You’re probably wondering if more people are using cryptocurrency for transactions, should it not help stabilize the price? The answer is yes if you’re talking about what’s called velocity, which measures how fast money changes hands. However, we need to think about the difference between small-scale velocity and large-scale velocity.
When you pay for a hot dog with bitcoin at a street vendor in Mexico City, that’s an example of small-scale velocity—it doesn’t affect the whole market. On the other hand, when you buy $100 million worth of BTC, that impacts the entire market because it affects supply and demand.
Even as cryptocurrency markets become more widely used for everyday transactions (small-scale velocity), it’s still not being used enough for them to impact prices.
Investing is Getting Riskier
People are very interested in this new technology, but it is changing so fast that it makes investing in the currency riskier. Bitcoin is the most well-known and widely used cryptocurrency. However, there are many different cryptocurrencies. Each one has a different approach, and some have huge differences from Bitcoin.
The blockchain technology that underlies all of them has made great strides during its short existence, making it even harder for people to predict what’s next for cryptocurrencies or if they should invest at all. Cryptocurrency prices are unstable because the technologies involved have improved so much over such a short period.
Another reason investors aren’t sure how to value cryptocurrency is that not all cryptocurrencies are alike. For example, Bitcoin has a fixed supply (there will only be 21 million Bitcoins). Other cryptocurrency supplies vary dynamically based on user interest and market conditions. That makes valuing them difficult because their worth isn’t tied to an underlying asset like other currencies are tied to gold. It’s tied to user adoption, which is hard to quantify as an investor.
No Way to Predict
It’s important to understand that the price of cryptocurrencies is not set in stone. The cryptocurrency value, like any other investment asset, is based on supply and demand. If a cryptocurrency has a high demand and a low supply, its value will increase. Additionally, if more people want to buy it than sell it, its price will increase.
All of this is to say that there are no guarantees when it comes to predicting the future cryptocurrency value — which means there’s no way of knowing whether you’re making a good or bad investment by purchasing it.
There are tools out there that claim they can predict what’s going to happen with the market in the future (these are often referred to as prediction markets). However, these tools have not always been very accurate at forecasting outcomes for anything other than short-term events.
Lots of New Investors
Cryptocurrency values are increasing because more people are buying them. When demand increases, so too do the price.
That creates a self-fulfilling prophecy: as more people buy Bitcoin and other cryptocurrencies because they expect the price to increase, they drive up the price. When this happens, more people buy it because they believe it will keep rising in value-driving up the price even further. It’s easy to see why investors keep coming back for more: if you had bought $100 of Bitcoin in 2010, you would now have around $73 million.
Turning to Cryptocurrency as an Alternative
You have some money, and you have to decide what to do with it. There’s the stock market and real estate, but those are all about buying low and selling high, so you need to be lucky and can lose a lot if you’re not. You could put your money in a savings account or a CD at a bank.
Well, you know how banks work. They loan out your money to people who want to buy stuff right now but don’t have enough cash saved up yet. That way they can get what they want today while the bank makes money off of your savings because they’re charging interest on loans.
It’s a win-win, except that when many people suddenly want their money back from the bank—when times are tough, and other options look better than holding onto cash—then there might not be enough cash in the vault for everyone to get their money out when needed. That’s why we have government-backed FDIC insurance for our deposits. So, we won’t lose everything if there’s ever a run on our banks.
However, what happens when even FDIC insurance isn’t enough? What if more than 5% of Americans lose confidence in the banking system? Well, then maybe that 5% will turn elsewhere for their financial needs—may be a cryptocurrency?
Lots of People are Investing
It is important to note that cryptocurrency is a risky investment. Many experts believe in its potential, but this volatile market is hard to predict and lots of people are investing right now. If you’re one of them, it’s helpful to understand the reasons for price fluctuations. These factors are a mix of things that may or may not be entirely within your control.
You don’t need to be an expert investor to make good decisions. Do your research before you invest and keep track of changes in the market so you don’t get caught off guard by sudden dips or surges.
There are benefits and drawbacks to cryptocurrency investing, but there are many who feel that the pros outweigh the cons and that in time, we will regard paper currency as nothing more than a quaint relic of another age.