cryptocurrency prices fluctuate so often? What factors drive their value and exchange rate?
In this article, we’ll explain the key factors that influence cryptocurrency prices.
But first, let’s take a step back and clarify what a cryptocurrency actually is.
What is a cyptocurrency?
A cryptocurrency is a digital or virtual currency characterized by several key features:
- Decentralization: It’s not controlled by any central authority, like a bank or government.
- Anonymity: Transactions occur through a blockchain network without collecting personal data.
- Transparency: All transactions are recorded in a public ledger, ensuring transparency and boosting security.
How do cryptocurrency prices work?
Determining cryptocurrency prices is pretty straightforward.
Supply and demand dictate cryptocurrency price movement, much like other financial assets such as gold, stocks, or oil.
Basically, if there’s strong demand for a certain cryptocurrency (and its supply is limited), the price will eventually rise.
On the other hand, if the market participants are not interested in buying and the supply is abundant, prices will drop.
Of course, this is only a simplified explanation.
How do supply and demand affect cryptocurrency prices?
To better explain the impact of supply and demand on cryptocurrency prices, let’s use an example.
Let’s say there’s someone who holds a large quantity of a specific cryptocurrency in their portfolio (the term “whale” is often used to describe a person who holds a large amount of a single cryptocurrency).
If this person decides to sell everything one day, a large quantity of that cryptocurrency will suddenly flood the market.
If there isn’t enough demand for that cryptocurrency on the market, its price will drop.
There’s also the reverse situation, where someone appears on the market wanting to buy a large amount of cryptocurrency (let’s call it XY).
If only a small quantity of cryptocurrency XY is available on the market, and this person decides to buy everything, it would drastically lower the supply.
In that case, the price would increase because there wouldn’t be enough of the cryptocurrency to meet the high demand in the market.
Although supply and demand are key factors that dictate market prices, there are also other factors that influence supply and demand, and thus the value of a cryptocurrency.
Why do cryptocurrency prices change so much?
Earlier, we talked about how supply and demand affect the prices of cryptocurrencies.
But there are also other things that can make prices go up or down.
Some of the biggest factors that affect crypto prices include:
- Market sentiment (this is often tracked by something called the "Fear and Greed Index")
- Crypto regulations and laws
- Big market events
- Crypto whale activity
You might have heard that cryptocurrency prices are "speculative."
Basically, that means people often buy or sell based on their feelings or opinions, rather than facts.
These feelings usually come down to either panic or greed.
For example, if a "whale" suddenly sells a large amount of cryptocurrency, it can cause panic.
People start wondering why whales began to sell.
Once the whale sells its crypto, it becomes a domino effect where others follow his/her step, thinking that it’s better to sell now while the price hasn’t dropped further.
On the flip side, when prices are rising, people can feel like they’re missing out (FOMO), and they start buying at higher market prices because of greed.
There’s even something called the "Fear and Greed Index."
It’s a tool that most crypto websites use to show how investors feel at any given time.
If you want to find out how emotions drive investing decisions, make sure to read our article:
Regulation is another big factor.
When governments or institutions take a tougher stance on crypto, prices often drop because people worry about the future of cryptocurrencies.
Lastly, global events also affect the crypto market.
As we’ve seen in recent years, when the global economy or financial markets go up or down, the crypto market tends to follow.
What determines whether a cryptocurrency’s price will rise or fall?
The first thing to remember is that no one can accurately predict the price of a cryptocurrency.
However, there are certain factors that can serve as a template for research and may help you forecast whether a project is heading in a good or bad direction (which will ultimately affect its price).
These factors include:
Crypto project utility (Technology and Purpose)
Some cryptocurrencies have a clear application and purpose.
For example, Ethereum aims to be an ecosystem for developing various decentralized applications.
The cryptocurrency ETH is used to pay "Gas" fees within the network (one of its functions).
If a crypto project has a clear and understandable product with broad use, this can be a strong indicator that demand for its native token will increase in the future.
2. Tokenomics
Every cryptocurrency has its own type of economy.
If you want to learn what tokenomics is and how it works, check out this article:
What is Tokenomics and How Does It Affect the Value of Cryptocurrencies?
If the token’s economy is built on solid foundations (such as having a well-defined consensus mechanism, total supply, and a “burn” mechanism), there’s a good chance the project will attract many investors.
How can you tell if a project has good tokenomics?
All this information can be found in the project’s “whitepaper” document.
If a project doesn’t have its own whitepaper or its tokenomics seem overly complicated, there’s a high chance you’re looking at a bad investment.
3. Project Governance
As you might know, every crypto project should be decentralized in its nature.
In other words, every crypto user should have a role and a voice in its future development.
However, that’s not always the case.
Many founders (individuals or companies) decide to give a portion of the total token supply to the community after the project launches, while keeping the majority for themselves.
Why is this risky?
There’s a potential risk for small investors.
If the project’s cryptocurrency price rises significantly, the founders may decide to sell their tokens and take profits.
This could cause the price to drop, hurting retail investors who believed the project had long-term potential.
To avoid this, always look for information on project governance and the distribution of tokens among the founders, early investors, and the community.
This information can also be found in the project’s whitepaper.
4. Project Liquidity
Liquidity in any project is a simple concept. It measures how quickly and easily an asset can be converted into cash.
Let’s take Bitcoin as an example.
As the most valuable cryptocurrency in the world, Bitcoin has high liquidity. You can easily buy or cash out Bitcoin.
However, there are smaller projects that are just starting out and aren’t yet listed on major exchanges. These projects usually have low liquidity.
Many people rush in and invest in such crypto projects, expecting big returns.
But due to low liquidity and low demand for the token, they often struggle to sell the tokens they’ve bought.
That’s why it’s crucial to research whether there’s enough interest in the cryptocurrency and whether it has sufficient liquidity.
How do crypto charts work and what is their connection to crypto prices?
If you frequently track the prices of Bitcoin, Ethereum, or other altcoins, you’ve probably noticed charts that update in real time.
What is their purpose?
Charts provide a visual representation of what’s happening in the cryptocurrency market at any given moment.
Along with current data, charts also show the price history of cryptocurrencies over time (from the beginning of record-keeping, over the past year, week, or the last 24 hours).
All this information helps investors recognize patterns in price movements, which ultimately helps in better predicting trends and making informed decisions (in other words, deciding the best time to buy or sell a cryptocurrency).
Crypto charts are like maps.
Maps give you information about the best routes and potential obstacles, helping you find the most efficient way to your destination.
Similarly, charts give investors a visual overview of market data, helping them avoid certain pitfalls and recognize trends, ultimately allowing them to make the best possible decisions when trading.
Conclusion
The price of cryptocurrencies depends on the balance between supply and demand in the market, where higher demand increases the price, and higher supply decreases it.
Additionally, external factors such as regulations, the economic situation, media narratives, and competing cryptocurrencies also affect the price.
The structure of an individual crypto project (its technology, purpose, and industry application) is an additional factor that can have a significant long-term impact on the cryptocurrency's price.