Who decides the prices of cryptocurrencies?
Whenever we buy or sell something in any market, its price is bound by the limits of MRP, which stands for Maximum Retail Price. It implies that a particular commodity cannot be valued or sold for an amount of money greater than the Marked Price. Once the MRP of any commodity is set (decided by the manufacturer in most of the cases), it is revised in certain periods of time and the amount by which the MRP can be increased or decreased is bound by a set of various rules.
We all know that cryptocurrencies do not have any set Marked Price associated with them; but then, there has to be some authority or agency or person who decides or regulates the prices of all these cryptos.
If someone happens to be deciding the prices of cryptos, the person/ agency, certainly, is quite whimsical, changing the price ever so frequently, almost every 2 minutes or even less, and that too by any amount! But what if we tell you that there is neither any agency nor any person who sets the prices of cryptocurrencies and these prices are actually in a way decided by the traders themselves?
How does crypto pricing work?
Cryptocurrencies employ a Decentralised Control approach; it means that no single agency, authority or person has the complete autonomous control over the cryptocurrency and its value,number of units in circulation and its cap. This is opposed to currencies which are a legal tender(like INR or USD) and are issued by the government. By having the control of the cap, how much money is printed, etc. the Central Banks can regulate the value of the currency and thus gain greater control over the economy of the system.
This is the beauty of a decentralised financial setup, there is no apex body and the control of the entire setup is distributed, meaning, no one decides the price of cryptocurrencies and no one controls the number of units that are in circulation, only some cryptocurrencies have a fixed limit of the maximum number of coins that can be there. The price of cryptocurrencies is decided by a number of variables like:
- Supply and demand
- Cost of production
- Internal Governance
Supply and Demand
How the principle of Supply and Demand affects the price of cryptocurrencies is quite simple to comprehend.The demand of a crypto token may increase or decrease due to any reason like Government norms and regulations, introduction of any new upgrade (hard forks and soft forks), increase in popularity, mentions by any influential personality, availability over various exchanges and so on. Any positive press or occurrence induces a rise in the demand; conversely, any negative press or occurrence causes a decrease in the demand.
If the demand goes up, consequently the price of the token also increases because it has to be met with the number of tokens that are currently in supply and if the demand decreases, the price also decreases as a surplus of sort is created due to less demand.
Cost of Production
Mining is the process through which new cryptocurrency tokens are created and it usually requires extensive usage of computational resources. Using a computer to verify the next block on the blockchain by solving complex computational problems is known as Crypto Mining. In exchange of expending the computational resources to verify the block, the protocols generate a reward in the form of cryptocurrency tokens, plus any fees paid to the miners by the trading parties. As mining expenses rise, for the need of better equipment to verify the blocks faster, the value of the cryptocurrency must rise as well. Miners will not mine if the value of the currency they are mining is insufficient to cover their costs. And, because miners are required to make the blockchain work, the price will have to rise as long as there is a demand for it.
There are dozens of different cryptocurrencies, and new projects and tokens are launched on a frequent basis. New competitors face a low barrier to entry, but producing a valuable and sustainable cryptocurrency also necessitates the development of a network of cryptocurrency users. A good blockchain application can quickly develop a network, especially if it improves upon an existing application’s restriction or adds something to the current technology. If a new competitor develops traction, it depletes the value of the incumbent crypto, causing the incumbent’s price to fall while the new competitor token’s price rises.
By stating Internal Governance as a factor that influences the price of any crypto, it is meant
- how the developers or the creators of the cryptocurrency want for it to function
- which protocols do they want for it to follow for functioning on the blockchain, etc.
Such changes include hard forks or soft forks that induce burning crypto, changing the validations algorithms, introducing smart contracts and much more, which directly influence the price by affecting the mining costs or the supply.
How do traders play a role in deciding the price of cryptocurrencies?
Traders always keep an eye out for any information regarding the above discussed factors. By analysing the various trends, they choose to invest in any crypto currency or take their money out of the existing investments.
When we use the word “traders” we refer to every person who chooses to buy and sell cryptocurrencies over any exchange, irrespective of the amount of money they trade with. This, therefore, equates to a very large number of people!
Out of the above mentioned factors, two of the most important ones are Supply and Demand and Competition as these two factors are directly driven by the traders.
The demand increases when traders want to buy more of a particular cryptocurrency and thus the price increases due to the immediate supply being lesser than the immediate demand and more and more people wanting to buy that cryptocurrency at the price at which it is available. By placing limit orders, people quote the price at which they wish to sell/buy and the quoted price which corresponds to the highest volume, or in some cases, highest or lowest value becomes in a way the buying/selling price
This is also the reason why pump and dump schemes seem to work, as prices are majorly influenced by the sentiments of the traders towards the cryptocurrencies, which can be altered.
Spreads in price are also caused in a similar manner.
Spread in the price of any cryptocurrency is the difference between its buying and selling price at any given point of time. We know that both the buying and the selling prices of any cryptocurrency over an exchange or trading platform tend to budge towards the price at which the majority of the traders using that platform wish to buy or sell the cryptocurrency, this results in causing the spreads. As human tendency is, the buyers wish to buy at the lowest price possible at any given point of time and sell at the highest; hence they place their transaction orders likewise. The exchange tries to maintain the price of the cryptocurrencies listed on their platform, almost equivalent to that in the global market by employing market maker algorithms that operate as a liquidity provider by keeping some inventory on hand to meet temporary order imbalances and keep the markets stable. A market maker’s job is to assist in restricting the spreads by establishing a trading price range.
To conclude, it is quite evident that the traders involved and engaging with any cryptocurrency are the major influence in deciding the price, among all the factors that influence the price of any cryptocurrency.
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