The price of Bitcoin, as with most other commodities in the market, is determined by the interplay of supply and demand, and also the expectation of future prices. Know more!
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Cryptocurrencies are ‘mined’. For better understanding of how cryptocurrencies are created, we can refer to Bitcoin, which is created by the process of ‘mining’. The ‘Mining’ process involves massive amounts of powerful computer hardware and resilient software. Mining is the process by which cryptocurrency transactions are verified and new units of cryptocurrency are created.
Each time a cryptocurrency transaction takes place, a cryptocurrency miner, who also serves as a node on the blockchain on which these transactions are taking place, tries to decrypt the block containing the transaction information. For example, if Person Y wants to send 0.1 Bitcoins to Person Z, then miners on the Bitcoin blockchain compete to be the first to decrypt the block that contains the transaction information.
Decrypting the block not only authenticates the transaction, but also provides the information about who sent how many Bitcoins to whom and at what time and date. Once the block has been decrypted and has been accepted by most of the nodes on the blockchain as being authentic, the block is added to the blockchain.
Now, the verification process is pretty resource intensive in terms of the computational power required. As such, individual miners often find the process too expensive and so they join pools to collectively use computing power.
Cryptocurrency (Bitcoin) Mining Reward
So, the question is, if the mining process is so expensive, why do miners compete to decrypt blocks? The answer to this lies in the rewards mechanisms. In return for their services, the cryptocurrency miner is rewarded with a fraction of new units of the cryptocurrency. In other words, the miners are paid in the cryptocurrency that they choose to mine. So, if a miner chooses to decrypt a Bitcoin block, then they will be paid in Bitcoin.
By pooling their resources, miners increase their chances of success and spread out the costs, but they also then get only a share of the rewards.
Cryptocurrencies are largely divided into two groups—coins and tokens. Coins and tokens are distinct and different from each other, and each has potential advantages for different types of businesses.
A coin is that application of cryptocurrencies that runs on its own blockchain, which is where all the transactions take place. Some of the larger examples of coins are Bitcoin, Etherium, Dogecoin, etc. These are the assets that people can invest in and exchange. If somebody wants to create a new coin, they would have to create a new blockchain.
A token, on the other hand, functions on top of an existing blockchain infrastructure and are often used like smart contracts, which can be used for physical objects as well as services, physical and digital. One of the main reasons companies consider issuing a token is for a security token offering, which various projects and start-ups use to raise funds.
In order to understand the pricing of cryptocurrencies, let’s take the example of the most famous one—Bitcoin.
The price of Bitcoin, as with most other commodities in the market, is determined by the interplay of supply and demand, and also the expectation of future prices. The pricing, in case of cryptocurrencies, is done solely through market dynamics.
The supply of Bitcoin is still growing, but at a slowing rate both because of an artificial limit set by the creator on the number of Bitcoins that can be mined and also the fact that mining the cryptocurrency is expensive and resource-intensive.
Demand for Bitcoin, however, is much more volatile. The demand for Bitcoin grew exponentially as the cryptocurrency became famous and as stories of people investing early and earning a fortune spread across the world.
This increasing popularity ties in to the other aspect that affects Bitcoin prices—the expectation of the price in the future. If the market feels that the price of Bitcoin is set to grow in the future, it will be more willing to pay more for it now. On the flip side, if the market believes that the price will fall in the future, more people will sell the cryptocurrency now while the price is higher than what it could be in the future. While selling, they will accept a lower price than they otherwise would, since they expect the future price to be even lower.
Individual influencers can also exert a huge influence on the price of a cryptocurrency. For example, Elon Musk’s various tweets about Bitcoin have each led to historic price swings in the cryptocurrency.
As we talked about earlier, the supply of a cryptocurrency also determines its price, working in tandem with demand. With Bitcoin, this supply is restricted by a phenomenon called Halving. Bitcoin Halving is an event that taken place every four years, where the reward for mining Bitcoin is halved. This halving will continue every four years until the supply of Bitcoin reaches its upper limit of 21 million Bitcoins, after which miners will have to be rewarded through some other mechanism.
But until that point, the dates of each halving are a very important landmark in the history of Bitcoin because the price usually spikes significantly following a halving.
In the next article, we will further explore the concept of Bitcoin Halving and how it has affected the price of the cryptocurrency.
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