Factors Contributing to the volatility of Crypto Market

The cryptocurrency boom came in 2017 and it's been here ever since. Bitcoin started
the year at a value of around $1000 per BTC, by July the value rose to around $5000
and by the end of November reached a staggering $20000. Bitcoin's rise wasn't just
bitcoin's rise, it was the rise of cryptocurrencies as a whole. This massive surge allowed people to see through the modern economic system's shortcomings to which they had now discovered a potential solution. Albeit, the majority looked at the growth chart of BTC and found a quick buck opportunity and nothing more. In this article we explore the various factors that led to the giant crypto boom of 2017. We try to gather
information that could perhaps help explain not just this particular event in the crypto
market but also evaluate the possible reasons that could cause the crypto prices to fall
at one moment and rise the another.

Supply

Any kind of asset that holds any value in the public eye does so because of a very
important factor and that is its scarcity. Gold today is seen as an investment asset while pebbles are kicked around in the streets not only because gold shines better but because it is one of the rarest metals on the planet. On the other hand you find pebbles lying around almost every time you step out the house.

Similarly, fiat currencies also hold value because they are produced in a "regulated" amount by governments. Now, in cryptocurrencies, the supply is one of the biggest factors in determining the value of a single crypto token. Some cryptocurrencies have a pre-determined number of maximum in-circulation tokens which when paired with the right demand gives the crypto a reasonably high valuation, e.g., Bitcoin, and some have an infinite supply which reasonably gives them a smaller valuation, e.g., Dogecoin.

Demand

Any kind of supply has to meet a certain demand in the market to stay relevant. Taking
the previous example we explored the supply of gold, which is fairly scarce. But why
would we want something just because it is less in number. What value would it add to
our lives? Well, you see, gold is not just a rare metal. It also happens to be an element of precious aesthetic quality. It shines in bright yellow color and draws attention towards the holder. In addition to this, gold also happens to be highly ductile, meaning it can be molded into the thinnest of wires. It is highly malleable, meaning you could get the thinnest sheets out of it. If rarity were the only factor determining the presence of an asset in the market, we'd be running around trying to dig out francium, which has
absolutely no practical use due to its mere 22 minutes lifespan.

Similarly, a crypto currency has to have a certain level of demand among the general
public for it to be a useful asset and merely restricting its production rate isn't enough.
The most in demand crypto currency in the market is the Bitcoin which proposed the
idea of decentralization to the masses which, when paired with its low production rates, makes it what it is today.

The “Whales”

To understand how these whales affect the crypto market, we must first understand
what exactly these whales are. Whales are People, just like you and I are, but there's a
difference. The difference is that they hold enormous amounts of the said
cryptocurrency. Let us take the example of the Shiba Inu(SHIB) token which recently
became the mass favourite crypto token. Shiba has a circulating supply of 590 trillion
coins, pretty huge, huh? We talked about how supply affects the valuation of a
particular cryptocurrency. So it should be intuitively obvious that a single SHIB token is
destined to have a lower value associated with it.

Between October and November 2021, Shiba Inu gained popularity which resulted from its massive surge in valuation.This surge in valuation was the result of lots of SHIB owners putting in more buy orders for the token in order to bring a competitor to the infamous Dogecoin into the market.

The biggest contributors to this surge in SHIB valuation were 8 of its biggest whales.
These 8 whales controlled 70.52% of the total circulating supply at the time with one of
them owning over 40%. Due to the big orders put in by few whales, every average
investor started to believe that there is something of value in the token and hence
many other investors started putting the money in. This rise in demand caused the
prices to go up by around 248% by the end of October 2021, which is when the whales
decided to pull out in order to enjoy their ~250% profits and the prices went back to
normal. Another popular cryptocurrency is the bitcoin the original crypto intended to
bring a solution to the common banking problems like the transaction times. It was
nowhere as close to its current valuation of $24000 back in 2016 so what happened?
How did BTC gain so much trust amongst the general public. Well, a fair amount of
credit has to go to the idea behind BTC but that idea wasn't causing any turn of heads till 2017. In 2017 the BTC whales, or the users holding huge amounts of BTC decided to
place big orders to buy more BTC, and again the people around the world felt that since there are so many orders for this particular crypto, it must be something of a fruitful investment and they invested too, driving the demand up and the supply still pretty limited hence the rise in value.

