What determines the price of cryptocurrencies?
Cryptocurrencies are purely digital. They have no physical form and only exist within the code of a blockchain. Because of this, some people believe they shouldn’t be worth anything. But that’s not how pricing works.
Cryptocurrencies are a tradable asset, much like stocks, commodities, securities and so on. Their price is determined by how much interest there is on the market in buying them – that’s called demand – and how much is available to buy – that’s supply. The relationship between the two determines the price.
If there is significant demand for a particular coin, but the currently available supply is limited, then the price increases. The demand for coins sometimes rises regardless of the currency’s true value – this is termed overbought. Alternatively, if a significant quantity of a coin is sold without a solid reason, it is described as oversold.
CRYPTO PRICE ESSENTIALS
- Price is determined by the relationship between supply and demand.
- The total amount of most cryptocurrencies is limited by max supply.
- Overbought coins are in high demand and are usually expensive.
- Oversold coins are in high supply and are usually underpriced.
Supply and demand of cryptocurrencies
The law of supply and demand is an economic theory that determines the relationship between the supply of a particular good or service and the demand for it, to see what effect that has on its price. The theory describes the fluctuations in the price of anything that can be exchanged on a market.
If a coin is in short supply or if the demand for it is high the situation results in an increase in price. Those who wish to buy it are willing to compete by offering ever higher prices. Alternatively, if a cryptocurrency is in abundance and if the demand for it is low, the prices fall.
Generally, the law of supply and demand predicts that if the demand for something rises, the suppliers will make more of it. Manufacturers are willing to expand their production to sell larger quantities, intending to profit from more sales. But that is impossible when it comes to most cryptocurrencies for two simple reasons: they are limited by max supply and they are distributed.
Max supply determines the total amount of each particular crypto that will ever exist. When it comes to Bitcoin, that number is 21 million. Over 18 million BTC have already been mined and the rest are slowly being added to the pool of total bitcoin supply. But couldn’t someone just change the protocol to release more coins? The simple answer is no. On a distributed network, a person who wanted to abuse the system by double spending coins simply could not do it unless they were willing to spend a lot more money than they would gain.
Can cryptocurrencies be overbought or oversold?
There are plenty of factors that have an influence on the demand for cryptocurrencies. The usefulness and purpose of what is in demand often takes a back seat to trends, media recognition, and endorsement by public figures. Even the idea that someone might miss out on easy profit (FOMO) can play a big role in investment choices. Thus we might ask whether it is really justifiable that a stock, security or cryptocurrency experiences astronomical growth regardless of its inherent value?
People who think that it isn’t justifiable would describe such an asset as overbought. A combination of reasons, like those above, spark interest in a particular asset. Traders rush in to purchase it, and since its supply can no longer keep up with the demand, the price experiences substantial growth. Those who believe the asset is trading above its true value might perceive the hype as unreasonable and the investment misplaced.
The reverse can take place, as well. An asset the supply of which is higher than the demand for it can be considered to be oversold. The number of people who want to sell it is greater than the number of buyers. With little or no interest in the asset, its price falls. A keen trader, recognizing the hidden potential of the asset, will make a purchase despite a prevalent negative atmosphere surrounding it. If the asset really were oversold, its price will correct back upwards and the trader will make a profit.
Versatility vs. equilibrium in cryptocurrencies
When supply and demand are the same, they bring balance to the market. The amount of goods or services supplied is the same as the amount demanded. Market stability eliminates volatility, which brings about equilibrium.
In reality, no market is ever completely in equilibrium. Since crypto markets are still relatively young, they are even further from equilibrium than long-standing markets might be. Perhaps one day in the future the price of crypto will stabilize. But for now, its high volatility is part of what makes crypto so exciting, because it raises the stakes for traders. A market where prices move rapidly brings higher risk for traders, but also the potential for higher rewards.
Keeping your eye on the market that is open 24/7 is essential when you want to invest in cryptocurrency. An exchange like Bitstamp gives you all the tools to monitor the market and act quickly when you want to make a move. Register a free account or download our mobile app to never lose sight of your investments wherever you go.