What Determines the Price of 1 Bitcoin?
What Determines Bitcoin’s Price?
Bitcoin is a cryptocurrency developed in 2009 by Satoshi Nakamoto, the name given to the unknown creator (or creators) of this virtual currency. Transactions are recorded in a blockchain, which shows the transaction history for each unit and proves ownership.
Unlike investing in traditional currencies, Bitcoin is not issued by a central bank or backed by a government. And buying a bitcoin is different than purchasing a stock or bond because Bitcoin is not a corporation. Consequently, there are no corporate balance sheets or Form 10-Ks to review.
Understanding What Determines Bitcoin’s Price
Unlike investing in traditional currencies, Bitcoin is not issued by a central bank or backed by a government; therefore, the monetary policy, inflation rates, and economic growth measurements that typically influence the value of currency do not apply to Bitcoin. Conversely, Bitcoin prices are influenced by the following factors:
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
The exchanges on which it trades
Regulations governing its sale
Its internal governance
Supply and Demand
Countries without fixed foreign exchange rates can partially control how much of their currency circulates by adjusting the discount rate, changing reserve requirements, or engaging in open-market operations. With these options, a central bank can potentially impact a currency’s exchange rate.
The supply of Bitcoin is impacted in two different ways. First, the Bitcoin protocol allows new bitcoins to be created at a fixed rate. New bitcoins are introduced into the market when miners process blocks of transactions, and the rate at which new coins are introduced is designed to slow over time. For example, growth slowed from 6.9% (2016), to 4.4% (2017) to 4.0% (2018).1
This can create scenarios in which the demand for bitcoins increases at a faster rate than the supply increases, which can drive up the price. The slowing of Bitcoin circulation growth is due to the halving of block rewards offered to Bitcoin miners and can be thought of as artificial inflation for the cryptocurrency ecosystem.
Secondly, supply may also be impacted by the number of bitcoins the system allows to exist. This number is capped at 21 million, and so when this number is reached, mining activities will no longer create new bitcoins. For example, the supply of Bitcoin reached 18.587 million in December 2020, representing 88.5% of the supply of Bitcoin that will ultimately become available.2 When 21 million bitcoins are in circulation, prices depend on whether it is considered practical (readily usable in transactions), legal, and in demand, which is determined by the popularity of other cryptocurrencies.