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What factors influence the price of Bitcoin?

Posted by: Yoyokuo 2021-05-26 Comments Off on What factors influence the price of Bitcoin?

Bitcoin has fallen by more than 50% since it hit a record of nearly $65,000 in mid-April, and other mainstream coins and air coins have been bloody. This time, everyone seems to be particularly hit. Various negative reports are simply blatantly persuading investors to move away from cryptocurrency, blockchain, and the bubble industry. But in contrast, Musk hinted that Tesla will not sell Bitcoin, the “women stock god” is still optimistic that Bitcoin will rise to 500,000 U.S. dollars, and Justin Sun throws more than 280 million U.S. dollars to buy the bottom… In short, the polarization is very special. serious.

I will not do more analysis on the reasons for this plunge. This article uses Bitcoin as a representative to explore in depth the factors that determine the price of cryptocurrencies from a more macro perspective.

1. Supply and demand

We all know that, unlike investing in traditional currencies, Bitcoin is not issued by the central bank and has no government endorsement support. Therefore, the monetary policy, inflation rate, and economic growth measures that usually affect the value of currencies do not apply to Bitcoin.

Countries that do not have a fixed foreign exchange rate can control the amount of currency in circulation by adjusting discount rates, changing reserve requirements, or participating in open market operations. Through these choices, the central bank can potentially influence the exchange rate of a currency.

The supply of Bitcoin is affected in two different ways:

  • First, the Bitcoin protocol promotes the birth of new Bitcoins at a fixed rate. When miners process transaction blocks, new bitcoins will be introduced into the market, but the rate of introduction into the market will slow down over time. For example, the growth rate of Bitcoin slowed from 6.9% (2016) to 4.4% (2017) to 4.0% (2018). This may cause the demand for bitcoin to grow faster than the supply growth rate, and it will also drive up the price. The slowdown in Bitcoin circulation growth is due to the halving of block rewards provided to Bitcoin miners, which can also be considered artificial inflation in the cryptocurrency ecosystem.
  • Second, the supply of bitcoin may also be affected by the number of bitcoins. Satoshi Nakamoto stipulates that the upper limit of the number of bitcoins is 21 million. Once this number is reached, mining will not be able to create new bitcoins. For example, the Bitcoin supply reached 18.587 million in December 2020, accounting for 88.5% of the total Bitcoin supply. Once all 21 million bitcoins are in circulation, the price depends on whether it is considered to be of practical value (usable for trading), compliance, and demand, which is determined by the popularity of other cryptocurrencies.

The artificial inflation mechanism of block reward halving will no longer have an impact on the price of cryptocurrencies. However, according to the current adjustment speed of block rewards, the last Bitcoin will not be mined until around 2140.

2. Competition

Although Bitcoin may be the most well-known cryptocurrency, there are hundreds of other tokens competing for users’ attention, including Ethereum (ETH), Tether (USDT), Binance coin (BNB), Cardano (ADA), and Alternative currencies including Polkadot (DOT) are its closest competitors. Competition will cause prices to fall, which is definitely good news for investors and the entire ecosystem. Fortunately for Bitcoin, its high profile gives it an advantage over its competitors.

3. Production costs

Although Bitcoin is an invisible and intangible digital currency, it is still a produced product and will have production costs. So far, power consumption is the most important factor, and this is where Musk complains. Bitcoin “mining” relies on a complex cryptographic mathematical problem. Miners are competing to solve this problem. The first miner to solve this problem will get new Bitcoin blocks and the accumulation since the previous block was discovered. Transaction fee rewards.

Bitcoin is unique in that, unlike other products produced, Bitcoin’s algorithm only allows one Bitcoin block to be discovered every 10 minutes on average. This means that more producers (miners) join the competition to solve mathematical problems, which will only make the problem more difficult to solve, and therefore more expensive.

Studies have shown that the market price of Bitcoin is closely related to its marginal cost of production.

4. Exchange applicability

Just as stock investors trade stocks through indices such as the New York Stock Exchange, Nasdaq, and FTSE, cryptocurrency investors trade cryptocurrencies through Coinbase, GDAX, and other exchanges. Similar to traditional currency exchanges, these platforms allow investors to trade cryptocurrency/currency pairs (such as BTC/USD or Bitcoin/USD).

The more popular an exchange is, the easier it will be to attract more participants, thereby creating a network effect. By leveraging its market influence, it can set rules and manage how other currencies are added. The existence of a Bitcoin exchange implies a certain degree of regulatory compliance, regardless of the legal gray area of ​​cryptocurrency operations.

