What exactly are the decisive factors that influence the prices of cryptocurrencies? This question is being asked by many investors even in 2022.
The reason for the question itself is that instead of just using a trading bot for Kucoin to foresee the most drastic changes in the exchange market, investors want to have the mechanisms themselves so as not to suffer from unexpected losses.
What Factors Influence the Prices?
Three things quickly became clear: the decisive factors differ greatly, they depend on the underlying structure of the currency, but also on the use of the respective blockchain.
To date, most research has focused on a limited selection of cryptocurrencies. In contrast, our study analyzes a broader range.
In the hypothesis, the price of each category of cryptocurrencies is driven by a different number of attributes; we attempt to show a statistically relevant relationship between cryptocurrencies and their respective value drivers.
To be able to analyze this statistical relationship, the available data was clustered and then analyzed in a univariate model. Similar to the valuation of traditional asset classes, it turns out that the value of an asset depends on several factors.
Bitcoin (BTC) is the largest, most well-known, and also most liquid cryptocurrency, with a total market cap of $1.03 trillion – and we’re talking here about November, 2021. Due to its programmatic scarcity (Bitcoin is limited to 21 million units), Bitcoin is regularly compared to gold.
Modeling Bitcoin's value similarly to gold was first proposed by Twitter personality Plan B (2019), who used the stock-to-flow approach to analyze Bitcoin's value.
Bitcoin-Halving
The incremental changes in the stock-to-flow ratio drives Bitcoin halving: Every 210,000 blocks, the block subsidy is halved. Currently, this stands at 6.25 BTC per block. The stock-to-flow ratio is therefore 50, which means that the amount increases by about two percent per year.
This is roughly equivalent to the growth in the quantity of gold. Theory suggests that the price of Bitcoin should rise as the new supply of Bitcoin becomes scarcer, i.e., as the stock-to-flow ratio rises.
The data supports the stock-to-flow ratio as at least one of the leading drivers of the Bitcoin price. After the price jumped in August 2016, the average price level began to rise in the following months. After Bitcoin halving in May 2020, the price level also increased in the following months.
Since market liquidity was low in Bitcoin's early years, only the two past halvings provide meaningful information. However, since the most recent halving occurred, the time horizon was not long enough to clearly confirm the stock-to-flow model as the main driver of Bitcoin's price.
Diverse Factors
Another correlation could be between the Bitcoin price and active addresses. Their number follows the price until mid-2021, but it does not explain the recent increase in the Bitcoin price.
Similarly, the difficulty of mining, which has increased sharply in Bitcoin since 2017, is not reflected in the price.
Other possible factors that could contribute to the Bitcoin price were developer activity on GitHub (historically very volatile) and social dominance (discussions on social media). These two factors could be confirmed as not being relevant to the price.
Active Network
Ethereum is the second largest cryptocurrency with a current market capitalization of around $300 billion. Ethereum also serves as a platform for decentralized financial applications (DeFi), decentralized apps (dApps), and smart contracts.
Ethereum's investment thesis is not to generate value through scarcity, but through an ever-expanding active network.
Consequently, the potential value drivers of Bitcoin and Ethereum differ. Similar value drivers to Ethereum can be attributed to other smart contract blockchains such as Polkadot, Cardano, and Tron.
However, the number of apps developed is not a relevant indicator for the value development of Ethereum. It is more of a lagging indicator: the number of dApps only increased significantly after the recent all-time high in 2020.
In contrast, the number of verified smart contracts shows an interesting behavior: During the crypto winter, this metric appeared to be a lagging indicator, whereas during the recent price spike, towards the end of 2020, it appears to be a leading indicator.
Similarly, the number of active addresses appears to be a value driver. In contrast, as with Bitcoin, there does not seem to be a strong correlation between price and mining difficulty for Ethereum.
Conclusion
At this point, the sometimes significantly different primary value drivers could only be discussed in excerpts for Bitcoin and Ethereum.
Bitcoin appears to be largely driven by stock-to-flow as a digital store of value, while Ethereum appears to be primarily driven by the number of verified smart contracts.
What awaits us now for the future - also given the current circumstances in the Western world - is difficult to foresee. What is certain is that despite hard blows to the economy, the two cryptocurrencies BTC and ETH have held their own and remain well positioned as market leaders.
Fortunately, the topic of cryptocurrencies themselves also remains something on everyone's lips, which creates a certain stability when it comes to investing and trading Bitcoin or Ethereum.
So, even if the numbers say one thing, we can confidently say that the real power of cryptocoins is that they may well become the gold of the 21st century - although only time will tell.
