If you know about bitcoin, then you will be familiar with its ever fluctuating price. Have you ever wondered what causes these price fluctuations? Is it something to be worried about? Also, what does the future hold for bitcoin?

It is assumed that the value of bitcoin is directly dependent on its use for transactions. It is believed that an increase in bitcoin transactions increases its value. But a working paper published by Hong Kong based Bitquant Research Laboratories begs to differ. Bitquant is a company involved in R&D supporting high risk/high reward open source financial systems.

Bitquant has derived a macroeconomic model for bitcoin. According to this model, the value of bitcoin is heavily dependent on people’s willingness to save it. The derived model, in its mathematical form clearly shows that the price of bitcoin is inversely proportional to the likelihood of a bitcoin transaction.

p b = 1 / l t α t ,

Where p b = price of the bitcoin, l t = likelihood of bitcoin transaction and α t is a constant (you can read the whole paper here).

We already know that the bitcoin price is also affected by other external factors like recent news updates etc. Any changes in the economic situation or certain new developments in the news causes the bitcoin price to increase or decrease. Any situation that may lead to bitcoin hoarding will trigger its price to slide.

Even though these fluctuations seem to make bitcoin appear as an unstable and unreliable currency, its long term outlook as a transaction alternative for fiat currency looks promising at this stage.

Reasons why you shouldn’t worry

Lots of people (including the bitcoin community) are still skeptical about bitcoin as the currency of the future. They doubt whether bitcoin will continue to exist in the next couple of years. The current technology lifecycle of bitcoin is still at its nascent stages. It is being adopted and used by a niche set of users. But it won’t stay that way for long. Once a large number of people understand bitcoin and start using it, we can expect it to be used on par with fiat currencies.

It is assumed that an increase in bitcoin users will cause it to fall into the liquidity trap. In a traditional scenario (with fiat currency) increase in demand should lead to hoarding of bitcoin. Given the total units of bitcoin is limited, it should be hoarded completely in no time, thereby leading to a big increase in its price. But according to the macroeconomic model, when bitcoin price increases, people will use it instead of fiat currency for transactions. Increase in bitcoin transactions reduces the amount of bitcoin hoarded in the system. This causes its price to fall. When the price hits a low, people start saving bitcoin, causing the price to go up again. This self-sustaining cycle in the bitcoin economy will prevent it from falling into the liquidity trap.

In a nutshell, this macroeconomic model removes any misconceptions about the reasons for fluctuations in the bitcoin price, and it also throws light on the future of bitcoin (it is here to stay!). In addition, it also shows how it will regulate itself to prevent the whole bitcoin economy from crashing.