The Causes of Bitcoin’s Price to Rise and Fall – David McNeal
Bitcoin’s rapid price volatility has often baffled even the most experienced economists, especially as its price movements rarely share any correlation with any other currency, commodity, or value store traded on global markets.
Bitcoin trading on global markets is also relatively new. Yet, after several years of close analysis, experts have noticed a trend of influences, unlike any seen before, that can cause bitcoin prices to change rapidly and dramatically. Below I broke down the most common and powerful influences to watch for when spot trading bitcoins on an exchange.
Most traders pay close attention to major exchange prices. Buyers want to pay as little as possible for their Bitcoin. Sellers want to sell Bitcoin for as much as possible. But, there is no such thing as a ‘stable’ or ‘fair’ price for Bitcoin.
When people talk about the price on a certain exchange, they mean the most recent “tick” price updated on a specific exchange. Because exchanges are not connected, price determination varies between each exchange.
The methods used to determine the price of bitcoin on each exchange varies by many different factors, including:
- The volume and quality of the trading data used.
- The weighted volume of each “fiat” invested in BTC.
- Supply, demand, sentiment, and behavior of its users.
An index price will show less of this localized disturbance over its duration. When talking about Bitcoin’s price, people are usually referring to either the USD price on a leading exchange Bitfinex , Binance , or Bitstamp or an index price based on multiple exchanges’ prices such as the Bitcoin Reference Rate (BRR).
As there’s no official Bitcoin price, certain sites and companies make a composite index price available. This price is calculated by weighting the spot prices of global currencies by volume and combining them as an average.
Every exchange calculates the price of Bitcoin based on its own volume of trades. This opens the door to arbitrage opportunities for experienced traders with enough capital.
What keeps prices more or less synchronized across exchanges is the process of Bitcoin arbitrage, the trading strategy that takes advantage of the price differences between exchanges. The effects of arbitrage are what keep prices aligned across leading exchanges.
As you can see in the image above, the buy side of the book lists all the standing offers to buy some bitcoins at a certain “bid” price. The sell side lists the offers to sell some bitcoin at a certain “ask” price.
Bitcoin’s price movements are often inaccurately explained as the ratio of buyers vs. sellers. But, what actually drives the price up or down is the spread is the spread between the best bid and the best ask price.
If buying is aggressive, sellers soon realize it and start raising the prices of their asks. This continues until buying pressure is exhausted, at which point the process will reverse. Over time, these impulses drive the price up or down.
So, what else causes the price of bitcoin to rise and fall? Please read on for more info and examples.
Let’s first cover the major events that can make Bitcoin’s price plummet.
As I mentioned earlier, bitcoin price is determined by buyers and sellers in the bitcoin exchanges. However, thin volume and short-term margin trading (using leverage) result in sloppy fill prices around 90 percent of the time, resulting in more losses and drives the price downward.
FUD stands for Fear, Uncertainty, and Doubt. Media FUD occurs when Bitcoin receives a very negative press. For example:
Over the years, Bitcoin has been declared dead more than 350 times. This type of media FUD can cause people to panic, lose faith, and sell short. Keep in mind that the media seeks to produce headlines and generate interest rather than conduct extensive detailed research.
So don’t rush to sell out when you hear Bitcoin is dead… yet again.
Dumping Coins on the Market
Generally, whenever a large amount of bitcoin is sold on the market, it drags the price down.
For example, when government authorities seize substantial amounts of Bitcoin from illegal operations, they auction these Bitcoins to the public. Since authorities aren’t in the business of maximizing trade profits, large amounts of Bitcoin are sold below the market price. This, in turn, causes Bitcoin’s price to fall.
Poor Exchange Platform Management
Prices started to get very unstable after hitting all-time highs in November 2013. Rumors of lack of safety at Mt. Gox exchange, as well as poor management, made traders anxious. People had trouble withdrawing their money from the exchange. The value reached a high of $1,230 on 4 December 2013. This dropped to about $750 by December 7th, a fall of around 39% over a couple of days.
In January 2014, trade stabilized to some degree to around $920. Nevertheless, another major crash happened at the beginning of February, around the time the Mt. Gox Exchange filed for bankruptcy protection in Japan. Bitcoin was trading at around $911 on February 4, but by February 16, it was cratering at $260.
There are also certain events that increase the price of Bitcoin. Let’s go over a couple of examples.
Most bitcoin whales hold or channel a large portion of their bitcoin to private investment funds(This has the same impact as long-term storage of bitcoin.) This adds to the perceived scarcity of bitcoin, effectively keeps bitcoins out of circulation, and leads to price appreciation as increasing demand for a limited supply of bitcoin raises costs per unit.
The same way that media FUD can create panic and sell pressure, media hype can generate increased purchasing pressure.
This was evident in the great 2017 Bitcoin rally, when the price was close to $20,000. Every day Bitcoin made headlines, attracting growing recognition, curiosity and, above all, excitement from the public.
While media coverage initially pushes up the price, if it rises too fast with weak investments, it causes a bubble which eventually bursts and crashes the market.
The approval of complex trading instruments such as Futures and Exchange-Traded-Funds (ETF) deepens liquidity, helps to balance unnecessary volatility, and attracts apprehensive investors previously discouraged by bitcoin’s price fluctuations.
Growing Distrust in Fiat
Since its inception, one of the main drivers behind the price surge in Bitcoin has been the loss of public confidence in conventional fiat currencies (USD, EUR, GBP, etc.).
Another main driver behind bitcoin’s price increase comes from its perceived scarcity. The supply of Bitcoin is capped at 21 million. To date, more than 85 percent of this amount has already been mined. Today, every 10 minutes on average, another 12.5 bitcoins come into existence, but this amount is halved every 4 years or so.
The next Bitcoin halving, in May 2020, will be the third halving. The first halving happened in November 2012. Then after 4 years, the second one happened in July 2016. Both halvenings were the precedent for a significant wave of Bitcoin acceptance, and a considerable appreciation in Bitcoin’s price was reflected within the following year.
Whenever adopted by major retailers, investors see bitcoin becoming more mainstream. This can cause speculators to drive the price upward.
Another major price driver comes from major financial instruments such as Bitcoin ETFs and Bitcoin futures . These financial instruments allow big institutions such as banks, hedge funds, etc. to invest in Bitcoin without actually buying the currency.
As long as Bitcoin continues to attract new retailers and investments from major financial institutions, there should be no reason for believers to worry about market volatility.
As prices lower, shaking out weak handed speculators, institutional investors are accumulating, adding to their bags and HODLing, waiting for prices to rise ahead of next year’s halving — an all cash buy and hold strategy seems promising.
Evidence suggests that ninety percent of short-term traders lose money. Most people are not seasoned short-term traders and don’t know when to buy in. So inexperienced investors should avoid buying short, as it involves competing with AI powered, high-speed trading machines. Holding on for the long-term is clearly a simpler plan and probably the safer one too.