Bitcoin, currently the most successful publicly traded cryptocurrency, has risen to over $4,300 this week. It has had a quick recovery from the recent ban on bitcoin trading in one of its largest market countries, China, which felt threatened by the potential replacement to its yuan. A big plus to the cryptocurrency came from Switzerland’s announcement to allow another bank to exchange bitcoin on the SIX Swiss Exchange. There have been many controversial theories about bitcoin’s success, like when billionaire Howard Marks proclaimed bitcoin to be a pyramid scheme. Others believe bitcoin is a bubble waiting to burst because of the overstated surrounding optimism. With such a high-risk investment, it is important to explain bitcoin’s advantages and flaws, and what makes it different from other cryptocurrencies, such as Dogecoin and GetGems.
There have been many concerns surrounding bitcoin’s growth, such as the potential for increased criminal transactions and money laundering. Bitcoin, which is not controlled by any central authority or middleman, and can be used anonymously, makes for an ideal currency for nefarious actors. This past summer, Russian cybercriminals were caught selling illegal drugs and weaponry using bitcoin. In July, Alexander Vinnik was arrested in Greece for laundering over $4 billion in bitcoin. Bitcoin’s remarkable self-sufficiency is widely debated, leading people to question whether this attribute is a strength or a weakness.
Investors worry that people will be turned off by a currency with no governmental enforcement or assurance. However, what gives bitcoin its value is quite similar to what gives any currency its value; a currency’s value is determined by how much people are willing to pay for it. The dollar has no intrinsic value, but the U.S. government guarantees its use as legal tender, and because people believe in the strength of the U.S. government, they are willing to use the dollar in transactions.
The amount of people that use the dollar, or have faith in the U.S. government’s financial position, determines its value. Bitcoin is similar, in that the cryptocurrency has no value by itself, but derives its value from other people who are willing to buy and sell it.
Because people are trading and investing in the high priced, limited supply of bitcoin, it means that bitcoin is valuable. The amount of electricity necessary to mine bitcoins is approximately as much as a small country would use to power itself. Additionally, bitcoin has a controlled supply, in that only 21 million bitcoins can be mined in total. Because of the difficulty of production and the total limit, bitcoin can act as a relatively stable currency.
Bitcoin might be experiencing a bit of a bubble lately, but that is normal for both new currencies and for technology considered to be highly innovative. Blockchain, the technology behind bitcoin, has been a real game changer. Blockchain is a new program for validating all bitcoin transactions and recording them into a permanent database. Major banks have been looking into this technology in the hope that it will minimize the number of participants in a transaction. They also believe it will lead to faster and cheaper banking processes. This can be useful for banks to efficiently spread into developing countries where people might only earn a few hundred dollars a year.
Some investors worry that bitcoin is a fad, with a dubious value that may diminish into nothing. While that is a valid concern, one counterargument can be made by looking at the purchasing power of the dollar over the last century, which has tremendously decreased.
Like any asset, there is always some degree of volatility. Bitcoin wants to be considered a new asset class where value may be stored, and what investors can use to diversify their portfolio. Since fiat currencies are inflationary in nature, investments are made into other assets in the attempt to avoid the loss of purchasing power. If bitcoin’s growth percentage is compared to the growth percentage of other investments, commonly regarded as bubbles, such as technology, biotechnology and real estate, it becomes clear that the cryptocurrency has outperformed all of them.
Compare bitcoin to another value storing asset: gold. Gold stores value so well not because of its use in jewelry or manufacturing, but because its value is not controlled by the government; there is a limited amount on Earth and the speed of mining gold is known. Bitcoin is cheaper to move, store and divide than gold. Some have even called it, the “gold for the internet age.”
If bitcoin takes just 5 percent of the estimated $8 trillion total market cap of gold, then each bitcoin will be worth $25,000. If an exchange traded fund is ever created for bitcoin, it is likely that it will receive a lot of money from institutional investors seeking to diversify their portfolios.
The price of bitcoin is determined by the amount buyers are willing to pay. As more merchants accept bitcoin, it will become more of a useful commodity. Bitcoin’s future relies heavily on whether we choose to accept it as a valid source of exchange.
As the market currently has much room to expand, bitcoin value is increasing at a reasonable pace. Once expansion steadies down, its growth will naturally slow down. Young investors with an endurance for long-term, volatile investments may do well to put their money in a new, exciting investment, such as bitcoin.