What makes the price of bitcoin change?

Not to be confused with the term “value” the price of bitcoin is simply the monetary cost of it, whereas “value” is a perceived regard for the benefits and usefulness of the cryptocurrency. Bitcoin price is expressed through exchange rates in relation to other currencies. As an example, the bitcoin-to-dollar exchange rate has been on average over $16,500 (Dec17) for one bitcoin.

According to a logarithmic release function, the amount of bitcoins in circulation will reach its cap of 21 million over the course of 100 years. This might seem like an exaggerated amount of years considering that almost 17 million bitcoins are in circulation as of this article, but it isn’t. The reason for such a big number of years is because by design, the rate at which new blocks are discovered through mining slows down drastically throughout the years as more bitcoins go into circulation.

As bitcoin is embraced by a wider audience, its demand is always on the rise. The supply of bitcoin is always constant and as a result the demand of it is constantly increasing. Because of this, the only thing that can vary in the equation is its price, which, assuming an increase in demand will keep increasing over the years.

The functionalities of bitcoin

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While bitcoin has many different functionalities and uses, we’re only going to be taking into consideration the ones that are relevant to its price increase and occasional decrease:

  • Bitcoin Payment Network – bitcoin as a currency
  • Bitcoin Storage and Transfer – bitcoin as a store of wealth and medium of value transmission
  • Bitcoin Exchange Rate – bitcoin as a market instrument and commodity

The bitcoin payment network

Transactions done over the network don’t really have a direct effect on its market price. But, there is an indirect influence due to the high activity of the network, showing that there’s a lot of usage and demand for the currency. For a direct impact on its price, bitcoins have to interact with other currencies, like it does in exchanges.

Buying bitcoin

Bitcoin transactions made through an exchange have a direct effect on its price, buying bitcoin via fiat currency or another cryptocurrency tends to increase the price of bitcoin. This happens because bitcoins change hands – from the exchange’s wallet to the wallet of the user that purchased it. Alongside the exchange transaction is a bitcoin network transaction, but, only the exchange transaction has a direct influence in the exchange rate of bitcoin.

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Selling bitcoin

As mentioned previously, transactions made through exchanges affect the price of bitcoin, and in the case of selling bitcoin, it causes the price to go down. So, let’s give an example of how this happens:

A man working in the US, getting paid in USD, would like to send money to his family in Venezuela. Since international banks aren’t an option anymore, the person chooses to use the bitcoin payment network, buying bitcoin from an exchange that offers BTC/USD. Then, the person sends the bitcoins to a Bitcoin address owned by a relative, and 30 or so minutes later, the relative receives these and uses a local exchange that offers BTC/BSF.

The bitcoins purchased in the BTC/USD exchange cause an increase in its price, even if small. 30 minutes later however, the sale of these bitcoins through a Venezuelan exchange causes a small decrease in the BTC/BSF rates.

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This example also illustrates the effect of money flow, which causes currencies to increase at the expense of others. Additional to this, there are more routine bitcoin sales that have an influence on the exchange price of bitcoin, such as:

  • Merchants accepting bitcoin
  • Miners that “cash out” to pay their bills and expenses with fiat currencies
  • The redemption of transmission bitcoin (as explained above)
  • The conversion of bitcoin salaries into fiat currency
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It’s often said that merchants convert any bitcoins received straight to fiat currency because of the often volatile prices of bitcoin. This is considered a good strategy, but it’s also worth noting that different businesses go for different strategies depending on certain policies. It’s not unlikely that some businesses look for some investment advice and end up holding bitcoin amounts or channel them into investment funds. This proves to be a good idea too, as it has the same effect as long-term bitcoin storage. Keeping bitcoins out of circulation effectively leads to an increase in its price because the demand keeps increasing and the supply of bitcoin is limited.

There is indeed a decrease (even if small) on the price of bitcoin when merchants convert any bitcoin receipt straight to fiat currency, but this never truly affects it too much because there’s a certain balance that is caused by the consumers that purchase bitcoins and eventually spend them. Even if the prices of bitcoin aren’t exactly something constant, both the merchants and the consumers balance each other’s predominant buying or selling tendency.

Bitcoin as a trade instrument

A big volume of the bitcoin transactions made on a daily basis are based on speculation, which is a remarkable thing to say the least. No speculative instrument experienced the exponential growth that bitcoin has, so it doesn’t come as a surprise that the speculative market has the ability to influence the price of bitcoin.

 

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The volume of the transactions discussed in the previous section can be considered minuscule compared to the large amount of bitcoins that are sold and bought on a monthly basis in the speculative market.

Buy and hold investors aren’t included here, mainly because they buy and sell infrequently. However this category does include early adopters of the coin, including Satoshi Nakamoto and most of the early bitcoin miners. They have considerably sized bitcoin holdings and because they’re founders of the bitcoin network, they’re entitled to profit-taking for buying houses, cars and any other sizeable purchase made that is typically only possible with fiat currency.

In this category, the main groups that have an influence over the price of bitcoin are:

  • Retail exchange traders
  • Early adopters of bitcoin that “cash out” to fiat currencies.
  • Investment funds and ETFs

Bitcoin and the Government

It’s no secret that central banks and governments are together because of shared interests, and their way to maintain control of things and staying in power is through money. Because of this, it won’t come off as a surprise that money that they cannot control becomes a problem for them.

 

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Therefore, it’s only natural that these authorities go through extraordinary efforts to make this “threat” go away. However, not all of them go against it, some authorities actually do the opposite and embrace bitcoin by encompassing it in their legal framework, creating tax codes specifically for cryptocurrencies and then encouraging its use.

The mere thought of regulating bitcoin makes users nervous, but quite frankly it’s more beneficial than anything, since statements of the following kind tend to result in big price fluctuations:

  • Statements by governments and central banks
  • Parastatal bodies talking about regulation
  • Incomprehensible legalese
  • Any mention of taxation

Do announcements have an influence on bitcoin prices?

It’s debatable, but evidence suggests that users are more prone to take action because of a news article. However, the direction of the price movement tends to be unrelated to the actual article itself and is mostly determined by the social mood at the time.

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To sum it up

There are plenty of things that have an influence on the price of bitcoin, like the gradually rising supply/demand curve, or the speculative trade of thousands of bitcoins that goes on a daily basis through exchanges. However, checking the price chart of bitcoin you can see that the average price is always on the rise, thanks to the balance in tendencies between merchants and consumers. And while some banks and governments are still against the cryptocurrency, it’s slowly being embraced by more and more institutions, meaning that price increases in the future are very likely.

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