Why is Bitcoin Going Down / Up? What Determines Price?
By: Ofir Beigel | Last updated: 5/1/20
Bitcoin’s price is probably the most commonly searched aspect of the digital currency. This post explains how the price is determined and what makes it go up or down.
Why is Bitcoin Going Down / Up Summary
Bitcoin’s price is defined by the last trade conducted on a specific exchange. Price goes up when buying pressure increases, and goes down when selling pressure increases. There are several major factors that can cause the price to go up or down such as:
- Media hype / FUD
- Lost of trust in fiat currencies
- Institutional adoption
- Supply shortage
- Dumping of coins on the market
That’s what affects Bitcoin’s price in a nutshell. For a more detailed explanation keep on reading, here’s what I’ll cover:
- What is Bitcoin’s Price
- What Determines Bitcoin’s Price?
- Why is Bitcoin Going Down?
- Why is Bitcoin Going Up?
- Frequently Asked Questions
When talking about Bitcoin’s price, people are usually referring to either the USD price on a leading exchange (such as Bitfinex, Binance, or Bitstamp) or a composite price made from the average of multiple exchanges’ prices (e.g. CoinGecko).
When people talk about the price on a certain exchange, they mean the price of the last transaction made on that specific exchange.
So for example, if the price of Bitcoin on Bitstamp is $10,000, this means that the last trade made on Bitstamp was closed at $10,000. Once a new trade is conducted, the price will be updated accordingly.
As Bitcoin is a decentralized asset that trades on many exchanges and between countless individuals around the world, there is, in fact, no singular Bitcoin price.
Each exchange has its own price for Bitcoin, although these prices are usually quite similar. This opens the door to arbitrage opportunities for experienced traders with enough capital (explained below).
As there’s no official Bitcoin price, certain sites and companies make a composite index price available. This price is calculated by weighting the prices of various leading currencies by volume and combining them as an average.
For example, the Coindesk Bitcoin price index represents an average of bitcoin prices across leading global exchanges that meet certain criteria.
These indexes can be useful pricing mechanisms because they smooth out the effect of any unusual trading activity on a single exchange.
For example, say a large trader decides to sell 25,000 BTC on Bitfinex. The price will be greatly suppressed on that exchange and take some time to recover back to the international average price. An index price will show less of this localized disturbance over its duration.
Price discovery describes the process by which buyers and sellers meet on a crypto exchange to reach agreement on the price at which they’ll trade.
Buyers want to pay as little as possible for their Bitcoin. Sellers want to sell Bitcoin for as much as possible. Both must compromise upon a certain price before any trading can occur.
As I’ve mentioned before, the current price of Bitcoin, on any exchange, is simply the most recent price a buyer and seller have agreed to.
Let’s take a closer look at how buyers and sellers on a crypto exchange reach an agreement.
The Order Book
The trading interface on any standard crypto exchange features what’s known as the “order book.” It’s not a real book of course—rather the display page for market information that relates to the execution of buy and sell orders.
On the buy side of the book are listed all the standing offers to buy Bitcoin at a certain price—also known as “bids.” On the sell side are all the offers to sell Bitcoin at a certain price—also known as “asks.”
Recent trades are often displayed too, in a list and/or chart format.
Here’s an example of BitStamp’s real-time order book, as displayed via the interface of BitcoinWisdom.com:
Asks are listed at the top right; showing the price the sellers want for their coin and the number of coins they are willing to sell.
Additional asks are present in Bitstamp’s order book, but only a dozen or so asks that are closest to the last price are visible here. Below are the closest bids, showing the price and number of coins the buyers want.
At the bottom is the trade history, which shows how many coins were traded and at what price. The most recent trade will be the one that set the last price.
This last price reflects the current valuation of Bitcoin on the exchange—in other words, the current Bitcoin price. It will change only as further trading occurs.
Makers and Takers
Bitcoin’s price movements are often explained away as more buyers than sellers, or vice versa. In practice, this isn’t really true since it always takes two parties to trade (if someone bought Bitcoin, someone else sold it).
What really drives the price up or down is the side that’s more aggressive in “crossing the spread.” The spread is simply the difference between the best bid and the best ask price.
In our Bitstamp example, the best bid (i.e. buying price) is $9,350, and the best ask (i.e. selling price) is $9,400, so the spread is $50.
Whichever side is more motivated to trade will pay the $50 spread cost in order to execute the trade immediately. This side is known as “the taker,” as it’s taking the offer listed in the order book by “the maker” (the person who created the trade).
Let’s say that multiple buyers, convinced that price will hit $10,000 by Friday, are acting as takers.
Buyers believe they’ll profit by buying below $10,000. This makes them more likely to pay the spread to buy up all the coins on offer at $9,400—they expect to make $600 minus the $50 spread.
Once buyers have absorbed all the coins offered at $9,400, the next best ask then becomes coins offered at $9,450—and after that, coins offered at $9,500, and so on, up the ask list.
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.
This process happens across all Bitcoin exchanges. 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 trading venues.
For example, if Bitcoin is cheap on Bitstamp but expensive on Coinbase, then traders will buy on Bitstamp and sell on Coinbase. The effects of arbitrage are what keep prices aligned across exchanges.
Finally, it’s worth noting the effect of market-leading exchanges. Those with the highest volumes (i.e. the highest number of coins traded) tend to be considered as having the more “official” price.
