What drives the price of Cryptocurrencies?

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What drives the price of Cryptocurrencies?

Over the past few weeks, Bitcoin has been hitting new milestones. Since the onset of the coronavirus pandemic, BTC has gained about 1250%. To put the price of Bitcoin into perspective, let’s take a quick look into its historic fluctuations. It started trading in August 2011 at $10.90 and crossed the $1000 mark for the first time in November 2013. Since Bitcoin hit highs of $19,666 in December 2017, it took another three years to cross the $19,000 in December 2020. Between December 2020 and February 2021, Bitcoin has been setting new record highs almost weekly. As of this writing, Bitcoin was trading just above $52,500 – the highest ever, but this was up until another tweet by Elon Musk which led the price sway again! In this guide, we will look at Bitcoin price drivers and determine what drives the price of cryptocurrencies overall.

Where Does Bitcoin Derive its Value From? 

Before we dive into the factor that drives up the price of BTC, we should first understand where Bitcoin gets its value. In a traditional fiat financial system, a currency’s price is impacted by factors such as a country’s economic growth, inflation rate, monetary and fiscal policies. We have a full guide on fiat currencies if you want to delve into more detail. However, since Bitcoin is decentralized, the factors that typically impact fiat currencies do not affect Bitcoin’s price. So what are the main Bitcoin price drives then? Here are the factors that influence the price of BTC.

1. Demand 

Typically, the price of any asset is determined by supply and demand. However, Bitcoin is limited in supply. Its supply has been capped at 21 million Bitcoins – this means that once the number of Bitcoins in circulation hits 21 million, no more Bitcoins will be created through mining. As of this writing, there are about 18,632,125 Bitcoins in circulation. Note that the Bitcoin mining protocols are designed to allow the creation of new Bitcoins at a fixed rate. More so, Bitcoin halving slows down the mining process, which reduces the rate of release of new Bitcoins into the market. That implies we cannot expect 1 million Bitcoins to be added into circulation overnight. 

This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.

Due to the finite supply of Bitcoin, demand is primarily what makes Bitcoin go up. This fact primarily makes Bitcoin valuable since the scarcer a resource is, the more valuable it is. Thus, if the demand for Bitcoin drops, its price will also drop. Conversely, when demand for Bitcoins increases, the price goes up. This was witnessed in 2020 when Bitcoin’s demand skyrocketed, pushing the price from lows of $3850 in March 2020 to the current highs of above $52,000. While an example of Bitcoin’s price drop was greatly witnessed on 13th May 2021 Musk announced that he’s Tesla will no longer accept Bitcoin as a form of payment.

2. Regulations

Although Bitcoin is decentralized, several financial regulators globally have taken an interest in it. In the US, for example, the Securities and Exchange Commission (SEC) classified Bitcoin as tradeable security while the Commodity Futures Trading Commission (CFTC) has categorized it as a commodity. So, when it comes to regulation, what makes Bitcoin price drivers go up? Typically, one would expect this to cause jitters among hardcore crypto enthusiasts, but such regulations have paved the way for developing more Bitcoin-related products, especially derivatives. Currently, crypto derivatives account for about 55% of the total cryptocurrency market. Such products, especially Bitcoin futures, have been invaluable in increasing Bitcoin’s liquidity and aiding in price discovery. Here’s how. 

Although there are about 18,632,125 Bitcoins in circulation, it is estimated that about 20% of them are actively traded in the market. That is because most investors are not trading BTC speculatively but holding them as a store of value. Consequently, the BTC held in cold storages robs the market of much-needed crypto liquidity. The danger with this is that these whales could significantly distort market prices if they decide to dump their BTC holdings, which would create panic and push prices lower.  

Crypto derivatives allow trading BTC without owning the underlying Bitcoins. Crypto exchanges structure these derivatives by borrowing the BTC held in cold storages. This helps to free up BTC liquidity and makes price discovery more efficient since traders can thus speculate on the price of BTC by freely going long or shorting the derivatives.  

