ELi5:On What a Basis Do Crypto And Share Market Go Up And Down
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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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