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Over the past year, the value of bitcoin has gone from 1030.82 USD on 3 Jan 2017 to 10755.89 USD today. That's a price increase of 1000%. I'm only an amateur investor, but in my mind that increase is astounding.

graph

I've got a couple of non-digital currency investments and I'd be happy to get a 10% return on my money. These kinds of gains are claimed by scam artists; If I didn't know bitcoin, I'd think this was a scam. This sets off red-flags in my head. It's too good to be true, which means I'm misunderstanding exactly where these gains come from and what they represent. For example, where did all this money come from? It can't just come from nowhere!

So, why has bitcoin performed so well over the past year? Why has it gained so much so quickly? What's the downside to all this? There must be one?!

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    This is a question that cannot be answered, our natural inclination when observing anything unusual is to seek a cause in the available data, but in the case of financial markets, the proximate cause is as simple as a person or business entity choosing to buy. Buyers with deep-pockets can create huge price changes when they attempt to enter relatively illiquid markets. There is no way to get into the head of these buyers, they don't publish their reasoning. So we are left with speculation, which the financial media have been happy to provide, but ultimately the answer is unknowable. – brandondoge Nov 29 '17 at 18:21
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    @brandondoge I agree that a concrete answer cannot be known. Nonetheless the answers included already have helped me understand this trend much better. Even though the general answer may be "because the hype", this is a satisfactory explanation for me as an amateur. I didn't know this factor had such a large effect and it also explains why it's so volatile. People are volatile. – stanri Nov 29 '17 at 18:45
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    @brandondoge To the contrary, while I suppose the exact details of the answer cannot be known because there are too many complex issues, the general reasons for the increase in price are very well known and understood. For that matter, the fact that deep pocketed buyers are entering a relatively illiquid market is itself the main reason ... – Joe Nov 29 '17 at 20:30
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    There are some good answers below that are not opinion-based. This is an interesting question, and I'm voting to reopen. – Ben Miller - Reinstate Monica Dec 1 '17 at 15:55
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    I also declined to add a close vote because I think there is plenty to say about crypto currencies that doesn't require any opinion. – NL - Apologize to Monica Dec 1 '17 at 16:12
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Market cap doesn't mean that much money went into the system. Money in equals money out over time, and is not directly tied to market cap, which can actually be lower if price drops far enough. These concepts are the same for all traded assets, such as stocks, bonds, and commodities.

"Market cap" is simply the current price times the number of shares available in the market. So a $300 billion market cap does not mean $300 billion was paid to somebody to buy it all. Instead, what's happened is that some money went in at first, but much much less, and then price increased.

Bitcoin is a little different in that "money in" for many innovators and early adopters was in the form of time spent and contributing to the network (what they call mining). 1

Now, as to the price jump, that's an effect of market forces. For many reasons, the market has clamored to buy bitcoin over the last year 2, but many already holding bitcoin weren't ready to sell. Supply and demand worked in a way that increased price. Supply low, demand high, price increases.

This situation could easily reverse. Just as suddenly as the market wanted bitcoin it can decide it doesn't want bitcoin. Supply and demand would work in a way that would decrease price. Supply high, demand low, price decreases.

This kind of massive market price movement in this short timeframe is exactly what traders mean by "volatile". It's actually not that unusual, it's just that most stocks and other assets that experience such gains don't get much media attention. Further, gains like this often reflect "inflated" prices, market "euphoria", and trading "bubbles". All of these terms essentially mean "price will correct (go down) eventually, because price is currently much higher than actual value".

If the market loses all faith in the asset, price will drop to zero and the "money in equals money out" maxim breaks down. Some traders will be left "holding the bag", meaning they owned the stock at the moment trading permanently ceased. 3


NOTES:

  1. This early contribution was mostly driven by people with a vision for bitcoin, not traders hoping to profit. This may in fact be a major reason that supply has been so low, meaning, current holders don't want to sell. Many early "bitcoiners" believe bitcoin will serve a higher purpose and want to remain active in the community. Selling off your bitcoin represents an exiting from that vision and community.
  2. Exact reasons cannot be pinpointed with facts. Instead, we enter the realm of opinion on this point. In my opinion, bitcoin has increased massively in value mostly due to the media attention it has received. And this media attention is not new. It received equally pervasive attention in 2013. As an effect, price went from under $100 to over $1000 back to under $200 in about 20 months. It's great news if you're a trader. You could have made tons of money. As for the early bitcoiners, it was actually kind of annoying because it then brought in all the skeptics calling it a "ponzi" scheme or "pyramid" scheme, despite the quite obvious fact that bitcoin cannot be either by definition.

