Why Does Cryptocurrency Have Value?
How reasonable is cryptocurrency’s price and how is it supported? There are different opinions on this. In the summer of 2017, the American IT billionaire Mark Cuban criticized Bitcoin and the crypto as a whole on Twitter:
Anyone anywhere can buy a stock. #crypto is like gold. More religion than asset. Except of course gold makes nice jewelry. #crypto notsomuch https://t.co/xp334BCRa2
— Mark Cuban (@mcuban) June 6, 2017
After that, the rate declined, and Mark added:
You know it’s a bubble when a random twitter thread bounces the price. https://t.co/7gBGYU3JcQ
— Mark Cuban (@mcuban) June 6, 2017
However, later Cuban himself began to invest in ICOs and even advises people to keep 1/10 of their funds in cryptocurrency.
There are two main features for “successful” currency to exist – a store of value and a medium of exchange. Besides that, there are also important features such as scarcity, divisibility, utility, transportability, durability, and the ability to counterfeit it. In short, bitcoin meets all of the qualifications even better than fiat money. However, there is still an issue with cryptocurrency’s status as a store of value. Like regular fiat currencies, most cryptocurrencies, including Bitcoin, are not backed by the economy, precious metals (gold, silver, etc.) or other commodities. The value of Bitcoin throughout most of its life has been driven mostly by the speculative interest of market participants. Due to the relatively low market capitalization of Bitcoin and other cryptocurrencies compared to, for example, the stock market, it is easier to manipulate the price, thus artificially inflating or deflating the bubble. This is likely to decline as Bitcoin continues to see greater mainstream adoption and a constant increase in market capitalization, which makes it harder for a single manipulator to influence the price.
So what is the price driven by?
Firstly, cryptocurrency mining requires powerful equipment that consumes a lot of electricity and gradually loses its performance. Turns out that depreciation is partially transferred to the value of the coins. Miners are the ones who bring newly mined coins on the market. Since mining is quite an expensive process for every miner, they wouldn’t want to sell their coins cheaper than they spent on mining. This creates a scarcity that also significantly influences the price, because the reduced supply of coins with demand staying the same level or raising, this pushes the price up.
Secondly, blockchain. This is something that no other payment system has. The blockchain is universal, reliable, and decentralized. At the same time, it guarantees anonymity and high transaction speeds. And it is used in various fields, from the financial sector, to alternative energy. These are some obvious advantages that help determine the value of cryptocurrencies.
The market determines the value of these virtual coins. The greater the demand for a particular cryptocurrency, the higher its value. Demand, in turn, depends on the advantages that the coin offers. If tomorrow BTC is accepted as the official currency of China, for example, then its value will soar. Demand is heavily formed based on news, new developments, company announcements, and other factors.
There are also speculative leaps in the price – the so-called “pumps and dumps”. They are provoked by large traders (manipulators) on exchanges seeking to make money out of thin air. They are not particularly interested in how much coin costs. Due to a having a large amount of assets, they can have a short-term effect on the exchange rate.
Advantages and disadvantages of cryptocurrency
There are indeed a lot of advantages with cryptocurrency but, don’t forget to learn about the disadvantages this type of money has in advance.
| Advantages | Disadvantages |
|---|---|
| Anonymity. No information about wallet owner identity, only the wallet address. | Wallets are not insured as bank accounts, due to the lack of regulation. |
| The open-source code of the algorithm allows everyone to participate in blockchain operation. | Governments can negatively influence the use and adoption of cryptocurrency by its country residents. |
| Decentralization. No single entity controlling transactions and payments. | High volatility |
| No risk of inflation (for coins with limited emission, such as Bitcoin) | Loss of private key or seed phrase leads to the loss of funds because there is no way to restore the wallet without that information. |
| Security. Blockchain (as well as user wallet) can’t be hacked if the private key or seed phrase hasn’t been exposed. | Cryptocurrency mining difficulty is always increasing due to the increasing number of miners. This leads to losses from the outdated, low performing equipment. |
The high price volatility is one of the main drawbacks of cryptocurrencies, and the primary reason for mistrust of them. What about the other disadvantages of digital currency though? For example, regulation. Initially, BTC was a fully decentralized and independent currency. This meant that the network member in the USA and the network member in Burkina Faso are equal. However, more and more countries are thinking about regulating cryptocurrencies. And in some parts of the world (Bolivia, Indonesia, Thailand) it is prohibited.
The disadvantages also include reputation. Cryptocurrency, due to its anonymity, has become a payment tool used in the black markets.
A potential drawback is the “51% attack” threat. A situation when 51% of capacities or 51% of all coins (in the case of Ethereum) fall into the hands of one participant. Then this participant will completely control the blockchain and will be able to duplicate transactions. Roughly speaking, all your savings in wallets will be stolen. This is practically impossible though, because doing so doesn’t make any financial sense cost-wise. See the illustration below to better understand what “51% attack” is.
In other words, no one will benefit from such an attack. Moreover, the bigger the network, or the more users that are holding cryptocurrency, the more difficult it is to make the “51% attack”.