If you are looking for a daily adrenaline rush, try pulling up and tracking a Bitcoin price chart over the span of 24 hours. You might see Bitcoin prices fluctuate at a rate that is practically inconceivable for any other asset, a feat that can make even the most hardened adrenaline junkies drop a sweat. Some experts even suggest the thrill is part of the reason why people invest in Bitcoin, since the asset’s price volatility promises an excitement the stock market just can’t match.
However, wild price fluctuations are not exactly random. The Bitcoin market is influenced by several factors. While it is hard to guess Bitcoin prices round-the-clock, it is possible to understand what drives the prices thanks to price patterns that have emerged over the years.
If you want to understand why Bitcoin prices fluctuate, here is a guide to help you understand what drives the price of Bitcoin.
What Is Bitcoin Worth?
You might already be familiar with “Florida Man…” headlines that evolved into one of most enduring and entertaining internet memes of the last decade, but did you know about the crossover between the meme and the history of cryptocurrencies? Laszlo Hanyecz, a man from Jacksonville, Florida, made cryptocurrency history in May 2010, with the first ever real-world purchase with BTC when he bought two pizzas from Papa John’s in exchange for 10,000 BTC. 10,000 BTC equaled roughly $41 at the time. In a decade, that amount of BTC would be worth a couple hundred million USD.
Hanyecz, a programmer himself, was an active member of the early Bitcoin community when he made his offer on a Bitcoin forum after successfully mining some BTC during the day. At the time of his offer, you could probably buy two pizzas for around $30. For Hanyecz, it was an interesting experiment and a chance to make his mark on cryptocurrency history. In essence, he created a broader market for Bitcoin by selling his BTC for less than the market’s asking price, thus increasing the asset’s liquidity.
Nowadays, people use cryptocurrency exchanges to buy and sell Bitcoin but the same principle applies. Unlike fiat currencies, Bitcoin doesn’t actually have a fixed singular price at any time. Its price is entirely determined by what people are willing to pay for it. That is why Bitcoin price charts either show prices of the latest transactions on the leading exchanges such as Coinbase or track prices from several exchanges to calculate an average price for Bitcoin, like Coindesk.
What Determines Bitcoin’s Price?
There is no central authority regulating Bitcoin’s price, so essentially the price is determined by the market. Since Bitcoin is a decentralized currency, the market is simply anywhere Bitcoin is bought and sold, and that is cryptocurrency exchanges for the most part.
To put it simply, a cryptocurrency exchange is a marketplace for digital currencies. Some people want to buy digital assets and some people wish to sell them, so they meet each other in the marketplace to make their offers. Cryptocurrency exchanges list these offers in an order book, showing what each person is willing to buy or sell. There is also a record of the transactions on the exchange, and the very last transaction shows the most up-to-date Bitcoin price.
How Does the Value of Bitcoin Move On an Exchange?
For example, let’s say that the best sell order (lowest price) on an exchange is 10 USD and the best buy order (highest offered price) is 9 USD. Now, either the seller or the buyer will have to compromise in order to make a transaction. If the buyers think Bitcoin will be worth 15 US Dollars in near future, they won’t mind paying 10 dollars at the moment, and they will start accepting the sell offers.
They will buy as much as they can for 10 US Dollars and then move on to more expensive deals. As they buy more, the sellers will notice the high demand and increase prices. This will continue until a certain point where Bitcoin’s price will end up being higher. The opposite happens when the sellers keep offering cheaper prices for Bitcoin, creating a downturn trend. Bitcoin can see %5 to %10 shifts in prices in a single day on a prominent exchange.
What Drives Cryptocurrency Prices?
Now you have an understanding of how Bitcoin prices rise and fall on the exchanges, but the more important question is why the prices fluctuate and why they are so volatile.
In order to understand what drives Bitcoin’s value in the long run, we need to understand its dual role in terms of exchange of value and store of value. These are the main properties of economic assets that make them desirable.
Exchange of value simply means an asset can be exchanged for other desirable things. Money is a medium of exchange we use to buy goods and services. Fiat currencies like the US Dollar and Euro can be used around the world to buy the things you want. They are backed by central authorities such as banks and states and their purchasing power is guaranteed by these authorities.
Cryptocurrencies like Bitcoin (BTC) or Ethereum (ETH) are essentially software projects. They are not backed by authorities, so their exchange rates free float depending on what people decide they are worth.
Store of value means an asset can store value over time and can be used in the future with relative stability in its price. Gold is commonly accepted as a safe haven for investors since it has a high store of value – there is a reason “gold standard” has become a term.
Since Bitcoin has a limited supply, it is like gold in terms of scarcity. This is why some people believe it can replace gold in the future, even though the current price volatility makes it a poor store of value at the moment.
What Makes Bitcoin Valuable?