    Further upward market forces may have come from the fact that bitcoin is built on an innovative technology that may very well change the way we do a lot of things in the future. I'm referring to "blockchain". This effect can be seen in several failing companies rising from the darkness like Valkrie simply by adding the work blockchain to their name. I personally find this exactly analogous to the "dot com bubble", where companies in the late 1990's made millions in stock selloffs simply by adding ".com" to their name, despite having no profits or sometimes not even a working product.

  3. For high volatility stocks, this is not unusual. Many "penny stocks" fail, and typically the road down is faster than the road up. Bitcoin may indeed fail, but again, it's a bit different than a stock. Bitcoin is not a company. There's no financials for Bitcoin, no VC investors, board members to report to, no product to produce, etc. Bitcoin is designed to simply be a thing itself. The hope is to disrupt currency and commodity markets and create a new "store of value." Literally, Bitcoin is designed to have intrinsic value. Whether it's actually working at this point is still unknown.

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    @stanri as a sidenote, the whole concept of 'pay out' is not how many of us bitcoin believers think, because bitcoin is a currency, despite its common use as a speculative investment. It's intended to be used to buy/sell goods, and eventually replace fiat currencies such as the dollar – Felipe Nov 29 '17 at 20:49
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    @Filipe I am a bit confused about how bitcoin right now fits into a buy/sell goods model. I understand ultimately the goal is one day I go grocery shopping and all the prices are in bitcoin and not tied to another local economy/fiat currency. This transition period confuses me. I'll attempt to explain why. When I choose to buy a high risk investment, it's a conscious decision. I examine the risks and the market history and choose a once off amount and time to invest. Then leave it and watch it. ... – stanri Nov 29 '17 at 21:40
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    When I do my grocery shopping, I don't want to make a call on if I'm going to pay out some of that high risk investment because I need milk. In this transition period, my grocery store is in local currency, and every transaction is now a judgement call on the exchange rate. These two things are in conflict for me. High risk investment is treated very differently from a transactional currency and it seems very weird to mix them. – stanri Nov 29 '17 at 21:43
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    @PyRulez What are you referring to? – 26460 Nov 29 '17 at 22:04
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    @PyRulez I would contend that bitcoin is currently not very useful. Maybe it will be (that's why I bought in years ago), but it's not now. – 26460 Nov 29 '17 at 22:19
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where did all this money come from?

Investing in a currency, whether it's bitcoin, gold, USD, or another country's currency, is a risky investment because the average trader loses money (after transaction fees). This is not true of the stock market, since successful companies actually produce wealth. So in short, money made from selling bitcoin comes from the people buying your bitcoins.

why has bitcoin performed so well over the past year?

This is an extremely difficult question to answer, but I can point out some of the most prominent factors.

  • The number of bitcoins that can exist is limited. As new bitcoins are mined, the next bitcoins take much longer to mine. This is not true of a national currency, which can be printed off in virtually unlimited amounts.
  • Bitcoin is not tied to any country
  • Bitcoin transactions are easier to make anonymous
  • Bitcoin value has increased significantly

This last point is one of the biggest. With all the recent hype, more and more people want to try to get in on the action. No one can tell when or if the bubble will pop, though.

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    Haven't all of these statements have been true since Bitcoin launched (except the one that says the value increase - but this question is asking why)? Why would it be this year that it causes a 10x or more increase in price? – Rob P. Nov 29 '17 at 19:09
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    @rob Hype is like a snowball rolling down a hill. It sounds like begging the question, but it's actually correct. – 26460 Nov 29 '17 at 20:41
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    "Why has bitcoin performed so well over the past year?" "Bitcoin value has increased significantly." The First Rule of Tautology Club is the First Rule of Tautology Club. – Russell Borogove Nov 30 '17 at 1:58
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    @assylias Yes it is. The only way to know who owns the bitcoins in any given address is if the owner or receiver in a transaction tells you. – 26460 Nov 30 '17 at 18:40
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    @fredsbend Bitcoin is not anonymous by default - you have to go through a whole process to make it hard to link to you, but (a) most people don't do it and (b) even if you do, there is still a possibility that you could be traced. Numerous companies specialise in de-anonymising the blockchain with success. News about drug dealers etc. going to jail appear every week because they've been found through their bticoin transactions. – assylias Dec 1 '17 at 9:57
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Bitcoin prices are likely rising as a result of the simple issue of supply and demand. Supply is constrained as there aren't much in the way of new bitcoins coming into existence, and demand is high right now as a result of various events.

For example, this Reuters article goes into some detail as to some current influences. Mostly, crypto-hedge funds are buying a lot of bitcoins as a speculative move (i.e., believing the price will continue to rise).

The evidence suggests that few of the users are buying bitcoin to use it as a means of exchange, but are speculating to increase their capital.

Many describe the bubble as similar to the Tulip craze in seventeenth century Holland; from the same Reuters article:

“It’s got all the shapings of your tulip bubble chart (but) that tells you nothing about where that price line could go depending on the number of people who wish to own it,” Standard Life’s head of investment strategy, Andrew Milligan, said on Wednesday. “Who is to say it doesn’t reach $100,000?”

