What happened

Shares of Bitcoin Investment Trust (OTC:GBTC) are down by nearly 17% as of 2 p.m. EST, as bitcoin and other cryptocurrencies plunge on news that major banks will no longer allow speculators to buy digital currencies with credit cards. Because only a small percentage of all bitcoin in existence is available for sale at any given time, small changes in demand can have a pronounced impact on the currency's price.

So what

After an unusual 91-for-1 stock split, each share of Bitcoin Investment Trust currently represents ownership of approximately 0.001 bitcoin. Thus, at a recent price of approximately $6,920 per bitcoin, the digital currency backing Bitcoin Investment Trust is worth approximately $6.97 per share, based on my analysis.

Bitcoin plunged late last week when credit card issuers JPMorgan Chase, Bank of America, and Citigroup said they would shut off their cardholders' ability to purchase bitcoin with their credit cards. The news followed in the footsteps of a January decision by Capital One Financial to nix bitcoin purchases with its credit cards. At the time, Capital One said it was "declining credit card transactions to purchase cryptocurrency because of the limited mainstream acceptance and the elevated risks of fraud, loss, and volatility inherent in the cryptocurrency market." JPMorgan Chase said it didn't want to take the credit risk associated with funding online currency purchases.

A bitcoin token in front of a candlestick chart

Image source: Getty Images.

Since the price of bitcoin, like all asset prices, is governed by the basic laws of supply and demand, making bitcoin purchases more difficult lowers demand for the digital currency. Small changes in speculative demand can have an outsize impact on online currency prices, because the market for cryptocurrencies isn't particularly deep compared to traditional financial markets.

At the time of writing, a market sell order of 13,000 bitcoins would send the price of bitcoin plunging as low as $2,000 on one major online exchange, GDAX. Likewise, a market buy order of 7,500 bitcoins would send the price soaring as high as $12,000 on the same exchange, illustrating just how much impact the marginal buyer or seller has on bitcoin's market price at any given time.

Now what

As bitcoin soared to nearly $20,000 in December 2017, many speculated that the rising price may have been driven by credit card-fueled buying. It's notable that as bitcoin reached all-time highs, Google searches for "how to buy bitcoin with a credit card" also peaked. At the same time, a LendEDU poll found that as many as 22% of people who used credit cards to buy bitcoin couldn't afford to pay off their balance in full after their purchase, suggesting that some buyers were using plastic as a way to buy more bitcoin than they could otherwise afford.

Interestingly, Bitcoin Investment Trust shareholders aren't bearing the full brunt of the declining value of bitcoin today. At the current price, shares trade for about 44% more than the underlying value of the bitcoin backing each share, up from a premium of 40.5% at market close on Friday. When the premium rises, owners of Bitcoin Investment Trust enjoy higher returns than they would have earned if they simply purchased bitcoin through an online exchange, though the opposite is also true -- the trust lags bitcoin's return when the premium shrinks.

Though Bitcoin Investment Trust's premium can sometimes insulate its shareholders from price declines, it also makes the trust a generally unreliable way to speculate on bitcoin. On as many as one out of every three trading days, the trust actually moves in the opposite direction of bitcoin, rising on days when bitcoin falls, and falling in price on days in which bitcoin rises in value. Buyer beware.