Anyone familiar with cryptocurrency has an awareness of its volatility. This volatility makes some people hesitant to invest in cryptocurrency, but with the proper knowledge, it is possible to understand the fluctuations in the pricing of crypto, at least to some extent. Experts put their skills to use to analyze cryptocurrency, determining which factors impact the price and making predictions for the future. With some of their wisdom and some effort on your part, you will find yourself better able to predict crypto pricing, leading to smarter investments.
The Main Differences Between Crypto and Fiat
To better understand the pricing of cryptocurrency, it is helpful to compare it to fiat. After all, fiat is the currency that most people have a thorough understanding of, and that the average person compares new currencies to. Neither cryptocurrency nor traditional fiat currencies have gold or another underlying value backing them. This was previously true of fiat but has not been the case for decades.
Instead, the most significant difference between crypto and fiat is that a central government backs fiat currencies, declaring it as legal tender. The value of fiat currency comes from the central government stating its value and others placing their trust in the currency. In most countries, monetary reserves and central banks control the money supply, which controls inflation.
By contrast, cryptocurrencies do not have a central authority or government in charge of them. Additionally, few places accept crypto as a legal tender. Furthermore, cryptocurrencies tend to have fixed supplies while fiats do not. Because of this, devaluation cannot occur due to inflation.
Why Crypto Is So Volatile
Since cryptocurrency has a well-deserved reputation for volatility, it makes sense that experts have investigated why this is the case. The answer comes down to crypto still being a new market. By their nature, new markets tend to have volatility.
One of the reasons for that trend is the limited liquidity of new markets. Experts who compared the total value of all fiat versus all crypto found that there is 36,000 percent as much fiat as crypto, in terms of market cap. Trading volumes for crypto are also significantly smaller, around $14 billion compared to $5 trillion for forex. This also means that forex pairs tend to have smaller spreads than crypto pairs. All those factors combine to a thin market, resulting in quick movement and high volatility.
Unfortunately, price manipulation also plays a role in the volatility of cryptocurrency. Despite the focus on decentralization, central exchanges remain in control of the largest amount of crypto flow. This provides the exchanges with an incentive to manipulate prices to grow profits. A simple method that crypto exchanges can artificially manipulate prices would be to adjust the price feeds so people sell or buy. This type of manipulation only gets worse when it impacts those without much crypto knowledge.
The vested interests of new cryptocurrency holders also enhance its volatility. Some reports indicated that as of early 2018, 100,000 new users joined crypto exchanges daily. Most of the new people entering the cryptocurrency world find themselves with a vested interest, and that interest only makes cryptocurrency more disruptive. That disruptiveness, in turn, increases volatility.
Cryptocurrency is also volatile due to the fact that people are unsure about its future. Opinions on the future of cryptocurrency vary greatly and there is no way to know for sure. This leads to uncertainty which can cause its own fluctuations or mean that other factors cause greater fluctuations than they would with an established fiat currency.
Volatility Is Not Necessarily Bad
While the volatility of cryptocurrency does make it harder to predict, it is not necessarily bad. Volatility means that short-term cryptocurrency investments require a great deal of research. The bright side is that volatility increases the potential reward, but this does come with an increase in the potential risk.
If you take the time to understand the cryptocurrency price fluctuations and see where a crypto’s value is heading, the volatility can work to your advantage. Just remember that it does require an additional level of caution since there is more to lose with a volatile market.
Supply and Demand Influences Crypto Pricing
One of the biggest factors affecting the price of a cryptocurrency is supply and demand. This should not come as a surprise since it is a basic economic principle that impacts that price of any good or service. When cryptocurrencies have high token supplies and minimal demand, the price will be low. When a token with limited supply is in high demand, its price will go up.
Some cryptocurrencies keep this in mind with their structure and engage in buying back of tokens and then “burn” them. This burning process destroys the tokens, decreasing the supply of them. When demand remains the same or increases, this results in a higher value for the token.
Availability Influences Crypto Pricing
Availability is a factor influencing cryptocurrency prices that is closely related to supply and demand. It refers to the ability to find cryptocurrency on various exchanges. After all, the supply of a cryptocurrency means nothing if you cannot access that supply. The more access there is to a certain cryptocurrency via a range of exchanges, the more likely it is to have a higher price. This comes from the access to the supply as well as the increasing awareness of its existence from market participants.
Public Sentiment Influences Crypto Pricing
Another significant factor impacting the price of cryptocurrencies is the sentiment of the public. Typically, the price of a given cryptocurrency will drop if the public sentiment gets worse. Conversely, when tokens have positive public sentiment including good media coverage, their price tends to increase.
The public sentiment itself depends heavily on bad news, so any news that reflects poorly on cryptocurrencies in general or a specific token will cause the value to drop, in most cases. For example, in early 2014, the Mt. Gox scandal and bankruptcy were one of several factors that caused Bitcoin to lose significant value quickly.