You can see in the volume chart from blockchain.info that the trading volume for bitcoins has really increased - and if you look at the market price, you see a very similar movement.

However, if you look at the number of transactions per day, that number is basically constant - meaning the actual uses of bitcoins by people just buying or selling goods or services isn't really changing much, but the dollar amount is. That's indicative of a speculation-caused bubble.

Below is a graph I made from the data from blockchain.info above that overlays price with trading volume; you can see clearly the increase in volume and increase in price are nearly simultaneous.

Chart of Bitcoin Price and Trading Volume, Nov 2016-Nov 2017

Bitcoin itself has some actual utility, mostly for black market sellers and similar people participating in activities that are less than legal (not necesesarily ethically bad, for example people in nations with oppressive regimes that limit contact with the outside world or try to restrict foreign currency purchases). It's unlikely that the degree of adoption so far however has driven it to this level, and the fact that bitcoin can be broken up into very small chunks means that the big boom in price of individual bitcoins causes the demand-side pressure from the actual use of bitcoins to be alleviated (as there is now 1/10th the demand for bitcoins from people who use them for non-speculative reasons).

  • I like that you cite some sources. Great answer. I would, however, note that your depiction of supply in this context is incorrect, though your conclusions have turned out correct. Supply in this context is holders willing to sell, not total amount in existence. – 26460 Nov 29 '17 at 20:49
  • @fredsbend I suppose that's true to some extent, but with something like bitcoin those two things are more or less identical. Most holders of bitcoin are willing to sell, it's just a matter of at what price. Further, I'm not saying that the total supply available at any day is equal to the total bitcoin: I'm saying that supply is constrained by the fact that very few bitcoin are coming into existence. That's true no matter your feelings on total supply available to buy. – Joe Nov 29 '17 at 20:51
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    Your interpretation of the number of transactions per day seems to ignore the limit on how many transactions are permitted by the blocksize limit. – kasperd Nov 29 '17 at 21:19
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    Also, many "transactions" are done within an exchange. @kasperd – 26460 Nov 29 '17 at 21:23
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    @kasperd It does ignore that, and I'm sure without that limitation there would be some increase in that number. But that doesn't change the fact that since there are not more transactions occurring, the actual "use" of bitcoin for nonspeculative purposes can't be increasing significantly (it's just that there is an external pressure there). – Joe Nov 29 '17 at 21:23
3

This is mostly an addendum to @fredsbend answer, which appears to list reasonable causes, but ignores the technical cost aspect. The other answer lists the technical cause, but doesn't explain it in detail.

In addition to other valid causes listed, Bitcoin is a scarce resource and getting it recently has required huge investments in hardware -- reflecting on price.

Look at the two graphs (from Wikipedia).

This is how difficult -- in terms of computing power, meaning hardware costs and electricity costs -- it has been to mine bitcoins over years:

Bitcoin mining difficulty

This is how many total bitcoins have been made since the start of btc era:

Total number of bitcoins

Might not seem that different... until you realize that the difficulty graph... is on logarithmic scale! So... in 2017 it requires approximately one trillion times more computing power to mine the same amount as in 2009.

For contrast, the bitcoin production has been at around 2 million bitcoins per year, for all those years.

As you can see, the bitcoin mining is slowing down, and this is happening despite huge investment into hardware done by organized bitcoin mining entities.

This is by design. The bitcoin system is designed to produce 1 bitcoin in roughly 6 hours regardless of how many computers are thrown at it.

If you could use a home computer at start of bitcoin and mine 1 bitcoin a day on it, nowadays, you need to use specialized hardware costing thousands of dollars and pay huge sums in electricity costs in order to mine the same 1 bitcoin in a day, because there are so many much more mining operations, trying to mine more.

Since bitcoin mining was started on industrial scale somewhat recently, the cost to mine has skyrocketed comparatively recently as well and this has been reflected in the actual bitcoin exchange rate.

So, as the more hardware anyone throws at mining, the harder it becomes for him and everyone else extra hardware is used mostly in order to drive out smaller players and keep the general ability to mine, rather than to increase the mining speed.

All of these things drive the price up. While you could mine a bitcoin home it was no big deal. Now to make 1 bitcoin you have to invest a lot.

Half a year ago, a user decided to experiment on his home computer to see how much he needed to mine:

I did it just as an experiment, I'm not that stupid. I know even with an Antminer S9 you'll struggle to earn real amounts.

Anyways, I thought I'd share this if anyone is curious. BTW I know there are calculators out there but I wanted to do a real life test. And sooo after 33 hours of mining at full performance of a MacBook Pro I earned... 0.00000001 BTC.

