Why do cryptocurrencies grow?

In 2009, for just $1, you could buy more than 1,300 BTC, which today would be worth more than $55 million, which is how much your ca[ital would increase. Just imagine what your capital would be if you invested $100 or $1000.

Let’s investigate why cryptocurrencies are growing, what factors affect the growth of digital assets and are capable of leading to a drop in their value, how they provide passive income to investors, and what Elon Musk has to do with all of it. 

Background: what are cryptocurrencies and how did they appear?

Behind the creation of the world’s first cryptocurrency, Bitcoin, is an anonymous user or group under the pseudonym Satoshi Nakamoto, whose identity (identities) has not yet been confirmed. In August 2008, the Bitcoin Whitepaper was first presented which describes a unique decentralized payment system, created supposedly as a challenge to the traditional system.

This is pointed out by creator Satoshi Nakamoto himself, who cited the 2008 crisis as an example of a result of the inefficient functioning of the traditional financial system. As early as in January 2009, Satoshi sent the first transaction of 50 BTC to Hal Finney, one of the first crypto enthusiasts who supported Bitcoin from the very beginning. The transaction note contained the following text, which referred to the corresponding issue of the world-famous Times magazine:

“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”.

In 2010, the first market appeared where users could buy and sell BTC, called Bitcoin Market. In the same year, the exchange rate of the first cryptocurrency was set for the first time – $0.06 per Bitcoin. 

What is the reason for the growth of digital assets?

How is it that the digital currency Bitcoin, which does not even physically exist, is worth more than gold and most stocks, even though it’s not even backed by anything? The profitability of crypto investments has stunned even the most experienced traders. 

During the DeFi boom, for example, the ecosystem’s most sought-after tokens like Yearn Finance (YFI) and Aave (AAVE) rose over 30,000% in just one month. To understand why cryptocurrencies are rising in price, let us first take a look at their key benefits and how they differ from other types of financial assets.

Decentralization

Blockchain protocols are managed by many nodes. None of them can gain centralized access and manage transactions on their own. All nodes on the decentralized network agree among themselves on which transactions to add to the blockchain. If someone tries to add or double-spend an entry, the miners or network validators will not allow that transaction.

The first consensus algorithm was Proof-of-Work (PoW), and the process of generating coins this way is called mining. Special nodes called miners attempt to solve a complex computational problem. The one who succeeds first receives a reward in protocol coins.

The blockchain is recognized as an effective technology that protects against the double spending of coins – a situation in which people try to perform the same transaction twice, i.e. duplicate it. More modern blockchains support proof-of-stake (PoS) consensus, the security of which is ensured by validators; smart contracts support the autonomy of the decentralized network. This brings us to the next advantage of DeFi platforms.

Lack of intermediaries

To access a financial service on the blockchain, you do not have to go through a lengthy and tedious process of opening an account as you do with banks. It is enough to create a crypto wallet, add crypto to it, and connect to the platform, and all services such as farming, saving, lending and others will be available to you.

No one gets access to your account and no-one can manage it by freezing or blocking the withdrawal of cryptocurrencies. Only you have access to the crypto wallet as long as you have the private key. However, if you lose it, you can irretrievably lose your money. This is one of the main disadvantages of decentralization – only you are responsible for your assets, and no company can help you return your money.

Transparency and anonymity

All data on the blockchain is easy to trace, but at the same time offers anonymity, because unlike banks and other financial services, you do not have to verify your identity according to a KYC / AML policy.

Scarcity

Another main feature of these coins is their limited circulation. Earlier in this article, we briefly discussed how mining works in Bitcoin and similar protocols. A distinctive feature of the PoW consensus is that as the total processing power of the miners (hashrate) increases, so does the complexity of the network. It turns out that the more powerful the miners are, the more difficult the tasks they have to solve. This deflationary mechanism protects the network from issuing new coins at an unreasonably fast rate. Without this mechanism, miners would generate more and more coins and supply would quickly exceed demand, leading to a rapid decline in the cryptocurrency price.

In addition, the Bitcoin protocol has a halving mechanism that cuts miners’ rewards in half approximately every four years. As a result, it becomes increasingly difficult to mine new coins and the speed of their release decreases. As demand increases, this will cause a shortage of coins on the market and thus an increase in their price. Moreover, mining of cryptocurrencies will stop when the number of BTC reaches 21,000,000.

Such cryptocurrencies are called deflationary and are attractive for investment because the more people use the coins, the bigger the deficit, which has a positive impact on their rate. However, not all digital assets have limited issuance. There are also inflationary cryptocurrencies such as Dogecoin (DOGE) and Ethereum (ETH), which, like Bitcoin, are based on the proof-of-work consensus algorithm. Miners mine all new coins, but their number is not limited by anything.

However, in August 2021, Ethereum developers released the London Hard Fork (EIP-1559), an update that introduces a coin burning mechanism: with each transaction, a portion of ETH is removed from circulation, reducing issuance. In addition, the update places a “difficulty bomb” on the Ethereum network to prepare the blockchain for the transition to the new network.