For example, if Bitcoin’s price spikes on a major exchange such as Bitfinex, Binance, or Bitstamp and especially across several major exchanges at once, then it will almost certainly lead all other global exchanges to have higher prices too.
The reason for this leading exchange(s) phenomenon is simply that most traders pay close attention to major exchange prices.
Traders have the expectation that prices on major exchanges will filter through to minor exchanges due to the effect of arbitrage effects and the belief that other traders will act accordingly.
This leading exchange effect occurs even across exchanges that use different currencies.
For example, if Bitcoin that’s being traded in a high-volume country such as Japan, where it’s priced in JPY, starts dipping below the average international price, that’s likely to act as a drag on prices in USD, EUR, and other markets too.
Now that you understand what Bitcoin’s price is and how it’s determined, let’s go over some events that can make Bitcoin’s price plummet.
Price Near All Time High
Often when Bitcoin’s price reaches a point near a recent all time high, price resistance is met and the price fails to cross the previous high.
This is attributed to the fact that many traders place sell orders near historical all time highs. Therefore, when the price reaches these points, a selling pressure is felt that brings the price down.
FUD stands for Fear, Uncertainty, and Doubt. Media FUD happens from time to time when Bitcoin receives very negative press. Here are some examples of how Bitcoin has been declared dead over 350 times throughout the years.
This type of media FUD can cause mass panic and increase the selling pressure as people lose faith in Bitcoin.
Keep in mind that more often than not the media is looking to make headlines and generate interest rather than conduct extensive detailed research. So don’t rush to sell the moment you hear Bitcoin is dead yet again.
Dumping Coins on the Market
As a general rule, whenever a large amount of Bitcoins is being sold on the market, it will drag Bitcoin’s price down since the sell pressure increases.
For example, in certain cases, the FBI or different authorities seize substantial amounts of Bitcoin from illegal operations. When this happens, they usually auction off these Bitcoins to the public.
Since authorities aren’t geared towards maximizing profit and a usually large amount of Bitcoin are being auctioned, they are normally sold below the market price.
This, in turn, causes Bitcoin’s price to drop, as the auction winner usually sells some of his newly acquired coins on exchanges as well.
There are also certain events that increase buy pressure and make Bitcoin’s price go up. Let’s go over some examples.
Crossing an ATH
If Bitcoin’s price crosses a certain all time high, in many cases this generates positive buying momentum which increases the price even more.
Having said that, when extreme buying momentum occurs it’s highly likely a sharp drop in price will soon follow (also known as a correction). If you’re taking advantage of a buying momentum, keep this in mind and consider taking some money off the table before this happens.
Media Coverage / Hype
The same way media FUD can generate panic and selling pressure, media hype can generate increased buying pressure.
This was evident in 2017’s great Bitcoin rally when the price neared $20,000. Every other day Bitcoin was covered in the news, generating increased adoption, interest and mainly speculation from the masses.
The saying “buy the rumor, sell the news” implies that whenever the media coverage kicks in, it’s time to be wary about the price since a correction may soon come. So while initially, media coverage drives up the price, it can also cause it to crash if it rallies too fast.
Lost of Trust in Fiat
One of the major drivers behind Bitcoin’s price surge throughout the years was lost of trust in traditional fiat currencies (USD, EUR, GBP, etc.).
When people lose trust in their own currency (e.g. inflation) or banking system they look for an alternative to store value that isn’t controlled by any government or bank. Usually, Bitcoin, among other assets such as gold, is a popular solution.
When a major retailer or financial institution starts accepting Bitcoin, it usually signals the market that Bitcoin is becoming more mainstream. This may cause the price to rise due to speculation of future mass adoption.
Another major price driver is said to be the approval of Bitcoin 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.
Some believe that if major market players consider Bitcoin a legitimate investment, it’s only a matter of time until the general public starts investing in it as well, increasing the buying pressure.
Another main driver behind increased buying pressure is shortage in supply. Bitcoin’s supply is capped at 21 million. Until today, over 85% of this amount has already been mined.
Today, every 10 minutes on average, another 12.5 Bitcoins come into existence, however, this amount is halved every 4 years or so.
Some believe that Bitcoin’s halving event will drive up Bitcoin’s price as a shortage in supply of new Bitcoins will occur. The next halving event is scheduled for June 2020.
Why Does Bitcoin’s Price Fluctuate?
Bitcoin’s price is extremely volatile. It’s not uncommon to see price movements of 5% or even 10% in a single day. The reason for these fluctuations is that Bitcoin’s market cap is still relatively small.
The market cap = Number of Bitcoins in circulation * Price per Bitcoin.
Usually, the smaller market cap an asset has, the more volatile it will be. Imagine throwing a rock into a small pond. Now take the same rock and throw it into the ocean. The rock will have much more effect on the pond than on the ocean.
In the same manner Bitcoin (the small pond for now) is more volatile (i.e. affected) by everyday buy / sell orders (the rock). When Bitcoin’s price increases, so will the market cap and the price movement will gradually decrease.
Bitcoin’s price will probably continue to fluctuate until mainstream adoption will arrive. For now, big buy or sell orders by Bitcoin whales disrupt the market as the market cap isn’t big enough to withstand them.
The current unstable worldwide financial system may prove to be the final push Bitcoin needs to skyrocket, however, it’s anybody’s guess if indeed that scenario will play out.
What are your thoughts about Bitcoin’s price? Will it skyrocket, plummet or just stay the same? Let me know your thoughts in the comment section below.