ELi5:On What a Basis Do Crypto And Share Market Go Up And Down
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They go up and down based on what someone else is willing to pay. If you have 1 share of a stock and want to sell, you want to sell for the highest price possible. And the highest price possible is whatever someone else is willing to pay you for that share.
It all has to do with what other people are willing to pay.
Best I can figure, there’s two things that drive share price.
The first is the value of the company; it’s revenues, costs, risks, innovations, etc, etc. That is generally pretty stable day to day.
The second is emotion. And emotion can spin on a dime. Like when someone impersonating Eli Lilly & Co tweeted out “Insulin is free now”, Lilly’s stock price took an immediate hit. Nothing about the company had changed, but people panicked and that caused the price drop overnight.
My problem with crypto is that there’s no fundamental value behind it. None of them have established themselves as a widely used form of currency, it’s still pretty niche. So it’s value is driven almost exclusively by investor speculation. And investors are human. And humans are emotional creatures.
Crypto is driven by supply and demand of course but there are other component factors in each.
In supply, there is the available pool of crypto units. For BTC that will be limited to 21 million. Other cryptos have their own rules. Cryptos are “available” only insofar as people want to sell them, vs holding them in the belief they will rise in value.
On the demand side, there are factors such as utility: if I buy this thing, how can I use it? This touches on the adoption of crypto as a medium of exchange, which right now is very limited. There is security: are my holdings safe from loss and theft? There is stability: will my holdings suddenly lose value or will it be a reliable purchase? There is opportunity cost: do I have enough other currency to buy crypto?
Crypto is in an area that is between currency and investment without really being either. You’re not investing in the sense of lending money to an enterprise engaged in the pursuit of making something and sharing in the profits. And it’s not a currency because it has very little acceptance and is legal tender nowhere.
It’s just a thing that some people have decided is valuable to hold, will rise in value, and will become a viable currency when (if) regular money collapses.
As others mentioned, it comes down to supply and demand. But it might be helpful to understand the finance theory behind how stocks, crypto, real estate – or any asset class is valued, as all assets are demanded and purchased based on how much the investor values it.
The intrinsic value of an asset comes from something called a discounted cash flow. For example with a stock like Apple, we would try to estimate how much cash flow (profits) the company will generate in the future, and we ask how much we’re willing to pay for those stream of cash flows today (discounting). If investors find this value is above the current market share price, they will buy this stock until the intrinsic value = market value.
And so the theory is that these ups and downs of stock prices reflects how investors, on a large, aggregate scale, are trying to match intrinsic value = market value. They do this by buying when they think intrinsic < market value and selling when intrinsic > market value.
Of course as we’ve seen, not all investors buy and sell for these financially rational reasons. I don’t think GameStop investors were thinking about discounting future cash flows in their decisions. So there’s been some pushback on traditional finance theory as it looks like behavioural economics and emotions have a bigger role than we conceived.
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