We are going through turbulent times for both crypto and fiat currencies; we experience wide swings and sudden changes in price. What decides the price movements in these markets?
In general, the value of a traditional currency reflects the macro economic situation in the relevant country or region. And since the value is measured against other currencies’ value it is the economic situation in a country relative to another country’s economic situation that is measured. So a relatively weak currency does not necessarily signal an unhealthy economy, it just means that other countries have healthier economies.
Using the term currency about cryptos is controversial. In a sense “cryptocurrency” is a misnomer. The definition of a currency is a system of money that are in use and circulation in a certain country or region. Some definitions also include the need for a central exchange and a regulatory body (like a central bank). So the term “digital asset” is perhaps more precise, but I will continue to use the widely accepted term “cryptocurrency.”
Factors that influence fiat currencies
Inflation
Inflation measures the general price level and thus the buying power in a country. High buying power means that you get less goods for your money. An increase in inflation therefore reduces the relative value of a currency.Interest rate
The interest rate is the main instrument that the central bank has to influence the economy. A low interest rate stimulates more lending and thus increases inflation which in turn leads to a weaker currency. A high interest rate will ease an overheated economy and lower inflation which strenghtens the currency value.Government debt
If a country or a region has high debt they need to print more money to pay off that debt. This gives higher inflation and thus gives a weaker currency.International trade
The trade balance in a country measures the difference between the export value and the import value. A negative trade balance (trade deficit) means that the country imports more than it exports, so the demand for foreign currencies to buy the import goods is higher than the demand for their own currency, therefore the currency depreciates. And a positive trade balance (trade surplus) creates a demand for the country’s currency to pay for the export goods, and then the currency increases in value.Politics
To attract investors a country or a region needs stability. The political system and the economic regulations are factors that investors analyse. So a liberal and stable political system stimulates the economy and increases a currency’s value.Speculation
Speculation on a country’s currency is important for liquidity and for avoiding price spikes caused by shortages and manipulation. Speculation is the guarantee for the exchange to be a real marketplace and for supply and demand.
Factors that influence cryptocurrencies
- The USD
Since cryptocurrencies are mostly measured in USD, cryptos are directly incluenced by the relative strength of the dollar. Coins can have a healthy state and good utilization, but be outperformed by USD so the value goes down. However, this has not been the case lately, price change has largely been driven by massive media attention (both positive and negative). But in the future, when the regulation issues have been resolved and utilization is fully developed, then this relation will be relevant, in the same way that is is for other assets measured in USD.
Public opinion
Since the cryptos do not have a central exchange and central bank to influence price development, their value is at the mercy of public opinion. How much are people willing to pay for it? That is true market capitalism. However, when the utilization is more developed we can get more stable valuation.Media coverage
Up untill now and currently media exposure has been the driving force for price development. The cryptos have pretty much been behaving like a group with similar relative value. This is because the mass media look at cryptos as a group. Speculations about regulations and bans work negatively for price, while coverage of price increase in and of iself will drive price higher (the meta effect). The more the mass media accept cryptos as valid assets the more they will appreciate in value.
- Accessability
How hard is it to mine a crypto? The higher the complexity of mining and energy expenditure, the higher the value of the currency. Also, how easy is it to buy coins? Can you go to an ATM to take them out, or do you need to go to a broker to exchange it? This kind of accessability is also highly influencial for appreciation.
Utilization
What can the coin or token be used for? Payment at stores and restaurants, paying bills, circulation bills and coins, ATMs, capitalization in the markets, etc. The more uses they have, the higher will be the relative value of the currency.Investors
I want to add that cryptos need longterm investors AND short term speculators. Longterm holders is important for price stability and price increase, and speculators are needed for liquidity and higher trade volumes.Innovation
Will all coins just be copies of Bitcoin? Are there any new types of blockchain emerging? New P2P types? And what platforms can be integrated (like Steemit!)? The answer to these questions can potentially change the value of the relevant cryptocurrency.
Conclusion
As we have seen, the traditional fiat currencies are driven by the relative difference between different countries’ domestic macro economics. While the cryptocurrencies are currently driven by the mass media and their coverage, but future utilization and accessability can potentially change this dependency.