Bitcoin is the first modern cryptocurrency that hit the market. It was developed in 2009 by Satoshi Nakamoto, a name that was adopted by an unknown programmer (or programmers). Bitcoin is a decentralized digital currency that you can sell, exchange, and buy directly on cryptocurrency exchanges, without intermediaries such as banks.
The reason why Bitcoin doesn’t need any middlemen is because of its trustless nature. Bitcoin transactions take place on a peer-to-peer network that uses blockchain technology to verify the validity of the transactions. The blockchain consists of blocks, and every block is a transaction that was made in the Bitcoin network. In order for blocks to be attached to the blockchain, a miner uses a large amount of electricity and processing power to confirm the Bitcoin transaction. For every confirmed block, the miner gets rewarded in fractions of Bitcoin.
In this article, we’ll look at the factors that determine the price of Bitcoin, like the process of halving (reduced miners’ rewards). Finally, we’ll discuss the volatility of Bitcoin.
What Determines the Price of Bitcoin?
Bitcoin is a digital currency that has no intrinsic value. The price of Bitcoin isn’t determined by a central authority, such as a central bank or the government, as is the case for fiat currencies like the US Dollar and Euro. Therefore, the inflation rates, economic growth, and monetary policy qualifications that usually influence the value of fiat currencies don’t apply to Bitcoin.
So, what does affect Bitcoin’s price?
Demand and Supply
To start off, demand and supply have an effect on the value of Bitcoin, i.e. it’s based on the price that people are willing to pay for Bitcoin. In other words, if the demand for Bitcoin increases, then its price increases too, but if the demand decreases, the price decreases as well.
The supply of Bitcoin is controlled by complex algorithms on its blockchain: every ten minutes approximately 6.25 BTC are mined, and the maximum supply of Bitcoin is capped with an upper limit of 21,000,000 BTC. Because of this, the number of bitcoins in circulation is limited. This limits the supply, which, over time, increases the demand. Additionally, in order for Bitcoin to have a stable price, its demand has to follow the level of inflation.
The Bitcoin protocol enables development of new bitcoins at a constant rate. The newly mined assets are presented to the market after a miner confirms the upcoming blocks of transactions.
This can cause the demand for Bitcoin to increase faster than the supply rate (the speed required for new coins to get minted), which will inflate the price of Bitcoin.
The following factors influence the supply and demand for Bitcoin:
- The current Bitcoin supply;
- The costs for mining Bitcoin;
- The size of the mining rewards;
- The number of digital currencies involved;
- The Bitcoin exchange that you use to trade Bitcoin;
- The internal governance of Bitcoin;
- The public opinion and media.
Bitcoin miners affect Bitcoin’s market supply in a very specific way. In fact, they have to verify every BTC transaction by solving complex mathematical problems. This process secures Bitcoins’ network, and in return, miners earn from the block reward and the transaction fees for verification.
The block reward is defined as the amount of Bitcoin paid for confirming a block on the blockchain. At the moment, the Bitcoin reward is 6.25 BTC per block. The reward halves every four years, and this process is known as Bitcoin halving.
How does Bitcoin halving work? The reward is cut by half after 210,000 new blocks have been mined. In the beginning, the reward for the first 210,000 blocks was 50 BTC. By 2012, the mining reward was slashed in half to 25 BTC. In 2016, the reward reached 12.5 BTC, which is how it got to 6.25 BTC in 2020
Bitcoin miners can either keep their bitcoins or sell them on the digital market as soon as they get the block reward. They usually sell Bitcoin in order to avoid its volatility. Due to the fact that the price of Bitcoin is defined by demand and supply, the miners’ selling of the new bitcoins on the digital market will result in a decrease in the price of Bitcoin.
The Number of Cryptocurrencies
Bitcoin might be the first digital currency, but there are far more altcoins on the digital assets market. Some of the biggest rivals of Bitcoin are the following altcoins: Ethereum (ETH), Litecoin (LTC), Bitcoin Cash (BCH), and Ripple (XRP). The vast number of cryptocurrencies is excellent for investors as the bigger the competition is, the lower the price of the assets will be.
In order to mine bitcoins, you have to incur real expenses for the mining process, and electricity usage is the priciest by far. Bitcoin mining is based on cryptographic math tasks that miners compete to complete, as the one who solves the task first is the one who gets rewarded. Bitcoin’s algorithm enables one block of Bitcoin to be created every ten minutes. The number of miners affects the complexity of the math problem, meaning the higher the number of miners, the more difficult the problem, and this can cause more expenses in terms of the computing power needed to find a block or verify a BTC transaction. All of this will eventually increase the price of Bitcoin.
In order to buy or trade digital currencies, you need to use a cryptocurrency exchange such as Coinbase or Binance, for example. These cryptocurrency exchanges allow you to trade digital currency/fiat currency pairs, like BTC/USD. When an exchange platform becomes popular, it attracts more users. That, in turn, increases the liquidity of digital assets like Bitcoin, which increases the price of those cryptocurrencies.
Volatility of Bitcoin
The price of Bitcoin is volatile due to some of the following factors:
- Bad press and a fluctuating adoption rate. Thanks to several unfortunate events, such as the wildly illegal dealings on the Silk Road and the hacking of Mt. Gox, which led to the loss of 850,000 BTC, Bitcoin has ended up in numerous press headlines. These events led to a decline in the reputation of Bitcoin worldwide at the time, and led to a decrease in the price of Bitcoin.
- There’s good press, too. Good news has an impact on the price of Bitcoin, too – and a positive one, at that. For example, when PayPal announced that they soon will allow users and merchants to buy, sell, hold, and accept BTC and other altcoins as a form of payment, the price of Bitcoin got pushed higher.
- The recognized store of value of Bitcoin. Another reason for BTC volatilities is the store of value that they are perceived to have, i.e. the customers’ perception of the value of Bitcoin in comparison to other altcoins. To put it another way, the users’ belief in this cryptocurrency is what creates and drives up its price. Additionally, there’s one particular quality of Bitcoin that makes it different from fiat currencies – its limited supply.
- Security breaches create volatility. Just as past breaches have an adverse effect on BTC’s reputation and thus, its price, fear of future breaches can also turn away potential investors and decrease the liquidity of this coin, which in turn can devalue its price.
Can Bitcoin’s Price Reach Zero?
Some people think that in the end, Bitcoin will crash down to zero due to its lack of intrinsic value and loose regulations. However, many experts disagree and believe that the projected numbers are in favor of Bitcoin’s future.
In a report titled “Risks and Returns of Cryptocurrency” that was published in 2018, the authors use Bitcoin’s historical returns to calculate its risk, which they deemed far different from that of other popular asset classes (fiat currencies, stocks, etc.). Their findings indicated that the chance of an unspecified disaster crashing Bitcoin’s value to zero stands between 0% and 1.3%, and it was around 0.4% at the time of publishing.
A Few Words Before You Go…
In the end, we can freely say that the two main factors that impact the price of Bitcoin are market supply and demand. Another thing that we’ve hoped that you should get out of this article is that the price of Bitcoin isn’t fixed but rather, it’s volatile, which means that it can go up and down due to various factors, making it difficult to predict its future fluctuations.