How is the value of cryptocurrencies determined? Given that cryptocurrencies have no federal reserves or backing of any world government, how is the value of units of the cryptocurrencies arrived at? Well, we have come across the question of the valuation of digital coins as a form of currency on numerous crypto platforms and we want to answer the question in this article.
Read on to find out more about the qualification of cryptos as a form of currency and exactly how the value of a unit of cryptocurrency is arrived at.
For starters, it is imperative to acknowledge that cryptos fit all the criteria for becoming an internationally recognized currency.
For any means of payment to be recognized as a form of currency, it needs to have longevity and outlast its users. Cryptocurrencies are very durable as they virtually circulate within a secured network and there are no tangible units that are prone to damage.
Unlike fiat currency which comes in different physical denominations, cryptos are digital and their longevity is guaranteed. There are no physical notes or coins which will get lost or destroyed by elements.
For the easy control of demand of cryptocurrency, there can only be a limited number of units allowed to circulate in the industry. This is why there will only be 21 million bitcoins released into circulation and this makes it easy to not only value the bitcoins but control its supply in the market.
Although there are different types of cryptos, the established ones always have a cap on the amount that can ever be ‘mined’ and this maintains the value of the cryptos forever. No matter how high the demand is, the number of units in circulation will always be the same only the value will change.
One unit of a cryptocurrency is perfectly identical to the next one in terms of value and can be interchanged making them fungible as a form of currency. Irrespective of where in the world you are, the individual unit of currency will have the same value at any given time.
You can easily send cryptos from one part of the world in seconds when transacting qualifying the crypts as a form of currency. If anything, sending cryptos from one part of the world to the other is easier and quicker than sending other forms of currency like fiat currency or a unit of value like gold reserves.
All it takes to break cryptocurrencies into small fractions is a change in the core code. You can literally divide a cryptocurrency into very small units equivalent to cents of dollars. Bitcoin, for instance, can be divided into its lowest denomination which is 0.00000001 bitcoins. This makes it more accessible to more people and making microtransactions easier.
Now that we have seen how cryptocurrencies qualify as a means of transacting, let’s figure out how is the value of cryptocurrencies appeared? Here is a look at how the many cryptos in existence are valued.
The value of a cryptocurrency is directly pegged on the demand for the currency which boils down to the supply of the same currency in the market. The higher the demand for the currency, the higher its valuation if the supply is constant.
This is why the scarcity of a cryptocurrency is one of its most important attributes as a lack of proper structure to control the supply of the cryptocurrency would mean that the demand would dip. If everyone can easily access a currency, nobody would accept it as a form of payment for goods or services rendered.
The scarcity attribute explains why mining of cryptos such as bitcoin is so tedious and needs a lot of resources. Moreover, the fact that 18 million of the available 21 million bitcoins have been mined, makes it all too hard for people to get their hands on the cryptos. This leaves people transacting with the bitcoins which are already in circulation making it easy to control the value.
Although cryptocurrencies are not backed by any central government, their valuation is influenced by the state of politics in a country. The legislation in any country will determine the legality of crypto as a form of currency which will influence its demand and subsequently affect the value of the crypto.
A perfect example is a role China’s politics played in the decline of bitcoin’s value in December 2017 with reports of the government banning all initial coin offerings. Such policies have a direct hand in the valuation of cryptocurrencies and their feasibility in the business world.
Other factors that affect the value of cryptocurrencies are external factors such as hoarding of large amounts of coins especially by very wealthy individuals who can afford to buy them. This practice of ‘hodling’ cryptocurrencies has spiked in the last few months and it threatens to disrupt the balance in the entire cryptocurrency ecosystem.
It is always a big risk for few individuals to hold such massive reserves of a given currency as they will literally have control of the value of the currencies as they dictate their availability. This explains some of the sudden spikes in the price of some cryptocurrencies which are experienced in the business world.
To sum up, we can note that the valuation of cryptocurrencies is very similar to that of fiat currencies but the external factors don’t play as big a role as they play in fiat currencies. As a self-sustaining ecosystem, blockchain technology affords cryptocurrencies independence and only the actual users of the currencies can self-sabotage through practices such as hoarding.
Before the cryptocurrencies strike an even balance in the supply and demand in the entire world, they will always experience the fluctuations in price and valuation. But as more people absorb them into their financial undertakings, the currencies will carve out a permanent niche and their value will eventually become steady with fluctuations growing insignificant by the day.