A Beginner’s Guide to Understanding the Law of Supply and Demand in Cryptocurrencies

Beginner’s Guide / 16.03.2020

Cryptocurrencies are units of exchange, and they hold value because people decide that they do. While others like Bitcoin are not backed by any other type of currency or asset, stablecoins are backed by such currencies or assets, to stabilize them against the highly volatile nature of digital currency.

According to the law of demand, all other factors withstanding, highly-priced resources have less demand. In the same way, the law of supply states that the quantity supplied is directly proportional to the price. Therefore, this means that in the law of supply and demand, as much as people will avoid acquiring highly-priced goods that would make them give up something else of greater value, producers will generate higher revenue by selling more at a higher price.

Traditionally, the value and price of something go hand in hand, but it does not always guarantee that all highly-priced things are always valuable, and all low-priced things have less value. This introduces market speculation and predictions to supply and demand.

Since the bottom line of cryptocurrencies as units of exchange is trading, the price will go up when more people are looking to buy and others willing to sell. However, if more people are looking to sell cryptocurrencies and less are willing to buy, prices will go down.

Regional and global economic factors that affect fiat currencies also affect cryptocurrencies, and in most cases, the relationship is directly discernible. Such include inflation, disease outbreaks, political unrest, the discovery of natural resources, and sanctions. However, there are a few factors unique to cryptocurrencies, some of which are discussed in the following extract.

1. How volatility affects cryptocurrencies

Volatility is a measure of the extent to which a currency fluctuates over a specific amount of time. Some of the most volatile types of investments are cryptocurrencies, ForEX, stocks, and derivatives. On the other hand, investments like Cash, Savings accounts, gold, and bonds are types of stable investments.

Many people, especially in the traditional markets, consider the cryptocurrency market as highly unreliable and unstable due to its history and tendency of wildly fluctuating prices. It is common to see cryptocurrency prices going up with increased popularity, as more people try to get in as soon as possible before prices increase further, and they miss out on the chance to make greater profits in the future.

The crypto market is quite young, but it is growing fast, and despite much uncertainty and speculation, cryptocurrencies like Bitcoin have heard massive growth rates and crushes in a short period of time.

For example, cryptocurrencies experienced the biggest market collapse in 2018 for the first time, which saw the crypto market capitalization fall from a staggering $813 Billion to $100 Billion. The price of almost all coins fell by 90%, and most coins haven’t been able to recover their general prices like they were before the 2018 cryptocurrency crush.

2. Block reward halving

Cryptocurrencies are viewed and probably are hard to understand and to explain to the general population. The growing interest and advantages of cryptocurrency, together with the hype of quick profits, have attracted massive interest. This has opened up limited opportunities to people who can navigate the market, and as a result, many people have become wealthy from investing in them.

Most cryptocurrencies have a limited total supply, with a limited, defined divisible capacity, which guarantees that their ability to spread further depends on how high their price will be at the time. One of the ways to earn cryptocurrency is through mining. Block reward halving reduces the rewards that miners get by 50% to reduce the supply of coins and therefore increasing the price. Supply and demand, just before and after the halving event, tends to have an effect on the price of crypto.

3. Endorsement

Endorsements can have a positive effect on cryptocurrencies, especially when celebrities or experts in some disciplines say something about them, which might cause a hike in prices as more people start to invest in them.

However, endorsing can be used as a disguised advertisement of coins that have less value than indicated. Such instances mislead inexperienced investors, creating a temporary demand, and leaving them with coins with no immediate high returns as the endorsement claimed.

Endorsements can also happen indirectly in the form of a famous brand launching their own cryptocurrency, such as is the case with football clubs fans tokens and social media giant Facebook launching Libra. Such coins are anticipated by their huge customer base and will likely be in high demand and supply and feature a steady rise in their prices.

4. Pump and dump

Cryptocurrencies are elegant, inclusive, convenient, anonymous, cheap to transact with, and they represent limitless opportunities for individuals and the world economy. Each cryptocurrency is built on its own network and serves a particular purpose. They are also highly unregulated, which means that many loopholes open up the field for making quick money through schemes that are borderline manipulative and illegal.

Pumping and dumping is a scheme that often happens on cryptocurrency exchanges. It involves targeting and convincing unsuspecting investors to buy a certain asset to artificially inflate its price and later sell the asset after the price has risen high enough. It is prevalent and profitable and usually creates a demand for a certain coin until it is all sold at once and deflates. This is often done in the form of Initial Coin Offerings (ICOs). A report by Bloomberg showed that in 2019, close to 50000 pump and dump schemes on the Telegram messaging app.

Final Thoughts

In conclusion, It is clear that cryptocurrencies, as much they are revolutionary, are currently still bound to traditional market advantages and disadvantages. They are exciting, convenient, and profitable for both short and long term investment plans.

However, investors should be careful since not all supply and demand is genuine, and just as many people have lost their wealth to cryptocurrency scams as those who have made a fortune. As the technology that will usher in the fourth industrial revolution, it seems that according to the law of supply and demand, cryptocurrencies are in a for a revolutionary and interesting new decade.

Featured image courtesy of Shutterstock.

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Wayne is a Blockchain enthusiast and expert in crypto trading. Currently, he covers trendy issues on digital currencies.