Most investors have different reasons why stock prices fluctuate as they do. You’ll hear about the influence on stock prices like credit markets, interest rates, inflation, earnings or the employment rate.
While these factors do impact buyers and sellers, in reality, they have minimal direct impact on prices. These factors mainly change the supply and demand of stocks.
Like the stock market, crypto prices are also affected by supply and demand. Other factors such as news highlights, a project’s use case, the technology behind it and the team behind it primarily affect the desirability of owning a cryptocurrency. The supply and demand of a cryptocurrency project is what determines its price.
This article will take a step back to economics 101 and look at the basics of the law of supply and demand and how it affects the crypto market.
What is the law of supply and demand?
According to Investopedia, the law of supply and demand explains the interaction between sellers of a resource and buyers of that resource. In the simplest terms, it states that when an asset is scarce but many people want it, the price of that asset will rise. Conversely, if there is a larger supply of an asset than the consumer demand warrants, the price will fall.
The supply and demand rate often fluctuate until the market finds price equilibrium or a relative price at which the asset can be valued.
Cryptocurrency supply and demand
In the cryptocurrency sector, supply and demand work differently since some crypto assets such as bitcoin have a fixed supply (of 21 million) while others like solana have an unlimited supply. Some other cryptocurrencies like ethereum have a burning mechanism that reduces the amount of circulating tokens and prevents the supply of the token from growing too large.
The monetary policies are also different in each cryptocurrency. For instance, bitcoin’s supply increases by a fixed rate with each new block mined or generated on the Bitcoin blockchain through proof-of-work. At the time of writing, bitcoin miners are rewarded 6.25 bitcoin every 10 minutes for each successfully mined block. This way, the supply of bitcoin is slowly increasing while the demand also increases. However, the supply is limited to balance the demand and bitcoin’s price.
Other cryptocurrencies like Cordano implement a proof-of-stake (PoS) mechanism. Through PoS, token holders are rewarded for successfully validating blocks. Block validators are rewarded according to the amount of Cordano tokens (ADA) they own. Therefore, the amount of circulating ADA tokens is increasing at a certain rate. ADA tokens also have a fixed supply of 45 billion coins. Like bitcoin, this ensures token are supplied in the ecosystem in a way that balances the token demand and token price.
Ethereum is also another project that plans to use PoS. However, unlike Cordano it deploys a burning mechanism to reduce the number of circulating tokens. This ensures the token supply does not surpass the demand. Other projects that implement burning include Terra, Shiba Inu, and Binance smart chain, to mention a few.
On the other hand, other cryptocurrency supplies are dictated by the developers in charge of the project. In such a case, the team is entirely in charge of the supply and demand — they can choose to increase tokens when the demand is too high or lower the supply when the supply is too high.
Factors that might change the supply and demand of a cryptocurrency’s price
Cryptocurrency exchange listing
If a cryptocurrency is listed on more popular exchanges, it can increase the number of investors willing to buy, thus increasing demand. And if all else remains equal, including the supply, the price is set to rise.
Most cryptocurrency investors prefer projects that they have a say on what will happen to the network. For instance, proof-of-stake blockchain projects generally have more investors since staking tokens gives investors a say in the ecosystem and they also earn interest from their tokens. As such, they are in high demand.
If a cryptocurrency project has a useful application that improves on the limitations of the existing blockchain, it will build a network of users relatively fast and take value from existing projects. Therefore, its demand will increase, driving its prices higher.
Understanding the core principles behind every project’s supply and demand is crucial when making investing decisions. If you believe that a specific cryptocurrency has value and its demand will increase, you should consider whether the supply will keep up. If not, then this makes the project scarce, and it could be a good investment.