When it comes to valuation of any commodity there are two main players in the game, producers and investors. Let’s take an example from the real world orange juice market. There are producers, the orange farmers, who utilize their land to create material commonly known as oranges. The primary requirements to produce oranges are land, farming equipment and labor. Add the cost of the resources together and the farmer has a base price in which he is willing to sell them. Orange juice manufacturers are buyers of the oranges to produce a good, orange juice, that we all enjoy from time to time. The orange juice manufacturer must include the price of the oranges into their calculation of cost of producing orange juice. Other factors include processing the oranges into orange juice, advertising, etc. Each player adds a buffer of profit into the equation and the final product is delivered to stores and eventually sold to customers.
Investors in orange juice contracts offer a great hedging vehicle for all players in the process of producing orange juice. An investor buying orange juice contracts theoretically take ownership of the value of the finalized orange juice product at a price. If the cost of producing orange juice goes down, the willingness of investors to buy will decrease, sending the price of the orange juice contract lower. This seems simple enough to understand that the cost of production will have a direct effect on the value of the final product.
Investors have quite a bit more to consider when determining the price of an orange juice contract. What will happen to the price of the contract if orange juice suddenly is the cure for a major disease? Even though the cost of producing the product remains the same, the price of an orange juice contract will soar! Won’t the farmers eventually ask for more for their oranges? In the short-term yes, however the market for the orange will eventually adjust back down because more people will want to farm oranges.
What does this have to do with cryptocurrency? Well the market dynamics are very similar to the orange juice market. Substitute farmers with miners, and investors with…well investors, and you have the beginnings of cryptocurrency valuation. Miners produce coins through a process of solving difficult mathematical equations using computers. These computers require electricity to maintain competitiveness among the other miners trying to do the same. If a coin is worth mining, the machine is turned on, producing a hash rate. A hash rate is how hard the computer is working to solve the equations. The sum total of the individual hash rates is known as the network hash rate.
As you can see the network hash rate is the key metric in determining the overall demand to mine a particular currency. Couple this metric with the price of the currency on the cryptomarkets, and we have a great canvas in which to begin painting the valuation picture of a specific coin.
My goal is to report significant changes in both of these metrics. Thank you to CCN for inviting me aboard and I am committed to providing valuable, actionable and educational news from the core of the markets. Back to the blockchains for me!
-The Crypto Analyst
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Last modified: April 20, 2014 18:25 UTC