TL;DR Mining, you would have to run a MacBook Pro for 3 straight years at full performance in order to earn USD$0.02 (at present value).

Last year a friend and I were considering buying a couple specialized rigs, running on off-the-shelf powerful computers and using extra (gaming) graphics cards for number crunching. As we didn't get on the train fast enough, the graphic cards were bought up by bitcoin mining organizations en masse.

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    "despite rising difficulty and costs, the bitcoin mining is slowing down" Shouldn't that be because? – oerkelens Nov 30 '17 at 15:19
  • @oerkelens No, the difficulty doesn't affect the mining rate. The mining rate is hardcoded into the software. The software will adjust the difficulty such that a constant rate of mined blocks will be maintaned. The coins mined per block is periodically decreased to put an upper bound on the total number of coins ever mined. So the mining rate measured in number of coins mined will be slowing down and that is enforced by the software. The difficulty will depend on mining rate and the amount of hardware used for mining worldwide. – kasperd Nov 30 '17 at 15:28
  • @oerkelens i will reword this. I was trying to say that the increased hardware investment doesn't translate into faster bitcoin generation. – Gnudiff Nov 30 '17 at 16:18
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    I like this answer. It explains why miners, who are more like early adopters and innovators rather than speculators, hold their bitcoin more tightly. As an early adopter myself and hobbyist miner, I can confirm that the costs involved have ballooned significantly and therefore affect attitudes on value. – 26460 Nov 30 '17 at 17:19
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    And since the early adopters are the only ones you can actually buy bitcoin from on the exchanges, because they are the only ones who have it, they are essentially a gateway or a bottleneck, therefore they affect the price significantly. – 26460 Nov 30 '17 at 17:20
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Lots of long answers. The short answer is that speculation and growing confidence in the currency have increased demand. Supply and demand tells us that the price will increase until holders of the product are willing to sell, or until the buyers are no longer willing to buy.

My personal opinion is that we're seeing a bubble in action. But have we passed the point where the market will stabilize after a correction? Far too soon to say. If I knew I wouldn't say and I wouldn't be slaving at a 9 to 5 job.

-5

This are my opinions on the subject:

-People are tired of the corrupt system of bankers who poorly manage money, Bitcoin is built on trust, and more people are starting to trust it. Can you trust a banker? NO. Can you trust computer systems built on strict code that will always do what you tell them too? YES. To understand why Bitcoin is safe, one must first understand the block-chain technology. MORE INFO

-More companies are starting to accept Bitcoin as payment, which creates more trust in the system, which brings more people interest. LIST OF COMPANIES

-Bitcoin is a worldwide coin, you can pay your friend in Japan with Bitcoin and the transaction is done in 10 minutes, as opposed to 5-7 business day if done through a bank. The banker fee is huge, the Bitcoin miner fee is minimal.

-Bitcoin is like Gold but better, Bitcoin is not built for everyday transactions just like gold, its not built for buying coffee either, its built to retain value which is why there is a finite amount (21 million).

-A huge benefit of bitcoin is anyone with a smartphone or a computer can download an App and start accepting Bitcoins as payments. Gold is not easily trade-able. Bitcoins is as simple as sending a picture message. (NOTE: More than 2 billion smartphone users around the world around 3.7 billion internet users around the world all capable of one day trading using bitcoin) LIVE INTERNET USERS

-Keep in mind, there is more than one crypto currency, all built on different ideas and systems, all performing with incredible gains. MORE INFO

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    Of your list of companies which accept Bitcoin as payment, which ones do so at rates that are actually competitive (including the ~$6 transaction fee required to perform a BTC transaction without waiting hours or more for the blockchain to fill)? You say on one hand that "Bitcoin is not built for everyday transactions", but actually one of the founding principles was that it would be a currency for those too poor to afford bank fees. And in your one question give an example of paying your friends with it. There is inconsistency here which plays up the hype but not the downsides. – Grade 'Eh' Bacon Nov 29 '17 at 21:38
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    "Can you trust computer systems built on strict code that will always do what you tell them too?" Be careful what you wish for, lest an AI turns the whole universe into paperclips. – 26460 Nov 29 '17 at 22:12
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    ' Can you trust a banker? NO. Can you trust computer systems built on strict code that will always do what you tell them too? YES' Did people trust Mt. Gox? – Charles E. Grant Nov 30 '17 at 0:18
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    @CharlesE.Grant That was probably a weakness of Mt. Gox, not of Bitcoin itself. – glglgl Nov 30 '17 at 9:13
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    @glglgl Mt. Gox is just one of the many exchanges (not to mention individuals) to be hacked. The ability to irreversibly and instantaneously lose tens/hundreds of millions of dollars worth of BTC is a weakness of Bitcoin. – ceejayoz Nov 30 '17 at 13:46

protected by NL - Apologize to Monica Dec 1 '17 at 16:13

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