Bitcoin is a cryptocurrency developed in 2009 by Satoshi Nakamoto, the latter being the name given to the anonymous creator of this virtual currency.
Transactions are recorded in the blockchain, which displays the transaction history of each unit and is used to prove ownership.
Unlike investing in traditional currencies, Bitcoin is not issued by a central bank or backed by the government.
Also, buying bitcoin is different from buying stocks or bonds because bitcoin is not a company.
Thus, there are no corporate budgets or Form 10-Ks to review.
Buying shares gives you ownership in a company, while buying bitcoins gives you ownership of that cryptocurrency.
Bitcoin is neither issued nor regulated by the central government and therefore not subject to government monetary policies.
Bitcoin prices are mainly influenced by its supply, market demand, availability, and competing cryptocurrencies.
As of December 2020, approximately 88.5% of the total Bitcoin supply has been mined.
Where does bitcoin derive its value?
Unlike investing in traditional currencies, Bitcoin is not issued by a central bank or backed by the government.
Therefore, monetary policy, inflation rates, and measures of economic growth that usually affect the value of a currency do not apply to Bitcoin.
On the contrary, bitcoin prices are affected by the following factors:
Bitcoin supply and market demand for it.
The cost of producing bitcoin through the mining process.
Rewards issued to bitcoin miners for verifying transactions and adding them to the blockchain.
The number of competing cryptocurrencies.
The trading platforms on which Bitcoin is traded.
Regulatory regulations.
Supply and demand:
Countries without fixed foreign exchange rates can partly control how much their currency can trade by adjusting the discount rate, changing reserve requirements, or engaging in open market operations.
With these options, the central bank can influence the currency exchange rate.
The supply of bitcoin is affected in two different ways.
First, the bitcoin protocol allows the creation of new bitcoins at a fixed price.
New bitcoins are introduced into the market when miners process blocks of transactions, and the rate at which new coins are introduced is designed to slow down over time.
For example, annual growth has slowed from 6.9% (2016) to 4.4% (2017) to 4.0% (2018) This could create scenarios where demand for bitcoins increases at a faster rate than supply, which could drive the price up.
The slowdown in bitcoin trading growth is due to the halving of block rewards offered to bitcoin miners and can be seen as artificial inflation of the cryptocurrency ecosystem.
Second, the supply may also be affected by the number of bitcoins the system allows.
The bid is set at 21 million, as once this number is reached, mining activities will not generate new bitcoins.
For example, the supply of Bitcoin reached 18.7 million in May 2021, which is more than 88% of the Bitcoin supply that will eventually be supplied.
For your information, El Salvador recently submitted a legal tender for Bitcoin on June 9, 2021 and is the first country to do so.
The cryptocurrency can be used in any transaction where the company can accept it.
Although the US dollar is still the base currency in El Salvador.
The artificial inflation mechanism of halving the block reward will not have an impact on the price of the cryptocurrency.
However, at the current rate of block rewards adjusting, the last bitcoins are not set to be mined until 2140 or so.
The competition:
While Bitcoin may be the most popular cryptocurrency, there are hundreds of other currencies vying for user attention.
Bitcoin remains the dominant choice in terms of market capitalization, altcoins including Ethereum (ETH), (USDT), Binance (BNB), Cardano (ADA) and Polkadot (DOT) are among its closest competitors.
Production cost:
While bitcoins are virtual, they are nonetheless valuable products and incur a real cost of production, with electricity consumption being the most important factor by far.
Bitcoin mining, as it is called, relies on a complex cryptographic computational problem that all miners compete to solve, the first to do so being rewarded with a pool of newly minted bitcoins and any accumulated transaction fees.
What distinguishes bitcoin production is that unlike other commodities, the bitcoin algorithm allows only one block of bitcoins to be generated, on average, once every ten minutes.
This means that more producers (miners) who join the competition to solve a math problem only have the effect of making that problem more difficult, and therefore more expensive, to solve in order to maintain the ten-minute period.
Research has shown that the bitcoin market price is closely related to the marginal cost of production.
Availability of cryptocurrency trading platforms:
Just as stock investors trade stocks via indices like “NYSE”, “Nasdaq” and “FTSE”, cryptocurrency investors trade cryptocurrencies via “Coinbase”, “Binance” and other trading platforms.
Similar to traditional currency exchanges, these platforms allow investors to trade cryptocurrency pairs either with each other or against fiat currencies.
Regulations and Legal Issues:
The rapid rise in the popularity of Bitcoin and other cryptocurrencies has led regulators to debate how to classify these digital assets.
While the Securities and Exchange Commission (SEC) classifies cryptocurrencies as securities, the US Commodity Futures Trading Commission (CFTC) considers bitcoin a commodity.
This confusion about which regulator will set the rules for cryptocurrency has created a case ofUncertainty – despite the rising market capitalization of Bitcoin.
In addition, the market has seen the launch of several financial products that use bitcoin as a base asset, such as exchange-traded funds (ETFs), futures contracts and other derivatives.
This can affect prices in two ways:
First, it provides bitcoin access to investors who cannot buy physical bitcoin, thus increasing demand.
Second, it can reduce price volatility by allowing institutional investors who believe that bitcoin futures are overvalued or undervalued, to use their significant resources to bet that the bitcoin price will move in the opposite direction.
Updates and Governance Stability:
Since Bitcoin is not subject to a central authority, it relies on developers and miners to process transactions and keep the blockchain secure.
Even changes to the Bitcoin blockchain must first pass unanimously, but sometimes they lead to frustration in the Bitcoin community, as the underlying issues take a long time to resolve.
The issue of scalability was a particular weakness.
The number of transactions that can be processed depends on the size of the blocks, and the Bitcoin software is currently only capable of processing approximately three transactions per second.
While this was not a concern when there was little demand for cryptocurrencies, many worry that slow transaction speeds will push investors towards competitive cryptocurrencies.
The community is divided over the best way to increase the number of transactions.
Changes to the rules governing the use of the underlying software are called forks.
For soft forks, it is a rule change that does not lead to the creation of a new cryptocurrency, while changes to hard forks lead to new cryptocurrencies.
Previous hard forks included the emergence of new cryptocurrencies, Bitcoin Cash and Bitcoin Gold.