Table of Contents
1. Introduction
Another important feature of Bitcoin is its ability to provide irreversible payments. An example of when this is useful is in providing payments to a freelancer. With other payment methods, it is common for a cheque to get lost in the mail, or the employer to end payment early when the work has not been done to specification. It is very difficult for the employee to know whether the employer will keep his promise to end payment at a certain date, and the employee does not want to be constantly asking the employer whether he has sent the cheque. Payments through PayPal and credit cards can also be easily reversed. With Bitcoin, the employer can give a payment with assurance that it cannot be reversed at a later time, and the employee can be sure that he will never have to keep checking to see if a payment has been made, nor will he have to worry that he will be asked to return the payment. A large amount of funds can be held using a payment in Bitcoin to avoid possible exchange rate fluctuations.
The most important feature of Bitcoin is that it is a decentralized system; no single entity has control over it. It is a global system that will enable individuals to send money over the internet to other individuals or businesses, much like sending an email. Because it is a decentralized system, it will be less expensive to send money using Bitcoin. Decentralization also has other benefits. A common problem for people using credit cards online is the risk of the credit card information being misused. With Bitcoin, it will no longer be necessary to give a merchant your credit card information, reducing the risk of the credit card information being misused.
Bitcoin is an online communication protocol that facilitates the use of a virtual currency, including electronic payments. Bitcoin’s distinguishing features that enable its use as a payments system are: decentralization, its enabling of irreversible payments, and its facilitation of payments without the need for trust. All these features are explained in more detail in the section “The Network” and the section “How to Use Bitcoin”.
1.1. Overview of bitcoin
Bitcoin is the first decentralized digital currency. Bitcoins are digital coins you can send through the internet. Compared to other alternatives, bitcoins have a number of advantages. Bitcoins are transferred directly from person to person via the net without going through a bank or clearinghouse. This means that the fees are much lower, you can use them in every country, your account cannot be frozen and there are no prerequisites or arbitrary limits. Let’s look at how it works. I have my bitcoin wallet on my smartphone and that is also my personal wallet. I use it to pay for goods and services. In order to make a payment, I would take information from my wallet. I would then find where I am paying it to, scan their address with my smartphone and enter the amount then press send. It is as easy as sending cash digitally. This is advantageous because you are still able to send money no matter what time it is because it goes through 24/7 and there is no third party involved. Now let me briefly explain how bitcoins are generated. It is known as bitcoin mining but it is not the type of mining you would think of. When you mine for gold, you are actually digging through soil and rocks to get to gold. Bitcoin mining is just using computer power to solve complex mathematical equations. You are not digging virtual coins out from the ground like gold. But rather you are solving equations to find coins. The mining process involves compiling recent transactions into blocks and trying to solve a computationally difficult puzzle. The first participant who solves the puzzle gets to place the next block on the block chain and claim the rewards. The rewards incentivize the mining and include both the transaction fees and newly released bitcoins. This process increases the security and fairness of the currency because it does not allow the same person to add two blocks consecutively to the block chain. The difficulty of the mathematical equations automatically adjusts and the number of bitcoins generated per block reduces over time. This means that the production of bitcoins will slow down and come to a halt at 21 million limit. The last bitcoin is expected to be mined in the year 2140.
1.2. Current state of the bitcoin market
The overall sentiment of all information, be it from the mainstream media, industry reporting, or blogs, is that of a roughly 70:30 split of positive sentiment to negative sentiment. Currently, the financial markets are experiencing a new paradigm, one where information, any and all information, has a direct data point in how the market moves. The cryptocurrency market is an extremely speculative space, although some would call it educated, rational speculation, but speculation nonetheless. This is clear due to the influence and power of news on price action. The speculative nature of the market has always lent itself to high volatility. Brexit’s effects on the pound and euro are a good example of this for modern times. COVID-19’s effect on the stock markets has been another brilliant example of how unstable the market can be. But, with an increase in data-driven analysis, a theory could be put forth that cryptocurrency is starting to head the way of more traditional data-based effects. Bitcoin happens to be the leader of these cryptocurrency assets, and given recent technological advancements in analysis, there can be an argument that recent price trends are direct effects of data points on bitcoin, which now have models to show foreseeable effects or correlations with changes in data points. This would all lead to the belief that although price is still volatile, its degree of volatility is beginning to steadily decrease. (Fact needed) This increase in rational analysis in bitcoin data points could have effects on the speculative market and connotation of cryptocurrency as a whole, but this is not a point that can have accurate speculation as of the moment, but should still be considered.
