The Bitcoin hype is upon us, and the thousand dollar marks are passed one after the other. Usually, the news stories appear when the price reaches new record-highs, of which there has been no shortage in in 2017. From being worth only a couple of cents in 2010, the price today is over 10,000 US dollars. More and more people have heard about Bitcoin, and more and more people are also investing in it, all across the globe. There is also an increasing awareness among the population that Bitcoin might perhaps threaten the established financial system and revolutionize the concept of money.
However, if this is true, doesn’t that mean one actor could enter the market and swoop up all existing Bitcoins? Is there anything stopping them from doing that if Bitcoin is such a threat? And with its big price fluctuations – will Bitcoin ever be capable of replacing the established traditional currencies?
In this article, we are going to cover the fundamentals on how the Bitcoin price actually is determined, and why the price, like other financial instruments, does not function in the same way as the price of apples and cars. Finally, the article will give you the insight into why it is harder and harder for single actors to control the market as Bitcoin rises in popularity.
In order to explain how the price of Bitcoin is established, imagine a little village in the middle of two mountains, or steep hills. The village has a marketplace in the middle, and this is where people come to buy and sell bitcoins. From the west, people are coming because they want to buy. From the east, there are people who are coming to sell. Two lines of people are formed, one from each side. At the front, there are those who are willing to pay the most and sell the cheapest.
The people in front of both lines constantly settle on a price and complete trades continually. This marketplace never sleeps. Some are here all the time, both to buy and sell. Also, there are thousands of new people who come here every day. They all leave the marketplace satisfied after buying or selling. Some buy and sell dozens of bitcoins at the time, whereas others buy and sell just tiny amounts.
However, not everyone actually come down to the marketplace. Some people keep their distance because they are not quite satisfied with the price. These people are situated in both hills overlooking the village. In the eastern hillside people hold Bitcoin and would like to sell, but only if the price goes to 15 000 USD. The higher you get up the hillside, the higher the prices become. Here, a Bitcoin is valued at 17 000, 20 000, 25 000 USD. Of course, nobody comes all the way up here to buy these bitcoins. They have absolutely no reason to, considering that the exact same product (BTC) is available at $10,000 at the marketplace.
In the western hillside, everybody does want Bitcoin. Some have never owned it, and some already have it and want more. However, they think the price is too high. The higher you go up this hill, the lower people’s offers are. Some of them, however, grid their teeth and defiantly buy a little bit, just to obtain the feeling of owning some Bitcoin.
Over the hills in the east, there are people whose bitcoins are not for sale at any price. Over the hills in the west, people have barely heard of Bitcoin, and are not interested in buying. For these people, Bitcoin is not on the list of things they intend to spend any money on. The price is irrelevant if you are not on a market place; the price essentially does not exist.
Most people in the world today are not at the marketplace at all, and most bitcoins that exist are not for sale.
One day a group of very wealthy men come to the marketplace. They are intending to buy several thousand bitcoins, and get right in front of the line. However, the men come to face a “problem”: As they sweep up all available coins that are available for 10,000 dollars, the marketplace is suddenly empty of sellers, and there is nobody left willing to sell for under 12,000 dollars. As a result, people start coming down from the eastern hillside. Suddenly, they are the ones first in the line of people wanting to sell, but their prices are at 12,000, 13,000, 14,000 and so on. The wealthy men have made up their minds anyway. They want a thousand bitcoins each, and they are not done until they have bought the last Bitcoin for over 15,000 dollars.
The next guy in line had originally planned to buy 0.5 Bitcoin for 5000 dollars, but is disappointed to find out there is not a single seller left at the 10,000 dollar price. They all sold their bitcoins to the wealthy men. Begrudgingly, he must face the fact that the lowest offer for half a Bitcoin is now 7,500 dollars. Not 5,000 dollars, as he had expected. However, if he doesn’t strike now, there might not be any sellers at this low a price tomorrow. He doesn’t want to take that risk, and buys 0.5 Bitcoin for 7,500 dollars.
A few hours later, there are more and more people coming to the marketplace to take some profits now that the price has gone up so much. Everybody is talking about the price increase now, and this could really be a golden opportunity to sell high. However, they soon come to realize that there were not that many people who were actually willing to pay as much as 15 000 dollars for one Bitcoin. Instead, the price has come back down to 10,000 dollars.
