The world’s largest cryptocurrency, bitcoin, fell to $34,656 on Sunday afternoon, a 3.9% drop from Friday evening, according to prices from CoinDesk. Bitcoin slid below $34,000 to about half of its all-time high of $67,802 in November earlier in the afternoon.
So What Determines Bitcoin’s Price?
Bitcoin (BTC) is a cryptocurrency developed in 2009 by Satoshi Nakamoto, the name given to its unknown creator (or creators). Transactions are recorded in a blockchain, which shows the transaction history for each unit and proves ownership.
Unlike traditional currencies, Bitcoin is not issued by a central bank or backed by a government. For investors, buying a bitcoin is different from purchasing a stock or bond because Bitcoin is not a corporation. Consequently, there are no corporate balance sheets or Form 10-Ks to review, no fund performances to compare, or other traditional tools for choosing an investment.
Learn what influences Bitcoin’s price so that you can make more informed decisions about choosing it as an investment.
Major Points to Consider
- Purchasing stock grants you ownership in a company, whereas buying bitcoin grants you license of however much cryptocurrency your money bought.
- Bitcoin is neither issued nor regulated by a central government and therefore is not subject to governmental monetary policies.
- Bitcoin’s price is primarily affected by its supply, the market’s demand for it, availability, competing cryptocurrencies, and investor sentiment.
- Bitcoin supply is limited—there is a finite number of bitcoin, and the final coins are projected to be mined in 2140.
Bitcoin Acts More like a Commodity.
Bitcoin is not issued by a central bank or backed by a government; therefore, the monetary policy tools, inflation rates, and economic growth measurements that typically influence the value of a currency do not apply to Bitcoin. Bitcoin acts as more of a commodity being used to store value, so the following factors influence its price:
- The supply of Bitcoin and the market’s demand for it
- The cost of producing a bitcoin through the mining process
- The rewards issued to Bitcoin miners for verifying transactions to the blockchain
- The number of competing cryptocurrencies
- Regulations governing its sale and use
- The state of its internal governance
- Developmental and community news
Effects of Supply on Bitcoin’s Price
The supply of an asset plays a vital role in determining its price. A scarce asset is more likely to have high prices, whereas one available in plenty will have low prices. Bitcoin’s supply is generally well-publicized, as there will only ever be 21 million produced and only a specific amount created per year. Its protocol only allows new bitcoins to be built at a fixed rate, and that rate is designed to slow down over time.
The rate at which Bitcoin is created is reduced about every four years. Called a halving, where the number of coins given as a reward for successfully mining a block is cut in half, the last of which was in May 2020.
Bitcoin’s future supply is therefore dwindling, which adds to demand. This is similar to a reduction in corn supply if harvests were to be reduced every four years until no more was harvested, and it was publicly advertised that it would happen—corn prices would skyrocket.
Bitcoin’s Price and Demand
Bitcoin has attracted the attention of retail and institutional investors, increasing demand fueled by an increase in media coverage and investing “experts” and business owners touting the value Bitcoin has and will have. Additionally, it is popular with those who use it to transfer large sums of money for illicit and illegal activities. Bitcoin has also become popular in countries with high inflation and devalued currencies, such as Venezuela.
It means that shrinkage in future supply has coupled with a surge in demand to fuel a rise in bitcoin’s price. However, its price still fluctuates in alternating periods of booms and busts. For example, a run-up in Bitcoin’s prices in 2017 was succeeded by a prolonged low, then two sharp increases and downticks through 2021.
Production Costs and Bitcoin Price
Like other commodities, production costs play an essential role in determining bitcoin’s price. According to some research, bitcoin’s price in crypto markets is closely related to its marginal cost of production.
For Bitcoin, the production cost is roughly a sum of the direct fixed costs for infrastructure and electricity required to mine the cryptocurrency and an indirect cost related to the difficulty level of its algorithm. Bitcoin mining consists of a network of miners competing to solve for an encrypted number—the first miner to do so wins a reward of newly minted bitcoins and any transaction fees accumulated since the last block was found.
An indirect cost of bitcoin mining is the difficulty level of its algorithm. The varying difficulty levels of bitcoin’s algorithms can hasten or slow down the bitcoin production rate and affect its overall supply, thereby affecting its price.
Solving the hash to open a block and earn a reward requires brute force in the form of considerable processing power. The miner will have to buy many expensive mining machines in monetary terms. The bitcoin-mining process also requires costly electricity bills. According to estimates, electricity consumption for the bitcoin-mining network equals more than that of some small countries.
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