2. Pros of investing in bitcoin
Two primary factors make Bitcoin an attractive investment to a large number of individuals and institutions. The first is its potential for high returns. The cryptocurrency has, over time, enjoyed an increasingly volatile and upward trend in terms of value. This has led to a higher than average rate of return for investors. High returns are always the primary goal for any investor and Bitcoin provides just that. The other is the increasing acceptance and adoption. This is evident with it being stored in the future, spent at various Bitcoin merchants, and being held as an investment. This string of adoption and usage will only continue, which will lead to the increase of its value in the long term. This mentality has and will draw in investors. This aspect will culminate in its acceptance as a legitimate store of value, its transfer resulting in transferring of money, and the use as a hedge against currency-related fluctuations. One of the toughest aspects of investment is finding a good way to diversify and make your money work for you without your constant attention. Diversification aims to smooth out unsystematic risk events in a portfolio, essentially allocating your wealth in a way which will lessen the blow of any one type of risk. Bitcoin’s non-correlating nature to other markets has led it to act as a great tool for diversification. This can be seen in a study by the Brattle group which shows that adding Bitcoin to a portfolio of global stocks and bonds can actually enhance the expected return per unit of risk. With Bitcoin’s integration into the global capital markets, it has become easier to allocate a portion of your investment wealth into Bitcoin. Said allocation will also require less frequent monitoring due to the larger amount of ways to invest in Bitcoin in the form of more traditional financial products.
2.1. Potential for high returns
In 2017, the price of Bitcoin skyrocketed. In December, it reached an all-time high of $17,900 per coin. The potential high returns on your investment might just be sliced short due to the high volatility in its price. It’s great when prices are rising, but when on a downturn, some people who have invested may get scared and sell their investment at a lower price than what they got it for. High volatility is something that makes the prospect of high returns on an investment possible, but it also makes the potential for high losses likely. With Bitcoin now being a decade old, there has been no other asset that has increased in value at such a substantial rate. It does have the potential to take you to the edge of glory or the depths of hell, financially speaking of course. There are multiple accounts of people investing in Bitcoin in its early years and becoming multimillionaires over the years. This is perhaps the number one motivator for people wanting to invest in Bitcoin. If you do decide to invest, one piece of advice is to only invest what you can afford to lose. And if you still make a profit, keep reinvesting the profit until it accumulates into a substantial amount. Definitely do not take out loans to invest in Bitcoin. The potential for high returns might make you rich, but there is also a chance of making you poor. These loans will have to be paid back, regardless of the potentially high returns on investment.
2.2. Increasing acceptance and adoption
Microsoft has been accepting Bitcoin for use in its online stores since December 2014. In case of this happening, Bitcoin has been seen as a digital commodity rather than a currency by many people in the US. It is clear that Japan has recently passed laws to accept Bitcoin as a legal tender. Companies such as AT&T and Overstock and many others currently accept Bitcoin. Using a digital currency is more attractive as doing so saves the corporation 2-3% on each transaction, allows for infinite transfer of funds between countries, and doesn’t reveal any customer’s personal information. This will only increase over time, especially for first-tier institutions. Global acceptance of Bitcoin: there are 1.2 billion people with access to the internet or mobile phones who don’t currently have access to a traditional exchange. These people are cut off from banking services or may not have documentation to get these services. A cryptocurrency will be the answer to these people, and it will have global acceptance with a quicker and easier transaction-based method. This is a huge positive for Bitcoin and it will continue to rise in value and increase global acceptance. It is already accepted as a payment method in many countries and is approximately equivalent to PayPal in terms of the number of people it reaches. Bitcoin has great potential in terms of global acceptance and investment in it now will result in a great ROI. It would be even more financially beneficial to invest in a Bitcoin mining company such as Bitfury or to purchase shares in such a company. In essence, an increasingly global acceptance of Bitcoin will net a good result for investment in the currency itself or by the method of mining. This is the most opportunistic time now to do so, especially for a large corporate investment due to the competing market and slight turmoil of the currency itself.
