What determines the price of bitcoin?
Bitcoin (BTCUSD) is a cryptocurrency developed in 2009 by Satoshi Nakamoto, the name given to the unknown creator (or creator) of this virtual currency. Transactions are recorded in a blockchain, which shows the transaction history for each entity and proves ownership.
Unlike investing in traditional currencies, bitcoin is not issued by a central bank or backed by a government. And buying bitcoin is different from buying stocks or bonds because bitcoin is not a corporation. As a result, there are no corporate balance sheets or Form 10-Ks to review.
- Buying stock gives you ownership in a company, whereas buying bitcoin gives you ownership of that cryptocurrency.
- Bitcoin is neither issued nor regulated by the central government and is therefore not subject to government monetary policies.
- The price of bitcoin is primarily influenced by its supply, market demand, availability, and competing cryptocurrencies.
- As of December 2020, approximately 88.5% of the total bitcoin supply was mined.
Understanding What Determines the Price of Bitcoin
Unlike investing in traditional currencies, bitcoin is not issued by a central bank or backed by a government; Therefore, monetary policy, inflation rates, and economic growth measures that usually affect the value of a currency do not apply to bitcoin. Conversely, bitcoin prices are influenced by the following factors:
- Bitcoin supply and market demand for it
- The cost of making bitcoins through the mining process
- Rewards issued to bitcoin miners for verifying transactions in the blockchain
- Number of competing cryptocurrencies
- Regulations governing its sale and use and the state of its internal governance
- news development
The supply of an asset plays an important role in determining its price. A scarce asset is more likely to be priced higher, while one that is available in abundance has a lower price. The supply of bitcoin has been dwindling since the beginning. The cryptocurrency’s protocol only allows new bitcoins to be created at a fixed rate, and that rate is designed to slow down over time. Thus, the supply of bitcoin declined from 6.9% in 2016 to 4.4% in 2017 and 4% in 2018. The bitcoin halving event, which occurs every four years, generally corresponds to a significant jump in its price as it means the cryptocurrency’s supply has diminished.
Although bitcoin has not yet been favored as a medium of exchange, it has attracted the attention of retail investors. The location of demand for bitcoin varies based on economic and geopolitical considerations. For example, citizens of China may have reportedly used cryptocurrencies to circumvent capital controls in 2020. Bitcoin has also become popular in countries with high inflation and devalued currencies, such as Venezuela. It is also popular among criminals who use it to transfer large sums of money for illegal activities. Lastly, with increasing media coverage has also increased investor demand for the cryptocurrency.
All this means that a decrease in supply combined with an increase in demand has acted as fuel for the price of bitcoin. The alternating periods of booms and busts have become a feature of the cryptocurrency ecosystem. For example, the bitcoin price rally in 2017 was followed by a long winter.
cost of making
Like other commodities, the cost of production plays an important role in determining the price of bitcoin. According to research, the price of bitcoin in crypto markets is closely related to the marginal cost of its production.
For bitcoin, the cost of production is roughly the sum of the direct fixed costs for the infrastructure and the indirect costs related to the electricity required for the cryptocurrency and the difficulty level of its algorithms. Bitcoin mining consists of miners competing to solve a complex math problem – the first miner to do so wins a reward for newly-mined bitcoins and any transaction fees accumulated since the last block was found.
Brute force is required in the form of sufficient processing power to reach the solution of the problem. In monetary terms, this means that miners will have to spend money racking up miners equipped with expensive processors. The bitcoin mining process also incurs expensive electricity bills, which, by some estimates, account for between 90 and 95% of the total cost.
According to estimates by some sites, the electricity consumption for the bitcoin mining process is equal to or higher than that of the entire country. The indirect cost of bitcoin mining is the difficulty level of its algorithm. Different difficulty levels of bitcoin’s algorithms can speed up or slow down the rate of bitcoin production and affect its overall supply, affecting its price.
Although bitcoin is the most well-known cryptocurrency, there are hundreds of other tokens for crypto investment dollars. As of 2021, bitcoin dominates trading in the cryptocurrency markets. But over time its dominance waned. In 2017, bitcoin accounted for over 80% of the overall market capitalization of crypto markets. By 2021, that share had dropped to less than 50%.
The main reason for this was the increase in awareness and capabilities of alternative coins. For example, Ethereum’s Ether (ETHUSD) has emerged as a strong competition to Bitcoin due to the boom in decentralized finance (DeFi) tokens. Investors seeing its potential in recreating the tracks of modern financial infrastructure have invested in ether, the cryptocurrency used as “gas” for transactions on its network. As of October 13, 2021, Ethereum accounted for approximately 18% of the total market cap of the cryptocurrency markets. Ripple’s XRP (XRPUSD) and Cardano’s ADA have also grown in popularity, while the rise in stablecoins has drawn investors’ attention to Binance’s BNB token.
Even though this has taken away investment dollars from the bitcoin ecosystem, competition has drawn investors to the asset class as well. As a result, demand and awareness about cryptocurrencies has increased. As a flag bearer for the cryptocurrency ecosystem, Bitcoin has benefited from attention, and its price has increased.
Bitcoin was issued after the financial crisis due to easing of regulations in the derivatives market. The cryptocurrency itself remains mostly unregulated and has earned a reputation for its border- and regulation-free ecosystem. Bitcoin’s regulatory status has its benefits and drawbacks. On the one hand, the absence of regulation means that it can be used freely across borders and is not subject to the same government-imposed controls as other currencies.
But it also means that using and trading bitcoin in most financial jurisdictions can invite criminal consequences. Most institutional investors are still wary of putting their money into the asset class, which results in less liquidity and more volatility for its ecosystem.
El Salvador made bitcoin legal tender on June 9, 2021. It is the first country to do so. Cryptocurrency can be used for any transaction where the business can accept it. The US dollar remains the primary currency of El Salvador.
The more governments around the world incorporate bitcoin into their economies and markets, the more likely it is to become a legitimate asset class for investment. Cryptocurrency investors and traders closely follow regulatory developments related to bitcoin as it is an indicator of liquidity in the crypto markets. These developments put pressure on its price as they affect its supply and demand.
For example, China’s move to ban bitcoin trading and limit the operation of bitcoin mining infrastructure affects the supply and demand of the cryptocurrency. in the United States,