It was in 2009 that Bitcoin was created by Satoshi Nakamoto, an unknown person/group/organisation. It is a way of carrying out transactions in a decentralised manner where the information for each transaction is recorded in a Blockchain.
Bitcoin price fluctuations are a source of worry to potential investors. After all, it’s not like buying a stock or a bond. There are no balance sheets to check or speculate in this case. And 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.
Contrarily, bitcoin prices are influenced by the following factors:
- Supply and market demand for Bitcoin
- Competing cryptocurrencies
- The exchanges it trades on
- Regulations governing its sale, typically imposed by governments
- Its internal governance
Supply and Demand
Countries not having fixed foreign exchange rates can partially control how much of their currency circulates by manipulating the discount rate, changing reserve requirements, or engaging in open-market operations. In these ways, a central bank can potentially impact a currency’s exchange rate.
The supply of bitcoin is impacted by two major factors:
- First, the bitcoin protocol makes sure that new bitcoins are created at a fixed rate. New bitcoins come up when miners process blocks of transactions. The rate at which new coins are introduced is designed in a way such that the rate will slow over time. For example, growth has slowed from 9.8% (2015) to 6.9% (2016) to 4.3% (2017). This creates scenarios in which the demand for bitcoins increases at a faster rate than the supply increases, which can drive up the price.
- Secondly, supply is also impacted by the number of bitcoins the system allows to exist at once. This number is 21 million and once miners reach it, mining activities will no longer create new bitcoins. For example. the supply of bitcoin reached 16.8 million in January 2017, and this represents 80% of the supply of bitcoin that was ultimately made available. Once 21 million bitcoins are mined, 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. In case it is deemed positively, the prices will shoot up again.
Bitcoin may be the most well-known cryptocurrency but there are many others, including Ethereum, Litecoin, Dogecoin, and Peercoin. To top it off, new Initial Coin Offerings (ICOs) are constantly coming up, due to the relatively few barriers to entry. The abundance is good news for investors because the widespread competition keeps prices down. But Bitcoin has an edge when it comes to visibility. In fact, let’s have a look at how Facebook Libra disrupted the scene.
Bitcoin was already trading above $9,000 when Facebook formally unveiled Libra. Despite many commentators arguing the current bitcoin price spike is due to the social media giant, a glance at data puts bitcoin’s momentum far ahead of Libra. Facebook revealed a website for its cryptocurrency scheme on June 18, when BTC/USD was hovering around $9,200. After the website went live, the Bitcoin actually dropped in price for several days before surging up to current highs above $11,300.
Nonetheless, the idea Facebook is surging the bitcoin price rise continues to permeate the press. “Bitcoin has slowly – by its own standards – been rising in recent months but the launch of Facebook’s Libra has clearly been a catalyst for the recent surge,” Craig Erlam, a senior market analyst of the financial trading firm Oanda stated. “The publicity that the launch has once again brought to space, combined with the legitimacy it offers, has understandably excited the community,” Erlam added.
Availability on Currency Exchanges
Cryptocurrency investors trade cryptocurrencies over Coinbase, GDAX, and other exchanges. These platforms let investors trade cryptocurrency/currency pairs. Popular exchangers draw in partners and create a network effect. And by capitalizing on its market, it may set rules governing how other currencies are added.
Regulations and Legal Matters
The rapid rise in the popularity of bitcoin and other cryptocurrencies has caused congressmen to debate as to how to classify such digital assets. While the Securities and Exchange Commission (SEC) classifies cryptocurrencies as securities, the U.S. Commodity Futures Trading Commission (CFTC) considers bitcoin to be a commodity. This confusion has created uncertainty—despite the surging market capitalizations. The market has also witnessed the rollout of many financial products that use bitcoin as an underlying asset, such as exchange-traded funds (ETFs), futures, and other derivatives.
This can impact prices in two ways:
- First, it provides bitcoin access to investors who cannot afford to purchase an actual bitcoin. This increases its demand.
- Secondly, it can reduce price volatility by allowing institutional investors who believe bitcoin futures are overvalued or undervalued, to make bets that bitcoin’s price will move in the opposite direction.
Forks and Governance Stability
Because bitcoin is not governed by a central authority, it relies on developers and miners for transactional processes and blockchain security. Changes to software are consensus-driven and fundamental issues typically take a long time to resolve.
The number of transactions that can be processed depends on the blocks’ size, and bitcoin software is currently able to process three transactions per second. This wasn’t a concern when there was little demand for cryptocurrencies, people now worry that slow transaction speeds will push investors towards competitive cryptocurrencies.
The community is divided over the best way to increase the number of transactions per second. Changes to the rules governing the use of the underlying software are called “forks”. “Soft forks” relate to rule changes that do not result in the creation of a new cryptocurrency and “hard fork” software changes result in new cryptocurrencies. Past bitcoin hard forks have included bitcoin cash and bitcoin gold.
WHY THE RECENT PRICE RISE IN BITCOIN?
- Institutional over retail hype: In late 2017, Bitcoin’s historic surge to nearly $20,000 was driven mainly by retail investors. This time the public is still largely on the sidelines, according to Google Trends. In fact, the number of Google searches for “bitcoin” is only around 10% of what they were in 2017. Retail investor FOMO has not even started yet, which may suggest that BTC price could go much higher than last time. On the other hand, institutional demand for bitcoin has soared. As of June 17, open interest at CME Group saw 5,311 contracts totalling 26,555 BTC, or approximately $246 million — dwarfing the volumes during the 2017 price peak.
- Better network fundamentals: Bitcoin is more secure than ever and would require an unending amount of computing power to affect the network. Meanwhile, other fundamentals have also grown side by side with hash rate. Daily on-chain transaction volume, block size, and other parameters are also confirming that more people than ever are using bitcoin. Additionally, network transaction fees have remained relatively low compared to 2017, with optimizations like SegWit and off-chain scaling solutions like the Lightning network helping in easing the congestion.
- Long time to go for reward halving: Reward halving is set for May 2020. This is when mining block rewards will be cut from 12.5 to 6.25 Bitcoins, thus reducing the bitcoins received by miners who are naturally market sellers. Interestingly, the previous halving event occurred in the summer of 2016 — or more than a year before the price skyrocketed. This time, BTC price rises are getting ahead of the halving, as it is still 333 days away.
- The Bigger picture: Intraday BTC price moves are not very important for low time preference investors. These “hodlers” are confident that bitcoin — with its fixed supply — will outperform fiat currencies, whose supply continues to grow over the long term. On June 18, European Central Bank head Mario Draghi hinted that a monetary stimulus is on the way if the economy doesn’t improve. This is an increasingly peaceful tone that was applauded by the financial sector. At the same time, he was criticized by United States President Donald Trump, who said this would lead to unfair European competition against the U.S., whose Federal Reserve bank is also suggesting it will hold off on raising interest rates. The scene looks bright for bitcoin investors who are dumping ever-depreciating fiat currencies for hard-capped “digital gold.” Investors are starting to see that bitcoin’s supply is fixed, transparent, and it’s also the world’s first neutral, open-access money that no authority can control. In other words, what the internet did to information, bitcoin is starting to do to money.