Is it ever too late to join the bitcoin bandwagon? After a crash that took four years to reach its $1000 watermark again, bitcoin has now reached a value of over $11,000 USD (when this article was written). This means that the price of a single Bitcoin token has risen by more than 333199900% in 8 years. This year alone, bitcoin’s price skyrocketed by over 700%, completely leaving the 90’s ‘dot com boom’ a relic of the past.
Skepticism and apathy by some still limit the growth of bitcoin’s price and adoption. When most of us try to explain bitcoin or even try to scratch the surface of how it operates, our brains can become frazzled. Does bitcoin have any intrinsic value? Is it a fiat currency if it’s not government issued? How do we determine bitcoin price? What even is bitcoin mining?
Take a deep breath. Bitcoin follows the same laws of supply and demand and price indexing that all currencies do. Here, we’ll explain how we calculate bitcoin’s price and what factors are driving its growth.
Bitcoin is a Fiat Currency, but More Trusted
First, let’s provide a little background about bitcoin so you can understand how it operates over exchange markets.
While many people compare bitcoin to gold, it holds no intrinsic value. It’s essentially a proof of work for bitcoin miners who conduct complex algorithms using bitcoin mining technology. Bitcoin as a currency does not affect its price. Only when bitcoin is exchanged using other currency does the price of bitcoin rise or fall in terms of that currency.
Bitcoin holds a set supply of money at 21 million coins, which will be slowly reached in the next 100 years. This has many advantages of over government issued fiat money because new money cannot be printed to pay for wars and social programs that cause rapid inflation and devalue savings.
Essentially, the price of bitcoin in USD is the same as we’d value a euro in terms of USD. Unfortunately, exchange rates can be more volatile for foreign currencies that delve too much into quantitative easing. This brings up to an important factor affecting bitcoin’s price in exchange markets: trust. With high trust and short growing supply, bitcoin is turning into a pseudo-bubble because it’s more trusted by its adopters than fiat currencies.
Reasons why bitcoin is highly trusted:
- There‘s a set supply that can be reached at 21 million coins
- Supply is always calculable because of the blockchain
- Supply increases at a steady rate and asymptomatically of price volatility
- Cryptocurrency is hard and almost impossible to regulate (Can only be regulated fiscally through taxation if exchanged for government recognized currency)
- E-commerce platforms have begun to accept bitcoin as a medium of exchange for basic goods
While there may be a little more than a trillion US dollars in circulation, there are tens trillions of more that exist through due to fractional reserve banking, publicly issued debt, and unfunded public liabilities. With a set supply, cryptocurrency cannot be manipulated to accomplish particular ends.
The blockchain also provides trust and security for transactions by promoting transparency. This sends clearer signals to investors and bitcoin owners, leading to more sustainable investment and speculation.
Price is not Determined in the Bitcoin Payment Network
Decentralized currency is difficult to understand because it’s not government issued and its value is wholly determined by its adopters. It’s important to clarify the myth that the price of bitcoin is determined inside its payment network. Bitcoin is a protocol while bitcoins are the currency. The bitcoin payment network can only be interpreted to indirectly influence its price over speculative markets. Consider this, over $2 billion worth of exchanges are being conducted over cryptocurrency exchanges each day, but the rate of transactions has not risen proportionately.
Supply, Demand, and Early Adoption
Bitcoin’s price is determined by the law of supply and demand, just like all products free of government intervention. In simple terms, each time a bitcoin is purchased, the price rises as the supply shrinks. In more complex terms, the perceived store of value or expected future appreciation of a bitcoin token increases demand and thus its price.
The rate of its adoption or the amount of people now mining or investing in bitcoin also influences the price. With relatively low velocity, many people have begun to store bitcoin or incorporate them into larger investment portfolios. This further increases the value of bitcoin over the long-term and promotes growth in its speculative market.
Bitcoin enjoyed very little price change in its early days because of low cap stock and few early adopters of the cryptocurrency. As more people began to purchase bitcoins, it resulted in more speculation and rapid price increase, in terms of USD. But, it wasn’t until major international companies and banks began conducting high volume bitcoin trading did its value begin to rise exponentially. Similar phenomenon has occurred in other popular cryptocurrencies, such as ethereum and litecoin.
Volatility in Bitcoin
Bitcoin’s low trade volume and small rate of early adopters made it inherently volatile over speculative markets. This volatility decreased trust in bitcoin resulting in massive crashes in its early days. When this occurs it reduces a currency’s store of value. Of course, this swing also increases its velocity and currencies soon recover.
Now as bitcoin receives mainstream adoption from major financial institutions its long-term volatility has been reduced to short and interim shocks. Many economists contend that bitcoin’s volatility will continue until its payment network and exchange system can be scaled beyond the blockchain ledger.
One factor that influences bitcoin’s volatility is the volatility of other exchange currencies. As countries around the world devalue their currency and international currency markets become more unstable, banks will start to invest more into assets, such as gold and cryptocurrencies. Of course, the inverse is true. A stable currency exchange market will result in reduced bitcoin investment and low-volume bitcoin selloffs.
Externalities: From Online News to International Banks
Finally, bitcoin price has been determined by externalities that have discouraged consumer trust in the currency as a store of value. For one, cryptocurrency is digital, which leaves it vulnerable to hacks. A prime example was the bankruptcy of Mt.Gox, which handled 70% of the world’s bitcoin exchanges up to 2014. When it filed for bankruptcy, it was discovered that over $450 million worth of bitcoin had been lost or mismanaged.
Accidents like this and media firestorms over cryptocurrency vulnerabilities further exacerbate bitcoin’s volatility. Attempts to tax and even regulate bitcoin mining also add to shocks in bitcoin’s price index.
On the other hand, major financial institutions and foreign governments have also added to bitcoin’s popularity and made it into a bull market. Asian countries, such as China, India and Singapore have been a major impetus in bitcoin’s early adoption. In countries across Asia P2P trading makes interstate transactions easier and more transparent.
Bitcoin’s price is determined by a number of factors; the most important being consumer trust. Volatility in its price index will continue as countries continue to threaten regulations and diminish their own currency’s PPP. The future of bitcoin and cryptocurrencies looks bright. Judging from bitcoin’s breakout year, we should see many ICOs and the price of bitcoin continue to climb in value, as well bitcoin’s importance in international financial markets.