Hopefully this gives you an insight as to how the whales control the crypto market and
can make the prices go up and down at will. With this in mind one can conclude that
investing in a cryptocurrency that has the most diversity in terms of the number of
users would be a good idea.

Marginal Cost Of Production

The value of a cryptocurrency also, to some extent, depends upon the marginal cost of production. Cryptocurrencies are mined by miners in the same blockchain network. These miners are some computers connected to the blockchain network and are aimed at producing these cryptocurrencies by solving some complex computational puzzles. In case of bitcoin, the puzzle is to find the correct sequence of some alphanumeric text which when passed through a hash function like SHA256 returns a sequence of 0s and 1s that matches the criteria for a pre-defined output. In this way a BTC miner authorizes 1 transaction and as a reward earns a certain amount of BTC.

Now this certain amount of BTC that a miner earns for validating a transaction gets lesser and lesser overtime and the computational puzzle gets tougher and tougher. Hence overtime it takes more and more computational power to mine BTC.

Bitcoin has a limit as to the maximum number of Bitcoins that can be in circulation at any point in time, which is 21 million Bitcoins. The complex algorithm used to mine BTC ensures that the bitcoin remains in use for a long time before another currency of the same sort replaces it, when its maximum circulating supply is reached and no amount of credit can be obtained.

Now as you might have guessed, the energy invested in mining BTC has to be compensated for in some way and that is the gas fee. You pay the miner a certain amount of this gas fee as a reward for facilitating the transaction or as a compensation for the energy used in validating a transaction. The difficulty of the algorithm used for validating a transaction could sometimes hasten or slow down the production rate hence causing a shortness in supply which in turn affects the value of a cryptocurrency.

Media Coverage

Another important factor that plays a role in determining the value of a cryptocurrency
is the amount of media coverage it receives. The more coverage the media gives a
cryptocurrency, the more people will get to know about it and maybe even consider
investing. Thus , a rise in Demand is witnessed, which drives the prices up and when the said crypto is shown in a negative light, some people might decide to pull out causing a fall in demand and hence driving the value down.

While talking of media today we cannot just talk about the conventional television
media. We have to talk about the new age media, which is social media. A research
paper published in January 2018 by five finance professors from reputed Business
Schools across United States shows that social media is an important predictor of
Bitcoins Market price. "More bullish (or bearish) forum posts are significantly associated with higher (or lower) next-day bitcoin market price. Yet not all social media are created equal. Content contributed by relatively inactive users has a larger effect than that from active users." This is surprising but true. The valuation of the world's most famous cryptocurrency is subject to the public's opinion of it, just like stocks. This raises a few questions like if BTC really is fit enough to replace the current monetary system.

Talking about the implications of this result sounds super appealing but this article is
not about that. We might cover that some other day but for now the key takeaway is
that cryptocurrencies have a volatility which arises as a result of user sentiments.

Competition from Other Cryptocurrencies

There are now more than 12000 cryptocurrencies in the world at the time of writing this
article. Not all of them have distinct use cases. In fact most of them have the same use
case, that is to decentralize the world economy. Since there are so many players in the
market trying to solve the same problem, it is natural that they are competing with each
other to gather the biggest user base. As of today, Bitcoin enjoys the biggest user base
mainly because of the originality of the idea and the fact that it is the world's first
decentralized cryptocurrency. All other cryptocurrencies which aim to provide the world similar services as bitcoin are called "Altcoins" and are built by forking the bitcoin
algorithm but with little variations in order to fix some of Bitcoin's perceived
shortcomings.

When a certain Cryptocurrency sees a surge in its valuation, it is not out of bounds that
its competition would lose value. But such a notion is not universally true. A Research paper published by a Tel Aviv University Economist Niel Gandal and banker Hanna
Halaburda shows that the Bitcoin and Ethereum prices are hugely proportional to each
other. A surge in Bitcoin's price is usually followed by the a surge in Ethereum's price
and same for a decline in their prices.

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