Bitcoin is known as the progenitor of digital currencies and was introduced by Satoshi Nakamoto in 2009. The transactions that take place using Bitcoin are stored in a blockchain. So, there’s a record of transactions, which is essential for ownership.
It should be known that buying Bitcoin is unlike purchasing commodities, stocks, or any other asset. This is because Bitcoin isn’t a company or organization. The result- there’s no Form 10Ks or company balance sheets to review. And, in contrast to physical assets, or stocks, Bitcoin isn’t issued by a central bank or monitored by any authority, so the inflation rates, economic growth estimations, and monetary policy don’t really hold any impact on its value.
Listed below are some of the determinants that influence the value of Bitcoin-
- The production cost or the cost of development incurred during the mining process
- Its competing cryptocurrencies
- The supply and demand of Bitcoin in the current market scenario
- The donations or rewards that are provided to developers for authenticating transactions.
- The crypto exchanges it trades on
- How it gets governed internally
- Regulations regarding its purchase and sale
Cost of Production
It’s known to everyone that Bitcoin is a form of virtual currency but it has to be developed at the end of the day. And, anything that has to be created or produced requires factors of production. The cost incurred for paying for these inputs is called the production cost. For mining Bitcoin, the electricity cost is probably the most important input. The process, “Bitcoin mining” is a complex method where developers try to solve cryptographic puzzles. The first miner to find the correct solution gets rewarded with a new batch of Bitcoin and transaction fees collected since the previous block was found.
For Bitcoin, there’s one unique thing. On average, the algorithm working on Bitcoin allows one batch of Bitcoins to be mined every ten minutes. This means that if more developers are joining the competition and participating in solving the math problem, it will make the problem tougher, raising its cost.
While Bitcoin may be the most renowned cryptocurrency but there are several other reliable ones. Even though Bitcoin still holds the hegemony when it comes to the market capitalization of all cryptocurrencies, there are some altcoins, such as Ethereum, Bitcoin Cash, Litecoin, XRP which are its closest competitors. Furthermore, developers are always coming up with new tokens and providing ICOs (Initial Coin Offerings) for regular investing. The reason being it’s not difficult to enter the crypto market for a new developer. This competition proves to be a blessing in disguise for the investors as it helps to keep the prices low. The only edge Bitcoin has over its competitors is its reputation. Being the progenitor of digital currency, it’s strongly backed by significant organizations and individuals, making it easier for regular investors to trust.
Supply and Demand
Some countries follow a fixed foreign exchange rate system and their currency values lie within a narrow range. These countries can somewhat decide on how much of their currency is available in circulation by regulating the discount rate, allowing open market operations, and/or altering the reserve requirement. A central bank can use all these options to control its currency exchange rate.
In the case of Bitcoins, the influence may be in two ways. First, the protocol for cryptocurrencies including Bitcoins permits new Bitcoins to be introduced at a predetermined fixed rate. For introducing new Bitcoins in the market, miners create transaction blocks and the rate of new Bitcoin generation slows down with time. For example, the growth of the introduction of new Bitcoins was 6.9% in 2016, it came down to 4.4% in 2017 and further decreased to 4.0% in 2018. This slowing down of new bitcoins flushed into the market for circulation is due to the division of block rewards into two parts. The bitcoin miners receive only half of the rewards and it affects the artificial inflation of the cryptocurrency. This in turn drives up the prices of the crypto very fast as the rate of increase in demand is always more than the rate of increase in supply.
In the second scenario, supply is affected by the total number of Bitcoins the cryptocurrency ecosystem supports. Like, for Bitcoins, this number is limited to 21 million and when this number of bitcoins are present in the blockchain, mining actions will not create new Bitcoins. In December 2019, the supply of Bitcoins touched 18.1 million that is 86.2% of the total Bitcoin supply that will finally be available. If the current rate of mining of new Bitcoins and settlements of block rewards continues, miners will have to mine till the year 2140 to reach the number of 21 million. And when the number of Bitcoins in circulation touches 21 million, the practicability of use, the legality of transactions, and demand will regulate the prices. In such a situation, the artificial system of halving the block rewards of the miners will not affect the prices of Bitcoins.
Availability on Currency Exchanges
Cryptocurrency exchange, also called Digital Currency Exchange (DCE) is a platform that allows its clients to trade in cryptocurrencies. This can be compared to indexes like Nasdaq, NYSE, and FTSE in which equity traders/investors trade stocks. GDAX, Coinbase, Binance, are some of the DCEs that allow investors to trade in cryptocurrency/currency pairs (For example, in Bitcoin/U.S. dollar or BTC/USD).
As the popularity of an exchange increases, additional cryptocurrencies are made available to the clients so it creates a larger network. Cashing on this, the exchange then sets its own rules that govern how other cryptocurrencies/currency pairs are added.
The recently released SAFT or Simple Agreement for Future Tokens provide a framework on how ICOs could follow the security protocols. The availability of Bitcoin on the cryptocurrency exchanges will mean that it has to follow certain regulatory protocols although cryptocurrencies have some grey areas.
As Bitcoin is a decentralized virtual currency, not monitored by any authority, it’s dependent on miners and developers to process transactions and keep the blockchains safe. If there are changes to be made with the Bitcoin protocol, it has to be approved by the entire Bitcoin community. This is frustrating as the community has members with different opinions and ideologies and seldom agree with each other, making it difficult to solve the system’s fundamental problems.
The scalability of Bitcoin is another big issue for the community. Every block has a fixed capacity that can store a particular number of transactions. The algorithm only allows the processing of only three transactions every second. This was a system developed 11 years ago when there was low demand for the token, but now most developers feel that investors might turn to other cryptos with a higher speed of processing transactions.
People associated with the development of Bitcoin are divided on the solution to this “common problem”. “Forks” is the name used to refer to such changing of fundamental rules of the underlying technology. Soft forks are the rules which don’t completely change the core rules of the crypto. On the other hand, hard forks are tough software changes that could change the entire fundamentals of the token and in fact, create a new token. Earlier, hard forks have led to the creation of Bitcoin Cash and Bitcoin Gold.
Regulations and Legal Matters
The instant rise that Bitcoin and altcoins are getting just after they are launched is unusual for regulators who are confused about classifying them. There’s obviously the major regulatory body, SEC (the Securities and Exchange Commission of USA) that classifies digital assets as securities, while the CFTC (the US Commodity Futures Trading Commission) classifies them as commodities. Despite the huge rise in popularity of the cryptos, there’s still confusion on who the primary regulator is and who sets the regulations. The market has also seen a rollout of several financial products, such as derivatives, futures, and Exchange-Traded Funds (ETFs) that have Bitcoin as its backing asset.
The effects of this can be two-fold. The first scenario makes bitcoin available for trading even for the investors who cannot otherwise afford to purchase a Bitcoin, thereby increasing the demand. Second, it allows institutional investors who find bitcoins to be overvalued or undervalued. So, they make bets on the price of bitcoins that it will follow the opposite trend, thereby decreasing the price of the cryptocurrency.