What Determines the Price of Bitcoin?

If anything, Bitcoin is well known for its volatility. The price of Bitcoin has gone from $0.09 to an all-time high of $65,000 in November 2021, which has dropped to $26,000 as of writing this.

Have you ever wondered what makes Bitcoin’s price rise or crash? There are a lot of factors influencing Bitcoin’s price. In this blog, we will understand why its value varies from time to time and what causes sudden price swings.

• Supply and demand

Bitcoin’s price is significantly determined by its supply and demand. If demand cannot match the supply, its price will increase and vice versa. By design, Bitcoin’s supply is predictable. We know that only 21 million Bitcoins will ever exist on the network. This makes it scarce and valuable.

Throughout its history, Bitcoin has attracted the attention of giant institutional investors, business owners, and companies by being in the headlines for huge price swings. It has also gained popularity in countries with weak financial systems. For instance, El Salvador became one of the first countries to adopt Bitcoin as a legal tender in 2021. During that period, Bitcoin’s price peaked as the demand was significantly higher than its supply.

Bitcoin’s demand can increase along with its utility. When large institutions, including banks, investment firms, and other business entities, adopt Bitcoins, the price may rise due to an increase in demand and credibility as a leading cryptocurrency. As of today, over 15,000 businesses, including giant corporations like Microsoft, Etsy, and NewEgg, already accept Bitcoins. As more businesses start accepting Bitcoin, its popularity will grow, and so will the price.

• Competition

Over 22,904 cryptocurrencies have emerged since the inception of Bitcoin. Approximately 8,832 are still active. Although Bitcoin is the most popular cryptocurrency, its market cap has reduced by 30% since 2017. That’s primarily because newer currencies like Ethereum are just as secure as Bitcoin but consume a lot less energy to secure the network. (See our full comparison between Ethereum and Bitcoin.)

Many investors have started diversifying their portfolios by investing in multiple cryptocurrencies, which also reduces Bitcoin’s market cap. With time, Bitcoin’s competition is only getting fiercer. Despite that, it is still a widely accepted cryptocurrency with a market cap of about 50%. However, if its demand decreases due to the competition, it may start losing value and vice versa.

• Government regulations

Government laws and regulations play a vital role in Bitcoin’s growth and adoption. A few countries, for instance, have completely banned the use of cryptocurrencies. On the flip side, there are countries like Germany and Switzerland that encourage the use of crypto by offering tax benefits and a lenient regulatory framework. (Also see: How crypto is regulated around the world?)

Favorable regulations and a clear set of guidelines can accelerate Bitcoin’s adoption and drive its price. However, if governments decide to ban Bitcoin and other cryptocurrencies, it may hinder its growth and adversely affect its price.

• Technological developments

Bitcoin is far from perfect. Mining Bitcoin is energy-intensive, and it can only handle 7-10 transactions per second. To overcome Bitcoin’s existing limitations, the Lightning Network was released in 2018. It stretches Bitcoin’s capacity from 7 transactions per second to millions. What’s more, the Lightning Network reduces the transaction time from 10 minutes to a few seconds and also enables micropayments.

The Lightning Network is considered to be the biggest upgrade in the history of Bitcoin. Now, Bitcoin payments are faster, more efficient, and can be as small as 0.00026 USD. Such technological adoptions can positively influence Bitcoin’s price by maximizing its utility and fostering greater demand. 

• Production cost

New coins are introduced into the network by a process called Bitcoin Mining. Miners use their computing power to verify transactions by solving an extremely complex mathematical problem. The one who successfully cracks the code first gets to add the next block on the blockchain. For every successful block added, the miner receives a reward in the form of Bitcoins.

Bitcoin mining requires expensive equipment and can cost a significant amount of electricity. As more participants join the network, the hashpower of the network increases accordingly. This eventually makes mining difficult. Miners have to continue upgrading their equipment to match the mining difficulty. Ultimately, this increases the cost of mining.

For miners to continue their operations, it is important that the value of Bitcoin is enough to offset their expenses. And because miners are crucial for Bitcoin to function, its price will go up as long as there is demand for the Bitcoin blockchain.

FAQs