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Creating Stable Pricing In Cryptocurrencies

Summary

Cryptocurrency prices are fluctuating on a daily basis.

Prive valuation between traditional and cryptocurrency market caps.

Cryptocurrencies are known to fluctuate for a variety of reasons.

It is not unusual to see the price of a cryptocurrency decline 5% and then go up 10% later that day. The blockchain and cryptocurrency industries are still in their early stages and are not even ten years old yet. Unfortunately, the nascency of the industry makes it easier for fraud, manipulation, and collusion to occur. The more often these factors are present, the more likely it is for cryptocurrency prices to fluctuate.

Price Valuation

One factor that goes into cryptocurrency valuation is market capitalization (or market cap). In traditional finance, the market cap is the total value of the company's outstanding shares. In cryptocurrency, the market cap is the total value of the outstanding tokens.


Top ten cryptocurrencies by market cap

Source: CoinMarketCap

The current market cap of BTC is $125,125,745,828 and the current price of BTC is $7,334.64 (5-28-18). When you divide the market cap by the current price, you’ll find that there are 17,059,562 BTC in circulation. The higher the market cap, the more valuable the currency will be. Back in December 2018, when Bitcoin hit it’s all time of high nearly $20,000, the market cap of BTC was $334,510,487,209 and the price of one BTC was $19,974.10 (CoinMarketCap). On the other hand, the lower the market cap, the lower the currency is going to be valued. With a low liquidity currency— a currency with a small market cap— it is easier for individuals with massive amounts of money to fraudulently increase or decrease the price of the digital token.


The ten cryptocurrencies with the lowest market cap

Source: CoinMarketCap

Volatility


Cryptocurrencies are known to fluctuate for a variety of reasons. To name a few, cryptocurrencies are susceptible to fraud and manipulation, cryptocurrencies tend to be highly correlated, and cryptocurrencies are highly speculative.


Fraud and Manipulation


If a cryptocurrency has low-liquidity, it is easier for individuals with a lot of wealth to influence the price. A very wealthy individual could buy $100 Million of a token with a market cap of $50 million— buying in with an amount that is double the market cap will more than likely raise the price of the cryptocurrency— and once the price of the digital token rises from the buy-in, the manipulator could sell all of their tokens for a profit. The people who bought in because they saw a currency with a rapidly increasing price will suffer a devaluation once the high-roller sells off. This scheme is referred to as “the pump and dump”. For a period of time, pump and dump schemes ran rampant in the world of blockchain and cryptocurrency through popular messaging apps like Telegram.


High Correlation


On some exchanges, the price of altcoins is highly correlated with the price of Bitcoin. For example, when the price of BTC is falling, some algorithms are programmed to sell altcoins for BTC. Afterward, the algorithm immediately sells the BTC for a cash position and then waits for the price of BTC to decline so it can buy back in for cheaper. This strategy has the tendency to affect the price of cryptocurrencies and push them toward the same price trend.

Highly correlated market - February 2nd, 2018

Source: CoinMarketCap


Speculation


Cryptocurrencies are still a highly speculative asset. One reason we can credit the all-time highs reached between December and January of 2017-2018, is because of the new investors that joined the market for speculative purposes. Blockchain and cryptocurrency were all over the media, it was in newspaper headlines, and it was featured on local news channels. When retail investors— an investor who makes investments on their own behalf— caught word that cryptocurrency was a hot investment and that investing in crypto could multiply your wealth overnight, the “dumb money” started pouring in. Individuals began making investments because everyone was praising cryptocurrency as an effective investment vehicle, however, retail investors were not really doing research on the investments themselves. When the dumb money poured in, the smart money—experienced investors— left the market. Subsequently, the price of Bitcoin declined and kicked off a five-month bear market; Bitcoin is currently down from its all-time high in December.


Low Volatility Cryptocurrencies?


But not all cryptocurrencies are as volatile as large-cap currencies like Bitcoin. Some cryptocurrencies were designed to be stablecoins; cryptocurrencies with low volatility that are usually pegged or backed to tangible assets. For this reason, most stablecoins provide investors with a way of knowing the exact value of their investment. For example, Kinesis has backed their Kinesis currencies with precious metals; one Kinesis currency is equal to one gram of fine gold, which is currently valued around $41.00

Stability


It is estimated that by 1950, 65% of the world's gold had been mined. The finiteness and scarcity of gold and other precious metals tend to lead to a general price increase in the long run. That is why precious metals like gold and silver are typically safe and reliable stores of wealth.

Gold prices from 1960-2018

Source: Realterm


Some nations even view gold as one of the best ways to pass wealth down from generation to generation. Gold is an investment with no default risk, you do not have to worry about a company or individual paying you back for holding the asset. And gold is typically not affected by factors that affect fiat currency like geopolitical issues, taxation, and printing money. When confidence in the government is low, the price of gold usually increases, that is why gold is called a crisis commodity.


Diversifying Away Risk


Because gold is not usually affected by the same factors that affect the fiat underlying aspects of the economy, gold is a useful investment vehicle for hedging away risk. Similar to gold, stablecoins are useful for hedging away risk; stablecoins are usually pegged or backed to tangible assets that are not typically affected by the same factors that cause cryptocurrency prices to fluctuate. The cryptocurrency market is still highly speculative and nobody really knows how to determine the exact value of digital assets yet. But holding a low volatility asset like a stablecoin at least gives investors some assurance that their money is actually worth something, and that the value of their money will not decline by 5% around breakfast, and then rise 10% around dinner time-- something that is often the case in the cryptocurrency market.