Understand how cryptocurrency price is determined

Understand how cryptocurrency price is determined

The US Dollar price we see listed for major cryptocurrencies is an average that takes all the major crypto exchanges into consideration. For example, on Coinmarketcap, there is a specialized tab that lists the sources for the current listed price, under “Markets”¨:

As you can see, Coinmarketcap sorts the sources by 24 hour volume. This makes sense, since the higher the volume the more relevant the data. Take, for example, an obscure exchange where only a few thousands of U$ were exchanged in the past 24 hours at an outlier price of U$ 15000 per Bitcoin. Were these smaller exchanges to have the same weight as the large ones, the price average would be artificially skewed towards U$ 15000.

Therefore the public price we see is formed through a weighed average. Which is the volume from each exchange divided by the total 24 hour volume, thus each reported price takes on a weight proportional to how much volume was exchanged at that price.

Notice that US Dollar is not listed for several of the top markets on the above screen capture. In fact, the first exchange to report a U$ price is Bitfinex, the top two use USDT instead of USD. This is indeed a controversial practice, given that Tether’s are not the same as US Dollars. We’ve talked about this in detail in the past.

Also note that there’s a complex relationship between FOREX rates and cryptocurrency rates. For instance, some of the highest volumes are negotiated in Japan, where the volume is listed in Yen and not in US Dollar. How come then the right hand side column reports a U$ volume? Obviously the JPY rate is converted to USD in real time before reporting, but this is also not very accurate because it injects a three way variable into the mix. The US Dollar will oscillate against the Japanese Yen, which in turn oscillates against Bitcoin, inserting a complex and volatile relationship into the mix. For example, the quotation of JPY itself against the USD is a different weighed average taken from FOREX data sources. The propagation of these variations inserts several layers of volatility into the final reported price.

As you can see, the formation of the current Bitcoin price is a complex process that involves hundreds of markets, currencies, averages and even other cryptocurrencies like Tether. Crypto investors get used to the volatility by adapting to the nature of Bitcoin pricing. 10 to 20% fluctuations in a matter of minutes are not uncommon. As with everything else in the world of cryptocurrencies, Bitcoin pricing is a different universe with its own rules and idiosyncrasies!