Chapter 1.4 Bitcoin Prices
“Bitcoin isn’t backed by anything. It has no value.”
When you ask people about the value of bitcoin, they may say things like that.
There’s some truth to that statement – but it’s also really ignorant to say bitcoin is “backed by nothing”.
Bitcoin has no inherent value because it’s not tied to a certain physical object like gold. You can’t exchange your bitcoin for gold, for example, and there’s no connection between bitcoin and any physical asset.
However, bitcoin has plenty of real value from its underlying technology. The entire value of bitcoin is based on its technology. That technology allows bitcoin to be used as a revolutionary store of value and an efficient currency. The value of bitcoin is based on its usability. Usability is linked to supply and demand.
As bitcoin’s usability rises, the demand for bitcoin increases. The supply of bitcoin, however, never changes and will never change. There’s a total supply of 21 million bitcoins. No more than 21 million bitcoins can ever be created.
As of May 2018, approximately 17 million bitcoins have been mined, leaving 4 million available to be mined. Of the 17 million bitcoins in circulation, it’s believed that approximately 2 to 4 million bitcoins have been lost – the owners have lost their private keys, for example, which means the bitcoins are still available on the bitcoin blockchain, but they cannot be accessed.
All of this information leads to a simple conclusion:
As the usability of bitcoin increases, demand for bitcoin grows. Supply, however, has remained the same over time. Increasing demand and a stable supply leads to higher prices.
That’s how the price of bitcoin is determined. It also explains why the price of bitcoin has steadily risen year-after-year.
In comparison, look at currencies like the USD. Governments don’t want a fiat currency that fluctuates in value between $1 and $100. That would be disastrous for the economy. That’s why governments print money. They increase the supply of money in response to demand. The goal is to keep the value of the currency stable within a certain range. Over time, this typically leads to inflation: the total supply of USDs is constantly rising, which means the value of the $10 USD you hold today will not have the same value 10 years from now – despite the fact that your $10 USD is always going to be worth $10 USD.
There Are Two Factors Behind the Price of Bitcoin
This all boils down to the fact that there are two factors behind the price of bitcoin, including:
Utility and Usability: As bitcoin becomes more usable, the demand for bitcoin increases. In the early days, bitcoin was a nifty online currency, but it wasn’t very usable. There weren’t good wallet apps, for example, and no major merchants accepted bitcoin. Today, things have changed, and bitcoin is more usable than ever before.
Scarcity: The other MAJOR factor behind the price of bitcoin is its scarcity. As the price of bitcoin rises, the supply of bitcoin never changes. There’s always a total supply of 21 million bitcoins. A few bitcoins are constantly released through the mining process as we approach the 21 million bitcoin limit. However, the increasing supply of these bitcoins does not keep up with demand, which is why we’ve seen the price constantly rise over time.
Other Factors Affecting the Price of Bitcoin
The two major factors affecting the price of bitcoin are supply and demand. Supply is influenced by the scarcity of bitcoin and its 21 million unit limit. Demand is influenced by the usability and utility of bitcoin.
However, there are other factors that affect the price of bitcoin, including things like all of the following that can affect demand:
Market Sentiment: Market sentiment is another way of saying ‘demand’. Market sentiment refers to how major exchanges, communities, investors, institutions, and markets see bitcoin. How does the community feel about bitcoin? Has recent bitcoin news been priced into the market? Are markets bullish (believing the price will rise) or bearish (believing the price will fall)?
Regulatory Changes: Crypto prices plummeted in September 2017 when China announced the closure and ban of bitcoin exchanges. Some people called it the end of bitcoin. The price of bitcoin, however, quickly recovered and rose to an all time high a few months later. Regulatory changes around the world can have a major effect on bitcoin. If the United States, South Korea, or other major bitcoin-using nations ever announce a widespread ban to bitcoin, for example, the markets will be flooded with people looking to sell their bitcoins. History tells us the price of bitcoin always rebounds after regulatory changes, but you never know what the future holds.
Exchange-related Issues: Other major bitcoin price movements have occurred due to exchange-related issues. The infamous Mt. Gox hack, for example, caused the price of bitcoin to plummet from $1400 to $200. The world’s biggest bitcoin exchange was hacked and hundreds of millions of dollars of bitcoin were lost. Some people saw it as the end of bitcoin – it was simply too insecure to be a real currency. These hacks and other exchange-related issues can substantially influence the price.
Is Bitcoin a Bubble?
You’ll find plenty of people calling bitcoin a bubble. Any time demand for any asset rises suddenly over time, you’ll find people calling it a bubble. There are real estate bubbles, for example. There are also historically famous bubbles like “Tulip mania” in the 1700s and the Dot Com bubble of the 1990s.
Is bitcoin a bubble? Is it doomed to collapse like bubbles of the past?
It could be. Like with all aspects of bitcoin, it’s impossible to predict the future.
However, it’s important to remember that bitcoin isn’t like any traditional asset in the world today. It could buck the trend. Bitcoin’s bubble might never burst. Or, bitcoin might not even be in a bubble.
A bubble is only a problem when a large group of people suddenly decide to sell that particular asset. This is when the bubble bursts. Sometimes, the bubble never bursts. Sometimes, the market cools and a small group of people decide to sell. The bubble deflates slightly but never bursts.
Would a large group of people ever suddenly sell bitcoin? Would the market ever be flooded with people who are trying to sell their bitcoin but can’t find a buyer? It’s certainly conceivable. We’ve seen similar events occur in the past when certain countries ban bitcoin or when certain exchanges get hacked.
Remember: a fast rise in price doesn’t necessarily constitute a bubble. Instead, artificial over-valuation of an asset causes a bubble.
Bitcoin’s rise could be legitimately fueled by people who understand and believe in the future of the currency. Or, bitcoin’s rise could be fueled by people who bought bitcoin because they expected to get rich quick.
To date, bitcoin has recovered from every major hurdle it has faced. Numerous people have announced the death of bitcoin and the bursting of the bubble – but so far, the price has steadily grown over time.
Maybe the drop from $20,000 to $10,000 between December 2017 and January 2018 was the “bubble bursting”. Maybe the price will drop to $100 within a few months when the United States announces harsh bitcoin regulations. We just don’t know – and that’s what makes bitcoin exciting.