As more people become interested in Bitcoin, especially as the price rises, the question becomes: why exactly does Bitcoin have value?
Bitcoin is the world’s first cryptocurrency that was created in 2009 by an unknown author under Satoshi Nakamoto’s pseudonym. All transactions are recorded in special blocks of the common chain, which can not be changed. And each coin and even its part has only one owner, although the history of ownership can be verified from the moment of creation to the present.
Buying Bitcoin differs from buying securities or stocks. BTC does not have corporate balance sheets and internal reports. Unlike investments in traditional currencies, Bitcoin is not issued by a central bank and is not backed by a government, so monetary policy, inflation rates, and economic growth measures that normally affect the value of national currency are not relevant to BTC. So the inflation of the leading digital asset is carried out according to completely different laws. Therefore, the classical indicators of economic growth used in forecasting cannot be applied appropriately to Bitcoin either.
For many people, it is not easy to understand how something that exists in digital form can have any value at all. Let us find out how the price of Bitcoin is determined.
What determines the price of bitcoin?
Among the main factors affecting BTC price are:
- Supply and demand
Countries that do not have fixed exchange rates can partially control the volume of their currency by adjusting the interest rate, changing reserve requirements, or participating in open market operations. Bitcoin supply is influenced in two different ways.
First, the Bitcoin protocol allows the issuance of new coins at a fixed rate. Once every four years, the supply of BTC is reduced by half. This issuance limit rule was written in the cryptocurrency algorithm itself to regulate the creation of a large number of coins. In such a way, fewer and fewer coins appear in circulation, and the level of supply and demand in the crypto market can be controlled.
Second, the number of Bitcoins is capped at 21 million coins, and once that number is mined, no new coins will appear. For example, at the end of January 2017, the BTC supply reached 16.8 million, which is 80% of the total BTC supply that eventually became available.
Take gold, for example. Why is gold worth so much? Simply put, it is relatively expensive because it is rare, hard to find, and its supply is limited. Moreover, gold has multiple uses from which consumers derive satisfaction utility. Hence the comparison of BTC with gold, the amount of which is also limited. And this, in turn, is a direct factor affecting the bitcoin exchange rate and the hype that is constantly increasing around this cryptocurrency.
However, Bitcoin must also have utility to gain value over time. Like gold, Bitcoin is fully fungible (one Bitcoin is like another), divisible (you can pay someone a small portion of BTC if you want), and easily verifiable (via the blockchain). Bitcoin also has other desirable features. It is a fast, borderless, and decentralized service that can change the financial world for the better. Currently, it is of value not only as a payment system but also as an asset class (store of wealth). It is also useful because it is based on open protocols, which means that anyone can innovate and improve the network.
Bitcoin also has undeniable utility compared to other, newer cryptocurrencies. Right now, there is simply no other cryptocurrency that is as widely used and integrated. Network effects have created exponential growth so that more and more people use Bitcoin, and more merchants accept payment in BTC.
- Decentralization nature
If you have fiat money in a bank account, the financial institution can dispose of it, for instance, block or withdraw your funds. Unlike fiat money, digital assets are not controlled by the state, and the global economic conditions do not determine their price. Bitcoins, like other cryptocurrencies, are assigned to their owner, who is solely responsible for their disposal. Consequently, the cryptocurrency began to attract more attention as a secure way to protect assets from inflation.
The popularity of Bitcoin and other digital financial assets has prompted regulators to debate how to classify them. Each state perceives cryptocurrencies in its own way. For instance, the Securities and Exchange Commission, or SEC, in short, has classified crypto as a security while the Commodity Futures Trading Commission (CFTC) considers BTC a commodity.
This confusion over which regulator will set the rules for cryptocurrencies has created uncertainty despite the growing market capitalization. In addition, the industry is seeing the introduction of many financial products that use Bitcoin as an underlying asset, such as exchange-traded funds (ETFs), futures, and other derivatives. This can affect prices in two ways. First, it gives investors more opportunities to access BTC, thus increasing demand. Second, it could reduce price volatility by attracting more institutional investors.
- Forks and network improvements
Because a central authority does not manage Bitcoin, it relies on developers and miners to process transactions and keep the blockchain secure. For instance, the Bitcoin
scalability issue has been harrowing. The block size limits the number of transactions on the blockchain that can be processed. While this was not a problem when demand for cryptocurrencies was low, many are concerned that slow transaction rates will push investors toward competing cryptocurrencies.
The community is divided on the best way to solve the Bitcoin scalability issue. Changes to the rules governing the use of the underlying blockchain are referred to as forks. Soft forks refer to rule changes that do not result in the creation of a new cryptocurrency, while hard forks software changes result in a new coin.
In 2021, Bitcoin underwent its first major upgrade since August 2017. Bitcoin’s Taproot update consists of three Bitcoin Improvement Protocols (BIPs) — BIP 340, 341, and 342 — that should bring more privacy, improved smart contracts, and lower transaction costs to the network. A smart contract is the main innovation force on the Ethereum network. They enable the development of applications and businesses on the blockchain. So improving smart contracts could open the door for Bitcoin to the world of decentralized finance (DeFi) and non-fungible tokens (NFT).
Why is Bitcoin volatility declining?
Cryptocurrencies are often considered risky investments due to their high volatility. The size of the overall Bitcoin market is still relatively small compared to others. That means that only a few large purchases or sales of Bitcoins can affect the price, so it is still quite volatile.
Nevertheless, Bitcoin’s price fluctuations were steadily decreasing, resulting in enhanced network stability. Of course, Bitcoin’s volatility with 4.46% at the time of writing significantly superiors 0.67% of Euro against the dollar. However, this is a significant drop compared to the peak price change of 16.11% on June 13, 2011.
The bitcoin volatility index determines how much the price of the cryptocurrency changes
per unit of time. If the indicator’s value is high, the price of an asset can change by 10% during one trading day.
This factor is influenced by the digital currency’s market capitalization and the total number of coins in circulation. For example, if the capitalization of the project is low, the price of buying new coins increases at the moment. The opposite is true, for example, the US dollar does not dramatically change its value when buying a currency due to its huge market capitalization. The overall decrease in BTC price fluctuations is a good sign that could indicate the growing market maturity.
Furthermore, according to Arcane Research, Bitcoin’s correlation with the S&P500 peaks in 2022. The latter is a stock index that includes 505 stocks of the largest issuers. The indicator reflects the general state of the US stock markets and the global economy, since most of the index companies are of international importance.
Bitcoin’s dependence on the stock index means that:
- The cryptocurrency is becoming more dependent on the external market. This is due to the increasing popularity of the leading crypto. Institutional investors connected to the stock market are appearing on the blockchain. Moreover, the coin is becoming a classic instrument for an investor’s portfolio.
- Predicting the bitcoin price is becoming easier. If this trend continues, it will be possible to estimate the coin value in the future. Consequently, the instrument could become more attractive for long-term investments.
- The level of interest in BTC grows. Thus, Bitcoin is becoming a traditional means of payment and asset storage.
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