Currently, at $18,727, Bitcoin (BTC) is looking for one final push above its all-time high of $20,000. However, this year’s rally is backed by major institutional participation with some big players in the financial space pouring millions of dollars into this digital gold.
With the rising institutional participation, financial giants have started working out Bitcoin investment instruments that cater to the institutional demands. Some of the regulated financial giants like CME and Bakkt are already offering to trade for the Bitcoin futures. On the other hand, there’s enough work going around introducing Bitcoin ETFs in the market.
But for all these investment products to exist in the market, it is important to understand the price discovery mechanism for the asset class. Let’s take a look at what does Bitcoin Price Discovery means in reality.
Understanding the Bitcoin Price Discovery Mechanism
The price discovery mechanism basically means deriving the price of an asset within a market based on the buyer and seller interactions. The Bitcoin Price Discovery means setting up a spot price for Bitcoin (BTC) trading which depends on a number of tangible and intangible factors.
Apart from the classic economic principles of demand and supply, there are a number of factors that come into the picture of the BTC price discovery. This can include factors like the flow of information among crypto markets, exchanges, as well as the interactions with the traditional markets. As we saw this year, the global economic condition and uncertainties also have a considerable weightage on the price discovery.
As said, at the core of the Bitcoin Price Discovery is the most important demand and supply factor. Also, the Bitcoin Price Discovery depends largely on the futures and options market. Traders in this market have better information and judgment to take the desired action. In the case of any external information or news affecting market conditions or the economy, the actions taken by the speculative traders feed new information in the derivatives market which further drives the price movements.
The Bitcoin futures and options market plays a key role in the Bitcoin price discovery since they are the first ones to react as the transaction costs are much low here as compared to the spot markets. Thus, they include the element of future prediction about what is likely to happen.
Factors That Play A Key Role in the Bitcoin Price Discovery
As we all know Bitcoin works completely on a decentralized blockchain network and there’s no regulatory body governing it, unlike other asset classes. Bitcoin, and cryptocurrencies in general, is a very volatile asset and has been the subject of major price manipulations in the past.
Interestingly, although Bitcoin’s decentralized blockchain shields it from any external tampering or attacks, a number of exchanges where BTC trade are still centralized. Over the last few years, we have often heard things like massive exchanges with millions of dollars worth BTCs getting stolen and unaccounted for. Moreover, as most of the exchanges are not regulated, it hinders the accuracy in determining the BTC price value.
In order to determine the Bitcoin spot prices, the BTC price on the top-ten exchanges considered to be trustworthy is monitored. Usually, the BTC price movement is then monitored against other base fiat currencies like USD, EUR, GBP, KRW and JPY, or stablecoins like Tether (USDT).
Bitcoin Price Discovery has remained a tough task for a long-time. But as more regulated exchanges and marketplaces are coming into the picture, the scenario is improving. The institutional participation in BTC is likely to push further the demand for investment vehicles like Bitcoin ETFs and others.
Since such products only operate through regulated platforms, it will help to curb BTC’s price volatility and unpredictable behavior. During a panel discussion last year at Invest: ASIA in Singapore, Lennix Lai, financial market director at OKEx told Coindesk:
“If you can only buy or sell particular underlying tokens of bitcoin and you don’t have the capability to short, basically speculate in another direction, then the market would be a lot more volatile because it would be entirely driven by sentiment.”
“For example, you can view bitcoin as being much more volatile before CME Futures were introduced … so we should have more financial instruments like options to assist further in the price discovery process in relation to volatility.”
The recent participation from hedge funds, veteran investors, institutions, and other big players will bring more clarity to this concept of Bitcoin Price Discovery as the market matures.