3. Competition from Altcoins 

Bitcoin is the oldest crypto in existence but not the only cryptocurrency in the market – there are over 5000 cryptocurrencies. These altcoins are in direct competition with Bitcoin in terms of functionality. Bitcoin is the dominant cryptocurrency with a market capitalization of about $978.2 billion, about 62.5% of the entire crypto market. Note that market capitalization is the total market value of all Bitcoin in circulation. It is arrived at by multiplying the total amount of Bitcoin in circulation by Bitcoin’s current market price. 

However, with the explosion of decentralized finance (DeFi), altcoins have become substitutes to BTC. The DeFi platform is built upon the Ethereum infrastructure, largely incompatible with BTC. Thus, as DeFi gains mainstream popularity, altcoins will be in higher demand, potentially lowering the demand for BTC (more on this in our Bitcoin vs Altcoins article). Since the price of BTC is driven by its demand, this could potentially lower its value. 

This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.
This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.
This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.

What makes Bitcoin’s price go up? 

Since the onset of the coronavirus pandemic, Bitcoin has experienced the most persistent (and one of the longest) bull-runs in history. Let’s examine why this has been the case. 

1. Increased Demand

As we have mentioned above, the most significant determinant of Bitcoin’s price is its demand – and 2020 delivered exponential growth in demand! This is how it started. Once the pandemic wreaked havoc on the global economy, governments and central banks were forced to implement unprecedented expansionary fiscal and monetary policies to avoid irreversible depression. These policies involved issuing COVID-19 relief cheques, lowering interest rates, and engaging in aggressive quantitative easing measures. While they have been largely successful in avoiding devastating economic depressions, these measures spell doom for fiat currencies.  

The continued loss of confidence in fiat currencies is what makes Bitcoin go up, hence one of the main Bitcoin Price Drivers out there. The expansionary policies lead to an increase in the money supply, yet the economic fundamentals remain unchanged. This increase in the supply of money was bound to result in inflation within the fiat financial system. In the long-term, this increase in money supply will significantly impact the purchasing power of money. It means that fiat currencies became a poor store of value; money could lose its purchasing power in the future. This drove investors towards cryptocurrencies, seeking a safer store of value for their financial assets and effectively hedge against inflation.  

Notice here how the recovery of BTC after the initial onset of COVID-19 coincides with when the expansionary policies were implemented in March 2020

Recovery of BTC after the initial onset of COVID-19 mapped on graph
Source: TradingView

Remember that since cryptocurrencies are decentralized, such policies do not have any impact on them. The supply of Bitcoin will always remain finite. This puts investors’ minds at ease since they can verify the scarcity of Bitcoin. 

Note that the US is still going on with the COVID-19 relief programme by issuing stimulus cheques. This will continue increasing inflation which is bound to make further Bitcoin go up. 

2. Mainstream Adoption of Bitcoin 

Historically, retail traders have been the majority traders of BTC. However, 2020 saw institutional investors and traders flock to the Bitcoin market for various reasons – diversifying their portfolio, speculative trading, and hedging against fiat inflation. The transaction functionality of Bitcoin has also been on the rise as more retailers, merchants, and financial service providers accept BTC as a mode of payment. PayPal users can now buy, hold, and sell Bitcoin. Visa also partnered with Coinbase – a crypto exchange – to create a crypto-backed debit card allowing users to convert BTC to fiat easily. 

5/5

As with any asset, the value of Digital Currencies can go up or down and there can be a substantial risk that you lose money buying, selling, holding, or investing in digital currencies.

Institutional investors transact in large volumes driving up the demand for BTC, and are a contributing phenomenon in what makes Bitcoin go up. Since institutional investors’ entry, Bitcoin’s market capitalization has increased from $131.5 billion in January 2020 to over $978 billion in 2021. 

Some of the most notable institutions to adopt BTC in 2020 included MicroStrategy Inc., Square Inc., and, most recently, Tesla’s $1.5 billion investment in BTC. When Tesla announced that it had invested in Bitcoin and planned to accept BTC as payment, Bitcoin’s price surged about 23.8% within a few hours. 

