Factors of the Bitcoin’s value

Introduction


In the modern world, new technologies become important factors of the development of financial sphere of world economy. Emergency of such cryptocurrency as Bitcoin is connected with both great opportunities and certain risks for the users of this cryptocurrency. The aim of the present work is to determine the main factors which affect the price of Bitcoin.

Factors of the Bitcoin’s value


Bitcoin’s characteristics

“Bitcoin” was created in 2009 by a hacker with pseudonymous name Satoshi Nakamoto. Satoshi then created the first entirely virtual and decentralized money. Bitcoin gained a great attention around the world since its creation. This currency is very different from traditional currencies such as dollar, euro, yen and others. For example, the value of a national currency is determined by law, whereas it is impossible to convert Bitcoin and no government has an authority over it. Bitcoin, therefore, seems more like a free market system with no need for a central bank or a commercial bank.

Bitcoin system works as a peer-to-peer network — investors carry out their business transactions directly without an intermediary. Therefore, Bitcoin works without trade barriers and facilitates the business process. With more companies accepting Bitcoin its perceived value becomes real. However, Bitcoin has significant shortcomings which threaten the overall existence of this currency – such as security concerns, inflexible money supply coded by mathematical formulas, as well as unpredictability of the currency.

In many respects, the popularity of Bitcoin is determined by the fact that it has a range of advantages for its users. People who would potentially use digital currency such as Bitcoin can prefer virtual money because of low transaction costs, peer-to-peer network, its independency from government and global design, as well as the opportunity to obtain certain products (for example, illegal drugs). Nevertheless, potential users can withhold from using digital money for such reasons as low acceptability of the currency or high uncertainty of the system. Another reason can be unstable prices of the virtual currency.

If to look at Bitcoin currency as a risky investment, demand for the asset can make the currency’s price more unstable which leads to losing potential users. In order for currency to be successful medium of exchange, there should be balance between potential users and investors.

Hypothetically, if such digital currency as Bitcoin is used to purchase goods and services, it will influence fiat currency, which are such government currencies as the US dollar or euro. Then the digital currency would have an impact on the value of the fiat money and thus on the monetary policies of a central bank. In case if digital money is used essentially as an investment, it will affect such government’s assets as government bonds, stocks and commodities, and probably will play an insignificant role. In case of either currency or an asset, the possible impact on the economy in general relies upon the success of Bitcoin or other digital currencies in comparison with existing currencies and assets.

Price of Bitcoin and its fluctuations


“Bitcoin has previously been compared to gold as they have many similarities; the primary value is derived due to scarcity of supply, supply is not controlled by a government but independent agents, both assets have high price volatility and total supply is finite. As gold has well-known hedging capabilities against stocks, bonds and the American dollar bitcoin might exhibit similar correlations.”
Before the price crash of 2013, the price of Bitcoin has been characterized by an inverse asymmetric volatility phenomenon. Increasing in periods of economic or financial confusion when market stocks fall. Investors transmitting the increase of uncertainty and volatility of the stock markets to the Bitcoin one.
This show that shocks to return were positively correlated with shocks to volatility. On the other hand, in time of rising stock markets, investors will sell Bitcoin and thus signal a low uncertainty, leading to a decrease of Bitcoin prices and a transmission of decreased volatility to the Bitcoin market.

Subsequently, as the price of Bitcoin increases, its volatility decreases less. This inverted asymmetry phenomenon adds similarities between gold and Bitcoin.

The value of Bitcoin has increased quite quickly which made it an attractive asset for many investors. Furthermore, no analyst could have predicted the price of Bitcoin surpassing the gold rate, dependent upon US inflation rates, china’s trading opportunities and political instability, as gold being in a league of its own. Overnight Billionaires where made in matter of seconds when the price jumped from $700 to $2100+. On the other hand, the price of gold remained flat in 2017 while virtual currencies erupted bringing down the flat currencies.

It is difficult to forecast the future value and usage of Bitcoins as its supply, being predictable, will continue to increase in slower steps until 2040 and remain at that level ad infinitum, while the demand will remain unpredictable. However, it is possible to expect deflationary effects and the Bitcoins used as an investment rather than as a medium of Exchange if the demand continues to increase steadily, becoming larger than the supply.

Bitcoin has a large share in capitalization of all cryptocurrencies and volatility of its price had gradually decreased, however, it often remained higher than the price of gold and other currencies. Bitcoin owns 41 % of the calculated cryptocurrency capitalisation and therefore can be regarded as the most favored cryptocurrency. Nevertheless, the nature of Bitcoin prices is ambiguous and difficult to explain. The average monthly fluctuation of Bitcoin is higher than volatility for gold and many foreign currencies, while the lowest monthly fluctuation of Bitcoin is less than the highest monthly volatility for national currencies and gold. Bitcoin value was comparatively stable in the period from 1st May 2012 to 30th April 2017. Afterwards, prices fluctuated dramatically due to the growing interest of investors in Bitcoin.
Despite the popular belief, even though Bitcoin is considered to be a speculative bubble, the long-term fundamentals seem to be the main factors affecting the variability of Bitcoin price. The short-term price variation can be the consequence of the great amount of media coverage of Bitcoin since its creation in 2009, as well as a lot of speculation of the future of this digital money. Some scholars argued that Bitcoin could be a huge speculation with no guarantee of returning money.

