Learn How Bitcoin Price Gets Determined: The Ultimate Guide

The standard lore in every traditional financial market is that the price is the one piece of data that tells you everything you need to know about a Forex trading pair, a commodity, the company behind a stock,  or any other financial instrument. While experts who prefer fundamental to technical analysis disagree on this, the fact remains that the prices drive all markets and they determine if you make a profit or if you lose money.

Cryptocurrency markets are not that different from traditional markets in that regard (though there are many crucial differences). Since Bitcoin remains the most critical digital asset in the world, and because all other coins are linked to it through trading pairs in crypto exchanges, everybody follows Bitcoin’s price. Bitcoin alone has driven the whole market up or down in the past. But unlike commodities, Forex, or the stock market, very few people have a sound idea of how BTC’s price is determined.

What do we mean by Bitcoin’s price, anyway?

Bitcoin is included in trading pairs against almost every other altcoin in the world and many fiat currencies as well. A different number characterizes every pair, obviously, so the question of what is BTC’s price is not as straightforward as it may seem. But the answer is quite simple when you know it. It refers to the number that the world’s leading exchanges report on the BTC/USD trading pair, or to an average of all the available prices (which is the price that sites like CoinMarketCap report).

It behooves us to keep in mind that Bitcoin is a decentralized asset that trades all over the world at every possible time. It’s in the nature of the beast that every exchange in the world reports the price it’s offering, according to the laws of supply and demand, and that different exchanges will show different numbers.

There’s no unified Bitcoin price. The ciphers across the board are usually are very alike but never exactly the same, so while the general trend is the same all over the world, the small details are different from platform to platform. It’s all about the activity each exchange has, the geopolitical zone, even the time of the day. So while average values are useful, you should expect to find slight differences in the price when you go in to perform a trade.

If we want to understand how Bitcoin’s price works, then we need to understand how Bitcoin’s price is settled in an individual cryptocurrency exchange platform. Let’s see.

Discovering the price

It’s the process by which traders come together, negotiate a trade, and reach an agreement on the price they will adopt. Buyers want to pay as little as possible while sellers want to get as much as they can. So they meet in the middle after negotiating and compromising a little.

The price that any exchange reports is quite simply the price at which the most recent trade happened.

This brings us to another question: how do buyers and sellers manage to agree on any given number? Let’s find out.

The order book

Every trading organization includes a thing called “the order book.” It’s not a physical book, but a page filled with market data. It’s like the story of the day’s market transactions. Every buy and sell order is in there.

The buy-side features all the standing offers (also called “bids”) and the prospective price; the sell-side includes all the offers to sell the asset (also called “asks”). The book consists of and displays recent trades too. It’s usually formatted as a list or as a chart.

The top right lists the asks. It shows the price the seller wants, as well as the number of coins he has for sale. The bottom contains the trade history, which tells you the number of traded coins as well as the trading price. The last price is the current asset value in the exchange. That is the Bitcoin price, and it remains steady until further trading happens.

Makers and takers

Supply and demand are usually invoked to explain the price away. If there are more buyers than sellers in the market, then the price goes up and vice versa. This is a bit too simplistic because it takes two to tango. Neither bulls nor bears can decide on the price because they have to negotiate with each other to reach an agreement.

The driving force behind the price is more about the degree of aggressivity that the bulls or the bears are willing to show. The side with the most motivation is willing to pay higher spread costs (the difference between the best bid and the best ask) so that the trade is settled as soon as possible. Those are the “takers,” as they’re taking the offer in the book. The maker is the one who initiated the trade.

Takers and the price

Let us consider the following scenario. Say that a group of uncoordinated but determined buyers is feeling sure that the price is going to surpass the USD 10.000,00 level in the next five days. If they’re so persuaded, then they’ll know that any price under the 10k line will make them profit in a matter of days so they’ll be willing to buy and accept the spread.

If the current price happens to be USD 9.400,00, then the buyers will make USD 600,00 minus the spread (which could be typically around USD 50,00). The determined buyers, in our example, will buy everything available at the current price. Then everything there is at USD 9.450,00 and so on. They will keep going up the ask list until they get near 10k.

If the bulls are energetic enough, the sellers will quickly notice. Consequently, they will rise their ask prices. That will keep driving the price up until the buying pressure dilutes. At this point, things could turn around. This is how prices go up and down over time.

