How is the value of a cryptocurrency determined?

How is the value of a cryptocurrency determined?

How does it work?

Bitcoin is born and lives on the blockchain (chain of blocks). And what is the blockchain? It isn’t easy to offer a simple explanation, so let’s take an example. Imagine that the Internet is a schoolyard. There, the children exchange stamps, food, or toys, but all transactions are carried out under the control of the teacher, who keeps a commission. One day, the children decide to ‘decentralize’ their exchanges and create a common and transparent account book. This book is made up of identical blocks or nodes, where the information of the exchanges is automatically updated, and each child has access to one of them. They cannot be manipulated or falsified, and there is no longer a need for a central authority.

Simplifying, the blockchain is a public, transparent, secure database in the hands of all users who want to use it to exchange information, goods, or services. “This is what makes it so secure because the only way for these types of operations to be credited is for all of us to have the same copies,”

Virtual currencies have flourished thanks to this blockchain system, and bitcoin is the highest value and the one with the highest adoption. It is the first use case for blockchain technology globally, and it is “super secure, there has never been a case of duplication of operations on the blockchain,”

How much is a bitcoin worth?

One of the main debates is whether bitcoin has the characteristics of traditional money and whether it can be a legal tender such as the dollar, the euro, or the peso. The detractors say no because its price varies a lot: one day it can go up 30%, but the next it can fall 20%. In April, the cryptocurrency reached a record high of $ 63,410.3 per bitcoin (approximately 1.3 million pesos), and by that time, its price had risen 800% in 12 months. Since then, the price has dropped 50%, to about $ 33,000.

Despite the doubts, bitcoin increasingly has more uses for the sale of products and services, encouraging greater adoption. This makes its value go up. But for something to be money, it must accomplish three things, explains Javier Molina, analyst, and spokesperson for eToro:

  • That it be a store of value.
  • That it be a unit of measurement.
  • That it be a medium of exchange.

At the moment, it only meets the last one, but the high variation in its price makes it difficult for it to become a stable and reliable currency in the short term.

In the long term, the situation can change. In 2020, for the first time, there were cases of the real use of bitcoin by companies: Tesla, in addition to investing in the currency, announced that its cars would be able to be bought with bitcoins. Mastercard and Pay Pal also indicated that they would allow buying and paying in this cryptocurrency on their platforms.

“Suddenly, the whole traditional market moved towards the crypto market, and big companies and people said: ‘You have to move here.’ If you look at it, now there are fewer and fewer people selling their bitcoins. The supply is shrinking, and that’s why the price is going up,” .

Another of the differences of bitcoin with other currencies that work as a currency, such as a dollar, is that the offer is limited, says Molina. The limit of bitcoins is 21 million, which will protect its value in the future and limit the variation in its price since this, with the supply capped, will depend solely on demand.

What are cryptocurrencies?

A cryptocurrency is a digital asset that uses cryptographic encryption to guarantee its own and ensure the integrity of transactions and control the creation of additional units, that is, prevent someone from making copies as we would, for example, with a photo. These coins do not exist in physical form: they are stored in a digital wallet.

How do cryptocurrencies work?

Cryptocurrencies have several differentiating characteristics concerning traditional systems: they are not regulated or controlled by any institution and do not require intermediaries in transactions. A decentralized database, blockchain, or shared accounting record is used to control these transactions.

In line with regulation, cryptocurrencies are not considered a means of payment. They do not have the backing of a central bank or other public authorities and are not covered by customer protection mechanisms such as the Deposit Guarantee Fund or the Investor Guarantee Fund.

Regarding the operation of these digital currencies, it is very important to remember that once the transaction with cryptocurrencies is carried out, that is, when the digital asset is bought or sold, it is not possible to cancel the operation because the blockchain is a record that does not allow deleting data. To “reverse” a transaction, it is necessary to execute the opposite.

Since these coins are not physically available, you have to resort to a cryptocurrency digital wallet service, which is not regulated to store them.

How many types of digital wallets are there?

A digital purse or wallet is a software or application that can store, send, and receive cryptocurrencies. The truth is that, unlike a physical money purse, what is stored in wallets or digital purses are the keys that give us ownership and right over cryptocurrencies and allow us to operate with them. In other words, it is enough to know the keys to transfer the cryptocurrencies, and the loss or theft of the keys can mean the loss of the cryptocurrencies without the possibility of recovering them.

There are two types of purses: there are hot and cold ones. The difference is that the former is connected to the Internet, and the latter is not. Thus, we find web wallets, mobile wallets, and desktop wallets within the hot wallets, the latter only if the computer is connected to the Internet. On the contrary, there are hardware wallets and paper wallets within cold wallets, which is simply the printing of the private key on paper.

These custodial services are neither regulated nor supervised.

How is the value of a cryptocurrency determined?

The value of cryptocurrencies varies depending on supply, demand, and user engagement. This value is formed without effective mechanisms that prevent its manipulation, such as those present in regulated securities markets. In many cases, prices are also formed without public information to support them. We recommend that you read this statement from the Bank of Spain and the National Securities Market Commission (CNMV) about the risks of buying cryptocurrencies.

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