The determinants of Bitcoin price (part one)

What are the determinants of Bitcoin price? Are there some features which drive the price of the most famous cryptocurrency in the world more than others? To answer these questions we have to first remind that, unlike fiat currencies, cryptocurrencies transactions are recorded in a blockchain, which shows the transaction history for each unit and is used to prove ownership.

This is why developing a price model for Bitcon is different than developing a price model for a fiat currency. Bitcoin is not issued by a central bank or backed by a government. This is why macroeconomics variables which are usually used to predict fiat currency prices, such as interest rates, money supply, inflation rates, and so on cannot be used to predict bitcoin prices. Otherwise, bitcoin prices are influenced by some other variables: the market supply/demand; the cost of mining process; the rewards bitcoin miners get for verifying transactions to the blockchain; the number of alt-coins; the exchanges it trades on; regulations governing its sale; its internal governance.

The supply of bitcoin is peculiar indeed and has specific features. First, the bitcoin protocol allows new coins to be created at a fixed rate. The new coins are generated through the so-called “mining process”, with blocks of transactions and the rate at which new coins are minted designed to decrease over time. The growth rate has decresed from 6.9% (2016), to 4.4% (2017) to 4.0% (2018). This mismatch creates an excess of demand on the market, provoking an increase of the Bitcoin price. The reduction in the issuing is due to the halving of block rewards offered to miners.

Secondly, supply depends on the number of bitcoins the technology allows to exist. The number of circulating bitcoin cannot exceed 21 million units. Once this number is reached, mining activity will halt. What will happen to prices when all these 21 million bitcoins are in circulation? This will depend on whether Bitcoin will be used for transactional reasons, its legal status and the popularity alt-coins will achieve. Of course, the imposed inflation mechanism of the halving will no longer have an impact on the price. At the current rate of adjustment of block rewards, the last bitcoin is forecasted to be mined in the year 2140, so it will take time to see the process completion.

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