The Invisible Hand: How It Affects the Crypto Market

Does it ever seem like financial markets move with no discernible rhyme or reason? Though some market fluctuations are random, others have a hidden logic to them. Many events can be explained through the economic theory of "the invisible hand,” a term originally coined to explain why capitalists might occasionally make decisions that benefit society as a whole. However, it also has some surprising applications for investments and crypto markets. To learn what the invisible hand is — and why it matters to you — we present this helpful guide.

Key Takeaways:

• The economic theory of the “invisible hand” states that a market will automatically adjust to meet the needs of the public.
• In terms of crypto trading, it refers to the idea that prices naturally reach an equilibrium to suit both buyers and sellers.

What Is the Invisible Hand Concept?

The invisible hand is an economic theory that states the market will automatically adjust to meet the needs of the public. In crypto trades, it means prices will naturally reach an equilibrium that suits both buyers and sellers.

How Does the Invisible Hand Work?

To fully understand the concept of the invisible hand, we need to look at the theory that gave birth to it. The original concept dates back to a 1776 economic treatise published by economist Adam Smith. In it, Smith states that even though every individual in the market is acting in their own self-interest, all of these separate actions combine to create a capitalist society that benefits the entire nation and prevents a financial crisis. For example, renters want to pay the lowest possible price for rent, while landlords want to charge the highest possible price. All of these forces will create an "invisible hand" that keeps rent from being either too high or too low.

This theory was created centuries ago, but it still has many applications for modern financial markets and crypto investors. It essentially describes the way a free market economic system can be influenced without apparent factors. Even if a government isn’t officially setting prices, everyone can come to an agreement about how much a certain asset is worth. 

As crypto purchasers, sellers and creators work to satisfy their own needs, each one’s individual self-interest can create a system that works well for everyone.

Why Is the Invisible Hand Important?

The invisible hand provides a useful model for conceptualizing changes to the crypto market. Instead of seeing market fluctuations as completely random, it allows people to consider underlying causes. And from a more philosophical viewpoint, this can be a useful way for investors to remain calm and logical about market fluctuations. Instead of panicking the second that prices dip, investors can recognize that the system is a free market, one which will inevitably adjust to accommodate the individual self-interests of its users.

On an even more practical level, the invisible hand model is important because understanding crypto markets is often the first step to predicting them. Investors can use economic theory to analyze the way crypto exchanges move, and to consider what will happen next. By considering how their own self-interest and other people's choices will impact the market, investors can try to predict what will happen next.

How Does the Invisible Hand Affect the Crypto Market?

The invisible hand is constantly impacting the prices of crypto. Keep in mind that this complex economic theory covers a lot more than just simple supply and demand. Instead, it refers to all of the various factors that end up influencing the free market. 

For crypto, the invisible hand can include everything from computer processor prices to internet memes. Any time prices rise or fall without direct influence from regulators, the invisible hand is at work. Taking a look at some of the most notable examples of the invisible hand theory in crypto can show the many ways in which this concept affects the market.

Effect on Bitcoin

Several 2023 Bitcoin price spikes show the effect of the invisible hand. Recently, investors have speculated on market prices by purchasing call options. This type of option contract gives you the right to buy crypto at a certain strike price, providing profit if BTC prices rise. In order to actually supply the crypto for this contract, a market maker must step in to provide the necessary tokens. However, when investors are focused entirely on calls, market makers end up in a negative feedback loop that pushes crypto prices higher and higher.

Fortunately, the invisible hand steps in to prevent overvalued crypto. The tremendous fluctuations in crypto prices increase the price of options themselves, and purchasers start to worry that Bitcoin prices can’t rise any higher. Ultimately, the increased risk and price combine to calm option purchases, and market forces encourage Bitcoin prices to decline. In this way, the invisible hand has intervened to help stabilize Bitcoin prices.

Effect on Ethereum

Since Ethereum is so frequently used as the base for other DeFi projects, there are a lot of different ways in which users' needs can impact the market. For instance, consider the 2022 Otherside project, from Yuga Labs. During this hotly anticipated NFT launch, investors noticed an unfortunate side effect: Due to the way Ethereum is set up, increased market activity leads to higher gas fees. Users had to pay a premium to ensure their transactions actually went through, and a total of $175 million was spent on fees alone.

This resulted in a lot of backlash and controversy, with Yuga Labs announcing plans to entirely change the way they mint NFTs. Other innovators took note of the problem as well, and have subsequently announced plans to create their own blockchains instead of building on Ethereum. 

Ultimately, the Ethereum community was encouraged to moderate activity and design new projects in a way that won't excessively impact gas fees. This situation highlights the fact that the invisible hand can encourage progress without requiring outside regulators to get involved.

Effect on Other Cryptocurrencies

The most common way that the invisible hand affects cryptocurrencies is through prices. When a popular coin's price starts to drop, users buy up a lot of coins and push the price right back up. Meanwhile, when a crypto's price spikes, fears about market instability tend to drive prices back down. Thanks to the invisible hand, crypto prices remain fairly stable.

The invisible hand also impacts regulation for other crypto participants, such as exchanges. Despite fears that unregulated crypto exchanges could cause a financial crisis, many nations have demonstrated that the invisible hand still encourages highly effective self-regulation.

The Bottom Line

Ultimately, the concept of the invisible hand created by Adam Smith is a highly useful tool for crypto investors. Though no single economic theory can fully summarize cryptocurrency markets, the invisible hand theory does help to explain why cryptos often settle at certain price points, and how markets can regulate themselves. By recognizing the way market forces impact the free market economic system, we gain a better understanding of crypto markets, enhancing our ability to predict certain recurring patterns.

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