Bitcoin price surge after Tesla invested in Bitcoin. on a graph
Source: TradingView

Regulations around cryptocurrencies signalled the mainstream acceptance of Bitcoin – most notably the US Office of the Comptroller of the Currency (OCC) authorizing US banks to provide custodial services for cryptocurrency holders. This is what encouraged most institutional investors to take up the crypto on their balance sheets. Such regulations also paved the way for the development of BTC derivatives such as ETFs and Bitcoin futures, which easily allowed large institutions to trade and invest in BTC without owning the underlying coins. 

3. Bitcoin Halving 

Bitcoin has an inbuilt anti-inflation mechanism called halving. Bitcoin miners are rewarded in Bitcoins, which increases the number of Bitcoins in circulation. Halving cuts the miners’ reward in half after every 210,000 blocks have been mined – approximately every four years. This ensures that there is no inflation in Bitcoin since the assets stock-to-flow ratio increases with each halving. This is the ratio between Bitcoin circulation and the number of new Bitcoins mined each year. Read all about our Bitcoin halvings guide here.

Of all the factors driving Bitcoin’s price, halving plays the fundamental role in what makes Bitcoin price go up. Historically, BTC halving coincided with a significant spike in Bitcoin’s price, with subsequent halving producing a higher Bitcoin’s price spike. November 2012 was the first Bitcoin halving, with the resulting bull run ranging from $12 to about $1,150 in under one year.  The next halving was in 2016, resulting in a bull run that topped $19,000 in December 2017. The third Bitcoin halving was in May 2020, and we are still experiencing the resultant bull run from $8181 to the current historic high of above $52,500. 

Bitcoin halving puts BTC at a significant advantage over fiat currencies which are susceptible to inflationary pressure. This explains why halving is followed by massive bull runs.  

This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.

4. Media Hype and FOMO 

The price of Bitcoin has been the major topic in almost every media outlet – from reputable financial houses to fringe social media blogs. Social media has, by far, been the major source of hype for Bitcoin. Positive tweets from prominent investors or celebrities tend to drive up the price of Bitcoin. For example, in the past few weeks, whenever Elon Musk tweets about Bitcoin, the tweets are followed by an almost instantaneous surge in Bitcoin’s price. 

The positive media coverage tends to create a contagion influencing other people to jump into the buying frenzy. Although the media coverage is not meant to be an advertisement for Bitcoin, it creates the irrational fear of missing out, which drives more people to invest. This inadvertently is what makes Bitcoin price go up. 

The Future of Bitcoin and its price 

About 88.7% of all Bitcoin has been mined. At the current mining rate, Bitcoin is expected to reach a maximum of 21 million by October 2140. So, what will happen after the last Bitcoin has been mined? We will come to a period of zero inflation! Miners will only be rewarded from transaction fees. 

Most crypto enthusiasts argue that there is no way but up for Bitcoin and its price. And they might be correct. We expect that institutional adoption is what will make Bitcoin go up as more investors seek to hedge against the unending inflationary pressure inherent in the fiat ecosystem. Most notably, it is expected that more fortune 500 companies will follow in Tesla’s footsteps and adopt Bitcoin on their balance sheets. The city of Miami has also shown the intent of adopting Bitcoin. However, with this in mind, Bitcoin still remains one of the most volatile cryptocurrencies out there.

Concluding on Bitcoin Price Drivers

As we have mentioned throughout the article, Bitcoin is scarce; its supply is fixed. The future value of a scarce commodity can be modelled using the stock-to-flow model. The basic principle of the stock-to-flow model is that as the ratio increases, so does the commodity’s value. 

Bitcoin halving almost doubles the stock-to-flow ratio, which results in a significant bull run. With every halving, the resultant increase in Bitcoin’s stock-to-flow ratio has led to a massive surge in Bitcoin price. Based on the model, it is projected that there will be a 20% monthly increase in Bitcoin’s stock-to-flow, which is expected to push the Bitcoin price beyond $100,000.  

Bitcoin's stock-to-flow model graph
Source: PlanB

Historically, the stock-to-flow model has been astonishingly accurate in predicting the price of BTC. Thus, with the projected 20% monthly rise in the stock-to-flow ratio and the constant increase in demand, the $100,000 target isn’t so outrageous after all.  

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