“The report of my death was an exaggeration,” Mark Twain famously wrote.1 If cryptocurrency could talk, it might say the same.
Headlines have reported more than one “crypto collapse,”2 described chilly “crypto winters,”3 and asked repeatedly whether we have come to the “end of crypto.”4 In fact, one web site has counted 473 “obituaries” for Bitcoin alone.5
In the narrow context of the day's events, these headlines may have made sense. Cryptocurrency prices have spiked and swooned, rattling active investors and discouraging newcomers. However, in taking the long view of the (short) history of crypto, a different story emerges: the jagged fluctuations smooth out into an arc of growth for the major cryptocurrencies — and for the crypto industry in general.
Take bitcoin: It's true that it's worth less today than it was at its peak in autumn 2021.6 Then again, it's worth thousands of times more than it once was. In 2010, an early adopter paid 10,000 bitcoins, then worth about $41, for two pizzas. Today, the bitcoins that bought those pizzas are worth more than $300 million.7
No one can say whether the cryptocurrency bought today will appreciate or fall in value, or when, or by how much. However, we can explore the factors that drive changes in cryptocurrency demand. Understanding the influences moving the market offers a different perspective on weathering the inevitable ups and downs.
The value of cryptocurrency — in aggregate and individually for most well-known currencies — is vastly higher now than it was a decade ago. Yet, in the context of past highs, we are currently in one of the valuation troughs known as a “crypto winter."8
What causes these changes in cryptocurrency prices? One recent development: Cryptocurrency prices have started moving in line with the overall economy, sinking along with stock market indices in early 2022.9 Other than macroeconomic factors, though, the main driver of cryptocurrency price is, of course, demand. The more people who want to buy a certain cryptocurrency, the higher the price.10
Here's where it gets tricky: Not only does demand drive prices, but prices can also drive demand, causing a cycle with higher highs and lower lows. When investors or would-be investors see the price of a cryptocurrency declining, they may take it as a sign that this currency won't be a profitable investment and therefore sell or avoid buying, driving the price even lower. Inversely, a price hike may attract more investors, adding momentum to an increase.
With bitcoin in particular, the data supports the notion that price hikes drive demand, writes a team of researchers from the Bank for International Settlements: “The fact that adoption rises in the wake of price increases suggests that users enter the system attracted by high prices and in the expectation that prices continue to go up.”11
Every deep dip in the price of major cryptocurrencies like bitcoin and ether has been — eventually — followed by a higher peak. So far in 2023, bitcoin prices have been rising again.12 Are we now recovering from the crypto winter that began last year? It's too soon to say.13
Of course, the price fluctuations described in the first section affect market sentiment. But so do market events. Negative events, like the collapse of a crypto exchange, can drag down investor sentiment, and therefore cut demand. For example, the collapse of the FTX exchange in late 2022 unsurprisingly led to a dip in market sentiment and demand, illustrated by a 22% price decline in less than one day.14
Good news can change market sentiment for the better. A series of positive events, including the sale of a Beeple NFT for $69 million in ether, El Salvador adopting bitcoin as legal tender, and upgrades to ethereum and bitcoin, for instance, helped drive a massive spike in demand in 2021.15
Some events are hard to categorize as positive or negative until their full impact is felt. Regulation can be like that. After all, freedom from regulation is one of the things that attracted the first crypto enthusiasts.16 Some regulatory activities — when China banned crypto mining and trading, for example — hurt market sentiment and sent prices tumbling.17 But other regulations, including the establishment of legal frameworks for expanded use of crypto, have coincided with spikes in demand.18
In general, investors understand that well-crafted regulations could help protect consumers and investors from the negative events that caused past crashes. Because of that, the movements toward crypto regulation in the US and in other countries — if carried out well — will likely improve market sentiment, and possibly increase crypto demand. 19
Researchers have found that the price of bitcoin tends to increase when transactions using the currency grow.20 It makes sense, right? The more useful any given cryptocurrency is for buying things, the more in demand it should be.
Fortunately, crypto adoption is indeed growing. Enterprise blockchain company Ripple estimates there will be 5.5 million crypto payment users this year, which it calls a 350% increase over three years.21
People are using crypto more — and are expected to keep increasing their use — because crypto services are becoming more useful. Always a major application, global remittances and cross-border business transactions using crypto are expected to expand further as nations roll out pilot Central Bank Digital Currencies (CBDCs), which are virtual currencies backed by central banks.22 More businesses accepting crypto payments23 and a growing number of companies doling out cryptocurrency as rewards should also drive adoption.
Of course, there are still hurdles to be cleared before everyone from your corner bodega to your health insurance provider begins transacting in cryptocurrency. Stronger, better security measures must be implemented and, just as importantly, consumers need to be educated about how crypto works and how the new security measures can make it safer and more reliable.
Another major hurdle to clear: Consumers must be able to use crypto within their established financial routines instead of having to sign up for new accounts with unfamiliar companies. When consumers can pay their mortgage in crypto, take out some of their pay in crypto, or earn crypto interest on deposits, they may begin to prefer this new kind of currency for its ease, low transaction costs and speed.
Imagine you stumble across a new online auction site with great functionality and a beautiful user interface — way better than existing sites. The items you see for sale have great prices, too. However, after browsing for a few minutes, you go back to your old standby.
Why? Because the largest auction sites have more users. They have more sellers, which attracts more buyers, which in turn attracts more sellers.
That's a network effect. A business or technology benefiting from a network effect becomes more attractive as more people participate in it.24
The network effect is a big driver of demand for the most popular cryptocurrencies. For instance, bitcoin and ether have both gained enough users to give their currencies real utility.25 If you want to buy something using either, you can pretty easily find a seller who will accept it. The same can't be said for many less popular cryptocurrencies—at least not yet.
Price movements, market sentiment, adoption, and network effects — these are all the demand drivers that could bring cryptocurrency safely out of the crypto winter and on to the next wave of expansion. Although we have addressed each driver separately, all are intertwined. Market sentiment can cause price movements; adoption can affect sentiment and price; and network effects can push adoption as well as buoy both sentiment and price.
A bright crypto spring is possible, in which consumers and businesses are able to tap the promise of these innovations to participate in a more equitable, accessible and streamlined financial system. What's needed to make this spring arrive on time? We don't hold all the answers, but we know what could make a very good start: innovative companies, more consumer education, thoughtful regulation, and the integration of crypto into the services and brands consumers already use. Progress along these paths would be like April showers on the crypto landscape, bringing the potential for a riotous spring bloom and hearty summer growth.
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