There has been a very interesting mystery that has been occurring for many years. It’s known as the paradox of value or the water-diamond paradox. Many economists and philosophers have tried to figure it out without much success. The main idea behind this is the contradiction that although water is essential for survival, its price in the market is much lower compared to the price of diamonds. We all know that diamonds don’t have much practical use in our everyday life, especially compared to water.
The concept of utility is the main thing behind this contradiction. As we just mentioned, water is very important to all of us, and its utility value is incredibly high. On the other hand, diamonds are an expensive luxury item with limited practical use, making their use value very low. At the same time, when we compare the prices of both in the market (not in all places in the world, but overall), the price of a diamond is many times higher than the one of water. This raises the question of what determines the market value and what are the most important factors that affect it. Is utility the main factor behind the market value or there is something else?
In the world of cryptocurrencies, a very similar discussion has been taking place for a long time — likely since the birth of this new type of market. Most investors believe that crypto prices should be and are very much related to utility. However, as we have already seen from the water-diamond paradox, maybe this is not always valid.
One reason for this could be that the price is not dependent only on the utility but also on other factors like supply and demand, for example, which can affect price action regardless of the utility. Another important factor that can affect the price of a cryptocurrency can be the cost of minting. This can affect the market value no matter what the utility is. If the expense of production of a coin is high, its price may also be high — even if its utility is very limited. Likewise, the opposite is also true. If the cost of the token is low, the price may be low too — even if there are plenty of use cases behind it.
Join the community where you can transform the future. Cointelegraph Innovation Circle brings blockchain technology leaders together to connect, collaborate and publish. Apply today
Another explanation for the disproportion between utility and price can be the concept of network effects. In the case of cryptos, the value of a coin is often tied to the size and strength of its network. This means that the more people use a particular coin, the more valuable it becomes, even if it has only one utility — as a store of value, for example. This is because a bigger network brings more liquidity for the coin.
However, the opposite is also true. If a cryptocurrency doesn’t have many users or is not widely adopted, its utility value may be high, but its price may be low. This is because there are fewer opportunities to use the coin, and it is less liquid. Keep in mind that if we go back to the paradox, we can find out that even this doesn’t always have the same effects on price. As we know a lot more people use water on a daily basis compared to diamond users, but water is still the cheaper option.
Furthermore, one big factor that can impact the price of a cryptocurrency is speculation. Cryptocurrencies are very often viewed and advertised as speculative investments. There are plenty of people who are buying them in the hope that their prices will increase over time. Such speculation can increase the price of a coin, even if its utility value is low. This is because investors are ready to pay more for an asset if they believe its price will go higher in the future.
If you want to put this into practice, you may try to use these guidelines:
- Analyze historical price trends and relations in order to find out if speculation has affected the prices.
- Check the indicators showing the supply and demand, such as trading volume and market depth, to see their impact on the price.
- Study the active user base, adoption rates and network growth for signals of network effect on up-and-coming protocols.
- Keep track of the effect that specific news, events and industry developments have had on the price.
- Examine the community platforms and search for factors that have affected the price substantially.
- Be informed about the expenses coming from mining or minting the tokens to understand their effect on prices.
- Do research on the utility and its effect on the price of the asset.
In conclusion, the water-diamond paradox highlights the complexity of market value and how it is determined by a variety of factors. Although utility can be an important component of market value, it is not the only one and it may not have the most significant effect on the price.
In the world of cryptocurrencies, the same can be said. The utility may be a serious factor in determining the price of a coin. However, other things such as cost of production, supply and demand, network effects and speculation can even play a more crucial role. By taking these factors into account, we can have a better understanding of how market value is determined, so we can make better-informed decisions when we are analyzing crypto-investing opportunities.
Bogomil Stoev is the CMO of Seasonal Tokens — the ERC20 token system designed to make cyclical trading profitable.
This article was published through Cointelegraph Innovation Circle, a vetted organization of senior executives and experts in the blockchain technology industry who are building the future through the power of connections, collaboration and thought leadership. Opinions expressed do not necessarily reflect those of Cointelegraph.