How Does Cryptocurrency Gain Value?
Some coins increase in value, some stay the same, and others decrease in value. But what makes the difference?
Since the crypto market started in 2008, the combined market cap for all cryptocurrencies has grown from near zero to over $1.6 trillion. And because of this huge gain, lots of people now want to get in on the action.
At the same time, there are a lot of crypto investment pitfalls to avoid, and you’ll need to understand that some cryptocurrencies have turned out to be worthless. For example, BoringCoin (ZZZ) was released in 2014 and attracted some interest on crypto forums like bitcointalk.org.1But it is now listed as a “dead coin” on Coinopsy.com, and practically no one mines it anymore.2
So, you may wonder, how can you know whether a coin will shoot to the moon like Bitcoin or flounder forever like BoringCoin? How exactly does a cryptocurrency gain value?
In this article, I’ll attempt to answer that question. We’ll cover factors like use demand, investment demand, inflation, mining costs, and other elements that affect a coin’s perceived value over time. I’ll go over all of the most important causes for a coin to rise in price.
But before we discuss these factors, we need to consider an important distinction between two different types of coins: proof of stake and proof of work.
Pro Tip: Before you start investing, you’ll want to make sure you’re doing so legally. Brush up with our state-by-state guide to the crypto industry.
Proof of Stake vs. Proof of Work
Most cryptocurrencies fall into two broad categories: proof of stake (PoS) and proof of work (PoW).
If you put up cryptocurrency as a bond to insure the work of a validator, this is called “staking” the cryptocurrency. You earn more cryptocurrency over time if you do this, similarly to the way you earn more cash over time by putting it into a savings account. A coin that can be staked like this is called a PoS cryptocurrency.
Some examples of PoS cryptocurrencies include Avalanche (AVAX), Fantom (FTM), Harmony (ONE), Solana (SOL), and Cardano (ADA). Most newer cryptocurrencies are PoS.
However, the two largest cryptocurrencies by market cap, Bitcoin and Ethereum, are PoW coins. This means they are created by burning electricity, a process called mining. You cannot stake PoW cryptos to earn more crypto.
Did You Know: If you’re looking to purchase crypto, you’re likely going to do so on an exchange. That said, not all of them are created equal. Read more on that in our guide to determining if an exchange is legit.
Depending on which category a crypto falls into, there are different factors that cause it to rise in price. So I’ll discuss each of them separately.
The next section is about PoS cryptos.
How Does a PoS Coin Gain Value?
So what causes a PoS coin to go up in price? Over the long run, a PoS coin gains value if the demand grows faster than coin supply.
Let’s break this down a bit.
In order for a PoS coin to go up in value, the amount of money spent on the coin has to increase. But there are two different kinds of demand for PoS coins: demand from users and demand from investors.
Demand from users
Some people want a coin because they want to use its network. They want to play blockchain video games, trade tokens, invest in DeFi apps, or use the network in some other way.
But each time a user submits a transaction, they have to pay a gas fee, and most of the crypto used to pay this fee is destroyed in the process of paying it.
What is gas fee?: A gas fee is a fee that users have to pay each time they do a blockchain transaction. The more complex the transaction is and the more congested the network is, the greater the gas fee. On PoS networks, most of the gas fee is destroyed or consumed in the process of paying it.
So this is one force pushing up the price of a PoS coin. If the number of transactions on the network is increasing, this demand from users will tend to push up the price of the coin.
Demand from investors
Not everybody wants to actually use their crypto. Some people buy cryptocurrencies as an investment because they want to earn even more crypto.
On a PoS network, you can delegate your coins to a validator to be staked. Validators are required to hold a certain amount of coins as a bond to ensure that they won’t process fraudulent transactions. So if you delegate your coins to a validator, this helps to prove that it is trustworthy (you shouldn’t delegate your coins to a node that you don’t know and trust).
When you delegate your coins to a node, the node will pay you a rate of return based on the amount of coins you delegated. The more coins you delegate, the more coins you earn over time.
FYI: Crypto investors are constantly looking for opportunities to earn a high yield on PoS networks. And as more investors buy these coins and stake them, this creates additional demand for the coins. This demand from investors is another force pushing up the price of PoS coins.
On a PoS network, validators get paid out of newly minted coins. In other words, their rewards are a form of inflation. If this inflation is too high, it may cause the price of the coin to decline. This is especially true if the validators sell most or all of their rewards each year.
For example, let’s say that a coin pays 8 percent per year to validators, but demand is rising by 10 percent per year. In this case, the coin may go up in price even if all of the validators sell their rewards.
But if validators are getting paid 50 percent per year instead (and demand is still only rising by 10 percent), the coin may be in danger of a price decline from validators selling their staking rewards.
So coin supply is a factor that may cause a PoS coin to fall in price over time.
FYI: There are a lot of U.S. crypto regulations you’ll need to familiarize yourself with to make sure you’re staying above-board while trading.
Factors that may lead to a rise in price
So for a PoS coin to go up in price over time, demand for it needs to increase faster than supply. Here are some factors that may cause this to happen:
- The network has fun and useful apps.
- Developers are working on new apps that users are excited about.
- The coin has gotten new exchange listings, making it easier for users to buy it.
- The exchanges on the network are gaining greater liquidity.
- The media is talking about the network a lot, raising awareness about it.
- The network has a low inflation rate.
These are the things that can cause a PoS coin to gain value. Now let’s move on to PoW coins.
How Does a PoW Coin Gain Value?
So what causes a PoW coin to go up in price? Over the long run, a PoW coin gains value if the cost of producing it increases. This happens if the number of computers mining it increases or the mining reward decreases.
Usually, the number of miners will only increase if the amount of money spent on the coin by speculators increases, so you can also consider speculative demand to be a factor in increasing a PoW coin’s price.
FYI: If you’re confused, you’re not the only one. What causes PoW coins to increase or decrease in price is one of the most puzzling and controversial subjects in the crypto community. If you want a more detailed, academic answer to this question, be sure to check out Adam Hayes’ landmark paper on the subject.3
Otherwise, here is the TL;DR version of the answer: PoW coins increase in price when speculators spend money on the coin at a faster rate than its mining reward rate.
Here are a few factors that may cause speculators to buy a PoW coin faster than its reward rate:
- The coin has a fun logo or meme associated with it.
- The media is paying a lot of attention to the coin.
- It was one of the first cryptocurrencies and is becoming valued as a piece of history.
- The number of merchants accepting the coin as a payment method is growing.
- It is being listed on more exchanges.
These factors can cause a PoW coin to gain in value.
The cryptocurrency market has grown tremendously over the past 14 years, from near zero to trillions of dollars in combined market cap. But while some cryptos have gained in value, others have failed to gain any traction at all.
How can you tell the difference between a great coin and a coin that is destined to stay the same price or even go lower? Great coins typically are very useful, can produce a high income, or have a passionate community behind them, or all three of these things. If you think you’ve got a winner, head over to our deep dive on how to buy crypto coins safely.
And if you want to buy a coin that will rise in value, you may want to stay away from BoringCoin (ZZZ).
Looking to learn more about the exciting world of crypto investing? Our Everything You Need to Know about Cryptocurrency article will give you all the information you need.