Note.The terms Eth 1.0 and Eth 2.0 are no longer used due to the many contradictions that arose in the project community, as the developers decided to abandon them. Many users thought that they were different networks in different coins, which is used by scammers who sell fake cryptocurrencies to investors. Instead, now only the term “Ethereum Upgrade” is used.

Why is the price of cryptocurrencies rising? The main factors

Crypto trading in the analysis of quotes requires an integrated approach in order to accurately predict the future dynamics of cryptocurrencies. Conventionally, the factors affecting the rate of cryptocurrencies can be divided into two types: external and internal. External factors :

• Economic: financial crises, defaults, increases and decreases in the key rate, devaluations, falling stock and currency markets.
• Political: regulation of the crypto market, bans on transactions with digital assets, their recognition as legal tender, wars and trade conflicts.
• Environmental: epidemics, natural disasters and cataclysms.
• Psychological: fear of missing out (FOMO) and “fear, uncertainty, doubt” (FUD).

Internal factors:

• Growth or fall of the main cryptocurrency, the level of its dominance. Often Bitcoin serves as a market indicator: when BTC rises or falls, altcoins follow.
• Activity of developers of a financial service or DeFi platform: frequency of updates, important updates, introduction of new features, etc.
• Activity on social networks – investor interest, media exposure.
• Competition: outdated protocols may displace new, more promising platforms.
• Hacks and bugs in the operation of protocols or their applications, security breaches.
• Pump & Dump.
• Other factors unique to the crypto market or specific blockchain platforms.

In terms of the nature of the impact, positive and negative factors are distinguished. Consider the most popular factors that have the strongest impact on the price of digital assets.

Regulation of cryptocurrencies

The actions of states can seriously affect the rate of digital assets. For example, in May 2021, the Chinese government banned the mining of cryptocurrencies in the country, and later other operations with cryptocurrencies: crypto trading, issuance, purchase and sale of digital assets, as well as crypto business. This was one of the main reasons for the decline of cryptocurrencies. Miners were forced to capitulate to other countries that were more favorable to the mining industry – North America, Russia, Kazakhstan, and a number of other countries with access to cheap electricity. The hashrate of the Bitcoin network has fallen to a two-year low of 56 TH /s.

At the beginning of 2022, a new trouble hit the crypto market — due to mass protests in Kazakhstan caused by a sharp increase in prices for liquefied gas, Internet access was turned off in the country for several weeks, as a result of which the miners were forced to suspend production. As a result the network hashrate fell from 216 TH / s to 157 TH / s according to the Blockchain.com.

But in 2021, an important positive event occurred, which was expected by cryptanalysts from all over the world: in September, El Salvador officially recognized Bitcoin as legal tender. Although El Salvador is not a large country with significant influence on the crypto industry, the news of this caused a wide public outcry and gave investors hope for a bright future for cryptocurrencies.

Note: Journalists mistakenly believe that El Salvador was the first country to legalize and officially recognize Bitcoin as a means of payment. In fact, payments with cryptocurrencies were already legalized a few years earlier in Japan and Germany.

Financial crises

Economic instability has a twofold effect: on the one hand, a collapse of stock markets can cause investors to look for a “safe haven” and switch to alternative financial instruments such as cryptocurrencies. On the other hand, the collapse of the markets can force you to divest from volatile assets. As early as 2016, crypto analysts discovered a strong correlation between stock indices and cryptocurrencies, which strengthened over time. But the nature of this relationship depends on many factors.

Let us go back to the events of 2019, when the trade war between the US and China led to tensions between these countries and sanctions on production, export and import of goods. This put pressure not only on the stock market, but also on currencies. As a result, against the backdrop of falling stock market indices cryptocurrency prices rose and vice versa: while the S & P500 rose, the BTC price fell:

But in December, a correction in the stock market led to a fall in the value of digital assets, while most of the time the price movements of the index and friend:

Media exposure

Do not underestimate the network effect. The impact of social networks on our daily lives is hard to overestimate – the same is true for cryptocurrencies (in both respects). You have probably heard of the Shiba Inu Memcoin – since its launch in the fall of 2020, this token has rapidly gained popularity, and in just six months, token growth has been in the millions of percent.

This not only attracted the attention of investors, but also formed a real hype around the cryptocurrency, so much so that in less than a month the token rose from the 50th place and even broke into the top ten leaders of CoinMarketCap, overtaking such large altcoins as Dogecoin (DOGE) in terms of capitalization (also Terra (LUNA) and Uniswap (UNI)).

But in fact, SHIB is just an analogue of another Dogecoin (DOGE) memcoin, that is, a parody of a parody, which does not even have its own blockchain. 

Famous and influential personalities have a great impact on cryptocurrencies. Of particular note is Elon Musk, after whose tweets the price of Dogecoin repeatedly shot up. We cannot say unequivocally that it was the tweets that caused the growth, but a certain pattern can be observed.

