Cryptocurrencies are constantly gaining popularity among investors and people that just want to take advantage of the huge associated value. Businesses keep popping up and try to basically make money through cryptocurrency investments of different types. The big problem in many cases is that it is not properly understood what drives cryptocurrency prices.
One of the most important things to remember about practically all cryptocurrencies is that the market is highly volatile. Price fluctuations are often unpredictable. As new ICOs and cryptos are launched, the equilibrium in the market is disrupted.
At a fundamental basis, cryptocurrency price is similarly determined to most other assets. The big things that count are supply and demand. Most of the cryptos have finite supply, with a clear limit being set on how many coins are going to appear. This means that the factors that mainly influence crypto price are closely driven by factors that normally affect demand.
Demand and value for all currencies, especially the fiat currencies, are derived from user trust in the ability to preserve purchasing power. As the currency loses trust, value drops. The same thing happens with the cryptocurrencies. The big traction Bitcoin had was largely linked with the fact that users actually believed in the offered security and anonymity of the blockchain ledger. Because Bitcoin cannot be tampered with or hacked, value is preserved. Litecoin showed something similar as its value quickly increased because users understood there are many features that were surpassing what Bitcoin was offering, like transaction speed.
If you ever want to invest in cryptocurrencies, one of the first lessons you learn is that you have to watch the news. This is also related to trust. Government trust plays a really big role in crypto success or failure. This is largely connected to regulations that do affect valuation.
Governments are now looking at cryptocurrencies with more positive eyes. They fully understand the fact that they are valuable and that they do represent the future. This mainly happened as governments started to understand blockchain technology and the advantages they offer. As governments get involved, valuation becomes different, with valuations changing.
Further reading: The Future Of Cryptocurrency Is Trust
Prospective Market Valuation
Many of the investors that are now active in the market estimate value based on capitalization of the assets or processes that are to be replaced. This is done through estimation of the market share that cryptocurrency is going to control. For instance, those that hold Bitcoin usually think that Bitcoin is similar to gold, but in a digital form. That is why we often see references taken from the way the gold market evolves.
In the event Bitcoin controls 1% of the market cap of gold, valuation drastically increases to around $70 billion. If the current valuation is of $35 billion (purely to be used as an example), it means the asset is undervalued.
The problem with such a currency valuating method is that it does depend on various factors that cannot be predicted, like the possibility a new cryptocurrency will be launched and it will be more efficient than what we see used now.
Further Reading: Cryptocurrency market valuation to hit $1 trillion
Similarly to all assets, speculation can have a huge impact on cryptocurrency value. Speculation is always affected by brand new developments, updates and how they are perceived. As an example, liquidity improvements through the launch of brand new exchanges will lead to price increases because speculators think more people start using the considered currency. As a brand new coin is introduced, when it has the same function as one that already exist but that has an advantage like lower cost and increased transaction speed, existing coin valuation would go downwards.
At the moment, the cryptocurrency market is filled with high short-term swings in terms of prices. Seeing 1000% increases in just one week automatically means that investors and traders become interested. Wild swings are possible for practically all cryptocurrency coins.
We have to understand that most traders do not really know anything technical behind the crypto market. They just want to make money and do not care about asset fundamentals. This leads to trend following. When many trend followers exist, price movements are exacerbated. Herd mentality only leads to higher volatility.
The last reason why speculation is increased is that traditional markets have overvalued metrics and low volatility. Speculators want to make money faster so cryptocurrencies become really profitable and interesting for them. Huge returns can appear due to the high volatility.
Further Reading: Why Is The Cryptocurrency Industry So Volatile?
The Perspective Of The Investor
Cryptocurrencies will always be driven by demand-side factors. So many economists and investors think cryptocurrencies are in a bubble. ICOs attract much capital. This is similar to the past dotcom boom. People brag about the fact that it is really easy to make money with crypto. However, there are also others that think this is just the start of the moves leading to huge crypto value increases.
Opinions are definitely different and investors think differently but the highest possibility is that some of the cryptocurrencies will stand out and will survive, no matter what. However, most can actually disappear as they become useless and investors lose interest.
Further Reading: How to become a successful cryptocurrency investor
The most important thing to remember about what drives cryptocurrency prices is demand. However, we should take into account the fact that the market is highly volatile. This practically means that any investor interested in making a profit has to be aware of what is happening in the industry. Government decisions and even the appearance of new cryptos can modify prices.