Many investors don’t understand the concept of blockchain economics because they are used to perceiving a more traditional definition of economics and financial sectors. Despite the wide acceptance of cryptocurrencies in different areas, this concept of money still remains unclear to many. That’s why we decided to write this short guide and reveal some of the most complicated intricacies related to blockchain economics.
The Value of Cryptocurrencies
Probably, your interaction with the world of cryptocurrencies began when you heard your first news about Bitcoin breaking its price records. This has happened several times already and everyone could hear it from media all over the world. However, while being impressed with such extreme fluctuations, many people don’t actually understand how it happens and what actually determines Bitcoin’s value.
This is quite difficult to understand because any cryptocurrency seems to be just a virtual token with no actual financial reserves. Despite its virtual nature, similar to stocks, the value of cryptocurrencies is determined by the demand for them, although this demand differs from the one you could see in the stock market when it’s driven by the current performance and expected revenue.
Let’s take a closer look at some key factors that determine the demand for digital coins:
Supply
From that perspective, cryptocurrencies resemble commodities: the more difficult it gets to get an asset, the more valuable it might become. Cryptocurrency supply is generated through the mining of coins. However, not all blockchains make this supply limited, which makes their tokens not as rare as competitors. But when the supply is limited and users see how many tokens are left to be mined, they might perceive the value of crypto differently.
Utilization
Most cryptocurrencies are governance and utilization tokens that power their native blockchains. The richer the functionality of this blockchain is, the higher the demand for the token will be. This happens because blockchain networks are used by developers and businesses, and if they provide something unique and useful, the demand for their governance units will rise.
The utilization of cryptocurrencies also refers to their acceptance as payment methods by businesses. Digital coins are convenient to pay for goods and services online, and the more widely a certain coin can be used, the more users are likely to buy it.
Social media
Have you heard about Dogecoin? Probably, this is the best example of how a meme with a funny dog can become a real financial asset and get to the same level of use as many fiat currencies. Although this value determinant is extremely volatile, it still remains relevant to blockchain economics where the acceptance, utilization, and relevance of certain assets heavily depend on the social media hype.
Trustworthiness
Cryptocurrencies are virtual tokens powered by blockchain networks. If a blockchain network doesn’t seem to be reliable and efficient, nobody will invest in its token. That’s why cryptocurrency investors pay specific attention to studying security measures and the potential pitfalls of popular protocols.
Regulation of Blockchain Economics
Although digital coins are called cryptocurrencies, you shouldn’t think that they function as actual currencies. Real or fiat currencies, such as the U.S. dollar, euro, Great Britain pound, and others are issued by governmental bodies that regulate their supply and determine key things in the monetary policy.
The lack of regulation in blockchain economics is one of the reasons why cryptocurrencies are so volatile. Many governments still don’t have any rules on how digital assets can be used within their countries. This makes many citizens concerned about the legitimacy of such assets. On the other hand, when regulatory bodies and governments try to impose limitations like China did, the demand for cryptocurrencies may fall causing extreme value fluctuations and increasing anxiety of coin holders.
The Relation Between Blockchain Economics and Traditional Economics
The occurrence of the crypto winter serves as a prime example of how anticipated economic downturns can impact what was once deemed a purely virtual realm. This winter unfolded concurrently with discussions surrounding a potential recession, resulting in a bearish trend that devalued the entire cryptocurrency market from $3 trillion to $993 billion.
The question arises: Why did this devaluation occur, given that most cryptocurrencies lack backing by tangible assets susceptible to economic downturns? The primary factors contributing to this phenomenon are investor anxiety and uncertainty. As discussions surrounding an economic downturn gained traction, a significant number of investors sought out safe havens. Unfortunately, cryptocurrency failed to establish itself as a reliable safe haven, prompting many holders to sell their digital assets and shift towards more dependable options capable of mitigating risks such as inflation and increasing interest rates.
The vulnerability of cryptocurrency to economic changes highlights the interconnectedness of this digital asset class with the broader financial landscape. It underscores the importance of understanding the influence of economic sentiment on the valuation and market dynamics of cryptocurrencies. As investors seek stability and reliable hedges against economic risks, the future of cryptocurrencies in relation to economic fluctuations remains a subject of ongoing exploration and scrutiny.
