What actually gives cryptocurrency value?

Other than a few reliable cryptocurrencies such as Bitcoin or Ethereum, new streamer/meme coins or any other form of cryptocurrency does not gain much traction and ends up failing or is seen as a way to scam and make money off of investors by “rug pulls” (where owners with a major stake sell all their coins for profit). Like real currencies, there will definitely be disparities in terms of valuations. However, if cryptocurrencies are not backed by governments or securities like gold, where do they get these values from?

Fig 1. Bitcoin- the most widely-used cryptocurrency

To best understand this, it is important to understand what characterizes any object as ‘money’ or a ‘currency’, and the best way to do this is drawing parallels between paper currency and the world-famous Bitcoin, which was created by anonymous user (pseudonym Satoshi Nakamoto) to take control over money away from. Traditional currencies have certain characteristics- scarcity (a limited resource), divisibility (the ability to be split into smaller denominations), acceptability (must be accepted by a large number of users), portability (easy to carry/transport around), durability (able to last for long), and uniformity (all units are the same and difficult to duplicate to prevent fraud). If you compare Bitcoin and its 21 million cap, with division up till 8 decimal places and online existence on databases, it fulfills many of these criteria, making it suitable currency.

Now the main part, what gives it its astounding value of USD 77338? It mainly comes from demand for the coin. When investor demand to purchase the coin or trade using its volatility to make profits gets coupled with its limited cap, the value starts skyrocketing. Other than traders, institutions or firms purchasing the coin can also drive up prices. Greed (to earn more money) and fear of missing out on gains are also 2 main factors that drive up demand from even amateur traders and is also a reason why it is so volatile and susceptible to major price variations. Hope from investors in terms of market predictions also contribute to Bitcoin’s volatility.

Fig 2. Cryptocurrency volatility compared to the S&P 500

The value of cryptocurrencies also come from their utility (or usage in daily life). As more businesses start to adopt cryptocurrencies as a more mainstream form of payment, or they come to use in the form of smart contracts (contracts that do not require a middleman or rules/regulations) and decentralized apps (apps that run on smart contracts- meaning no third party regulating party, just blockchain and users), there are a greater number of people using cryptocurrencies, increasing its value, and overall importance. Due to the lack of material backing for a value, a large chunk of its valuation comes from speculation (creating spikes and bubbles- Read more to understand about bubbles in our AI article!) and belief that the coin/asset will perform well.

To conclude, due to the lack of any solid asset such as government issuance or ties to another asset like a precious metal, cryptocurrencies such as Bitcoin draw their valuations primarily from consumer demand for the coin, increasing usage and adoption into real-world uses, and most of all trader emotions such as greed, fear or beliefs that drive demand. However, this lack of backing by either governments, the central bank, the obligation to accept it as legal tender in a nation, or even representation of a country’s economic status like many fiat currencies (basically USD, SGD, etc.) raises a concern about how sustainable the volatility of these cryptocurrencies are, and whether they will ever become stable enough to succeed.