How Is the Value of Bitcoin Determined?

To have a review, Bitcoin; the world’s most popular and largest cryptocurrency by market cap is based on specifications outlined by “Satoshi Nakamoto” in 2009. Bitcoin transactions are recorded in a ledger known as blockchain, this ledger, which is used to prove ownership, stores the entire transaction history for each Bitcoin.

What Determines the value of Bitcoin?

It should be noted that buying bitcoin is very different from buying bond or stock. Bitcoin is not a company, hence, no financial report, balance sheets or Form 10-Ks to review. There is no costs, revenues, or profits to create a baseline against other digital currencies. Bitcoin, unlike the traditional currency, is neither issued by a central bank nor backed by any government. As a result, economic growth measurements, inflation rates, monetary policy, and other economic factors that normally affect the value of fiat currency do not apply to Bitcoin.

This is the main reason why the value of bitcoin fluctuates confusingly. A number of factors that can determine the value of bitcoin include:

  • Supply and demand of bitcoin
  • Competing cryptocurrencies
  • Regulations
  • Internal governance.
  • Speculations

Supply and Demand of Bitcoin Cryptocurrency

There are two processes that affect the supply of bitcoin. One, the bitcoin protocol allows the mining/introduction of new bitcoins at a fixed rate and this rate is planned to slow down over time, for instance, the rate has slowed from 9.8% in 2015 to 6.9% in 2016 to 4.3% in 2017. This can ultimately cause an event in which the demand for bitcoin would exceed the supply for bitcoin, and this can drive up the price.

Two, the number of bitcoin that the system allows to exist can also affect the supply of Bitcoin. This number is capped at 21 million, this means that once this number is achieved, bitcoin mining activities will no longer generate new bitcoin. The supply of bitcoin reached 16.8 million last year January, this means that about 80% of bitcoin’s total supply has already mined. Once 21 million bitcoins are mined, the price of Bitcoin will depend on whether it is considered practical, legal, and in demand. Of which the demand for bitcoin then will depend on the popularity of other digital currencies.

Competition

Though bitcoin remains the most famous cryptocurrency, there are lots of other cryptocurrencies competes with it and from which investors can choose. These include Ether, Litecoin, Bitcoin Cash etc. the presence of these competitors apparently keeps the value of Bitcoin in check. Just like the value of the USD would have been different had there not been strong alternatives like Euro, or Pound Etc.

However, the quasi-legal status and speculative nature of cryptocurrencies make it difficult to understand how the rules of competition actually affect pricing. More reason why other factors, such as popularity becomes a major advantage for bitcoin.

Regulations and Legal Matters

The sudden rise in the popularity of bitcoin cryptocurrency caught regulators off guard. And it took until last year December before regulators could weigh in on cryptocurrencies. These regulations created substantial uncertainty in the crypto community, though this was not evident in the surging market cap. The regulatory approval paved way for the creation of financial products such as exchange-traded fund (ETF), futures, and other derivatives, that use bitcoin as the underlying asset.

This can influence the value of bitcoin in two ways. One, it opens up the cryptocurrency to investors who cannot afford to buy the actual bitcoin cryptocurrency, hence increasing demand. Two, price volatility can be reduced by making institutional investors who think that bitcoin futures are overvalued (or undervalued) to use their substantial resources to make bets that the price of bitcoin will go in the opposite direction.

Internal Governance

Though Bitcoin is not governed by a central authority, however, it relies upon developers and miners to process transactions and keep the blockchain secure. Changes to software are reached by consensus, and sometimes friction may occur. More so, the issue of scalability is another large source of friction in the bitcoin community. These frictions can lead to division, subsequently leading to “soft forking” in which no new cryptocurrency is created or a “hard fork,” in which a new cryptocurrency is formed. Investors may then ultimately decide if the value of the newly formed cryptocurrency is above that of Bitcoin or not.

Speculations

Bitcoin is not regulated by any governing body, more so it is not backed by any physical asset. Hence, it is easily affected by mere speculations. Anybody can come up with negative reviews or news about Bitcoin, also unexpected bad occurrence may happen in the Bitcoin community, all these will quickly drop the value of Bitcoin. On the other hand, good and positive news, as well as a favorable occurrence in the bitcoin community can quickly drive up the value of bitcoin, an example of such wild rise due to speculation was the rise in bitcoin value towards the end of last year.

Share this:
All content on this website is based on individual experience and journalistic research. It does not constitute financial advice. Cryptomartez is not liable for how tips are used, nor for content and services on external websites. Common sense should never be neglected!