Cryptocurrency is digital money that has no physical representation. When people buy or sell cryptocurrency, they make electronic transfers on their online accounts. However, how do people know cryptocurrency is worth anything? What defines its value? When we talk about fiat money, we understand that it is supported by gold and currency reserves. Cryptocurrency has no reserves that back it up, its price largely depends on the demand. As the demand rises, the price does as well, and vice versa.
Another factor that defines its value is the limited number of coins. While central banks take care of fiat money emission, the number of coins of cryptocurrencies is defined. For example, for bitcoin, the maximum number of coins is 21 million. When all 21 million coins are mined, the emission will stop. Therefore, there following features define the price of cryptocurrency:
- The supply and demand relation
- Limited supply
- Investment attractiveness
- Energy use
- Governmental policies
- Media coverage
- Innovation and technological advancements
- Price expectations, etc.
While some factors are economically reasonable, human factor does play an important role in defining the value of each particular cryptocurrency. The innovative blockchain technology that lies at the base of bitcoin and altcoins has proven to be very useful in many areas of business and technology. It is known for its highly secured system of transactions and difficulties in decoding it. This makes it almost bulletproof when it comes to fraud and scam. Many companies spend millions to develop and implement blockchain-based software in their operating activities. This fact makes many investors put their hopes up in regards to the future of cryptocurrency.
At the same time, cryptomining is highly energy consuming. This is one of the factors for some countries to lay restrictions on bitcoin mining and trading. Another one is an attempt to control the potential game changer in the financial system. Finally, media coverage of cryptocurrency news defines people’s perception of it as something of extreme value and prestige.
Dangers of Cryptocurrency Investments
The fact that cryptocurrency is not backed by gold or currency reserves makes it highly volatile. The price of the most famous cryptocurrency, bitcoin, is far from stable as well as prices of other cryptocurrencies. Many financial analysts believe cryptocurrencies, bitcoin in particular, to be the next bubble the last one of which led to the global economic crisis. Even though no one can know for sure, heavily investing in cryptocurrencies can result in heavy losses if it turns out to be a bubble after all. Still, it does have a chance to stabilize and make its way to substituting fiat money.