What Determines Cryptocurrency Token Value?
At the core of every economy is one basic concept: supply and demand. This concept holds true for every market today including commodities, traditional currencies, and even cryptocurrencies. In principle, if an object’s price is determined by the market, it’s price would be dictated by supply and demand.
Consider the metal iron. Iron is a very useful metal. So useful, in fact, that it has been used by humans for millennia. From that point of view, the demand for the metal iron is high. Therefore, its price should be high. However, considering that iron is the fourth most common element on earth, the supply of iron is also very high. The result? Since both the supply of and the demand for iron is high, its price is relatively low, especially when compared to gold. In contrast, gold is rare; it is even rarer than iron. So, the supply of gold is low. What about the demand for gold? As one of the metals of antiquity, gold has been used by humans even before recorded history. Over the years, the allure of gold has never faded and, as such, continues to enjoy great demand from the jewelry and metallurgic industries. In short, gold has a low supply but high demand. The result? Gold has been one of the most expensive metals in history and continues to remain so.
These examples show how the dynamics of supply and demand dictate the amount people are willing to pay for an object. These same dynamics would apply for services like auto maintenance and hair cuts. With cryptocurrencies, it is also supply and demand that dictate token value. However, different types of cryptocurrency tokens derive value differently.
The Different Token Classes
Currency tokens. By far the most popular kind of token, these tokens derive their value from its usefulness as a currency or as a general store of value. The first cryptocurrency Bitcoin is an example of a currency token.
Asset tokens. These tokens have value because they are backed by an asset. This ‘asset’ could be anything of value including currency, a physical property, or even units of energy. In any case, these tokens represent ownership of an asset. Applying the principle of supply and demand, if demand for the asset that the token represents increases, then the value of the token would increase as well.
Utility tokens. These tokens are valued based on its adoption and usage in the network. The more this token is used, the greater its value. The cryptocurrency Ethereum is an example of a utility token where you must pay in Ether tokens in order to participate in the Ethereum network. For utility tokens, usefulness of the token generates demand for the token, and this demand increases its value.
These definitions sum up the common classes of tokens in cryptocurrency. Interestingly, it is possible to have a token that falls under all three categories at the same time. While it doesn’t exist yet, there could be a token that is a currency token, an asset token, and a utility token at the same time. What a token that would be!