How Is the Price of Bitcoin Determined?

The bitcoin price increase has been exceptional in the last decade or so. From the starting price of $0.0008 to $0.08 in July 2010, Bitcoin has increased every year. In April 2021, it touched $65,000 per Bitcoin. In this article we will discuss about How Is the Price of Bitcoin Determined.

Bitcoin is always in news, and more often than not, the reason is – volatility. The price of Bitcoin keeps going up and down significantly. Have you wondered why the price fluctuates so much? Its highly volatile nature is one reason why many investors avoid investing in Bitcoin. However, if you understand price movement reasons (How Is the Price of Bitcoin Determined), you will invest in Bitcoin with more confidence.

Also Read: What is the Bitcoin Lightning Network | What is Hash Rate or Hash Power in Cryptocurrencies

The Supply and Demand Equation – How Is the Price of Bitcoin Determined:

 

How Is the Price of Bitcoin Determined

If you understand the basics of economics, you know how the price of everything is determined by supply and demand. Have you wondered why the price of petrol is increasing every month? The reason is simple – the petrol demand is more, and the supply is less. Similarly, the price of Bitcoin increases, if the supply is limited and buyers are more. When the demand falls, the price of Bitcoin falls. However, there is a difference between the price of Bitcoin and petrol. When the petrol demand increases, the supply can be increased to whatever level is possible. It brings the price back to equilibrium. The same does not happen with Bitcoin. Even if the demand increases, the production does not increase.

S2F Model:

The stock-to-flow (S2F) model is used to determine the price of an asset because of scarcity. The stock-to-flow is a number that tells you how many years are needed to produce the current stock at the current production rate. In other words, you can think of it as the inverse of an inflation rate of an asset. According to this model, the higher the S2F ratio, the higher the price of assets.

Let us apply the S2F model in Bitcoin. Every four years, the number of Bitcoin that is produced gets reduced to half. Hence, the flow of new Bitcoin reduces in the market, and the stock-to-flow ratio increases. If you apply the S2F model to Bitcoin, every trigger should increase the price. It has over the years. 

Why does the price change? – How Is the Price of Bitcoin Determined:

We have talked about the demand and supply equation. But we also mentioned that the supply is constant – there is only a certain number of Bitcoin – 21 million. By this logic, the price should always increase.

However, that is not true. You need to understand the difference between price and value. The value of something changes with the demand and supply equation. The price is determined by the market in which it trades. A better example to understand the price movement would be stock price. The number of stocks of a company is the same but the price changes. The price changes because of interaction between buyers and sellers, and they determine the price of the Bitcoin. 

Now the question arises – why are investors ready to pay more money for Bitcoin. For example, if the current price of 1 Bitcoin is $54000, why are investors willing to pay $54,500? When investors believe the asset price will be more in the future, they are ready to pay a higher price now.

Inflation and Deflation:

Inflation occurs in a system when the money supply increases rapidly. It causes the prices to increase as the value of a currency is reduced. Bitcoin is deflationary as it has a finite supply. For this reason, you will never see hyperinflation in Bitcoin. Central banks and governments can print unlimited money, and it could lead to inflation and hyperinflation. It has happened with countries like Zimbabwe. You need not worry about inflation while investing in Bitcoin.

Other Factors – How Is the Price of Bitcoin Determined:

We have already talked about the price movement because of the demand and supply equation on the trading platform. Other parameters that determine the price of Bitcoin are:- 

Other cryptocurrencies

Bitcoin is the biggest cryptocurrency in the world. Yet, it faces tough competition from Ethereum, Tether, Binance, etc. New cryptocurrencies are coming every month, and something disruptive could lead to Bitcoin price movement.

Cost of mining

We have talked about mining in great detail earlier. We know the cost of mining increases every passing year as solving the problem is getting harder. Research has shown that the price of Bitcoin is directly proportional to its marginal cost of production (mining cost).

Regulations –

Even though millions of investors have invested in Bitcoin, it is not a legal currency (except in a few countries). Any news related to the regulation of cryptocurrency increases or decreases the price of Bitcoin significantly.

Conclusion:

It is not always about supply and demand. Sometimes the prices of things increase because they are not only scarce but also useful. A perfect example of this would be gold. Gold is scarce and also used to make ornaments. Hence, its price always increases. The same holds for Bitcoin. It is scarce and has many different uses in different industries. 

Hence, it has both price and value that is determined by the supply and demand equation. So now you know, How Is the Price of Bitcoin Determined.

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