How Is the Price of Bitcoin Determined?
Taking a look at how the value of the price of Bitcoin cryptocurrency is determined will give you a better understanding of how your money is being invested in the virtual space.
The price of Bitcoin is a very hot topic right now. People all around the world are talking about Bitcoin and its current value. Those with interest or investment in cryptocurrencies are watching particularly closely, even if they have no direct investment in Bitcoin itself.
Bitcoin, otherwise known as BTC, was the first cryptocurrency to exist. Satoshi Nakamoto, whose true identity is still very much in question today, created and released Bitcoin to the world in 2009. BTC was the first currency implementing blockchain technology as a public-ledger. A true digital currency that didn't involve financial institutions, it was intended to be a step towards decentralization.
The Bitcoin (and Pizza) Enthusiast
In May 2010, crypto-enthusiast Laszlo Hanyecz made what is considered to be the first purchase using BTC. He bought two pizzas for a total cost of 10,000 BTC (valued at around 30 USD at the time)—to demonstrate that Bitcoin could be used a real-world currency. At the price of Bitcoin today, those two pizzas cost him 65,648,600 USD.
Despite the fact that Laszlo bought what are now the most expensive pizzas ever sold—he has no regrets. In fact, in February 2018 he decided again to prove that Bitcoin’s latest feature—lightning network—proved that Bitcoin still worked as a real-world currency. He only paid 0.00649 BTC for the two pizzas this time, which, after calculating the exchange rate, was valued at 68 USD at the time. When people ask, "How will Bitcoin become valuable in our society?" point them towards this example.
Determining the Price of Bitcoin
In less than 8 years, 10,000 BTC went from being worth 30 USD to over 65 million USD. This begs the question: What determines the price of Bitcoin?
The price of Bitcoin is directly linked to what people perceive it to be. The biggest difference between Bitcoin, fiat currency, and a commodity like gold is that Bitcoin is a finite resource, and we know the total amount that can ever exist is 21,000,000.
Knowing that, and that since the blockchain began, there would be 32 halving events. It’s currently predicted that all 21,000,000 will be in circulation by the year 2140.
The halving events make double the difficulty of mining Bitcoin. If your personal BTC mining farm produces 12 BTC/month right now, on the same power and Hash rate after the next halving, you will only be producing 6 BTC/month. Obviously, increasing the scarcity of a commodity increases the value; and thus, the price of Bitcoin will increase.
Gold may also suddenly get harder and harder to find, like Bitcoin does, and also may see a price increase. However, two months later, someone could discover a goldmine that contained so much gold that it was no longer a precious metal. This simply cannot happen with Bitcoin.
The price situation with Bitcoin gets a little more complicated. Although 21,000,000 will be the total amount in circulation, no one actually knows how many are permanently lost in forgotten or inaccessible wallets. The number is estimated to be anywhere from 10 to 35 percent of all Bitcoins mined so far. That is not a small number.
Trade-Pairs and Exchanges
Bitcoin may have set out to be a digital currency, and in a way, its succeeded amazingly—just not the way it intended. Although some stores accept Bitcoin, it needs time for more adoption on the internet and high-street. However, BTC is the biggest trading pair on all cryptocurrency exchanges—meaning that Bitcoin is your best bet to use a cryptocurrency if you want to buy other cryptocurrencies. Since it can be easily bought with a bank account online or even with fiat currency, it's a logical way forward.
Since there are many people now day-trading crypto, making small profits on repetitive swing trades between their chosen altcoin and BTC, people are using BTC as a currency without even realizing that is what they are doing, proving Bitcoin will stay around for decades.
However, with Ethereum (ETH) trade-pairs almost equal to the number of Bitcoin pairs, the fact that there are more and more USD trading pairs and the fact that a few big exchanges are introducing XRP exchange pairs, the price of Bitcoin cannot rely on this.
Supply and Demand—Basic Economics
Supply of Bitcoin is, in this case, not being the amount of bitcoin available, but the amount of Bitcoin available at a given price. Demand is the number of Bitcoins people are willing to buy at a given price.
A total of 1,000 Bitcoins are for sale and the lowest price is 200 BTC for 6,000 USD each. No one is willing to sell for less than this.
A total of 1,000 Bitcoins are wanting to be bought—the highest price bid is 6,000 each for 150 BTC, and it appears that no one will spend more than this.
So, now there are 50 BTC left for Sale at 6,000 USD, and 800 BTC for sale at higher prices. There are 850 BTC people are willing to buy, but now the highest bid is 50 BTC for 5,990 each.
The lowest sale price = 6,000USD
The highest buy price = 5,990USD
The current value equals the midpoint. The midpoint equals 5,995 USD. This establishes the market price of Bitcoin; and these transactions that people are making on a daily basis allude to the signs that Bitcoin is going mainstream.
Now each bitcoin exchange works exactly the same, which is why the price of Bitcoin is always slightly different on each exchange, as it depends what people are willing to buy and sell Bitcoin for at the given time. Arbitrage opportunities open up to people who see a big enough difference between exchanges, and buy and sell between the two. If one BTC cost me 5,900 USD on Exchange X, and sells instantly for 6,050 USD on Exchange Y, I’ve made 150 USD from simply moving my BTC from one exchange to another.
One of the most interesting things about Bitcoin is its volatility. The price of Bitcoin can drop 20 percent in the blink of an eye, and increase 300 percent in a month—it doesn’t take much to make Bitcoins price change. This may be changing as Bitcoin seems to have stabilized between 6,200 USD and 6,700 USD over the last few months.
No country holds Bitcoin or digital currencies (besides Venezuela) as legal tender, and bank accounts and fiat currencies are still preferred due to long term exchange being so volatile within cryptocurrencies. Predicting the future price of Bitcoin is impossible; we can take guesses, people can talk about technical analysis, but in the end, no one knows what the price of Bitcoin will be tomorrow, next week, or next year. It’s all just speculation.