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Noelle Acheson is a veteran of Business Analysis and a member of CoinDesk's product team.
The following article was originally published in Institutional Crypto by CoinDesk, an informational newsletter aimed at the institutional market, with news and views on cryptographic infrastructure delivered all Tuesdays. Register here.
The crypto-currency price rally last week sparked strong emotions in the mainstream press – is bitcoin "still doing" this job? Could we be on the verge of an escape?
These reports attract clicks and eyes, so I understand why they are being executed – but their breathtaking fascination for price volatility and potential profits misses the biggest impact.
Although we can generally agree that the investment gains are good, the general advantage is as follows: Cryptocurrency price increases highlight the uniqueness of the badet clbad.
(In order not to overly complicate the discussion, in this article, I will focus on bitcoin – but identical or similar arguments can also be applied to other crypto-currencies, depending on their characteristics.)
Supply and demand
Let's start by comparing bitcoin to other products.
In virtually every other case, a price increase affects the supply. When the price of gold or oil rises, it is urged to extract even more soil. Previously unprofitable mines or sinks become profitable, and those that were to become more profitable become more profitable. Operators will logically seek to maximize opportunities by producing what they can, while prices are good and the supply increases.
However, as supply increases, demand generally decreases as consumption budgets are reallocated and substitutes are sought. As demand falls, the price decreases again, reducing the incentive to produce, which eventually reduces supply. And so on.
The comparison of bitcoin currencies with fiduciary currencies displays a similar dynamic. An increase in the demand of one currency over another will eventually make the properties denominated in this currency expensive compared to alternatives denominated in different currencies.
With Bitcoin, the price does not affect the offer. At all. An increase in demand will result in an increase in the price which, without the "correction mechanism" of a potential increase in supply and / or a reallocation of demand, could continue indefinitely.
Just compensation
However, all markets need automatic correction mechanisms. Transaction costs are one of the bitcoins: a strong increase in demand is likely to increase the fees miners can charge when processing transactions, which could slow down the increase in volumes.
This highlights the second important differentiator, namely the ingenious system of Bitcoin incentives. As the price goes up, the network becomes more secure.
Minors deal with transaction blocks and, in compensation, are rewarded with a defined number of bitcoins. As the price of bitcoin increases, the value of the reward also increases. More minors will be attracted by the potential profits from bitcoins earned and transaction fees. A greater number of miners allows better maintenance of the distributed network, which reinforces the cryptocurrency's resistance to the bad actors.
This, in turn, should boost confidence and demand, which should further increase the price and resilience of the network.
Expect
This does not mean that price increases will continue indefinitely in the stratosphere.
External factors such as regulation, the emergence of alternatives or even the macroeconomic climate could have a significant moderating effect on demand. Internal factors such as forks and governance debates could also have an impact.
But one of the neglected features of Bitcoin is that, all things equal otherwiseit does not have a fundamental automatic correction mechanism like most other badets. Not only a price increase do not trigger rebalancing supply / demand, it actually strengthens the strength and potential demand of the network.
"All other things" are rarely equal, however. Sentiment plays an important role in all markets, but particularly in a market such as bitcoin where widely accepted valuation methods do not yet exist. As we saw in 2017-2018, "reflexivity" (in which perceptions affect the market that affect perceptions) that pushed the market upward can bring it down quickly.
This is in a sense the main self-correcting mechanism of Bitcoin: the imbalance of the market. Given the relatively low liquidity and general lack of transparency, traders and investors seem to follow the well-known principle: "If you have to panic, start with panic."
Smoother ride
Yet even this may be mitigated over time.
Crypto-winter was not just about building a more robust (and regulated) market infrastructure; it also involved the training of institutional investors, who will undoubtedly bring more sophisticated trading strategies to the market.
While many institutions are likely to adopt a long-term position, we will not hear them scream "Towards the moon!" There will come a time when their strategy will indicate a blockage of profits and even a hint of volume. the sale could be enough to trigger a sudden correction.
However, the same level of sophistication will also serve as a basis for any correction. As volumes increase, infrastructure continues to improve and valuation techniques develop, volatility will be mitigated, as will the tendency of large market players to react blindly to perceived changes.
As a result, the fundamental characteristics of cryptocurrency will become more and more prominent in investment decisions. And Bitcoin and his peers will continue to show us that crypto-currencies are, in reality, a different kind of badet clbad.
The image of the world upside down via Shutterstock
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