The price, the exchanges, and arbitrage

The price discovery process happens in every exchange platform around the globe, of course. It’s a continual phenomenon that never rests. It’s ongoing every day of the week and every hour of the day. Unlike Forex, for instance, that rests after the NYC session ends on Friday’s afternoon, the cryptocurrency market is always active.

The corollary we need to learn from this is clear: there is no such thing as an official Bitcoin price. Each platform is independent, and it will value the asset according to its internal trading forces. That doesn’t mean there’s not a general global trend that converges to a specific number. But it’s not an institutional thing but the side effect of the aggregated activity in all exchanges.

There’s a process that links the prices across exchanges, and that helps to consolidate the world’s trend in Bitcoin prices. It’s called arbitrage. Arbitrage is a trading strategy in which investors exploit the difference in price between platforms.

If Bitcoin is cheaper in BitStamp than in Coinbase, for instance, then you can buy at the first platform and sell at the second one and make a profit. It’s a quick and low-risk move. In this way, the traders create a link of sorts among the world’s platforms so that the general trend remains consistent everywhere.

The dominant exchanges

The world’s largest exchanges can affect the market significantly, and we also need to take that into account in understanding what makes the Bitcoin price tick. The platforms that mediate the most substantial trading volumes in the market tend to be considered more authoritative as sources for the correct price.

So if the BTC’s value surges in, say Binance, backed up by a substantial trading volume, the chances are that other exchanges will follow the trend. If it happens at many major platforms simultaneously, that will most certainly set a global trend in a matter of minutes.

So why are the most significant players more influential? Well, because traders pay more attention to the price in those platforms. Seasoned traders expect new trends to start at the largest exchanges and then permeate the rest of the market through arbitrage and general market sentiment. This phenomenon is global, and it’s completely independent of each platform’s local fiat currency valuation. Crypto is isolated from fiats for the most part because most of the trading pairs are crypto/crypto, instead of crypto/fiat.

The indexes

The lack of an official BTC price, even as general trends and price synchronization effects do exist within the market, opens an opportunity window for many private companies to compute a composite index for the price and make it available to the public.

There are several ways to calculate indexes, the most popular one being the weighting of prices according to trading volume and then coming up with a weighted average. This practice comes from Forex markets in which the world’s main domestic currencies (USD, EUR, CNY, JPY, etc.) have an index while they can have slightly different prices in every country.

The indexes are helpful in that they do show the global trends. Otherwise, the information from a single local market could deceive cryptonauts into making biased decisions. For instance, if a large sell order gets placed on, say, Bitfinex, the price in that platform will plummet, at least for a while. But does that mean that there’s a global crisis for BTC? Not necessarily as the price could keep steady in every other platform.

Final thoughts on determining Bitcoin price

Now you have a detailed, blow-by-blow, description of the market process that ends up deciding the Bitcoin price. It’s global, it’s quite complicated, but it’s essential to understand it as best as possible because otherwise, getting involved in the trade becomes a little too suspicious as lack of understanding breeds mistrust.

We’ve shown you something of what goes on under the hood. It’s all a bit technical, and it can be hard to follow. There’s no doubt about that. Nevertheless, it’s handy. If you’re car breaks down and you know a bit about mechanics, then you can see under the hood and, if the problem is not too bad, you’ll probably find a way to keep it running smoothly enough to get you home or to a shop for service. If however, you know nothing, then you’ll need to call for help, and you’ll be stranded while the help arrives and for as long as the car is in the shop.

The cryptocurrency markets are your car, but there’s one crucial difference: when something goes wrong, there’s no help. Nobody will come to your rescue, you’ll just get the stranded part, and you’ll pay for it with your hard-earned digital wealth. That’s why knowing what’s under the hood can be critical.

We’ve explained the whole process as it applies to Bitcoin. But the price for every other cryptocurrency in the market follows the very same mechanism. So if your cup of tea is Ethereum, Ripple’s XRP, or any other digital asset, the information should be exactly as useful as it is for BTC.

We hope you find this article illuminating as you navigate the cryptocurrency markets and that it will help you to make informed choices and keep your profit levels up. Happy trading!

Disclaimer: The presented information is subjected to market condition and may include the very own opinion of the author. Please do your ‘very own’ market research before making any investment in cryptocurrencies. Neither the writer nor the publication (TronWeekly.com) holds any responsibility for your financial loss.