The price of Bitcoin has been wildly volatile. From November to December 2017, it increased by 223 percent. It fell by 59 percent between January and February 2018, increased by 64 percent from February to March and then dropped again during March by 40 percent.
While this isn’t necessarily a reason to give up on Bitcoin, it does serve as a stark warning to those who plan to invest in it.
[ZH: Even though we note that Bitcoin's daily trading range has collapsed to a more reasonable level recently...]
Why does this digital currency have so many ups and downs? Many of the same factors that influence changes in the value of other items affect the price of Bitcoin. Because it’s so new and different than other currencies though, many of these impacts are exaggerated.
Here are five of the primary factors influencing the price of Bitcoin.
1. Supply and Demand
This one will be obvious to anyone who has taken an introductory economics course. Bitcoin, like other currencies, is subject to the impacts of supply and demand.
The supply of Bitcoin is analogous to that of gold. Just as there is a pre-determined amount of gold in the earth, the Bitcoin protocol has a predetermined number of Bitcoins within it. People need to mine gold to bring it into the marketplace.
Similarly, people must mine Bitcoin by using computing power to solve a complex mathematical equation. When miners successfully solve this puzzle, they earn Bitcoins, which increases their supply.
The demand side of the equation works the same for Bitcoin as it does for gold and other resources. The more people that want Bitcoin, the more the price of a coin increases.
2. The Media and Peers
Research has shown that media coverage is one of the biggest influencers of the price of Bitcoin. The more media coverage it gets, the more people are aware of it and may invest in it. Positive media coverage typically causes price increases, while negative coverage results in drops in prices.
This pattern doesn’t only apply to media. Opinions and behaviors of investors often influence the actions of their peers and, therefore, Bitcoin’s price.
Similarly, when new businesses decide to take cryptocurrencies as payment, awareness, investment and prices tend to spike.
More online and brick-and-mortar stores are starting to accept Bitcoin, causing more people to view it as legitimate. You can now even pay for doctor’s office visits with cryptocurrency in various places around the world.
3. Political Changes
As with other currencies, political events influence the price of cryptocurrencies.
However, the change in value is often opposite that of the relevant government-sponsored currency. Lack of certainty in a country’s economy causes people to put their trust in cryptocurrencies such as Bitcoin instead because it isn’t tied to any government.
The 2015 economic crisis in Greece led to a surge in interest in Bitcoin from Greek traders. Similar effects occurred when Britain decided to leave the European Union and when the United States elected Donald Trump as president.
4. Changes in Government Regulation
Because Bitcoin is such a novel concept, governments have struggled to determine how, and whether, to regulate it.
Bitcoin isn’t tied to any government, yet regulations can directly impact how the system works. Regulatory decisions involving digital currency have led to both surges and drops in their prices.
When China, the world’s biggest crypto market, cracked down on Bitcoin and shut down several coin exchanges, the price of Bitcoin fell dramatically. When the Japanese government officially recognized Bitcoin as legal tender, its price shot up over the next several months.
5. Changes to the Rules of Bitcoin
No single entity controls Bitcoin, but the Bitcoin community occasionally makes decisions that affect how the system, known as a blockchain, works. Miners run the software that verifies Bitcoin transactions and, so, determine the rules of what a valid transaction is.
Attempts to change these rules sometimes results in the creation of a fork, which causes the formation of two separate chains that each follow different rules. As long as there are miners willing to work on each chain, though, they are both valid.
In the past, the period before a fork occurs caused uncertainty and a drop in price. Afterward, the price typically increases again.
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Like any currency, Bitcoin has its ups and downs. Bitcoin’s changes just tend to be more extreme than other’s.
While the Bitcoin market may stabilize eventually, it’s expected to remain a wild ride, at least for now.