Token Utility Influences Crypto Pricing
The usefulness of a token also has an impact on its price. Typically, a cryptocurrency or token that resolves a serious problem and has real-world applications will have a greater value. The value of the blockchain platform that the token uses plays a similar role. Many argue that one of the reasons that Ether has a high consistent value compared to other cryptocurrencies is that its platform, Ethereum, allows developers to create decentralized applications.
Mining Difficulty Influences Crypto Pricing
In the case of tokens that use Proof of Work consensus mechanisms, the difficulty of mining will also influence a cryptocurrency’s price. In this case, tokens that are harder to mine have higher values. This is from the difficulty in increasing the token’s supply, which means the supply cannot increase easily even if demand rises.
No discussion of mining’s impact on crypto pricing is complete without looking at the energy consumption as well. Proof of Work mining consumes vast amounts of energy. This makes the practice of mining less profitable due to the high electricity costs. That lack of profitability discourages mining, decreasing the demand just like any other increase in mining difficulty would.
Regulation Influences Crypto Pricing
Regulation also has an impact on the pricing of cryptocurrency, although it is still not clear to what extent. This is still somewhat of a gray area since it is unclear what regulations will arise and they can vary between markets. Even with the still-changing nature of cryptocurrency regulation, enough examples have occurred to show a clear connection between regulation news and crypto pricing.
In April 2017, the price of Bitcoin increased when Japan announced its legalization in the country. Showing that this impact goes both ways, February 2018 saw China announcing blocking of all crypto trading websites, which led to Bitcoin and Ethereum losing value.
Adoption Influences Crypto Pricing
Based on all the other factors mentioned, it makes logical sense that adoption influences the price of cryptocurrency. After all, an increase in adoption will increase the public sentiment as well as the demand for cryptocurrency. Assuming the demand for crypto remains the same, this will lead to an increase in its prices.
Speculation Influences Crypto Prices
Speculation from investors can also have an impact on the pricing of cryptocurrencies. Speculation investors looking to diversify their portfolios are more frequently participating in the cryptocurrency market, but they can sell and buy quickly due to the nature of their trading strategies. These purchases and sales on short notice can lead to short-term swings in the market, impacting the price. The impact of speculative investments can be particularly significant in the case of investors who have vast quantities of a given crypto.
What Causes Cryptocurrency Fluctuations
All the previously mentioned factors that influence crypto prices will also cause fluctuations. If the public sentiment for a currency suddenly turns sour, this will cause a fluctuation toward the negative.
Understanding and Predicting Crypto Pricing via Analysis
Even with so many factors impacting the price of cryptocurrency and its market fluctuations, savvy crypto traders make a profit. You can get some advice for trades to make by reading expert suggestions and analysis, but you will get the most out of it by learning how to analyze the prices yourself. Learning how to complete this type of analysis will give you the background you need to better understand expert suggestions. It will also make it possible for you to trade crypto pairs even if you cannot find expert recommendations involving them.
There are three main types of analyses that crypto experts use to predict pricing: fundamental, technical, and sentimental. Fundamental analysis examines the factors driving numbers. Specifically, the management of the cryptocurrency’s company or blockchain or the economy. Fundamental analysis involves removing emotion from your analysis. The idea behind it is that the market might overestimate or underestimate the value of a crypto and there will be a correction at some point.
With technical analysis, you look at the historical activity of a cryptocurrency to find statistical trends. This means looking at trading volume and price movements. The idea behind this analysis is that the price of crypto will follow previous trends and history keeps repeating itself. To this end, technical analysis will look at the data to predict if the price of crypto goes up or down and by how much.
Finally, sentimental analysis involves looking at the market sentiment related to the crypto. With this method, you examine what the average person, as well as influencers and journalists, think about the cryptocurrency. The idea behind this type of analysis is that you cannot always get the complete story from data alone.
The thing to remember with these types of analysis is that they will not be foolproof. Market trends may not always repeat themselves and you may not see indications of changes in market sentiment until it is too late to take advantage of them. Ideally, you will combine all three of these types of analysis to create your plan, or at least two of them.
Many people find it overwhelming to try to understand the pricing of cryptocurrency due to its highly volatile nature. There are numerous reasons for its volatility, from the newness of cryptocurrency to its limited supply to uncertainty regarding its future. Despite the volatility, it is still possible to gain some understanding of crypto pricing and fluctuations, knowledge which can help investors and traders.
The price of cryptocurrency depends on a long list of factors, such as supply and demand, regulation, public sentiment, mining difficulty, speculation, adoption, and use cases. By paying attention to these factors and engaging in analysis, it becomes possible to predict the future prices of cryptocurrency more accurately. Experts tend to use a combination of sentimental, technical, and fundamental analysis to predict pricing. You as a trader can complete this analysis yourself or read the analyses of experts. Because of its volatility, the potential gains with cryptocurrency are significant, but you should take the time to understanding crypto pricing and the market to minimize your risks.
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