How is Bitcoin valued?
Market forces called supply and demand influence Bitcoin's price. The price typically decreases when there are more sellers or vice-versa.
Bitcoin (BTC) is a digital coin, which is not issued by any government or legal body, in contrast to fiat currencies like the dollar, pound, euro and yen. To create, store and move BTC, a dispersed network of users and cryptographic protocols are required.
Investors, carry out their commercial transactions directly as opposed to using a middleman. The peer-to-peer network removes trade restrictions and streamlines commerce. Satoshi Nakamoto first proposed the world's first cryptocurrency in 2008, which was launched in January 2009.
The number of businesses accepting Bitcoin is growing daily, giving it a real market value. However, this virtual currency has been severely hampered by security issues and volatility. Even at the height of its popularity, it was challenging to find precise answers to common questions like what determines Bitcoin's value, who sets Bitcoin’s price and whether Bitcoin has intrinsic value?
The same market dynamics, i.e., supply and demand, that affect the price of other goods and services, also decide the value of Bitcoin. Prices will probably rise if there are more buyers than sellers or vice-versa. Furthermore, it is essential to note that the price of Bitcoin is not determined by a single entity nor can it be traded in a single location. Based on supply and demand, each market or exchange sets its price.
What factors could impact Bitcoin’s price?
Various factors impacting Bitcoin's price include the supply and demand of BTC, competition from other cryptocurrencies and news, cost of production and regulation.
Supply and demand
Those with a background in economics are aware of the law of supply and demand. However, if you are unfamiliar with this concept, let's help you to understand. As per this law, supply and demand market forces work together to determine the market price and the quantity of a specific commodity. For instance, the demand for an economic good declines as the price increases, and sellers will produce more of it or vice-versa.
An event called Bitcoin halving impacts the Bitcoin's price like the situation in which the supply of BTC decrease whereas the demand for BTC increases. As a result of the high demand, the price of BTC will move upward.
Moreover, Bitcoin was created by Satoshi Nakamoto with a 21 million BTC hard cap. That said, miners will no longer receive new Bitcoin for confirming transactions once that cap has been reached. The four-year halving of block rewards might not affect the price of BTC at that point. The things that will determine Bitcoin’s value will instead be its real-life applications.
Competition and news
BTC faces competition from altcoins like Ethereum (ETH) and meme coins like Dogecoin (DOGE), making portfolio diversification appealing to investors. Any upgrades by the existing cryptocurrencies might drive BTC's price down in contrast to a completely different scenario in which Bitcoin was the only existing digital currency. Due to media coverage, you may want to buy crypto assets with a positive outlook and ignore those with a shady future.
Cost of production
Production costs for Bitcoin include infrastructural expenses, electricity charges for mining and the difficulty level of the mathematical algorithm (indirect cost). The various levels of difficulty in BTC's algorithms can slow down or speed up the currency's production pace, impacting Bitcoin's supply, which, in turn, affects its price.
Cryptocurrency regulations are constantly changing, from countries like El Salvador accepting it as a legal tender to China formally banning crypto transactions. The price of BTC could decrease if there is concern over a specific government's decision against cryptocurrencies. Additionally, regulatory uncertainty will create fear among investors, dipping Bitcoin's value even further.
Why is the Bitcoin price so volatile?
Uncertainty regarding the intrinsic value of Bitcoin and BTC's future value makes it a highly volatile asset.
A decreasing amount of new BTC is created each day since a finite quantity of Bitcoin exists. To maintain a steady price, demand must match this inflation rate. The Bitcoin market is quite small compared to other industries, and media coverage alone can drive its price up or down. For instance, news about Tesla's willingness to accept BTC will drive its value upwards or vice-versa, making Bitcoin’s price highly volatile.
Similarly, a tweet that the Bitcoin blockchain has been halted will drive its value down, followed by Bitcoin trading volume. So, considering high volatility, can the Bitcoin price go to zero? Technically, it is possible. For instance, the price of BTC is not pegged to any fiat currency like the U.S. dollar or any other real-world asset; it is susceptible to value crashes. However, we have seen that algorithmic stablecoins like Terra USD can create market turbulence too.
Nevertheless, for such a catastrophic event to happen in the case of BTC, many red flags, such as an extended bull market, will appear in advance to allow investors to protect their funds. Also, the complex Bitcoin architecture is not easy to destroy; however, its scalability issues may put its future at risk. But, that does not mean that BTC's price will suddenly fall to zero.
What will happen if Bitcoin's price crashes to zero?
If BTC's price drops to zero, it will impact the traders, institutional investors, price of other digital currencies, cryptocurrency enterprises and the whole financial system.
Now, assuming that BTC's price declines to zero, it will impact the price of other cryptocurrencies. As a result, many investors could just withdraw (completely or substantially) to reduce losses, depending on their type of investment.
Large institutional investors may be particularly at risk because more and more have made larger investments to diversify their portfolios. The most exposed would be those who invested more recently at high prices or in crypto derivatives, and they would need to liquidate other assets to fulfill margin calls.
Customers may lose faith in a system that appears to be crumbling, affecting cryptocurrency enterprises like Coinbase, Binance, etc., that depend on customers for transaction flow to generate revenue and funding/investments to grow. Investments in these companies may also stop altogether or significantly decline. Additionally, such enterprises may no longer be able to hire, pay or attract the personnel necessary to run and expand them.
Furthermore, the contagion may, at least temporarily, have an impact on the rest of the financial system due to:
- Downward pressure on other assets such as those sold in a fire sale to raise money to meet obligations, such as paying remuneration, margin calls, maintaining premises, etc., and
- The accumulation of bad debt or non-performing loans due to payment defaults amid the loss of revenue and capital.