Have you followed financial news in 2021?
If you have followed it, then you know that Bitcoin has had an amazing run in 2021 after a mostly mediocre 2020.
However, what you probably do not know is what exactly determines the price of 1 bitcoin. You may also be curious about why the price of bitcoin goes up and goes down.
To answer the first question as simply as possible, the price of bitcoin is determined by what someone is willing to pay for it. Yes, it really is that simple. Supply, demand, and attention all have an impact on the price of bitcoin.
Anyway, we will go into much more detail on the economics behind bitcoin and what factors determine the price.
Bitcoin Basic Tokenomics
Bitcoin has the simplest tokenomics in cryptocurrency. It will only take a few sentences to explain the tokenomics.
- Bitcoin has a total maximum supply of 21 million bitcoin. This supply will be reached in February 2140.
- New bitcoin are mined by miners at a rate of 6.25 bitcoin per block. It takes about 10 minutes to mine a block.
- The mining reward halves every 210,000 blocks (~4 years).
- Transaction fees are paid to miners. There are no native bitcoin burns, but plenty of people have lost their wallet keys!
- An individual bitcoin is divisible to the 8th decimal place (1/100-millionth), which is called a satoshi or sat.
That’s it for the tokenomics of bitcoin. As we said, they’re very simple and easy to understand. The important takeaways are that the total maximum supply is fixed at 21 million and new supply is added at a fixed rate.
All these factors come into play when determining the price of an individual bitcoin.
Factors That Determine Bitcoin’s Price
A few factors come into play when determining the price of an individual bitcoin. The number one factor, naturally, is the demand for owning an individual bitcoin.
The tokenomics are obviously quite nice because the coin does not inflate. However, the best tokenomics in the world mean nothing if no one wants to purchase one.
With that in mind, here are some of the factors that determine the price of one bitcoin.
Number of Users
One of the most important factors in determining the price of bitcoin is the number of users. Sadly, tracking this is a little difficult because of the decentralized, anonymous nature of bitcoin, but we can get a rough estimate by measuring the total number of Bitcoin wallets.
Now, the number of users is super important because of something called Metcalfe’s law, which states that the value of a telecommunications network increases as it adds more users.
Bitcoin is not a telecommunications network, but the same principle applies. Remember, Bitcoin is meant to be used as a currency. And a currency does not have any value if no one accepts it as a currency.
In other words, the price of Bitcoin should increase as it adds more users because more people accept it as having value. The opposite also applies – if everyone stopped accepting bitcoin as having any value (ie. after a double spend or hack), then the value would drop to zero.
To wrap it up, the price of Bitcoin is directly correlated to the number of people using it. More people using Bitcoin means more demand and fewer people means less demand for it.
Supply vs Demand
The previous point covered demand, but that’s only one half of the equation in determining the price.
Massive demand does not mean much with massive supply. You can look at the price of iron, Dogecoin, or Shiba Inu for a good example of that. All of those examples obviously have a lot of demand, but the supply is so high that the price of an individual token (or kilo in the case of iron) is not that much.
Bitcoin does a good job at managing the supply by greatly limiting the amount of bitcoin that can be mined as we covered in the tokenomics section. This actually makes bitcoin very similar to gold, but with the added benefit of knowing exactly what the new supply and total will look like.
No one will find a new place to mine bitcoin and increase the total supply. The same cannot be said about gold with stuff like asteroid mining, artificially creating gold, or simply finding a massive gold mine.
Unfortunately for Bitcoin, there are other sources of bitcoin to the open market. For instance, a whale could decide to sell $1 billion worth of bitcoin and completely crash the market.
This is why the supply available for sale must also be considered when determining the price. Again, it greatly helps that the newly mined supply is limited, but daily price swings are more a factor of supply on the open market.
To summarize, the supply of bitcoin on the open market combined with the demand is the determining factor in the price. Is there a lot of supply (people selling bitcoin) and not much demand (people buying)?
The price of bitcoin will fall until the demand increases.
Are there a lot of people wanting to buy bitcoin and not many people selling it?
The price of bitcoin will rise as buyers continue to purchase from sellers at increasing prices in the order book.
Bitcoin Market Manipulation?
We cannot discuss markets without at least mentioning market manipulation. People likely figured a way out to manipulate a market the day after the first market was launched.
This practice regularly occurs on so-called “regulated” markets in centralized finance (NASDAQ, NYSE, Nikki, etc.)
Most Bitcoin trading occurs on centralized exchanges like Huobi, Binance, and Coinbase. There is also Bitcoin futures trading, a Bitcoin futures ETF, and a Bitcoin trust.
The same market manipulation tactics used in centralized finance have likely spilled over into Bitcoin because a lot of the same entities have taken control of Bitcoin trading.
It’s also a completely unregulated industry, so it’s perfectly legal to manipulate the price of Bitcoin.
To summarize, we are certain that the price of Bitcoin is manipulated by centralized exchanges to some extent. We obviously do not know the extent, but it’s an unregulated asset, so it’s not even illegal to manipulate the price.
What causes Bitcoin to go up and down?
You have probably heard that cryptocurrency is volatile. But no one ever really explains why the cryptocurrency is so volatile.
Again, the reason for the volatility of cryptocurrency, bitcoin, in this case, is not very difficult to understand. There are a few main factors that cause so much volatility with the price of Bitcoin.
- Trading occurs 24/7.
- Trading occurs globally.
- It’s a very inefficient market because of its newness.
- The market cap is relatively small.
- It’s unregulated, which leads to even more market manipulation.
We hope that we did a good job answering the factors that determine the price of bitcoin along with some of the reasons that the price goes up.
The price is determined by supply and demand. Demand comes from the number of people using Bitcoin (more users = more demand).
The price swings come along when demand or supply changes. And it can be rather volatile due to the inefficiencies caused by Bitcoin being a relatively new trading asset along with the global nature of the cryptocurrency.