Who Sets Bitcoin's Price?
Bitcoin Is a Volatile Asset; How Is Its Price Set?
Bitcoin is a volatile animal. When the currency was first launched, it had no official price at all, because no one was selling it for US dollars. When the first exchanges began to appear, however, a price developed. It started small, at around 6 cents, and didn’t hit a full dollar until around February 2011. It spiked that June, reaching around $22, and then fell back again, ranging below $20 for the remainder of that year.
It wasn’t until February 2013 that bitcoin began to take off. It started climbing rapidly, reaching over $140 that April, and then topping $1,000 by December of that same year. It's no wonder speculators took such a large interest in the cryptocurrency.
But who sets that price, and why does it keep swinging so crazily?
A Variety of Factors
Bitcoin’s price isn’t set by anyone in particular. It’s set by the market, and to make things even more complex, it varies. Today, I looked up the bitcoin price on Google, and it told me that it was $311. Yet surfing to the Bitcoin Price Index for the popular bitcoin website CoinDesk, I was told it was $243. Then, surfing over to Winkdex, the bitcoin price index operated by the Winklevoss twins (who also have a bitcoin exchange-traded fund), I find the figure $243. Why the difference?
Part of the reason is where the data comes from. Bitcoin is never traded in one place. Instead, it is traded on multiple different exchanges, all of which set their own average prices, based on the trades being made by the exchange at any one time.
Indexes gather together prices from several exchanges and average them out, but not all of the indexes use the same exchanges for their data. And in any case, you can’t trade bitcoin via these index sites – all they’re doing is aggregating price information.
If you want to buy and sell bitcoin, you have to choose a particular exchange which will have its average price. The price of bitcoin fluctuates at any given moment, depending on who you talk to.
The price of bitcoin is very volatile anyway. This is partly due to liquidity, which is the amount of bitcoin which is flowing through the market at any given time.
If people are trading lots of a particular asset all the time, then it becomes harder for one person or event to shift that price in any single direction. Think of it as a stream of water; if you wanted to redirect a small stream by putting a few planks of wood in the way, you could make it happen. But if you wanted to redirect the Mississippi, you’d have a tougher time, because there’s simply too much of it.
With fiat currencies like the US dollar and the British pound, people trade huge volumes every day. With bitcoin, the volumes are relatively small, meaning that single events can make a bigger difference. But what kinds of event?
Events That Can Change Bitcoin’s Price
The market gets spooked by lots of things. If a large government lets slip that it’s uncertain about how to regulate bitcoin, as happened with China, then that can cause the price to fall.
The same thing can happen in criminal events. When the drug trading site Silk Road – which used bitcoin as its currency – closed down, the price of bitcoin plummeted.
There are also other factors affecting the bitcoin price. There are only so many bitcoins available, and they are produced at a predictable rate. The ownership of those bitcoins is unevenly distributed. Some bitcoin giants have vast hoards of the stuff. That, combined with the lack of liquidity, makes it easy for people to manipulate the market.
In some cases, the price can be driven down by large traders who sell bitcoins off in high volume. One such trader, nicknamed BearWhale, temporarily crashed the market that way.
What does this mean for your bitcoin trading strategy? Two words: be careful. Bitcoin is an extremely high-risk asset, and even the most experienced traders can lose money in a highly unpredictable, volatile market. This is not the way to boost your pension’s earnings potential.