Disappointed, many of them change their minds and go back to the hill where they’ll wait for the price to come back up. They missed the top that took place just as the wealthy men swept up the market.
The marketplace that has been described is really just a metaphor for the orderbook on the marketplaces (exchanges) where Bitcoin is bought and sold. This is where the price is determined. There are multiple marketplaces, and usually the price is fairly similar on each one. However, there is never one official price of Bitcoin. In theory, I could have sold to you 1 Bitcoin for 1 million dollars. In this case, the price would have been 1 million dollars, but as long as we are only talking about single trades, they are not significant. The most recognized price is usually the ones at the exchanges with the highest volume, i.e. where most trades are done, such as Bitstamp.
As we can see in the picture below, the marketplace is right in the middle. This is where buyers and sellers meet. On both sides, people have put in their buy and sell orders, which will be executed immediately should the price reach their target.
As we can see in the picture below, the trades are settled right between the green and the red line. It is simply the people who are willing to sell at the highest price and the people who are willing to sell for the lowest price. When the price for the first time approached 10,000 dollars in the end of November, there was a massive wall of sell orders. Seeking to take some profit following the astonishing price rise, many traders had put their sell orders in the 9,900-10,000 range. Thus, the price was lingering around 9,900 for many hours before violently breaking through the magical 10k level, hitting 11k only a few hours later.
The green wall (buy wall) on the picture shows the huge amount of sell orders right around 10,000 USD. It took many hours, but the sell orders were slowly eaten up by the buy wall throughout the day. Once the amount of symbolic 10k sell orders were exhausted, the massive buying pressure drove up the price a lot further.
In theory, the green and red wall could have not met at all, but that would mean that no trades were taking place, i.e. 0 volume. A new cryptocurrency with a low volume can be referred to as a shallow market, which is significantly more exposed to big price fluctuations. In a deep market – a market with a higher volume and most often a longer history – it takes much more for major fluctuations to happen.
Orderbook showing a low volume
In other words: There are very few trades because there are almost no people on the market. If one big actor comes in here, he has to buy at multiple prices and work his way up the price range. This means the price will increase drastically.
There are still big fluctuations in the price of Bitcoin, compared to the price of traditional assets. However, Bitcoin’s price volatility is on its way down as the volume increases. Compared to traditional currencies, Bitcoin is still very volatile, but compared to Bitcoin in the past, Bitcoin today is significantly more stable. As Bitcoin becomes a deeper and deeper market with a bigger liquidity, there is reason to believe that the short-term price fluctuations will occur less frequently in the years to come.
As discussed, Bitcoin does not have a price in the same way that apples and cars have a price. When we talk about the “price of Bitcoin”m we are really just referring to what a Bitcoin has just been bought for right now. This also goes for other financial instruments, such as stocks, bonds and currencies. The price always changes, and it will always be whatever the price was at the previous trade. There are certain websites, however, such as Coindesk, that calculate the average price of Bitcoin on several different exchanges.
The total market cap of Bitcoin (currently around 200 billion dollars at Coinmarketcap) is based on what the value of all bitcoins WOULD HAVE BEEN if all of them were to be sold at the same price as the current settlement price: $12,000 x 16 721 725 ≈ $200 000 000 000. However, even though the price of Bitcoin is whatever it is, this does not mean that all bitcoins are for sale at this price. As seen in the village example, most of the people who own Bitcoin are far up in the hills or up on the mountain, not looking to sell. And if they come to the marketplace, it is generally not to sell, but to buy more. Many people are so confident in Bitcoin that they are not looking to sell in many, many years.
Therefore, no one actor, whether it be the Federal Reserve or any other central bank, can take control over all the world’s bitcoins. Most bitcoins are not for sale. If you try to buy something that is not for sale, you either don’t get it, or you must pay an astronomical amount.
The price of Bitcoin, then, is simply a function of supply and demand. The price is determined by thousands or millions of individuals. The price is determined by you and by me. If there are more buyers than sellers, the price goes up. If there are more sellers than buyers, the price goes down. Nobody can know if you or I want to buy Bitcoin tomorrow. Therefore, nobody can know what the price will be tomorrow either.
