How Do Cryptocurrencies Gain Value – Some currencies will increase in value, some will stay the same, and some will decrease in value. But what makes the difference?
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How Do Cryptocurrencies Gain Value
Since the crypto market was launched in 2008, the combined market capitalization for all cryptocurrencies has grown from almost zero to over $1.6 trillion. And because of this huge development, many people want to participate in it, including some rather shady customers. Not that you will find any of these on your favorite cryptocurrency exchange. But it’s better to protect yourself from any online threat that comes your way with a standard digital device in your back pocket. (A reliable VPN is a good place to start.)
Why Cryptocurrency Has Value
At the same time, there are many other crypto investing pitfalls to avoid and you should understand that some cryptocurrencies become worthless. For example, BoringCoin (ZZZ) was launched in 2014 and attracted some interest on cryptocurrency forums such as bitcointalk.org.1 But it is now listed as a “dead coin” on Coinopsy.com and almost no one is mining it.2
So you might be wondering: How do you know if a coin will rise to the moon like Bitcoin or flop like BoringCoin forever? How does a cryptocurrency gain value?
In this article I will try to answer these questions. We will cover factors such as usage demand, investment demand, inflation, mining costs, and other elements that affect the perceived value of a coin over time. I will review the main reasons for the increase in the price of a coin.
But before we discuss these factors, we must consider an important difference between two different types of coins: Proof of Stake and Proof of Work.
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When you pledge cryptocurrency to ensure the work of a validator, this is known as “staking” the cryptocurrency. When you do this, you earn more cryptocurrency over time, just like you earn more money over time by putting it in a savings account. A currency that can be stacked in this way is known as a PoS cryptocurrency.
Some examples of PoS cryptocurrencies are Avalanche (AVAX), Fantom (FTM), Harmony (ONE), Solana (SOL) and Cardano (ADA). Most of the new cryptocurrencies are PoS.
However, the two largest cryptocurrencies by market capitalization, Bitcoin and Ethereum, are PoW coins. This means they are created by burning electricity, a process known as mining. You cannot stake PoW cryptos to get more cryptos.
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Did You Know: If you want to buy cryptocurrency, you can do it on an exchange? However, not all are created equal. Read more about this in our guide to determining if a trade is legitimate.
Depending on the category the crypto falls into, there are different factors that cause the price to rise. So I will talk about each of them separately.
So what makes a PoS coin go up in price? Eventually, the value of a PoS coin will increase if the demand grows faster than the supply of coins.
For a PoS coin to increase in value, the amount of money spent on the coin must increase. But there are two different types of demand for PoS coins: user demand and investor demand.
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Some people want a coin because they want to use their network. They want to play blockchain video games, trade tokens, invest in DeFi applications, or otherwise use the network.
But every time a user sends a transaction, they have to pay a gas fee, and most of the cryptocurrency used to pay that fee is destroyed during the payment process.
What is a gas fee?: A gas fee is a fee that users must pay every time they make a transaction on the blockchain. The more complex the transaction and the more congested the network, the higher the gas fee. In PoS networks, most gas charges are destroyed or consumed in the payment process.
So this is a force that drives up the price of a PoS coin. As the number of transactions in the network increases, this user demand tends to increase the price of the coin.
Understanding The Cryptocurrency Market
Not everyone wants to use their crypto. Some people buy cryptocurrency as an investment because they want to earn more cryptocurrency.
In the PoS network, you can hand over your coins to a validator for staking. Validators are required to hold a certain amount of coins as a deposit to ensure that they cannot process fraudulent transactions. So delegating your coins to a validator helps prove that they are trustworthy (you don’t need to delegate your coins to a node you don’t know and don’t trust).
When you commit your coins to a node, the node will pay you a return based on the number of coins you commit. The more coins you surrender, the more coins you will earn over time.
FYI: Cryptocurrency investors are always looking for ways to generate high returns on PoS networks. And as more and more investors buy and stake these coins, there will be more demand for the coins. This investor demand is another force driving the price of PoS coins.
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In a PoS network, validators are paid with newly minted coins. In other words, your rewards are a form of inflation. If this inflation is too high, it will depreciate the currency. This is especially true if insurers sell most or all of their premiums each year.
For example, put a coin that pays 8 percent per year to validators, but demand increases by 10 percent per year. In this case, the price of the coin may increase even if all validators sell their rewards.
But if, instead, validators are paid 50 percent per year (and demand continues to grow at only 10 percent), the coin faces a price drop as validators sell their rewards.
Therefore, the supply of coins is one factor that can cause the price of a PoS coin to fall over time.
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FYI, there are a lot of crypto regulations in the US that you should familiarize yourself with to make sure you are on top when trading.
For a PoS coin to increase in price over time, demand must increase faster than supply. Here are some reasons that can cause this:
These are the things that can cause a PoS coin to increase in value. Now we come to PoW coins.
So what makes a PoW coin go up in price? Over time, a PoW coin increases in value as the cost of production increases. This happens when the number of mining computers increases or the mining reward decreases.
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Usually, the number of miners increases only when the amount of money spent by speculators on the coin increases, so you can also consider speculative demand as a factor in the price increase of a PoW coin.
FYI: If you’re confused, you’re not the only one. What makes PoW coins go up or down in price is one of the most confusing and controversial topics in the crypto community. If you want a more detailed scientific answer to this question, be sure to read Adam Hayes’ seminal article on the subject.3
Otherwise, here’s the TL; DR version of the answer: PoW coins increase in price when speculators spend money on the coin faster than the mining reward rate.
Here are some factors that may prompt speculators to buy a PoW coin faster than its reward rate:
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The cryptocurrency market has grown exponentially over the past 14 years, from almost zero to trillions of dollars in combined market capitalization. But while some cryptos have appreciated in value, others have gained no traction.
How can you tell the difference between a great coin and a coin that is destined to stay the same price or even go down? Big coins are usually very profitable, generate high profits or have a passionate community behind them, or all three. If you think you have a winner, visit our deep dive into safe cryptocurrency purchases.
And if you want to buy a coin that will increase in value, you should stay away from BoringCoin (ZZZ).
Want to learn more about the exciting world of cryptocurrency investing? Our Everything You Need to Know About Cryptocurrency article will give you all the information you need. Bitcoin (BTC) is a cryptocurrency