Bitcoin’s price has seen a massive increase since its introduction in 2008, with big ups and downs along the way.
While Bitcoin is notorious for its volatility, its long-term record of building and maintaining value makes it an attractive investment. However, the stock does not hold value because it represents a portion of ownership of a company, nor does a bond, which means the value of a debt you will repay when the term ends. In addition, having a short history can be challenging to determine the value created by a decentralized, digital currency. And these swings can make investors wary and ask why Bitcoin has value in the first place?
Cryptocurrency is notoriously volatile, so it is understandable to wonder why they are valuable. For example, it’s common for Bitcoin (BTC) to increase or decrease the price by five or even ten percent on any given day, and smaller cryptocurrencies have even wider price swings.
Crypto isn’t usually governed or backed by a central authority. That is because government backing can improve faith in the value of a currency among consumers and provide a big spender and collector of the currency. Instead, cryptocurrencies derive their value from other sources like demand and supply, cost of production, availability on exchanges, competition, governance, and regulations due to their decentralized nature.
The value of anything gets determined by its demand and supply. When demand exceeds supply on a crypto app, prices go up. For example, grain and production costs rise if the need doesn’t change if there’s a drought. This same principle applies to cryptocurrencies.
The supply of cryptocurrencies is always known; cryptocurrencies like Bitcoin have a fixed maximum supply. Others, like Ether(ETH), have no cap on supply. In addition, some cryptocurrencies have mechanisms that “burn” existing tokens to prevent the circulating coins from growing too significant and slowing inflation. Burning a token on the blockchain means sending it to an unrecoverable address.
Each cryptocurrency has a different monetary policy on an investing app; Bitcoin’s supply increases by a fixed amount with each new block mined on its blockchain. With Ethereum, miners receive a fixed reward per block they mine and get rewarded for adding “uncle blocks” to the new block, which boosts the efficiency of the blockchain. Consequently, the supply increase isn’t as fixed. The amount of supply for some cryptocurrencies is managed entirely by the team responsible for the project, either by releasing more tokens to the public or by burning tokens to drive the money supply.
An increase in awareness or utility can increase demand for a project. An increase in demand and a reduction in supply is observed with greater adoption of cryptocurrencies as investments. The price of Bitcoin, for instance, dramatically increased in early 2021 when institutional investors began to buy and hold it as demand outstripped the rate at which new coins were created, effectively decreasing the total supply of bitcoin.
In addition, demand for Ether rises as more decentralized finance (Defi) projects appear on the Ethereum blockchain. No matter what cryptocurrency you use to transact with, you will need Ethereum to perform a blockchain transaction. Therefore, a project that defies the odds and gains traction will strengthen its token, resulting in more demand.