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What drives the price of cryptos?

08 April 2022 Jonty Sacks, Partner at Jaltech

The cryptocurrency market is notorious for its volatility, with investors in some instances experiencing gains and losses all within the same day. The question on many investors’ minds is what drives the price and volatility of cryptocurrencies.

What will surprise most readers is that many of the factors which influence the price movement of traditional markets affect the price and volatility of cryptocurrency. The major difference is that the cryptocurrency market’s volatility is far greater than what’s generally experienced in the traditional markets.

In this opinion piece, I break down a few of these factors.

Interest rate adjustments

As with most markets, where a Reserve Bank adjusts interests rates up, the market tends to retract from riskier investments into lower-risk investments as their yields increase making these investments attractive relative to their risk profile.

As such, tech shares and cryptocurrencies are one of the first asset classes to experience a contraction in price when interest rates are adjusted up. The opposite applies when interest rates are lowered.

Demand and Supply

Cryptocurrencies, similar to tradable assets, such as stocks, commodities, and securities are influenced by the basic principle of demand and supply. As some cryptocurrencies are limited to a defined number (for instance Bitcoin is limited to twenty-one million tokens) scarcity plays a significant role in price fluctuation. Simply put, as demand for a cryptocurrency increases so will the price increase.

Utility

One of the main reasons for the success of many cryptocurrencies is that they solve real-world problems. Take AAVE as an example, AAVE is a protocol that acts as a de facto bank, taking deposits and lending out billions of dollars in tokens to clients within seconds, whilst having no employees on its payroll. Thus, the ability of the protocol to replace a function of a bank will have a huge influence over its investment case and therefore the value of the AAVE token.

Adoption

Similar to the demand and supply principle mentioned above, the adoption of a cryptocurrency will have a significant impact on its price. Take Walmart and PayPal’s announcement that they will be accepting Bitcoin as a means of exchange or El Salvador legislating that Bitcoin will be accepted as legal tender, these levels of adoption will have an enormous impact on the value of a cryptocurrency.

Market sentiment

As with all markets, cycles affect cryptocurrencies. Effectively, a bull market will favour investors and a bear market will erode value. Market sentiment can be measured using the Fear and Greed Index. Based on a measurement of investors’ sentiments towards the market, the Crypto Fear and Greed Index indicates whether the market is bullish (high) or bearish (low).

Notable event

Another factor that influences a is a specific event. For instance, media hype around the launch of a cryptocurrency may have a huge impact on trading volumes as speculative investors would want to avoid missing out on the potential of making multiples on their investment, thereby driving the price of the cryptocurrency up.

Other examples include the listing of a cryptocurrency on a major exchange, a regulator announcing an outcome of an enquiry into a cryptocurrency, the launching of a new update such as Ethereum launching a new feature such as proof-of-stake etc.

Albeit the above factors are out of the control of the investor market, investors do have control as to the type of cryptocurrency they invest in. The type of cryptocurrency may not necessarily protect investors against short term volatility, however, an investor looking for sustainable growth will need to invest in cryptocurrencies that are showing signs of global adoption and are on track to solving a real-world problem.

In conclusion, all markets are affected by external factors, but the key to sustainable growth in any financial endeavour is selecting an investment that has good fundamentals at its core.

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