One of the first questions people have when they learn about Bitcoin for the first time is about the crypto asset’s price. This makes sense. This is because people hear about bitcoin for the first time via media coverage. Coverage of a major crash or massive price increase. For better or worse, betting on the bitcoin price is still a major use case of the digital asset. Also, the fact that the Bitcoin payment system has its own native asset differentiates it from all other online financial services. So, how is the price of bitcoin determined and why does it fluctuate wildly on a day-to-day basis?
In short, it comes down to supply and demand. The current bitcoin price is a function of how much demand there is for the asset. Then combine with how many coins are available for sale at any one time. There is no central bank that can help stabilize the price of bitcoin. However, that lack of a central backing entity is what makes the digital cash system valuable.
Bitcoin is wildly different from any other digital financial system that came before. For the most part, previous payment systems basically took the legacy, centralized banking system and allowed transactions to take place across the internet. Even in 2022, most people still use credit cards and debit cards, which were in creation more than 50 years ago.
Bitcoin is different from previous online payment systems, such as PayPal, in two key areas. First, the point of Bitcoin is for it to be decentral and uncontrol. This allows the system to remain apolitical and permissionless. Without these key features, the blockchain technology behind Bitcoin would have been mostly uninteresting because centralized databases can process transactions much more efficiently.
The other key difference with Bitcoin is that it has its own native asset in the form of bitcoin. If it were possible to create a form of digital, decentralized cash that was stable, then that definitely would have been preferable. However, the issuance of a new, digitally-native currency is what enabled Bitcoin to be decentralized in the first place.
The proof-of-work (PoW) mining system used in Bitcoin enables a dynamic and potentially-anonymous set of accountants, known as miners, and those miners are rewarded with newly-generated bitcoin (in addition to transaction fees). All known forms of stability also introduce at least a degree of centralization, and the entire system becomes less interesting once you trade censorship resistance for price stability.
While the popular crypto, bitcoin, is often refer to as a currency, it has more recently seem clear that the digital asset is much more like gold than the U.S. dollar. In other words, it would be more proper to refer to it as a commodity rather than a currency. Indeed, pending legislation in the United States has indicate that digital assets should be regulate by the Commodity Futures Trading Commission rather than regulators focused on currencies, banking, or stocks.
So, much like gold and all other commodities, the factors controlling the bitcoin price come down to supply and demand. Much like there is no central entity that controls the price of gold or wheat, there is no one who controls the price of bitcoin. And due to the crypto asset’s relative youth in the context of the entire history of the world, the market has had a difficult time figuring out how to value this new asset.
So far, people tend to get excited about the potential of bitcoin as a global reserve asset every four years or so, which creates an epic boom and bust cycle that both attracts and dissuades new users. That said, the overall volatility of bitcoin has tended to decline as the market as a whole has become better educated regarding the value proposition of this new financial technology.
Stablecoins Attempt to Solve Crypto Volatility Problem
One of the biggest talking points around the crypto hysteria of 2021 was stablecoins. These digital currencies intend to provide many of the benefits of crypto. However, the main issue with the most popular stablecoins come with a high degree of centralization. The reality is these are coins that are centrally in control by entities. Ones that could be easily target by regulators for shutdown and seizure of assets.
Indeed, both of these popular stablecoins have already implemented blacklisting capabilities. Capabilities that make it possible to freeze assets on the blockchain. There are a number of different projects in the works. Ones that would like to create a much more decentralized stable-coin. However, but issues such as the oracle problem remain unsolved at this point. At the end of the day, it appears a truly decentralized stablecoin is still a ways off. At least for now, we’ll have to deal with the popular crypto price volatility. Especially, when it comes to having a true form of digital cash.
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