How Is The Price of Bitcoins Set
Bitcoin is a commodity, just like company stock. Therefore it has value, and it can be bought and sold.
However, unlike a publicly traded company, Bitcoin is not decentralized – not governed by any central entity. Additionally, it does not have a balance sheet or even revenues that are often used to determine the prices of a company’s stock. So, how is the value of Bitcoin determined?
Like gold, Silver, or the Mona Lisa painting, Bitcoin derives its value from scarcity and high demand. Therefore, the key determinant of Bitcoin price is the interplay of the demand and supply market forces.
Demand and Supply Market Forces
The law of demand and supply says that a price of a commodity increases with the demand. When many people demand a product and the supply does not meet the high demand, the product becomes scarce and the prices rise. On the other hand, an increase in supply that does not balance the demand leads to a drop in price. The interplay of demand and supply is a key principle in determining the prices of commodities in the market.
Since Bitcoin derives its value from scarcity and operates as a free market, the demand and supply forces are primary determinants of its price.
Bitcoin’s market supply is determined by how many Bitcoins are available for sale. Sellers chose the price at which they want to sell their Bitcoins. Therefore, the number of buyers must exceed the number of sellers for Bitcoin to remain scarce to drive the price up.
Bitcoin is created and introduced into the network through mining. Users who help confirm and record transactions are rewarded with new Bitcoins, thus increasing the supply of Bitcoin.
Bitcoin is supply is capped at 21 million. There will be no creation of new Bitcoins once the maximum supply is reached. This will fix the supply of Bitcoin, and any increase in demand will cause scarcity driving the value of Bitcoin up.
The maximum supply is set to be reached in around 2140. The supply is regulated through the process called Bitcoin halving. Bitcoin halving reduces the amount of new bitcoin created through mining. The number is reduced by half after every four years. Satoshi Nakamoto, the first Bitcoin miner, earned 50 BTC for confirming the transaction. Currently, miners are earning 6.25 BTC when they confirm transactions.
Currently, over 91% of Bitcoins have been mined. However, a significant amount of Bitcoins have been lost to the point that they cannot be recovered.
The reduced supply of Bitcoins is designed to create scarcity as demand increases thus driving the value of the coin up.
A related factor under market supply is the production cost. Besides expensive infrastructure, Bitcoin consumes a lot of electricity which is costly. As the mining difficulty increases, the process becomes more energy-intensive, leading to increased costs. The increasing cost can slow down the Bitcoin production pace, impacting the supply, which ultimately affects the price of Bitcoin.
Bitcoin demand is determined by the number of Bitcoin buyers available in the market. Buyers derive the price of Bitcoin when they purchase the commodity. Once sell orders at a certain price are completed, the price increases to the lowest sell order price.
Many factors can inform customers’ speculations which often drive Bitcoin’s demand. News headlines are known to influence the behavior of Bitcoin buyers. Positive news headlines often stimulate market demand for Bitcoin. As the prices, media outlets offer more coverage, which causes further price increases.
Another factor is regulations. Government regulations can affect Bitcoin demand either positively or negatively. Regulations that make Bitcoin more accessible and safe for investors drive the demand up. However, other legal policies such as heavy taxes on crypto activities can discourage some investors from buying Bitcoin in the short term.
Competition from Altcoins
Bitcoin faces competition from other cryptocurrencies (altcoins) such as Ethereum (ETH), Ripple (XRP), and even the meme coin Dogecoin (DOGE). All these cryptocurrencies appeal to users differently. Since they are designed after Bitcoin, developers had enough time to study Bitcoin and correct the challenges that Bitcoin faces in their new projects. As such, cryptocurrencies such as XRP offers higher scalability. Ethereum, on the other hand, introduced a comprehensive smart contract that supports various functionalities that are not compatible with Bitcoin. The stiff competition affects the demand for Bitcoin, which influences its market price.
Since the Bitcoin price is out of the control of any individual player in the market, its price is often volatile. It is difficult to predict with certainty the future Bitcoin prices. Therefore, the price can either grow or fall depending on the development of the factors influencing the demand and supply.