How is the price of Bitcoin determined? Where, exactly, does the U$ valuation of Bitcoin come from?
In this article we take a look at how cryptocurrency prices are formed and we attempt to give you a better perspective on how to weigh this information. Cryptocurrency market cap is not always a trustworthy metric and investors, especially newcomers, should understand how crypto valuation is derived in order to make better informed decisions. So let's get right to it!
In the past, we've argued about how most cryptocurrency market cap is fake. How is this so? Isn't that too conspiratorial? No, it's not, and we've made an argument of why that is the case.
The markets require a comparison to the world's main reserve currency, the US Dollar. Without this benchmark it'd be impossible to attribute any real market value to cryptocurrencies. So, how is this value determined?
The current price of Bitcoin, as published by CoinMarketCap.com which is probably the most popular crypto valuation data source on the WWW today, is derived from a combination of both cryptocurrency, U$ transctions and transactions in many other national currencies converted to U$. For instance, here's a snapshot of the top volume for today :
As you can see, the biggest exchange volume in the past 24 hours comes from a BTC/USDT trading pair out of OKEx. Note that USDT is not the same as USD. In fact, USDT is a cryptocurrency that claims to be pegged to the value of one U$ dollar. But the U$ 538 million recorded for the past 24 hours did not take place using USD currency, but in USDT Tether instead. This is an important factor to notice, since a lot of new investors seem to consider USDT and USD one and the same, when they're not. At this time, there are only U$ 2.2 billion USDT Tethers in circulation. This means that all of the USDT in the world would not be enough to trade but a very tiny fraction of the total crypto market cap (which is over U$ 460 billion at the time of this writing). Therefore the USDT valuation and trading volume should not be listed in the same page as other currencies, in our opinion. But let's proceed.
The #2 volume is a BTC/USD pair with $ 416 billion dollars traded over the past 24 hours at Bitfinex, the world's largest crypto exchange which is based in Taiwan. Wikipedia describes this exchange as "controversial" :
Bitfinex is a controversial crypto-currency exchange trading and currency-storage platform, owned and operated by iFinex Inc.
There's good reason for this adjective. Bitfinex is the exchange behind the USDT Tether cryptocurrency. The main controversy comes from the fact that Tether has not been audited to prove that they actually hold U$ 2.2 billion in USD cash reserves. Since suspicions grew stronger about the real size of these cash reserves, Tether published a transparency page where they claim to show an audit by Friedman LLP. The status of this audit has even become the target of online jokes.
The point we need to make here is that the $ 416 billion which Bitfinex claims were traded to/from Bitcoin in the past 24 hours may or may not have been executed in actual U$ dollars. Is is likely that, Bitfinex being the issuers of USDT, have also mixed U$ and USDT volumes and reported it as one.
#3 shows more USDT volume reported as U$ and all the same precautions apply. The #4 volume is reported in KRW, which is South Korea's currency, the Korean Won. South Korea is a major player in the cryptocurrency space and they are responsible for a large slice of the reported Bitcoin market valuation.
In this case, the KRW exchange to USD is performed and its volume is reported in dollars. This brings another component to the mix: not only are cryptocurrencies evaluated directly against the US dollar and also against other cryptocurrencies, but there's also FOREX involved! Oscillations in the KRW/USD exchange rate directly influence the valuation of cryptocurrencies.
The most complex part of cryptocurrency valuation comes from crypto to crypto prices. This is where we've claimed the market cap is fake. Here's why.
Take, for instance, the #9 line in the above CoinMarketCap.com summary. This is a ETH/BTC pair which purports to show a U$ 182 million dollar trading volume for the past 24 hours. This information is absolutely fake. There was likely not even 1% of this dollar amount traded between that pair of cryptocurrencies. This dollar information is only a reference, a benchmark, and does not actually exist.
Let's take a moment to understand why the ETH/BTC pair is absolutely fake market cap.
U$ is exchanged for either Bitcoin or Ethereum, but 90% of the volume goes into Bitcoin. This gives Bitcoin a certain valuation in real U$ dollars. Then BTC is exchange for ETH somewhere - now ETH has obtained a value in BTC. We know the U$ dollar value of BTC because someone actually paid that amount for it, but nobody paid a single dollar for ETH in this process, yet ETH has obtained a U$ value indirectly when it was traded for BTC.
Below we show you two tiny 7 day price thumbnails extracted from CoinMarketCap.com:
BITCOIN PAST 7 DAYS
MONERO PAST 7 DAYS
Notice anything? The chart shows U$ Dollar prices and if you overlay these two charts you'll notice that they are almost exactly identical. How is this possible, when Monero oscillated 7% and Bitcoin 2%?
The answer is that the Monero volume in actual U$ trade is not influencing the price, but Bitcoin is. The only thing driving Monero's U$ price in the above chart is Bitcoin's own U$ price. Bitcoin goes up, Monero goes up, one goes down, the other goes too.
Let's make a seat of the pants estimate here: over 90% of altcoin volumes are derived from Bitcoin U$ trades, not their own. Therefore, the U$ volumes reported for these cryptos is absolutely inexistent. If anyone tried to trade a few billion Monero for U$, they'd be in for a big surprise. There isn't enough liquidity for this to happen.
Now for the big finale: if almost everyone's U$ market cap is derived from Bitcoin's market cap, this means the U$ value you see on CoinMarketCap.com is not real. As we've argued in the fake market cap article, the same U$ is being summed up several times over. A single U$ note that was traded for Bitcoin has been automatically added to the market valuation of 1500+ other cryptocurrencies!
As you can see, newbies can be easily misguided by U$ market valuations. It is recommended that new traders learn to take these two rules with them:
If you're a beginner, these two guidelines should help you avoid the pitfalls of cryptocurrency trading. Don't base yourself on U$ valuation for cryptos which are not directly traded for U$. The oscillations can be brutal and they're absolutely inaccurate to begin with.
Of course if after this article was published, suddenly Ethereum became as easily bought and sold in U$ or Euros as easily as Bitcoin is today, this same advice will apply to it, and to any other crypto which acquires relevant fiat money trade volume. The only reason Bitcoin is the "real U$" price at this point is due to its status as the crypto reserve currency.
Another interesting thing to notice is if you draw parallels between the crypto world and actual FOREX markets. Notice how Bitcoin shapes the value of other cryptocurrencies? The exact same thing happens in real world currencies! The Euro market cap is shaped by the U$ valuation, and most smaller currencies are shaped by the U$/Euro trading pair! Take this into consideration and you'll view the world financial markets in a completely different way, thanks to the financial tricks exposed by cryptocurrencies.