In January, Elon Musk’s company Tesla announced that it had begun accepting Dogecoin to pay for branded merchandise. As expected, the Memcoin rate reacted with growth:

Earlier last year, Elon Musk announced that Tesla would accept Bitcoin to buy electric cars, but after a while in May, the company abandoned this idea, citing unenvironmental (harmful to the environment) nature of mining. According to Elon Musk, Dogecoin is technologically and in other ways superior to the main cryptocurrency.

In addition, crypto analysts have found a certain pattern between the popularity of queries on Google Trends and the price of cryptocurrencies, especially Bitcoin and Dogecoin.

Source: Researchgate

Mass recognition

Let us qualify right away that the popularity of cryptocurrencies directly depends on the decisions of governments, but on the other hand, even its approval may not change the decisions of citizens and may even lead to protests. However, positive regulation generally favors the process of mass recognition of crypto assets.

Environmental factors

Natural disasters and epidemics shift consumers’ priorities: in such times, their primary concern is not to increase their investments, but to preserve their savings and survive. The pandemic that began in March 2020 forced governments around the world to take lockdown measures to prevent the spread of the virus. Because of this, consumers have been actively converting their assets into foreign currency to stock up on food and other essentials for the future.

As a result, both the stock market and the cryptocurrency market collapsed in just a few days. Bitcoin fell more than 50% in just one week, collapsing from $9200 to $3800:

After a few weeks, however, the situation began to stabilize, and the markets not only recovered but later reached new highs again. This was due to low interest rates, which made it unprofitable to hold funds in banks, and consumers began to invest in volatile financial assets in order to save and increase their savings and generate passive income.

Strong fluctuations of the first cryptocurrency

Regardless of the reasons for the fall of Bitcoin, in most cases altcoins either follow it or grow against the dynamics of the price of “digital gold”, which happens much less frequently. Bitcoin is even referred to as a “market indicator.” Some cryptoanalysts use the degree of Bitcoin dominance as one of the most important indicators: the lower the indicator, the higher the probability of an “alt season”.

When the Bitcoin price stagnates (is in a lull) or grows and falls sluggishly, traders switch to alternative cryptocurrencies to generate more income. This can justify the growth of Ethereum and subsequently other altcoins.

FOMO and FUD

Beginners in crypto trading are the most emotionally affected and therefore tend to trade impulsively. Thus, growing tokens and coins provokes even more growth, and “hamsters” (investors who make rash “emotional” trades) succumb to FOMO – the fear of missing out on profits. The cryptohype of 2021 is very similar to the hype that took place in the cryptocurrency market in 2017, but on a much larger scale.

When crypto assets fall in price, the opposite effect occurs – FUD or “fear, uncertainty, doubt,” which provokes hamsters to sell their assets in fear. This is what the organizers of the pump and dump scheme use: they choose an asset with low capitalization and first Conmen artificially pump up the price of the cryptocurrency, while at the same time spreading rumors in the media that something serious is about to happen to the cryptocurrency and agitating them to actively buy it.

There is hype around the crypto asset, and inexperienced investors are more likely to buy it. When the price is sufficiently “inflated” and growth slows, the scheme organizers get rid of the asset and let the price collapse, i.e. they “sell” the cryptocurrency and leave the deceived investors with losses.

In the crypto community, this is referred to as a “hamster haircut.” Pumps and dumps are easy to spot: they are characterized by an abnormal and unnatural price increase, followed by a drop back to the previous level or even lower. The situation with Elon Musk’s tweets can also be put in this category, although he did not aim to “pump up” the price and did not call for buying DOGE.

Developer activity

Decentralized platforms are constantly competing with each other. If you look back in time, you will see that the former top cryptocurrencies such as Lisk (LSK), Waves (WAVES) and Dash (DASH) have been replaced by new, more productive and technological platforms such as Solana (SOL), Terra (LUNA) , Polkadot (DOT) and Cosmos (ATOM) with a rich ecosystem of financial services.

To understand how promising the cryptocurrency is and whether its price will grow and provide you with passive income, follow the updates from the developers and news from the ecosystem. To build a foundation for growth, the platform team needs to regularly update the financial service to make it competitive among the many other cryptocurrencies that already number in the tens of thousands.

DeFi platform hacks 

In the decentralized finance ecosystem, regular platform hacks have become commonplace. Even security audits do not guarantee 100% protection against hacker attacks. For example, the well-known DeFi protocol Cream Finance, despite audit reports, was hacked three times in 2021, and the cumulative damage exceeded $130 million.

This is another major disadvantage of decentralization: DEX exchanges cannot prohibit the sale of tokens and cannot prevent hackers in any way. Such situations can have a negative impact in the long run, not only because of attackers selling stolen assets, but also because of users’ desire to get rid of stored assets and not buy them in the future.

Conclusion

The price of cryptocurrencies is influenced by many fundamental factors: political, economic, environmental, internal, social and others. When analyzing it, it is important to consider the totality and importance of these factors, i.e. their impact on the crypto market in the long run. If the tweets of a famous person have only a short-term impact, the bans imposed by the governments of large countries can lead to a long-term correction in the crypto market.