What Makes Cryptocurrency Valuable?

Money has some distinct characteristics that give it value. Let’s unwrap them.

Demand

The usage of crypto and fiat is similar in many ways. Both are a medium of exchange and a store of value. Hence they must derive their importance from society’s acceptance and usage. That leads us to the law of demand and supply which states that “All factors being constant, increased demand will stimulate a rise in prices, and increased supply will lead to a decline in price.” Cryptos are found by mining, and it gets tougher over time. The speed at which miners can access a unit of BTC on the other hand reduces as the difficulty level increases. Some top crypto coins, such as Bitcoin, have a fixed supply. As mining gets harder, the rate of supply falls. If there is more demand for such a coin, its price will definitely shoot up. Factors such as government crackdowns that were witnessed in China last year caused a scare among investors. Most of them started panic selling their cryptos, creating an excess supply that saw the price of many coins such as BTC fall.

Cost of production

Cryptocurrency isn’t free. Miners invest resources in setting up the right computing power to verify blocks on the blockchain. Mining is a high energy consumption activity and also requires high-performance computers. For limited coins such as Bitcoin, mining gets harder as competition rises, making it more expensive. In exchange, miners take home rewards in the form of small bits of crypto every time they successfully verify a new block. These rewards, plus any other fees paid to the miners for exchanging mined coins add up to the value of crypto.

Government Regulations

Cryptocurrencies were meant to be decentralized and free from government intervention. While central banks still have zero direct impact on the value of digital assets, governments have found ways to start regulating the usage of cryptocurrencies. El Salvador officially declared Bitcoin as a legal tender in September 2021. This step meant more acceptance of BTC, which would later see the demand for the asset shoot up and consequently its price. China on the other hand has banned Bitcoin since 2017 and has recently cracked down on Bitcoin mining rigs within the country. Considering that over 60% of the hash rate was in China, this crackdown discouraged global investors from getting involved in BTC. The price plummeted by more than 30%. This explains how the government’s acceptability of cryptos gives them value. The opposite is true.

Internal Governance

Crypto developers create and adapt projects according to the user community’s needs. Governance tokens give holders the autonomy to make future decisions on a project, according to how many coins an individual holds. That means there needs to be a consensus before any decision is made. Investors prefer putting their money in cryptos with stable governance, where new decisions are not easily made. That guarantees them that they have a reliable place to put their money. Consequently, demand for such tokens rises gradually impacting their overall value.

Celebrity Fad

Though the short term, the celebrity fad plays a role in the value of cryptocurrencies. Former president of the US Donald Trump has in the past launched a harsh round of attacks on Bitcoin causing its price to dwindle. Celebrity businessmen such as Elon Musk’s tweets are enough to crash or boom the crypto market. The Tesla boss tweeted in March “You can not buy Tesla with Bitcoin,” only to come back two months later and say that the decision was suspended. The market which had already risen by over 10% quickly plummeted following Elon Musks’ announcement of Tesla’s decision to stop accepting BTC.

Stock traders use several factors such as an intrinsic value to determine whether or not to buy a share. In order to come up with these valuations, they take advantage of key company data. Annual profits, sales, and balance sheets, all contribute to the computation of important ratios and metrics to help a stock trader come up with investment decisions. Is it possible to value cryptocurrencies? The answer is yes. Crypto valuation isn’t very different from that of company stocks. The same ratios and computations used in the stock market price modelling are used in digital currencies too, only that the inputs vary.

• Inputs for the crypto valuation model
• Replace “Revenue” with “Total Annual Revenue”
• Replace “Earnings” with “Protocol Revenue”
• Replace “Book Value” with “Combined Locked Value”
• Replace “Share Price” with “Fully Diluted Market Cap”

With this information, you can use the same formulae used in stock market valuation to determine the price to sales ratio, price to earning ratio, and market capitalization to dollar value. These metrics can come in handy during strong price swings. For example, now that BTC has been going down since the beginning of the year, you may be able to find out if it’s undervalued relative to fundamentals, and determine whether you should start going long already.