5. Regulatory and legal affairs

The rapid popularity of Bitcoin and other cryptocurrencies has caused a debate among regulators on how to classify such digital assets. Although the Securities and Exchange Commission (SEC) classifies cryptocurrencies as securities, the U.S. Commodity Futures Trading Commission (CFTC) considers Bitcoin to be a commodity. This confusion about which regulatory agency will set the rules for cryptocurrencies has created uncertainty and the amount of market capital has soared. The plummet on May 19 was largely due to the influence of domestic regulatory authorities’ policies.

In addition, the market has witnessed the launch of many financial products that use Bitcoin as the underlying asset, such as exchange-traded funds (ETF), futures and other derivatives. It mainly affects prices in two ways. First, it provides investors who are unable to purchase actual bitcoins with the right to use bitcoins, thereby increasing demand. Second, reduce price volatility and allow institutional investors who believe that bitcoin futures are overvalued or undervalued to use a lot of resources to bet that the price of bitcoin will develop in the opposite direction.

6. Stability of forks and governance

Bitcoin is not managed by a central authority. It relies on developers and miners to process transactions and keep the blockchain secure. Software changes are driven by consensus, which tends to frustrate the Bitcoin community because basic problems usually take a long time to resolve.

The scalability issue has always been a particular pain point. The number of transactions that can be processed depends on the size of the block, and Bitcoin software can currently only process about three transactions per second. Although this is not a problem when there is not much demand for cryptocurrencies, many people worry that slow transaction speeds will push investors to competitive cryptocurrencies.

The community is divided on the best way to increase the number of transactions. The changes to the rules for using the underlying software are called “forks.” A “soft fork” involves a rule change that does not lead to the creation of new cryptocurrencies, while a “hard fork” leads to the emergence of new cryptocurrencies. Past Bitcoin hard forks include Bitcoin Cash and Bitcoin Gold.

To Sum Up

Bitcoin is mainly affected by supply and market demand; mining costs; miners’ rewards for verifying transactions on the blockchain; the number of competitive cryptocurrencies; exchanges; regulations; and Bitcoin’s internal governance.

To make it easier to read, here is the FAQ about the price and value of Bitcoin:

1. How is the value of Bitcoin calculated?

The value of Bitcoin mainly depends on its supply and market demand for it. Its value is also attributed to other factors, such as alternative digital currencies, including supply and price, availability, and mining rewards. Based on block rewards, electricity prices, energy efficiency of mining hardware, and mining difficulty, the intrinsic value can also be estimated by calculating the average marginal production cost of a bitcoin at any particular point in time.

2. How did Bitcoin appreciate?

When Bitcoin approaches its maximum limit, the demand for it will increase. Increased demand and limited supply have driven the price of Bitcoin to rise. At the same time, more institutions have invested in Bitcoin and accepted it as a payment method, thereby increasing its utility and making it the preferred medium of exchange for consumers.

Due to cryptography and strong protocols, Bitcoin is relatively secure and can be obtained through several exchanges at any time. In addition, you don’t need to buy a full bitcoin to own it. Part of the shares can be used to increase its attractiveness and value.

3. How does Bitcoin make money?

Unlike stocks, Bitcoin does not represent ownership of a company or entity. Owning Bitcoin means owning digital currency, just as owning 1 dollar means owning paper money. Bitcoin miners are rewarded by completing verified transaction blocks, while Bitcoin owners make money as the price of each coin rises.

4. Why is Bitcoin so valuable?

The demand for Bitcoin is increasing, while the supply is decreasing. The size of each block is halved every four years on average, and the last Bitcoin mining time is about 2140. In fact, unlike most other commodities produced, Bitcoin’s supply rate cannot increase with a surge in demand.

The imbalance between supply and demand will cause prices to rise. Some consumers, companies, and investors favor Bitcoin because of its potential ability to hedge against inflation. The resulting epidemic helps increase demand, which leads to price increases.

5. What makes the price of Bitcoin rise and fall?

The price of Bitcoin fluctuates for various reasons, including media reports, speculation, and availability. Under the influence of negative news, some Bitcoin holders will panic, thereby pushing prices down, and vice versa. In addition, when the number of bitcoins sold on the market increases, the price will fall. As more and more institutions adopt Bitcoin as an investment and transaction medium, its price will rise.

In addition, many people have weakened their confidence in their fiat currencies and seek other sources to store their money. Since Bitcoin is decentralized and unregulated, it is a favorable alternative, which drives its price increase.