The value of Bitcoin and all other cryptocurrencies lies in how adaptable they are and how they perform at value roles. Fiat currencies are valuable because they are backed by national economies and they are widely accepted in exchange for goods and services. Gold is valuable because it has economic power even when national economies collapse. These assets have good exchange value and store of value properties. So what about Bitcoin?
Part of the confusion about Bitcoin’s value and the reason for its price fluctuations stems from Bitcoin’s possible role as an exchange value and store of value.
Bitcoin’s Exchange Value
At its conception, Satoshi Nakamoto designed Bitcoin as a privacy-oriented electronic payment system that people can use to make purchases and send small amounts of money without paying extravagant fees to banks. Bitcoin enthusiasts hailed the digital currency as the harbinger of a paperless and digitized economy, completely freed of middlemen and third-parties. This vision easily explains why Laszlo Hanyecz paid 10,000 BTC for 2 pizzas (and why he was willing to repeat his offer) back in 2010. He ordered the pizzas in the spirit of early Bitcoin, a virtual currency hoping to gain exchange value and wide adoption.
But within two months, the price of Bitcoin rose. By August, the price of 10,000 BTC reached 600 US Dollars and Hanyecz wrote he was no longer offering to buy pizzas with Bitcoin. By November that same year, 10,000 BTC was worth 2,600 USD. So even though Bitcoin was originally designed as an electronic payment system, it soon ceased to be used for everyday payments. This bit of history illustrates why using Bitcoin to make purchases could be a tremendously bad idea. While Hanyecz doesn’t regret his purchase, for most people, a million-dollar pizza would be pretty hard to stomach.
Bitcoin’s Store of Value
Bitcoin has a market cap of 21 million BTC. New bitcoins are created as miners validate Bitcoin transactions on the blockchain, but per Bitcoin’s algorithm, the amount of bitcoins generated by mining halves every four years. This means that not only is Bitcoin’s supply limited, but also that most bitcoins have already been created and mining rewards will generate less and less BTC as time’s arrow marches forward.
This scarcity is an important factor for Bitcoin’s potential store of value. Fiat currencies aren’t scarce, for example, as governments and central banks that control the money supply can print more currency to ease the effects of an economic crisis, though this could also cause high inflation and devaluation.
Experts who think Bitcoin prices will dramatically rise in the future often consider Bitcoin in terms of store of value. The immutability of the blockchain and the limited number of bitcoins means that Bitcoin could possibly replace gold, at least in private portfolios. In that case, the value of a single BTC could topple the 100,000 USD mark.
What Is Bitcoin’s Future?
These two different valuation methods reveal two competing but entangled narratives about what the future of Bitcoin holds. Think about it this way: when was the last time you paid for groceries with gold? It’s a cheeky question but it reveals the fundamental contrast between two separate but widely conflated Bitcoin narratives.
However, the path to the future may indeed converge, whatever the outcome is. This is where Bitcoin’s volatility comes into the picture.
An increase in Bitcoin’s value depends on its mass adoption either by people or institutions. In order to be widely adopted, Bitcoin either needs to gain the public’s trust or rise in value so much so that it becomes impossible to ignore for investors.
On the stock market, the stocks of a company rise and fall depending on the public’s perception of how the company is doing. This means industry-wide news, news relating to the company’s management, business reports, revenues of the company, and the success of its products as well as government regulations, all play a role in determining the price of an asset. Similar factors affect the way cryptocurrency prices change.
What Does This Mean for Bitcoin?
Bitcoin’s price depends upon its public perception and whether the public believes it is a sound investment. Regulations, technological advances and problems, and highly publicized stories of making and losing money all have a tremendous effect on Bitcoin. In fact, an empirical study of what drives Bitcoin price action concluded that the amount and the tone of online content about Bitcoin has a strong effect on the asset’s price action.
For example, exchange hacks, security breaches, and bankruptcies such as the Mt. Gox incident generate bad press and hurt the cryptocurrency’s value. On the other hand, the publicization of technological advances, like the adoption of the Lightning Network, raises the asset’s value.
While news of regulatory measures such as banning cryptocurrencies or Bitcoin mining usually affects the asset negatively, news about institutional support such as El Salvador declaring Bitcoin a legal tender, or PayPal accepting Bitcoin as payment generates hope that there is still hope for the future of Bitcoin. And of course, Elon Musk’s Twitter account continues to delight and agonize cryptocurrency holders in alternating measures.
A Few Words Before You Go…
Currently, extreme fluctuations make Bitcoin a troublesome payment method for everyday purchases, but they do open up a potentially rewarding investment avenue for those who don’t mind the high-risk nature of the asset. Even though nobody knows for certain what will become of Bitcoin in the long run, the current price volatility makes Bitcoin trading an attractive opportunity for many people, which increases its adoption rates. In fact, for a large percentage of millennials, Bitcoin and other altcoins represent a chance to generate wealth that traditional markets no longer provide. It seems that changes in public perception will continue to drive the Bitcoin price action for the foreseeable future.