Undoubtedly, the working principle of cryptocurrencies like bitcoin is quite complex for anyone looking at it for the first time. With so many technical terminologies to wrap your head around, it is only understandable if you are confused about why certain things are the way they are. One of which is the Bitcoin price and why it is so volatile.
If you are interested in bitcoin and want to invest in it, you must take the time to understand how it works. This article will teach you how cryptocurrency works and some factors influencing bitcoin price.
How does cryptocurrency work?
Cryptocurrency is a virtual or digital currency that uses cryptography to secure the network. Cryptocurrencies like bitcoin run on a public distributed ledger called the blockchain. The blockchain is made up of blocks in which transactions are stored. Cryptocurrencies like bitcoin are decentralized, meaning they don’t have a central agency or body governing them. Instead, such cryptocurrencies use a consensus algorithm to ensure their transactions are legitimately recorded.
When you perform a transaction, miners add it to the blockchain, abiding by the consensus mechanism. This involves referencing the last hash. But because of the nature of the blockchain, hashes are private and not revealed. Hence, miners have to solve complex cryptography puzzles to reference the hash, which requires immense computational power. It is also through this process that miners create new bitcoin.
Factors that influence bitcoin price
Bitcoin is ranked the number one crypto token in the industry by its market cap. But despite its massive market cap, the bitcoin price is quite volatile. Bitcoin is even more volatile than several crypto tokens in the industry. The question now is, what are the factors that influence bitcoin price?
The law of supply and demand will always be relevant in any market, including the crypto market. When the demand for bitcoin surpasses its supply, its price will increase, and vice versa. Another thing to note is that only a finite number of bitcoins can be mined. Prices will increase once all the coins are mined.
Mining difficulty refers to how difficult and the amount of time it takes for miners to find the right hash for each block. The more bitcoin mined, the more difficult it will become to mine. Mining difficulty can also be influenced by the number of miners in the network and their computational power. When fewer miners are on the network, mining difficulty increases, thus inflating the bitcoin price. Similarly, mining difficulty increases when there isn’t enough computational power in the network, thus inflating the bitcoin price.
There is also a significant amount of competition in the crypto industry, and it is also affected by bitcoin, the largest token in the industry. The biggest competitor with bitcoin in the industry is Ethereum, which competes well with bitcoin. Several developments have been introduced to the Ethereum platform, so some people choose Ethereum over bitcoin. Things like Ethereum smart contracts and dApp support attract several people to the platform. But because Bitcoin is several years ahead of Ethereum, it can still have more value.
Whatever is happening in the news can as well influence the bitcoin price. The news has much to do with investors’ sentiments, making them feel comfortable or uncomfortable investing in any industry. News spread like wildfire, especially in the crypto space, because of how on edge everyone is about the crypto space. With governments not truly backing crypto, any negative news about any crypto coin will cause the price to drop as people try to sell off their investment. Similarly, any positive news about any crypto coin will cause the price to increase as investors will try to invest in it.
Due to how popular bitcoin and the crypto industry are becoming, regulators can’t continue to ignore it. There are different regulators, and each regulator classifies cryptocurrency differently. For example, the SEC classifies crypto as security, whereas CFTC classifies it as a commodity. How a regulator classifies crypto influences the price, as it determines things like how much tax investors will pay and so on. If the regulators are friendly with a crypto asset, it helps the price increase, whereas if they aren’t, it could negatively influence the price.