Cryptocurrencies have been on the spotlight ever since Bitcoin jumped to the stage in 2009 and they have been the subject of controversy, conspiracy theories, and a whole lot of interest when it comes to how to trade them and how to earn money from them.
If you are looking to get started on trading these innovative financial assets, you should first learn the basics of how the function and how you can analyze their price before you place a trade.
Think of this article as a trading cryptocurrency for dummies guide, as it will dive into the most fundamental aspects of this activity to give you an overview of what you will be getting into.
Where do cryptocurrencies come from?
A cryptocurrency is the payment method that allows a user to make transactions within a certain blockchain.
Bitcoin (BTC), for example, is the token that people uses to pay for a transaction made within the Bitcoin blockchain and these transaction fees vary depending on the network congestion and other technical elements.
Most of the blockchains that have been created have issued their own currency – also known as tokens – which are required to pay the transaction fees resulting from using the blockchain. This is the case of Ethereum, Litecoin, EOS.io, and others.
In most cases, a limited number of tokens are issued for each blockchain which means that as time passes and the blockchain’s usage increases, the tokens become scarcer and this makes their price go up.
This is where trading cryptocurrencies starts being interesting, even though its just a part of why they have become a financial asset people and institutions currently trade with.
Why do people trade cryptocurrencies?
The main economic principle that makes it possible to trade cryptocurrencies is scarcity.
Take Bitcoin as an example. Only 21 million coins will be issued and once they are completely mined there will be no more in existence, which means that people who pay for transaction fees within the BTC blockchain must go to the market to buy enough satoshis – Bitcoin’s smallest unit – to pay for those fees.
That means that as the transaction volume goes up – assuming it does – the value of this cryptocurrency should go up over time as well given the limited supply that exists.
This is the main principle driving the value of essentially all cryptocurrencies, even though there is of course significant speculation playing a role in how much people are willing to pay for them.
Which elements influence the value of cryptocurrencies?
There are many variables that have an influence on the price of the different cryptocurrencies available and since it will be difficult to cover all of them this article will outline some of the most important ones you should keep an eye on.
Supply & Demand:
As with any other good, service, commodity, or asset, the laws of supply and demand apply to cryptocurrencies as well.
In this regard it is important to note that even though supply is usually limited, not all the coins of a certain blockchain are always released at once, as is the case with Bitcoin. With BTC, miners’ rewards are periodically halved to limit the supply of coins during a certain time frame, even though at some point all of them will be effectively mined.
With that in mind, there’s a supply and demand curve that can be drawn for Bitcoin. If the demand goes up and the supply remains the same, the price will respond by going up and the opposite will take place if the demand goes down.
On the other hand, if the supply increases or decreases for whatever reason and demand stays the same, the price should go down and up respectively.
Blockchain’s usage and adoption as payment method
Since crypto-tokens are used to pay for the transactions made within their blockchain it is fair to expect that their demand will go up as the usage of the blockchain increases.
Additionally, certain cryptocurrencies have already gained a significant degree of credibility within the marketplace, making them a payment method accepted by an increasing number of retailers, online businesses, and other establishments.
If this trend continues, the value of cryptocurrencies accepted will go up as this will be another source of demand that will open up, pushing the price because of their widespread adoption as a payment alternative.
Adoption as a financial asset
Investment managers are increasingly pointing to the benefits of adding cryptocurrencies to their customer’s portfolios as this asset class provides further diversification and higher risk-adjusted returns in some cases, especially from the most well-established coins available.
If this notion continues to gain traction, traders can expect the value of cryptocurrencies to go up over time as a result of their incorporation on traditional investment, retirement, and other similar portfolios.
This is at least a decent portion of what you should know to start trading cryptocurrencies now.
There is of course a lot more to learn, especially when it comes to technical analysis, but now you understand what is it that you are getting into and why cryptos have become an attractive financial asset for traders recently.