How is the value of Bitcoins determined?

The value of Bitcoin is determined solely by the simple economics of demand and supply. Although this explanation is rudimentary and applies to every goods and services, it is the prime reason for speculation and fluctuation in the market.

Demand for Bitcoin arises as people want to buy Bitcoins either to use it in the darknet markets, to diversify and hedge their investment portfolio and for remittances to their families in other countries. All these factors add to the represent the demand side of Bitcoins.

Supply-side comprises of people who want to sell their Bitcoins for some reasons similar to the demand side. In addition to that, in case the miner mines a new block, they are rewarded 12.5 Bitcoins of freshly created Bitcoins in their Bitcoin Wallet adding to the supply of Bitcoins. However, they need fiat currency to pay for the electricity bills, equipment, rent etc.; and therefore need to sell their Bitcoins they earned a reward.

When demand exceeds the supply, it drives up the price and when the opposite happens when the price falls. Since all the coins are not pre-mined and mining is an incentive-based process whose product is Bitcoin itself, the price of Bitcoin is highly affected by the decision of the miners.

In addition to that, a large amount of Bitcoin is held in a cold wallet and not being actively traded. As a large chunks get out of circulation and shrink the supply of Bitcoins, it increases the price of Bitcoins. Conversely, when someone sells the Bitcoins he has hodl in the cold wallets, adding to the supply side, it brings down the price of Bitcoins.

According to an analysis by Dennis Porto, Bitcoin price is guided by Moore’s Law. The rule was devised by Gordon Moore, co-founder of Intel which stated that technologies that grow exponentially have a doubling time period, i.e. the value of the technology becomes twice as costly periodically when the adoption of the technology increases exponentially. According to Porto, since the inception of Bitcoin, it was observed that the Bitcoin price had doubled every 8 months.

There are several external factors apart from network usage that drive the price of Bitcoin. These factors include Government or Institutional support, need for technological improvements and social media hysteria of buy or sell, speculative and manipulative approach that result in pump-and-dump schemes.

Various schools of thoughts try to explain the price movements, and there is a considerable analogy with the dot-com bubble as well, but differentiated by the fact that apart from being a proposed secure network it is also a store of value. Since it is also a store of value; its price is showing cumulative growth. The reserve value of some of the Bitcoin wallets kept in ‘cold storage’ holds more than 10 million US dollars each even during a slumped market.

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