How are Bitcoin price levels determined?

Bitcoin (BTC) has recently been consolidating around $40,000. There is a relatively simple model regarding the price level of Bitcoin, which is briefly described below.

Consider two types of Bitcoin users: those who use Bitcoin as a tool for value transfer, and those who hoard Bitcoin as a tool for storing value.

The needs of the first type of users are very simple, which is to transfer value from one person to another remotely and at low cost.

In response, Satoshi Nakamoto wrote in a forum post on August 27, 2010: “If it somehow acquired any value for some reason, then anyone who wanted to transfer wealth over a long distance could buy some, transmit it, and then have the recipient sell it.”

The reasons behind this value transfer activity can be varied.

It could be that Person A pays Person B with Bitcoin to purchase an item.

It is also possible that A buys and sells for the purpose of speculation, and then B takes away his Bitcoin.

The large amount of turnover activities by these people supports the liquidity of Bitcoin.

According to the classification, they are not coin hoarders. In other words, they are all fiat currencies.

Fiat — BTC — BTC — Fiat

Person A uses Fiat to buy some BTC and sends it to Person B. Person B sells the received BTC and gets Fiat.

This is the full circle.

They just use BTC as a medium of value transfer. Therefore, they don’t care whether the price level of Bitcoin is high or low.

In fact, the higher the price level of Bitcoin, the greater its capacity will be and the more transactions it will need to mediate.

Now we have to consider Bitcoin miners who are constantly producing new coins, in opposition to the demand side.

As long as there is demand for the use of Bitcoin, miners can sell the newly produced coins to them.

As long as the user demand is greater than the miners' demand for selling, it can support and increase the price level of Bitcoin.

Since these users do not care about the price of Bitcoin, rising price levels will not suppress their demand.

Whenever possible, miners will try to sell the bitcoins they produce at the highest possible price.

But miners are also fully competitive, so the price will not be infinite, but will tend to be suppressed to the cost of production.

So the equilibrium situation here is that the coin price is equal to the production cost (plus some reasonable profit).

Although the principle of economics is that demand determines price, not cost. Satoshi Nakamoto also pointed out in a forum post on February 21, 2010, "The price of any commodity tends to the cost of production. If the price is lower than the cost, then production will slow down. If the price is higher than the cost, you can make a profit by producing and selling more products. At the same time, increased production capacity (computing power) will increase difficulty, pushing production costs toward prices." "In the next few years, when the new coins generated only account for a small part of the total existing supply, market prices will determine production costs, not the other way around."

However, due to the uniqueness of the demand scenario of Bitcoin as a medium of value transfer, that is, the demand level will not be suppressed by the price level, the production cost plays an important role in equilibrium price discovery.

In this way, when Bitcoin production is halved every four years, the production costs of all miners will double, which will immediately lead to an immediate increase in the fully competitive price level of all miners, thereby increasing the equilibrium price.

This is the basic logic behind how halving of production will increase the price level of Bitcoin.

The second type of users are hoarders, who will hold on to their Bitcoins for a long time once they acquire them.

This type of user is more sensitive to current prices than the first type of users.

Although from a broad perspective, they are also a kind of value transmitter, it’s just that they transmit today’s value to a certain day in the future.

But in any case, in the short term, their hoarding behavior complements the miners' production behavior.

When the first type of demand decreases due to some external reasons, the price of the currency will fall to the point where miners are no longer profitable.

Although miners can persist on their own, the high operating expenses of PoW make it impossible for miners to support it in the long run, and they are inevitably forced to sell their coins. In extreme cases, they may even sell their coins at a loss.

Hoarders will act like sponges, absorbing the bitcoins that miners are unable to hoard, thereby buffering fluctuations in market supply and demand.

Coin hoarders and miners are actually two sides of the same coin.

As Liu Jiaolian wrote in “A History of Bitcoin”, ““The absolute urge to get rich and the passionate pursuit of value” are shared by miners and hoarders. But hoarders are just crazy miners, while miners are rational hoarders. The endless appreciation of value is what hoarders want, and it is also what smart miners want. But hoarders achieve this goal by rescuing Bitcoin from the circulation industry, while miners achieve this goal by repeatedly putting Bitcoin into circulation.”

In the early stages of Bitcoin’s development (and still today), it was actually these two groups of people who jointly funded (invested) in building the Bitcoin network.

From such a simple conceptual model as above, we can see a glimpse into the determination of Bitcoin price levels.