What Determines the Value of Cryptocurrency?

In September 2017, the value of Bitcoin reached an all-time high, surpassing $5,000 according to the CoinDesk Index or, by Bloomberg’s slightly more modest estimates, reaching $4,921. As Bitcoin, which is often regarded as the “reserve currency” of the cryptocurrency sector, continues to hover near this record-setting valuation, the cryptocurrency market at large boasts an all-time-high capitalization of more than $170 billion.

Like any form of currency, cryptocurrencies derive their value from universal agreement regarding their worth. However, since cryptocurrencies are digital assets untethered to a central government, financial institution, or physical commodity, the matter of their value is often a topic of inquiry and skepticism.

Despite concerns over their illusory value, the monetary worth of cryptocurrencies is closely tied to the basic economic principles that govern not only monetary systems, but product-based economies as a whole. Cryptocurrencies derive value from their utility and scarcity. The anonymity, security, efficiency, and decentralized nature of blockchain-based currencies make them attractive as both a method of payment and an investment vehicle. Since the public enjoys the ability to pay for an ever-growing number of goods and services using cryptocurrencies, value investors use this information to speculate on the currencies’ future value by comparing them to similar physical asset classes. For example, Bitcoin enthusiasts commonly reference the market capitalization of gold to determine the relative value of Bitcoin. This type of speculation can further influence a cryptocurrency’s value.

Despite their increasing popularity, cryptocurrencies exist in finite numbers. For example, Bitcoin carries a maximum capacity of 21 million units, and as of March 2017, there were 16.2 million Bitcoins in circulation. The usefulness and limited nature of cryptocurrencies have fueled cycles of supply and demand, while their transferability and fungibility enable them to exist as tradeable assets.

While the success of any currency depends on public trust, it is particularly important for those currencies that are not backed by a physical commodity, such as fiat and cryptocurrencies. Public confidence in the value and stability of a cryptocurrency is necessary for it to retain its purchasing power and to enable the decentralized system of governance facilitated by the blockchain to continue to be successful. Therefore, negative media coverage, security breaches, and market-related shifts in public opinion can impact the value of cryptocurrencies. While cryptocurrencies exist outside of national legislative boundaries, some degree of governmental trust is also necessary if they are to remain a legitimate monetary system. Regulatory hurdles will not only damage public perception, but hamper a cryptocurrency’s successful operation in a given jurisdiction. On the other hand, governmental support can send a cryptocurrency’s value soaring to new heights. In April 2017, Bitcoin significantly increased in price after both Russia and Japan moved to legalize it. Moreover, the price of Ethereum surged after it was acknowledged as a form of payment by multiple Asian governments.

The technical infrastructure underpinning a given cryptocurrency can also influence its value, as it plays a role in determining a currency's upkeep costs and rate of adoption. Cryptocurrencies supported by more complex blockchains, such as the large proof-of-work blockchain used by Bitcoin, can present energy requirements equivalent to that of a small nation. And while cybersecurity is a top priority for both emerging and established cryptocurrencies, more secure blockchains require more intensive mining processes which, in turn, lead to higher energy costs.

How Blockchain Could Change the Music Industry

While digital currencies have yet to achieve mainstream use, blockchain—the technology that supports all cryptocurrency exchanges—has continued to gain renown in recent years. The use of blockchain technology has expanded considerably since it was first introduced by its anonymous creator, Satoshi Nakamoto, and according to a recent article on Forbes.com, it is expected to have a significant impact on the work of professionals beyond the financial sector, including those within the music industry.    

Currently, a majority of musical artists must cooperate with large groups of intermediaries in order to secure payment for their work, resulting in a system in which the musician is the party who performs all of the initial labor, but is the last person to see the profits from his or her efforts. Blockchain may be the solution that finally allows artists to upend this process through the use of smart contracts, a technology that uses algorithms to set pre-established rules in motion when a given transaction is verified. These smart contracts would allow consumers to securely pay musicians directly for their music without the need for a middleman.   

The ability to circumvent the middleman in music sales would not only help boost the compensation that musicians receive for their own work, but it would solve a number of frustrating problems that artists face through the existing profit model. For example, the industry struggles to maintain an up-to-date, easily accessible database of copyright information, making it difficult for music professionals to keep track of who owns the rights to recordings and songs. Since blockchain technology functions as both a network and database, artists who store copyright information on the blockchain in the form of a cryptographic digital fingerprint would make their music’s data available to every person who accesses the network. This would allow all music professionals to view copyright information the moment that a song or recording is uploaded to the blockchain, providing more clarity about ownership rights.