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I recently have gained interest in the way currency value is derived in crypto-currencies and have researched the ins and outs of supply and demand. Is there a particular mathematical formula to compute both the supply and demand curves based off of data. In other words what data is needed in order to come up with currency value. I understand that supply of course is just the unit amount of a currency that is available for consumption. Demand however seems to be a bit tricky in that its curve can be adjusted by more than one factor.

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EDIT

I am by no means attempting to argue the legitimacy of crypto-curriences because I think the value of bitcoin alone explains for itself how much we value it regardless of any real physical asset to back it up. I am merely asking by what means is that value derived.

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  • $\begingroup$ Demand is adjusted by hype. Hype is very hard to quantify. $\endgroup$ – Hot Licks Dec 23 '17 at 1:58
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    $\begingroup$ To what extent supply and demand curves are useful concepts, they are embedded in some larger economic model. You would need to estimate that model. Otherwise, you have nothing to pin down the curves, and your analysis just tells you the current price of a crypto-currency is the intersection of those curves (regardless of what the price is). $\endgroup$ – Brian Romanchuk Dec 25 '17 at 18:07
  • $\begingroup$ I have always just assumed that currency value was a concrete number but by going off of what @BrianRomanchuk has said it seems the value can be determined using these economic models, but who is to say one analyst's model is more accurate than the other. So does this mean that the value we see on say Coinbase for various cryptocurrencies are just an average value based off of multiple different models? Also it seems to me that one can derive the demand especially for a crypto-currency by tracking the amount sold relative to the quantity over set increments of time correct? $\endgroup$ – StoneAgeCoder Dec 26 '17 at 19:28
  • $\begingroup$ Coinbase is an exchange? It should be quoting what people are willing to bid for the cryptocurrencies (or what they are asking to sell). Since for every buyer there is a seller, the quantity sold equals the amount bought, and the volume information has limited usefulness. In any event, I cannot recall any successful attempt to fit a supply/demand model for any financial asset market. $\endgroup$ – Brian Romanchuk Dec 27 '17 at 20:33
  • $\begingroup$ @BrianRomanchuk I am not so sure that it is completely useless for crypto in particular. The problem with the traditional system was cash, but with the blockchain it is possible to see an overall demand using volume information/time relative to supply/time. Couldn't one theoretically control volatility by controlling the amount minted relative to how much was bought/sold at any given increment of time? So say at some point the demand goes down for a number of reasons respective of the total amount bought and sold per day lets say. A self governing chain could adjust its new supply accordingly? $\endgroup$ – StoneAgeCoder Dec 27 '17 at 22:15
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This is a difficult question in that it is very difficult to prove that something is impossible. However, based on the types of analysis done in financial markets, estimating supply and demand curves is obviously difficult to do.

The usual methods for valuing assets in financial markets is to rely on some relative value versus a similar asset, or discounted cash flow. For a currency, we can compare the prices of similar items (hourly wages, goods prices) to get fair value. However, I am unaware of items sold at fixed prices in crypto currencies that would allow us to use a similar valuation method.

As for supply and demand, unless we have a reason to know that supply and demand curves follow some particular parameterisation, all that it says that for every buyer there is a seller. A price change can either be explained by the supply curve or the demand curve shifting (or both); we have no idea what happened. There is no clear method to go from observed transaction data to back out supply and demand curves.

For example, imagine there are a sequence of transactions at rising prices. Is that because there was an increased demand by buyers, or was it the result of existing owners being less willing to sell? Since every transaction has two sides, we have no idea. All we know for sure is that the price went up - which we could see by just looking at the time series of prices.

Furthermore, prices can change without any transactions. In the financial markets, prices jump on the release of economic or corporate news. This is much more easily interpreted as a change in fair value, rather than a shift in demand or supply curves.

Finally, it is unclear what a supply or demand curve represents. In the short term, a crypto currency supply is fixed (at least until the next coin is “mined”). How exactly can the quantity supplied or demanded change?

In other words, probably the only way to see whether “supply and demand” work is to build a model that works. I am unaware of any successful attempts in other asset markets to build such a model, so you have little guidance on how it could be done.

Addendum: It is difficult to control supply to keep an asset near a target level. Preventing the price from going up is easy, as you could just flood the market. Stopping the price from falling is difficult. You cannot destroy currency units held by people, and so you cannot reduce the amount outstanding. If people want to sell at a lower price, there is little you can do except buy the crypto up with some kind of currency reserves. (Which is how currency pegs are defended.) However, currency pegs tend to fail. (I believe some crypto currencies follow a backing strategy; I do not know how popular those currencies are are.)

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  • $\begingroup$ This answer is helpful and re-iterates thoroughly your explanation in the comments above. If one could theoretically build a model which "works" i could see it being useful as a means to control the supply as per block mined to provide incentive for those holding the currency to buy or sell via means of deflation or inflation.This in turn could control volatility over time making price a little more predictable for investors on a controlled curve. The benefit would also allow room for growth beyond the point of a market cap since supply would not be a fixed amount per block. $\endgroup$ – StoneAgeCoder Dec 29 '17 at 7:08
  • $\begingroup$ There is many holes in this theory as you have clearly explained just an additional thought however :). Would +1 the answer but have low rep it seems. $\endgroup$ – StoneAgeCoder Dec 29 '17 at 7:12
  • $\begingroup$ You could break out your question about trying to control supply. This website needs very specific questions; ones that are too general are impossible to answer. I will comment on it above. $\endgroup$ – Brian Romanchuk Dec 29 '17 at 13:39

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