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5 Nov 2020

What Determines The Price Of Bitcoin?

Nisha Ramesh

The popularity of Bitcoin is reaching greater heights.

Everybody is interested in Bitcoin because the prices are increasing every day. But what makes something which is digital hold value? And what determines the price of bitcoins? 

Owing to its decentralized nature, we know that the government or any central body has no role in fixing the price of cryptocurrencies. Also, no individual or entity has sole authority over the value of bitcoins. 

Then how does its value increase or decrease rapidly? 

Curious right… Let’s first talk about the basics of economics – Demand and Supply. 

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Demand & Supply Economics Of Bitcoin & Onions

Supply and demand are fundamental concepts in economics. No matter what you do for a living, the basics of supply and demand are twined in our daily life.

Supply is the total amount of a product or service available in the market. The higher the amount of the product or service is available to the consumer, the larger the supply will be. 

Demand is a desire consumers have for a product or service. The more people want that product or service, the higher the demand for it.

These two factors are most significant in influencing the price of anything. 

Let us pause for a moment and talk about onions 🙂

Most of us might know that just last month a ₹100 could fetch us nearly 5kgs of onions. This month (November 2020) the price of onions soared multiple times to fetch only 1kg for ₹100.

Weird is it not? 

This happened because of the lack of supply or scarcity. The monsoons are said to have damaged most of the crops, which means we have significantly fewer onions.

But on the other hand, there is no decrease in the demand for onions, and it has its utility throughout the year.

So the farmers increase the prices of onions knowing that with its utility and high demand, consumers are willing to pay more to get their fair share. 

Well okay… but how can the price of onions explain the price of bitcoins?

Its demand and supply determine the price of Bitcoins. 

Bitcoins Are Scarce (Limited Supply)

Bitcoins are the first-ever digitally scarce object.

It cannot be printed or created on-demand like fiat currencies. The main goal of introducing cryptocurrencies to the world was to eliminate the loopholes, such as inflation that are created by fiat currencies like USD, EUR, or INR.

Like gold, bitcoins are also scarce. 

Right from the beginning, the creator of Bitcoin, Satoshi Nakamoto, designed it in a way for bitcoins to be scarce. Two key elements make this possible.

  • The supply of Bitcoins is limited.

There will be only 21 million bitcoins ever produced. 

  • Bitcoin Halving

It is the systematic reduction of transactional rewards once every four years. Meaning, the reward for bitcoin miners is reduced by half every four years until all bitcoins have been mined. 

Bitcoins Have Utility (High Demand)

Bitcoins have undeniable utility.

They are fast, global, and decentralized with the potential to bring a revolution to the financial structure of the world.

Not only can it be used as an efficient payment system (Currency), but it has also proved itself as a useful store of value (Investment).

Nowadays, many businesses are starting to accept payment in bitcoins. 

So once more people adopt its usage, its demand will increase. And when demand rises with limited supply, the price of bitcoin tends to increase.  

Other Factors Determining Bitcoin Price

As explained above, the price of bitcoins is purely dependant on its supply and demand. This is the same way the cost of onions, gold, or just anything in the market is determined. But there are a few other factors also that impact the price of Bitcoins. 

  • Cost of Production

Since Bitcoins are available digitally, there is a common misconception that it is free of cost. But just like other goods, bitcoin ‘mining’ (production) also involves a high cost of production. Electricity used to mine these coins is the most prominent factor of all.

Bitcoin mining involves solving difficult math problems to find a block of transaction. The first one to complete it will be rewarded with bitcoins once every ten minutes. Now, what is interesting here is that the bitcoin algorithm only allows for one block to be found every ten minutes. So if more people join the process, it only makes the problems harder, and thus the value of Bitcoins become more expensive.

Research shows that the price of Bitcoin is also related to its marginal cost of production.

  • Network Effect

Bitcoin has a significant network effect. Network Effect means ‘An already useful product or service gains more utility when more people start using it.’

For instance, imagine that just a bunch of people is using youtube. You may get only a limited number of videos from it. Since everyone is using it simultaneously, youtube’s utility has increased significantly.

Similarly, the more people begin accepting and using Bitcoins, the higher will be its usage and thus its value.

  • Stock To Flow Ratio Of Bitcoin

The scarcity of bitcoins can be measured in a similar fashion used for gold using the stock to flow ratio. 

Stock Flow ratio (SF) = Stock (Total available amount) / Flow (yearly production)

Or we can think of it as how many years of production does it take to produce the existing stockpile/ reserves. So a higher stock to flow ratio means the object is increasingly scarce and vice versa. 

So far, gold has the highest stock to flow ratio among all commodities at 62.

Currently, there are 18.53 million bitcoins available and has a stock to flow ratio of 55.92, putting it on par with the value of gold. Maybe this is another reason why bitcoins are known as digital gold.

The higher the stock-flow ratio goes, the higher the value or price of bitcoins will also go.

Bitcoin vs Silver vs Gold: Stock To Flow Ratio

Bottom Line: Value Of Bitcoin

In a nutshell, the price of Bitcoins prominently on its demand and supply. Since the supply is capped at 21 million BTC, we can safely say that the demand for bitcoins is what drives its price.  

If you are thinking of grabbing the opportunity and investing in bitcoins before they run out; CoinSwitch Kuber offers bitcoins and many other cryptocurrencies at an investment amount of as low as 100 INR. Sign up in less than 7 minutes and start investing. 

[su_note] KuberVerse is an educational initiative. Anything expressed here directly or indirectly is not investment advice. And we ask you to do your own research before investing. [/su_note]

Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

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Nisha Ramesh

Content Writer

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