Furthermore, Bitcoin can be a victim of cyberattacks which may destabilize the whole network of Bitcoin. Another downside of Bitcoin is that it can be attractive to criminal activities due to the possibility to use currency anonymously and that transaction can be implemented any moment in any place in the world. Bitcoin can be used to purchase or sell illegal goods like drugs. Therefore, majority of the governments have not concluded on the legitimacy of Bitcoin.

The price of Bitcoin can be possibly determined via long-term fundamentals. Some researchers point to possible generators of Bitcoin price changes in the long run such as supply-demand fundamentals, the exchange-trade ration, equity market indices, the monetary velocity, exchange rates as well as oil prices and the calculated output volume. It is considered that the relation between supply and demand of Bitcoin is one of the main factors of Bitcoin price in the long-term perspective.

Moreover, the value of Bitcoin in the long run also depends on the global financial climate (for example, stock market indices, exchange rates and oil prices). Further, a growth of the estimated output according to the real volume of transactions causes a decrease of Bitcoin price in the long run. On the other hand, trade and exchange transactions boost the advantages of holding Bitcoin which leads to Bitcoin price increase in the long-term perspective.

Since January 2015, Bitcoin volatility seems to be on continued decline despite some slight ups and downs since 2016. Good news, as its volatility seems to be a major concern for most of the general public.

Bitcoin price appears too volatile for the period from December 01, 2010 to December 31,2014. Whereas, since January 2015, the price volatility become much less persistent (i.e., far from tending towards long-memory process). It seems that price dynamics has been more driven by negative (bad news) than positive shocks (good news) for the two investigated periods.

The risk of massive cyber-attacks to the Bitcoin system shows that, despite its current low volatility rate, Bitcoin market remains in a nascent stage and is far from being mature. The inherent asymmetry of information, as the system is relatively complex and may not be understood by all users is still a problem for Bitcoin. In another way, proper security measures are becoming more practical for the public, ensuring that bitcoin is as safe as possible and explaining its current low volatility.

It is useful to separate transactional demand, arising when using Bitcoins in the exchange of goods or services, from speculative demand, a bet on the price of the underlying asset or currency increasing for the investor does not need the asset itself. Investors have a variety of financial instruments, based on the asset or currency, to bet on the increase or decline in their value, the financial derivatives.

The suitability of Bitcoin as a payment instrument has been frequently put in question as there still is price volatility and scaling issues. On the other hand, Bitcoin as well as other blockchain-based currencies, should not be neglected as a new asset class that can mature into a valuable portfolio diversification instrument, for there is no need for a central authority to represent digital property.

Furthermore, blockchain technology offers a network which gives an opportunity for many applications. Favorable applications encompass applying colored coins, smart contracts, and such security options as using fingerprints to protect the data in a blockchain. This can significantly change the economy world as well as other areas.

Conclusion


It can be argued that determining the main factors affecting the Bitcoin price depends on which component of this cryptocurrency is regarded to be the most important. If Bitcoin is used to mainly pay for goods and services, then the main factors determining Bitcoin price will be the stock prices at the fond markets, gold price and currency prices in different countries, as well as informational coverage of Bitcoin market development.

If to regard Bitcoin as a speculative investment, then the factors determining its price will be almost impossible to determine, since it will depend on speculative demand that is nearly impossible to evaluate. Despite that Bitcoin cannot be regarded as merely speculative asset, its high price volatility tells us that besides fundamental factors (such as demand on other types of investments and assets, coverage of events on the Bitcoin market) the speculative demand has a big influence on Bitcoin price.

References
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Comments 1

    –1
    If Bitcoin is used to mainly pay for goods and services, then the main factors determining Bitcoin price will be the stock prices at the fond markets, gold price and currency prices in different countries, as well as informational coverage of Bitcoin market development.
    If Bitcoin will be mainly used to pay for goods and services this mean it will behave very close to usual currency.
    The currency price generally depends from volume of the goods/services market divided by the volume of the currency in circulation. That why when economy grows and there are more goods and services produced and available you need to add more currency for circulation (money are «printed») to prevent deflation.

    But bitcoin have fixed maximum of coins in circulation and if the number of goods on bitcoin market will grow this means that bitcoin price will grow. So, in the model, where Bitcoin is considered mostly as payment currency its price will mostly depends on the volume of the market where it is used.

    So, the statement in the article is incorrect. There is possible situation when stocks markets and commodities prices will fall in common currencies, but will still grow in Bitcoin price (and Bitcoin price in other currencies will grow as well). It will happens because you can't add more bitcoins to circulation to compensate growing market when Bitcoin economy grows.

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