The basic mechanism
In any market where buyers and sellers meet, the price at any moment reflects the balance between how much people want to buy and how much others are willing to sell. If more people want to buy at the current price than want to sell, the price tends to rise until enough sellers appear. If more want to sell than buy, the price tends to fall.
On a crypto exchange this process is visible in the order book, where buy orders (bids) and sell orders (asks) are matched. The last price is simply where a buyer and a seller most recently agreed.
A very simple illustration, with invented numbers: suppose at $10 there are orders to buy 100 coins and orders to sell 300 coins. Sellers outnumber buyers at that price, so the price would need to fall before more buyers join and some sellers hold back. If the numbers were reversed, the price would tend to rise. The point is the direction, not the amounts.
What is different about coins with scheduled issuance
Ordinary goods can be produced in greater or lesser amounts as prices change. Many cryptocurrencies instead follow rules set in advance. Bitcoin is the best-known example: its supply is capped at 21 million coins, and new coins are issued as block rewards that are cut in half roughly every four years at each halving. The details are covered in the fixed supply explainer.
This has several consequences for how supply and demand work.
- Supply is predictable. The rate of new issuance does not respond to price. If demand rises, more coins are not created to meet it, so the adjustment falls more on price.
- New supply is small relative to what already exists. Most of the coins that will ever exist have already been issued, so the daily flow of new coins is modest compared with existing holdings. What matters more for price on a given day is how many existing holders choose to sell.
- Not all supply is available. Coins held for the long term, coins in cold storage, and lost coins do not add to selling pressure. The part of the supply that is actively traded is much smaller than the total. This is related to circulating supply and lost coins.
What actually changes the balance
Because issuance is steady, changes in price are mostly driven by changes in demand and in the willingness of existing holders to sell. Some commonly discussed forces:
- Demand from new buyers. Interest increases when an asset gets attention, becomes easier to buy, or is offered through products such as spot ETFs.
- Sentiment. Optimism can reduce selling and increase buying, and fear can do the opposite.
- Holder behavior. If long-term holders start to sell, the effective supply increases. On-chain data such as exchange flows is sometimes used to look for this.
- Leverage. Borrowed money can add temporary buying or force selling, as with a short squeeze or a liquidation cascade.
- Miner and issuer selling. New coins reach the market as miners or project teams sell some of what they receive. The size of this effect is debated, as covered in miner selling.
- Scheduled releases. Some tokens have large amounts that unlock at set dates, which can increase the supply available to trade. See token unlocks.
- Access and liquidity. The money available to buy, including funds arriving through fiat on-ramps and stablecoins, shapes how much demand can be expressed.
Scarcity is not a guarantee
It is tempting to say that a capped supply means a rising price. That is incomplete. Scarcity can only support a price if there is demand for the thing that is scarce. Many assets with extremely limited supplies, including coins with a fixed maximum, have fallen to little or nothing because no one wanted them. A supply cap is one input, and demand is the other.
The same point applies to the halving. Because issuance falls on a known schedule, some commentators expect prices to rise after it. The evidence is limited to a few events, other conditions changed at each one, and so halving myths are a good reason for caution about any claim of a guaranteed effect.
Similarly, an expanding supply does not automatically mean lower prices. If demand grows faster than the issuance, the price can still rise. Questions such as burns, buybacks and issuance rates are best seen as ways supply may change, not as price rules.
Limits of the framework
Supply and demand is a useful starting point, but it has limits in crypto.
- Demand cannot be observed directly. We see trades and prices, and infer demand afterwards.
- Supply that is available to trade is hard to measure.
- Many participants are speculators whose views change quickly, so demand can shift abruptly without any change in a project’s fundamentals.
- Prices differ across exchanges, and one can see the effect of small markets in the order book.
Treat any claim that supply and demand allows precise forecasts with caution.
Cryptocurrency prices are volatile, past performance does not predict future results, and people can lose all they invest. Nothing here is financial, tax or legal advice.