What influences the exchange rate of cryptocurrencies?

A common feature of all cryptocurrencies is that they are prone to huge fluctuations in their exchange rate over short periods of time. However, despite this fact, the exchange rate of giants such as Bitcoin and Ethereum is continuously rising - despite short-term corrections, during which many analysts and crypto-skeptics herald the end of cryptocurrencies. In this article you will learn what the cryptocurrency exchange rate depends on and what factors should be taken into account when analysing it?

What influences the exchange rate of cryptocurrencies?

The value and exchange rate of cryptocurrencies often changes at a very fast pace, so as the fastest Bitcoin exchange we suggest what to look out for and what affects the exchange rate of Bitcoin and other cryptocurrencies.

What does the price of Bitcoin and other cryptocurrencies depend on?

Law of supply and demand

The valuation of cryptocurrencies is based on basic market mechanisms. One of them is the law of supply and demand. The higher the demand and the lower the supply for a given cryptocurrency, the higher its price will be. If the situation is reversed - that is, demand is low and supply is high, the value of a given cryptocurrency will decrease.

Unlike traditional currencies and many securities, the supply of most cryptocurrencies is strictly limited - for Bitcoin it has been set at a total issuance of 21,000,000 BTC and for Litecoin 84,000,000 LTC. However, there are projects in the cryptocurrency market that do not have a predetermined supply, these include DOGE and Ethereum.

The lack of a supply cap also avoids deflationary pressures, with gentle inflation taking its place. By 2140, the approximate date when all BTC will be mined, there will be gentle inflation in the Bitcoin network, which will diminish with each halving (i.e. re-fishing of the block reward).

Other supply-side systems are premined cryptocurrencies, which have been mined before the network goes public and are then put on the network as designed. There is also a scorched-earth system, which involves burning off parts of existing cryptocurrencies, which has the effect of reducing supply and directly pushing up prices.

Cost of mining cryptocurrencies

Cryptocurrencies are mined using devices called miners. These are both specialised, dedicated chips - ASICs - with which cryptocurrencies such as Bitcoin are mined, but there are also less advanced miners that have components reminiscent of personal computers - processor, graphics card and so on...

The cost of mining is a combination of many variables. We take into account the cost of mining equipment, the cost of electricity, but also the difficulty of mining a cryptocurrency, which is automatically regulated by the network. The more equipment there is on a given cryptocurrency's network, the more the difficulty of mining increases, which has a huge impact on virtual currency rates.

Legislation and regulations

The price of Bitcoin and the quotations of other cryptocurrencies are largely driven by regulations or requirements present within a country. National authorities and financial regulators of many countries have a keen interest in cryptocurrencies, which has a gigantic impact on their price.

If the regulations introduced are restrictive or somewhat repressive in nature, they can result in a significant fall in the exchange rate. In 2021, when the Chinese authorities tightened their attitude towards Bitcoin and the cryptocurrency market, the exchange rate of the virtual currency skyrocketed, the power of the network also fell, which only returned after a few months, probably due to the migration of cryptocurrency miners.

Similarly, friendly legislation, could have a positive impact on the cryptocurrency exchange rate - as more and more reports emerge about El Salvador's positive attitude towards cryptocurrencies, as well as increasing talk of Bitcoin's adaptation as an official means of payment in many South American countries.

The influence of classical media and social media

The power of media has had a powerful impact on the cryptocurrency market, but today traditional media, often referred to as the fourth pillar of power, no longer has the colossal leverage that social media does. In theory, traditional media acted as a turnstile to drive the sentiment of potential investors.

Today, sentiment is also largely created by traditional media icons such as the Times and The Economist, but they don't have the same clout as the usual... Tweet.

Elon Musk, known to the online community as the cheerful creator of Tesla, SpaceX and The Boring Company, has proved to have a colossal impact on the price of virtual currencies. A series of his tweets and his decision to use Bitcoin as a means of payment at Tesla saw the listing skyrocket.

The Dogecoin market reacted similarly when Elon tweeted warm words about the cryptocurrency.

Information conveyed through traditional media and social media are the only of the stronger factors regulating the price of cryptocurrencies.

Financial crises

Cryptocurrencies have been strongly linked to financial crises since their inception. It is worth mentioning that Bitcoin was created as a response to the crisis of 2007 - 2009, which was followed by a decline in confidence in banking and financial institutions.

If the traditional financial system collapses or its condition indicates the occurrence of dangerous phenomena such as rampant inflation or zero interest rates, people flee to other assets. Before the era of cryptocurrencies, real estate and precious metals were the most common escape targets, but nowadays more and more people are opting for the most modern form of capital security, namely digital currencies, with planned supply, inflation and clearly defined goals.

A huge advantage of cryptocurrencies over traditional finance is decentralisation, which in practice means putting the principle - everyone is their own bank - into practice. Transactions in cryptocurrencies are irreversible, and there is no authority that can stop or undo the transfer of funds in blockchain.

Poor network security and attacks

Young projects face huge threats from poor security and low computing power available on the network. In 2021, we have repeatedly seen attacks on Satoshi Vision's Bitcoin (BSV) network, which has much lower computing power than larger projects have.

Design similarities to the original Bitcoin and low computing power have made BSV vulnerable to 51% attacks, a concentration of 51% of the computing power of the network in the hands of one person. When launching an attack, transactions can be halted, cutting off other miners, but also spending the same funds multiple times.

The remedy for the 51% vulnerability seems to be a different consensus than PoW. The most commonly chosen successor is PoS (proof-of-stake), in which taking over the network would involve taking over half the resource of all tokens involved in validating transactions, which is in practice and theory impossible.

Security vulnerabilities are also a colossal problem. In 2021 we could witness an attack and theft of a record $600 million on PolyNetwork. The story ended happily and the funds were returned, but the situation illustrates how difficult it is to properly secure cryptocurrency networks against attacks.

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