Cryptocurrencies such as Bitcoin and Ethereum have exploded in popularity over the past two years. These cryptocurrencies, which contribute to an increasingly digitized global economy can be used to purchase goods online through peer-to-peer transactions, without the transaction fees that come with using credit cards or other methods of payment.
However, the value of these digital currencies is highly volatile, whereas regular currency such as US dollars has been relatively stable over time.
Despite these potential setbacks, many investors are still interested in gaining cryptocurrencies. How does cryptocurrency gain value?
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1. Cryptocurrencies Are Legal
Some cryptocurrencies are legal which makes their value recognized. For example, bitcoin is legal in the U.S., U.K., Japan, and most other developed countries. The United States Securities and Exchange Commission (SEC) approved the ProShares Bitcoin futures ETF application in Oct 2021.
Some businesses in the United States now accept Bitcoin as payment for goods and services.
2. Cryptocurrencies as Mediums of Exchange and Value Storage
Adam Smith said in The Wealth of Nations that “Money has no other use than the purchase of commodities.” Money is an instrumental commodity, and it must function if it is to become an effective means of exchange and store of value.
Thus, the value of a cryptocurrency lies in its ability to effectively do these things: facilitate transactions and act as a store of value. A medium of exchange can become a store of value, and if a cryptocurrency is to become a store of value, its value must be stable.
In order for a cryptocurrency to have a stable value, it must be an effective facilitator of transactions. For cryptocurrency to become regular currency, it has to be ubiquitous. The ubiquity of cryptocurrencies and the accompanying increase in value are known as network effects.
The wider the use of cryptocurrencies, the more flexible they are in facilitating transactions, which in turn stabilizes their value. The more people accept it as a valid payment method, the more people will use it as a payment method. As the popularity of cryptocurrencies increases, so does their value.
3. Cryptocurrencies Value are Based on Supply and Demand
When the price of these digital currencies increases, it is referred to as a “bull market.” As with traditional stock markets that rise and fall with demand, cryptocurrency prices also fluctuate with supply and demand.
If the demand for a particular currency increases, its price will go up. This creates an incentive for more investors to purchase the currency. But what causes demand to rise? One possible reason is increased recognition of digital currencies as a new asset class, which allows them to reach a wider audience.
The supply of a cryptocurrency depends on the specific cryptocurrency. For example, the total supply of Bitcoin is capped at 21 million BTC. The maximum amount of a particular currency available will slowly be mined over time and then no more units of that currency can be generated, thus creating scarcity.
The demand for a cryptocurrency is largely based on its potential to be used as a method of payment within a given country or community, as well as its popularity as an investment.
For example, if a national government were to announce that they would be adopting a certain cryptocurrency as their official currency, demand for that cryptocurrency could potentially increase drastically, thus resulting in a price increase.
4. Cryptocurrencies Usage
Another reason could be due to increased usage of cryptocurrencies for everyday transactions. So far, the primary use case scenarios for cryptocurrencies have involved large financial institutions. Cryptocurrencies are used as a means to store and transfer funds between institutions without having to go through traditional banking systems.
With this growing usage by financial institutions, experts believe that more people will begin using digital currencies in their everyday lives. Digital currencies are expected to be adopted by both individuals and businesses. This will result in an increase in demand for cryptocurrencies that are accepted within the community, which should also cause an increase in price.
5. Big Community
cryptocurrencies gain their value based on the scale of community involvement. The greater the number of people who hold a cryptocurrency, the more valuable it becomes. With a growing community, there are more users willing to accept digital currencies as payment for goods or services.