Fluctuations in cryptocurrency prices
The prices of cryptocurrencies can fluctuate insanely even within one day. In April 2021, the price of Bitcoin rose to almost $64,000, as the enthusiasm around the cryptocurrency market was very great. Coinbase, the largest cryptocurrency exchange platform, announced in a press release that it would begin public trading of its shares, and was ready to go public in just three days. Tesla has also announced that it will start accepting Bitcoin as a form of payment for its cars. A month and a half later, Bitcoin was trading below $40,000 as Tesla no longer accepted BTC, and Coinbase shares fell by about 30%, compared to their historical highs (ATH).
For newcomers to the world of cryptocurrencies, such price fluctuations can be wild, but for experts it is an opportunity to even use them to their advantage.
Let’s look at what you should know in order to use price fluctuations to the maximum benefit for yourself. First of all, let’s talk about what causes price fluctuations so that you can know exactly what to pay attention to when developing strategies that work in each specific situation.
What causes the price of cryptocurrencies to rise or fall?
There are many factors that cause cryptocurrency price fluctuations, and all of these factors work together to create price volatility. Understanding these factors can help you decide whether to invest in a particular coin, trade it, or just retreat from it.
Cryptocurrencies are generally decentralized, and fluctuations in their prices (also known as price volatility) are caused by factors such as:
- Supply and demand
Supply and demand affect the prices of most goods more than any other factor. The basic rule of economics is that the price of assets, goods, products or services largely depends on supply and demand. There are 4 basic rules of supply and demand:
- If supply increases and demand remains constant, the price falls.
- If supply falls and demand remains constant, the price will rise
- If supply remains constant and demand grows, the price will rise
- If supply remains unchanged and demand falls, then the price will fall.
For example, if there is a drought, the supply of agricultural products decreases, and demand increases, which leads to an increase in prices. The same principle of supply and demand works for cryptocurrencies. The cryptocurrency offer is always known and has a predetermined maximum volume. While some other coins have no production limit. In some cryptocurrencies, existing tokens are “burned” in order to prevent an excessive increase in the volume of working capital and slow down inflation. The burning of the token consists in sending it to an unrecoverable address of the blockchain.
Each cryptocurrency has its own monetary policy. Each new block mined on the network adds a predetermined amount to the coin stock. For example, Ethereum pays a fixed reward for each block extracted, but also compensates for the insertion of “uncle blocks” into fresh blocks, which increases the efficiency of the blockchain. As a result, supply growth is not so predictable. The supply of some cryptocurrencies is completely determined by the project management, which may decide to issue more tokens to the public or burn the tokens to control the supply.
Demand may increase as the popularity of the project grows or the scope of its application expands. Demand for cryptocurrency is growing as it becomes more widely recognized as an investment, which limits the circulating supply. For example, when institutional investors started buying and holding Bitcoin at the beginning of 2021, the price rose sharply as demand exceeded the rate of creation of new coins, which significantly reduced the total possible supply of Bitcoin.
- The cost of mining
Mining is a process during which new cryptocurrency tokens are created. Using a computer to confirm the next block in the blockchain is known as Bitcoin mining. The ability of cryptocurrencies to function is due to a decentralized network of miners. In exchange, the protocol generates a reward in the form of cryptocurrency tokens plus any rewards paid to miners by the exchanging parties.
To verify transactions in the blockchain, computing power is required. To do this, funds are invested in expensive equipment and electricity, as well as complex mathematical puzzles are solved. For example, when mining Bitcoin, miners verify legitimate transactions and create new coins as a reward for their work. A transaction is considered verified when a miner solves a cryptographic (mathematical) problem. The greater the competition for cryptocurrency mining in the proof-of-work system, the more difficult it is to mine it. As a result, the cost of mining increases, since more powerful equipment is required to solve issues and efficiently extract.
As the cost of mining increases, so does the cost of cryptocurrency. Miners will not mine if the value of the coin they mine is insufficient to cover their expenses. And since miners are needed for the blockchain to work, the price will rise as long as there is demand for it.
- Availability on exchange platforms
Bitcoin and Ethereum are the most popular coins listed on almost all cryptocurrency exchanges.
However, according to Coinmarketrate.com some small coins may only be available on a few exchanges, which limits the number of investors who can participate in trading such coins. In addition, if the cryptocurrency is not traded enough on a tiny exchange, the spread set by the exchange may be too large for some investors.
An increase in the number of exchanges on which the cryptocurrency is quoted can increase the number of investors who are ready and able to purchase it, and therefore increase the demand for such a coin. And all other things being equal, when demand increases, the price also increases.
As of March 2022, according to Coinmarketrate.com, there are more than 11,000 cryptocurrencies, and new crypto projects and tokens are launched daily. New competitors face a low barrier to entry, but the production of a sustainable cryptocurrency also requires the development of a network of cryptocurrency users.
A useful blockchain application can quickly develop a network, especially if it eliminates the disadvantage of a competing service and has a more reasonable usability. If a new competitor gains momentum, it reduces the competitor’s value, which leads to a drop in its price as the price of the new competitor’s token increases.
- Media hype
Another important aspect affecting the volatility of the cryptocurrency market is the hype in the media. Barriers to entry into the cryptocurrency market are significantly lower than in more traditional types of business (such as franchising or real estate). There are no requirements for lawyers, trading licenses or a minimum amount of investment. Thus, anyone with Internet access can immediately start trading.
However, the more retail investors join this process, the more confusing the market becomes for investors. This is one of the reasons why cryptocurrency markets can be extremely volatile during periods of media hype caused by investors with huge influence, such as Elon Musk. This causes panic or FUD (Fear, Uncertainty, and Doubt) and forces experienced investors to remain calm, while newcomers panic and want to sell – and this also means that cryptocurrency markets are more susceptible to disinformation manipulation.
Now you should have a correct idea about the volatility of the cryptocurrency market, and about its cause. This is not a reason for panic, but an opportunity to purchase a particular crypto asset.
Remember: volatility, and, consequently, fluctuation in value, is a temporary process. So don’t miss the opportunity.