Cryptocurrency is a word we frequently hear today. It is often the case that you must have come across terms like “cryptocurrency,” “Bitcoin,” “Ethereum,” and many others like this. There are innumerable posts about cryptocurrency on social media. Also, news outlets are filled with reports about the cryptocurrency market. Everybody is talking about it. But what is it?
In this article, we will try to understand cryptocurrency. We will also talk about how and why the prices of cryptocurrencies fluctuate.
What is cryptocurrency?
Cryptocurrency, as the name suggests, is a currency that is encrypted. In simple terms, it is a currency that exists virtually or digitally. And it uses cryptography for highly secured transactions. Unlike regular currencies like dollars and rupees, which are regulated by the Federal Reserve of the USA and the Reserve Bank of India, respectively, cryptocurrency is decentralised.
Cryptocurrency doesn’t require a bank to issue and verify transactions. Instead, it can be done between two parties from anywhere in the world with the help of blockchain and the internet. One difference between fiat (traditional) currency and cryptocurrency is that the latter’s value fluctuates a lot more than traditional currency.
Why does the cryptocurrency price fluctuate?
There is no regulatory authority to stop prices from fluctuating in the cryptocurrency markets. Hence, they are highly speculative. Cryptocurrencies, therefore, trade at a more uncertain rate than stocks.
This fluctuation, however, could be a good thing for many. You could make a decent amount of money if you buy and sell them at the correct time.
For example, if you had bought $20 worth of bitcoin in 2011 and held them until 2021, you would have made $60,000. The inverse of this, however, is also true, and you must be very vigilant when trading in cryptocurrencies.
The following factors are the primary causes of cryptocurrency price fluctuations in the market.
Hype and speculation
The biggest factor that contributes to the fluctuation of cryptocurrency is hype and speculation. When a new cryptocurrency is launched, it experiences a lot of interest as people hear about it for the first time. This drives up the price of the cryptocurrency. As more and more people buy the new cryptocurrency, it shoots up the price of that cryptocurrency to an unsustainable level.
Once people realise that the price of the cryptocurrency has been overvalued, they start selling it. And that results in a steep drop in its price. Seeing this, others also start selling it too. And this causes that particular currency to crash. This is all quite common for a cryptocurrency. Bitcoin, for example, was free at the beginning and has gone to a high of $65,000 in November 2021.
Celebrity endorsements are another major driver of cryptocurrency prices.It is often the case that a new cryptocurrency hires a celebrity or influencer to promote its coin. Backed by these celebrities, the new cryptocurrency imparts a sense of security to its investors. That results in the price of the coin going up.
However, soon people will realise that the celebrity endorsing the cryptocurrency was paid for the endorsement. They get to know that the celebrity doesn’t believe in the credibility of the coin. It is then that the currency crashes. The biggest example was Elon Musk’s endorsement of Dogecoin.
In March 2021, the Tesla and SpaceX-owning billionaires started endorsing Dogecoin. That resulted in its price going from 0.055 to 0.64. It was an increase of more than 100 times. Dogecoin, however, took a nosedive after Musk and his mother Maye appeared on the US comedy show Saturday Night Live and joked about Dogecoin. The unconventional businessmen’s mother, doing a segment on the show, said, “I’m excited about my Mother’s Day gift. “I just hope it’s not dogecoin!”
As soon as people heard the joke, the price of Dogecoin fell from 0.64 to 0.20 in a month.
Supply and demand
The price of a cryptocurrency also depends on the supply and demand of that currency. For example, when more people want to buy a specific cryptocurrency, the value of that coin increases. Since more people want to buy that coin than there are people available to sell it, the value of that coin shoots up.
After a significant price rise, many holders see it as an incentive to sell and gain a massive profit. This is when many start selling their share of the cryptocurrency, and soon the number of sellers outnumbers the number of people willing to buy. Naturally, the price of the coin drops massively.
Crypto Whales is a term used for large holders of a specific cryptocurrency. These “whales” hold a large number of coins. As a result of the huge quantity, they have significant power to move the market in their favour.
For example, if a person holds 25% of the entire cryptocurrency, he could make the prices drop massively by selling all of his stock at once. This huge price drop will further encourage others to sell cryptocurrency. This chain of events will further crash it.
Similarly, a whale buying a large quantity of cryptocurrency will make the price of that specific currency go up significantly. And that will make other individual buyers start buying. This, in turn, will raise the price.
It is evident from the past decade that cryptocurrency is very volatile. One moment it’s going down, and the next it could start rising based on the above-mentioned factors. This is why you should do proper research before investing in a cryptocurrency. You must also keep an eye on the developments around that specific cryptocurrency, which could make its price go up or down.
Not just that, but you must also diversify your investments in cryptocurrency so that you are safe when a specific cryptocurrency crashes. Other than that, you must also be prepared for cryptocurrency volatility and expect the market to go up or down. You should only invest the money that you can afford to lose, never the entirety of your savings. You can get more ideas about cryptocurrency on the website of Piramal Finance.