Bitcoin Basics Lesson 3: Bitcoin Exchange Rates
In Lesson 2, you learned that bitcoin is pseudonymous rather than anonymous and that you can make use of a wallet to protect and access your money. You also learned that bitcoins are stored in a public ledger called the blockchain, and that you can buy bitcoins on exchanges, with a credit card, or by using ATMs. We explored how bitcoin isn’t printed like regular money; it’s discovered, or ’mined’, by a network of computers worldwide.
In Lesson 3 you will learn:
- Bitcoin has a value set by the laws of supply and demand
- Because of its current adoption phase and limited distribution, exchange rates are often influenced by news
- Bitcoin has a fixed supply that is limited to 21 million units total
How is the value of bitcoin determined? Well, all currencies and commodities have an exchange value, agreed upon by the seller and buyer. Bitcoin is a currency because it is a limited medium which people have agreed possesses value. This agreement is no different from ancient merchants who at one time did the same thing with materials such as seashells, precious stones, gold, or silver. The difference between bitcoin pricing and the pricing of paper money is that bitcoin’s value is set solely by the supply and demand within the community. There is no governing body like a central bank e.g. The Federal Reserve to influence or control the flow of money. Given that bitcoin is in its infancy, and has yet to fully find its identity and function, the price is easily influenced by news and rumours.
Large markets like the EU, China, Japan or the US may announce new bitcoin regulations, either favourable or restrictive to bitcoin’s growth, causing the price to rise or fall respectively. Other factors that can influence the value of bitcoin are internal issues. Examples of this include miners’ conferences or a meeting to decide changes to the Bitcoin protocol. The price may sometimes dip if an agreement on a subject cannot be reached, or seems to be too far off.
Supply & Demand
The supply of bitcoin is limited to 21 million units. This was set according to the initial design of the Bitcoin software, and this limitation is fixed into the bitcoin algorithm. As more and more people come to use Bitcoin, the increased demand combined with the fixed supply will force the price to go up. Because the number of people using Bitcoin in the world is still relatively small, the price of Bitcoin (in comparison to a more traditional currency) can fluctuate significantly on a daily basis. As more people continue to use Bitcoin, the value of the network increases. In early 2011 one bitcoin was worth less than one USD, but in early 2017 one bitcoin was worth more than one thousand USD. If Bitcoin continues to grow, a single bitcoin could be worth more than a hundred thousand dollars.
Due to the limited number of bitcoins in circulation, and the fact that new bitcoins are created at a predictable and decreasing rate (currently 12.5 bitcoins on average every 10 minutes), the demand for bitcoin must follow the supply increase to keep the price stable.
Like any other money, the value of Bitcoin will grow with more user adoption and trust. This can be measured by its growing base of users, merchants, and startups. As with all currencies, bitcoin’s value is determined directly by people willing to accept them as payment.
This ends today’s lecture. Now you know that bitcoin has a value set by the laws of supply and demand, and because of its relatively early phase of adoption and limited distribution, prices are easily influenced by news. You have also learned that the total supply of bitcoin is limited to 21 million units.
Tomorrow you will learn more about how bitcoin wallets work.
Check out the other lessons: