In order to trade bitcoin effectively, investors should be familiar with the major variables that help determine the digital currency’s price.
At the most basic level, bitcoin’s price is a function of supply and demand. The total supply of this digital currency is capped at 21 million, which means only 21 million total units of bitcoin can exist at any time, according to current rules.
At the time of this writing, 16.9 million of these digital tokens have been mined. These units are created through the process of mining, which involves processing transactions in to a “block” in bitcoin’s blockchain.
Every time a block is mined, a “mining reward” is provided. This reward gradually declines over time. While mining the first block released 50 units of bitcoin (BTC), the mining reward has been cut in half (halved) approximately every four years. At the time of this writing, the mining reward was 12.5 BTC.
While these figures might prove helpful, it is worth keeping in mind that the information needed for many bitcoins has been lost. Nicholas Gregory, CEO of blockchain infrastructure company CommerceBlock said in late 2017, “There’s probably two or three million bitcoin that will probably never be used. There’s quite a lot that have been lost.”
While the aforementioned information covers the supply side, the demand side must also be explored in order to provide a full explanation.
Some market analysts believe that bitcoin’s price is largely a function of market sentiment, which could also be referred to as “animal spirits,” a term coined by legendary economist John Maynard Keynes to explain the emotional approaches that many investors take to decision making.
There is evidence to support the belief that media coverage is a major driver of bitcoin’s price movements, too. The digital currency’s price has experienced sharp increases during times when it was covered by the mainstream media.
This development can result in bitcoin following what is known as a hype cycle. Basically, widespread media coverage can cause the hype surrounding a technology (like a digital currency) to peak temporarily before eventually falling to a substantially lower level.
Bitcoin has already experienced several cycles where it underwent sharp price appreciation followed by notable losses. While it is difficult to attribute its price movements to a single variable, the digital currency suffered substantial volatility as it drew mainstream media coverage.
Another major factor that analysts have often cited as driving bitcoin’s price movements is macroeconomic and/or geopolitical turmoil. Analysts have repeatedly described bitcoin as a safe-haven asset.
Chris Burniske, a prominent analyst who worked for investment manager ARK Invest, told CNBC that bitcoin could be referred to as “digital gold,” stating that the cryptocurrency has many of the same qualities as the precious metal.
“When you look at the global markets, there’s lots of fear, uncertainty and doubts,” Burniske said. Investors have frequently flocked to safe-haven assets like gold during times of market turmoil.
Another major variable is regulatory developments. As stated earlier, the regulatory framework surrounding digital currencies is very immature, meaning it could change quite a bit over time. Digital currency exchanges have sometimes found that in order to attract institutional investors, they must proactively develop robust compliance in order to stay in accordance with regulations.