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The reasons for the rise or fall in the price of “traditional” assets do not raise questions. International or local financial crisis, political or environmental difficulties - all these factors directly affect the price of currencies, gold or natural resources. However, how to understand similar processes in relation to cryptocurrencies? Although digital assets have long been part of our everyday reality, many people rightly wonder - what is the security of bitcoin or any other crypto coin? This skepticism is largely justified, because the very nature and working principle of cryptocurrency is vastly different from what we are used to.
Theoretically, the greater the demand relative to supply, the higher the price, and vice versa. In other words, if more people want to buy cryptocurrencies than want to sell them, the price should theoretically go up. Conversely, if more people want to sell than want to buy, the price should theoretically fall. But what are the reasons why some people buy or sell cryptocurrencies? In general terms, we can describe them as being related to fundamentals, macroeconomics, sentiment and technical factors. These elements are not mutually exclusive and there is a link between them. In cryptocurrencies, supply is also often associated with the delivery mechanism of a particular token (tokenomics).
Some tokens are designed for fixed supply, such as bitcoin, while others are designed for non-fixed supply, such as ethereum. Some market participants believe that fixed supply tokens are subject to less selling pressure, and vice versa. Similarly, the upcoming release of an offering to large holders of total tokens (e.g., protocol founders, early investors) is sometimes seen as unfavorable to the price, as the market can expect sales pressure if these holders decide to sell their large holdings. The bitcoin price can also be affected by so-called halving and token burning. Halving is the regular halving of all existing bitcoins, while token burning is the process of permanently reducing the number of coins by removing them from circulation. Many observers believe that bitcoin halving events provide support for prices - since bitcoin's last halving in 2020, its price has risen significantly.
In stocks, fundamentals generally refer to factors that ultimately affect a company's earnings, growth and financial health (e.g. product or service sales volumes, profit margins and the amount of debt on the balance sheet). In cryptocurrencies, there are also some factors beyond traditional financial metrics that can indicate the “health” and growth rate of a protocol, although many protocols are sometimes criticized for not being profitable and lacking fundamentals in the traditional sense. The health and growth of a protocol can be measured by the increase in the number of network addresses, the number of nodes, developer activity, the number of decentralized applications (dapps) existing or being developed on the network, scalability and decentralization, network security, and the number of potential real-world use cases for the protocol.
Regarding blockchain scalability, which is the most important fundamental aspect, there are three interdependent concepts: security, speed and decentralization. Security: this refers to the level of protection against attacks from external sources and the resilience of the system to hacking. Generally, lower barriers to entry mean more decentralization but less security (because collusion can be easier).
For example, the hashrate of the Bitcoin blockchain can be seen as an indicator of its security. Protocols that are easily and/or constantly hacked or exploited can be considered to have a weaker foundation, and vice versa. Speed: the speed of transactions on a network is commonly used to assess scalability; the main factors are throughput (e.g. transactions per second, also known as TPS) and block confirmation time. Decentralization: this is the degree of diversification of ownership, influence and value in a blockchain. For example, in the case of a proof-of-stake (PoS) blockchain, the number of share pools or validators can be used to assess decentralization.
Macro factors are factors that affect the economy as a whole. Since cryptocurrencies do not exist in a vacuum, these factors also affect the price. For example, during an economic downturn, people may be less inclined to make investments or spend money (including on cryptocurrencies). This is because they may sell the investments they already have. This will also affect the prices of cryptocurrencies. On the other hand, when economic growth is high and investors' appetite for risk is high, asset classes such as stocks and cryptocurrencies tend to be favored, leading to increased buying.
Players in the cryptocurrency market are aware of the constant talk about interest rates and inflation. These are good examples of macroeconomic factors that can affect cryptocurrency prices. Central banks are fighting high inflation by raising interest rates, but they are concerned that raising them too sharply could lead to a recession in the economy.
Sentiment refers to factors that influence people's willingness to buy or sell a particular token, primarily based on their emotions rather than the fundamentals of the protocol. A particularly common example in the cryptocurrency sphere is the news and social media craze. People who see social media creating a stir around a particular token (e.g., their favorite celebrity or influencer buying the token) may feel fear of missing the moment and want to buy it. This increase in demand can lead to a higher price. For example, Elon Musk's tweets about Dogecoin sometimes cause the price of the token to react positively at the time of the tweet. On the other hand, some people may see many negative comments about the token and want to sell it, causing the price to fall. Emotion-based decision making belongs to a field of research called behavioral finance, which argues that people often make irrational decisions due to cognitive biases.
Other external factors can also influence the supply and demand of cryptocurrencies. For example, many traders use trading signals that tell them when to buy and/or sell. Since there are many popular signals, if everyone buys or sells at the same time using the exact same signal, the result can be a sudden burst of buying or selling. In the history of traditional finance, some stock market price declines were exacerbated when quantitative funds (which used automated trading strategies based on the same trading signals) sold everything at the same time because of the automated nature of their operations. This contributed to the selling pressure.
Of course, the opposite can also happen, meaning everyone is buying on the same signal, which adds to the buying pressure.
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