While many closely monitor crypto exchanges, few people know how cryptocurrency price is determined. Coins are very different from traditional assets, such as stocks and commodities, so the calculation of their quotations is associated with some features.
What the term “Cryptocurrency price” means
When talking about a price of Bitcoin, speakers are usually referring to its value in US dollars on one of the leading exchanges (for example, Bitfinex, Binance or Bitstamp) or a combined price obtained by averaging quotations on several exchanges (as on the CoinMarketCap website). Speaking about the value on a certain exchange, usually mean the price of the last transaction made on this exchange. For example, the fact that bitcoin on Bitstamp costs $ 10,000 means that the last deal made on this exchange was at that price.
When the new deal takes place, the price will change accordingly. Since bitcoin is a decentralized asset, circulating on hundreds of different exchanges, there is no single price for it. Each marketplace has its own Bitcoin price, although they are mostly equal.
The price setting process is that buyers and sellers meet at the crypto exchange (or other site) and find the value that suits both sides. Buyers want to buy bitcoins as cheap as possible, sellers tend to sell them a much higher price. To make a deal, both sides must come to a compromise. As mentioned above, the current coin price on any exchange is the latest price, agreed by sellers and buyers. Let's take a closer look at how the parties come to a compromise on the crypto exchange.
The Order Book
There is a so-called the “order book” in trading interface of any crypto exchange . Of course, this is not a real book, but simply a screen area displaying information on the execution of buy and sell orders.
In one part of the “order book” there are all active orders for buying bitcoins at a certain price, or the bid of buyers. On the sell side, there are all orders for sale at a certain price, or an sellers offers (asks). In addition, the most recent transactions are usually displayed as a list or table. Here is an example:
Asks are listed at the very top of the table. They show, at what price and what amount of crypto currency is available for purchases. In fact, there are more orders in the order book, of course, just usually the positions closest to the current price are shown. Below are the purchase orders. Similarly, each line displays the price and volumes of the crypto currency that investors are ready to purchase. The bottom of the table contains the trading history. It shows the parameters of the last transactions. The current rate of Bitcoin is the price of the last deal. It reflects the assessment of the currency on the exchange — its quotation — and will change only after the next transaction termination.
Makers and Takers
Bitcoin's price change is usually explained by the presence of a larger number of buyers or sellers on the market. However, this is completely wrong. In each transaction there are two parties — so the number of buyers and sellers, taking into account the volumes, is always the same. In fact, the high activity of one of the parties, ready for “crossing the spread," leads to a change in quotations.
Spread is the difference between the highest bidder price and the lowest price of the seller. For example, an investor is ready to pay $ 9350 for bitcoin, and the seller wants to get at least $ 9400 for it. In this case, the spread is $ 50 (9400-9350). To make a deal, one of the parties must pay it. It is called 'the taker', because it takes the offer made by 'the maker', the person who created the trade.
How Takers Affect Price
Let’s assume that buyers are convinced that bitcoin price will hit $10,000 in a few days. In this case, they act as the takers and are ready to cross the spread by purchasing all the volume of the coins offered at $ 9400.
If bitcoin will rise in price to $ 10,000, they will receive $ 600 profit. When buyers absorb all the coins offered at $ 9,400, they will go to the level of $ 9,450, then $ 9500 and so on. If buyers will be overly active, sellers will soon understand this and begin to raise the bid price. The process will continue until the pressure of buyers is exhausted, and then change a direction. Over time, such impulses lead to the price up or down.
Prices Differ Across Exchanges
The process described above continues uninterruptedly on hundreds of crypto exchanges around the world. Thus, the only "official" price of bitcoin does not exist — on each exchange it has its own and differs from others.
Arbitration supports prices at about the same level. This trading strategy uses the price difference between trading platforms. For example, if bitcoins cost less on BitStamp than on Coinbase, traders can buy a crypto currency on the one exchange and sell it on the other. The arbitration keeps prices at various sites at about the same level.
Finally, it should be noted the influence of leading exchanges. These are sites with the highest volume of trades, and the prices for them are considered more "official". For example, if the cost of bitcoin jumps on one of such major exchanges, as Bitfinex, Binance and Bitstamp (or three at once) — all other exchanges to have higher prices too.This phenomenon is explained by the fact that most traders closely follow the prices on leading exchanges and expect that they will be followed by smaller exchanges due to arbitrage and actions of other traders.
This effect works even if exchanges use different currencies. For example, if in Japan bitcoin starts to become cheaper in relation to the yen, other things being equal, European and American exchanges with pairs denominated in USD, EUR will most likely follow.
Since the official price of bitcoin does not exist, some sites and companies rely on the available data to calculate its index. To do this, they weigh the value in the various leading currencies by the volume of trades and average it. For example, the Bitcoin Liquid Index, offered by BraveNewCoin, is calculated based on the bitcoin price in US dollars, Chinese Yuan and Euro on the nine largest exchanges.
The advantage of such indices is that they mitigate the consequences of atypical trading activity on one of the exchanges. For example, a large trader decides to sell 25,000 bitcoins on Bitfinex. The cost of the crypto currency on this exchange will significantly drop and it will take some time before it returns to normal. The price index allows to mitigate such fluctuations.