2.3. Diversification of investment portfolio
The demand for investment crosses different societies around the world and economic situations, which are influenced by different factors and assets that contribute to the ultimate goal of preserving wealth. Due to these factors, investments do not always move in the same direction. For example, when stocks are performing poorly, commodities have the tendency to go in the opposite direction, and when the currency takes a beating, the residents of some countries have a tendency to buy into a stable foreign currency. If bitcoin continues its stable increase in value and stability, holding assets in the bitcoin form can actually provide some security, as opposed to holding another currency to preserve wealth. These are all ways to diversify, and bitcoin has the potential to make an impact if it’s around for the long run.
Investors often claim that diversification is the key when it comes to successful investing, and that means diverging your investments into uncorrelated asset classes and allocation. The investment opportunity is small if the investment in question can only be implemented in a restricted scope of investment. Bitcoin, unlike any other investment, due to its global nature, can be implemented in investment strategies in the most developed to the least developed countries. In today’s global economy, diversifying across borders becomes increasingly important, and bitcoin can assist with that.
3. Cons of investing in bitcoin
Another consideration we can take is the possibility of a hard fork in the cryptocurrency. This is a situation where a change to the protocol is so radical that it effectively creates an entirely separate cryptocurrency. Hard forks are highly likely in Bitcoin because the protocol and governance mechanism are not set in stone, and any proposal for change by stakeholders or developers is open to interpretation. A split in the currency would cause massive losses for holders in terms of purchasing power, especially if the split is tied to an unsolved issue like the collapse of Mt. Gox.
A significant problem for Bitcoin as it seeks to be taken seriously as a currency is that it is seen as a way to evade taxes, capital controls, and so on. This is tied in with its link to illicit transactions as it presents a method for these activities to be undetected, which brings us to how the cryptocurrency would perform in facing governmental and law enforcement interventions.
The primary disadvantage of investing in Bitcoin is its volatility. Over the past year, it has demonstrated a daily price movement of greater than 5%, compared to the daily average movement of the US dollar of about 1%. This means that it is difficult to have confidence in Bitcoin as a unit of account or a store of value. It also poses a greater risk of a change in purchasing power for Bitcoin holders, which would likely translate to changes in real wages.
3.1. Volatility and risk
Bitcoin is known for its rapid and frequent price movements. A lack of stability has prevented many from both using bitcoin as a currency and holding it as an asset. If prices are too volatile, it becomes difficult to price goods and services. For example, if the cost of a bottle of coke was 2 mBTC, the price of the coke relative to an alternative currency such as dollars or pounds could fluctuate wildly in a very short space of time. Suppose at the start of the day you purchased 2 mBTC and the price of bitcoin doubled. You would have essentially paid $5 for the coke. If the price of bitcoin then halved, you would have paid $10. In such a short space of time you would have had $5 and 2 mBTC using the unstable price of bitcoin, but the vendor would have the same 2 mBTC. The relative value of bitcoin has changed making price, one of the most basic valuations of a good, very hard to express. This is bad for both the vendor and you. Similarly, wages paid in bitcoin are a great way for people to work in exotic locations without necessarily having a bank account, however very few are going to want to price their hourly wage in a currency which can increase or decrease in value by 25% in a single month.
3.2. Regulatory challenges
The legality of Bitcoin has commonly been a concern, especially due to the illegal activities often associated with it (Sullivan, 2015). In terms of investment, a major concern about regulatory challenges is the legality for use in investment markets. Fisher and Lowry’s (2012) findings that investors are less likely to hold items that are illegal in the United States are relevant. This suggests that if Bitcoin is deemed illegal to hold in investment markets, investors are unlikely to continue holding the asset. This would have a large negative impact on the supply and demand for Bitcoin, and therefore its price. Although it has been suggested that Bitcoin can be regulated through its trade in investment markets (Cocco, Marchiori, and Santeramo, 2015), this may prove too difficult due to Bitcoin being traded across multiple currencies in decentralized markets. Another assumption is that illegalizing Bitcoin materializes the risk of government enforced shutdown of currency exchanges to enforce its ineligibility in investment markets, which would also greatly reduce demand for Bitcoin with a similar effect on its price. In the event that Bitcoin is illegalized for use in investment markets, or for any other reason, this would certainly have a very negative effect on the price of Bitcoin due to reduction in demand. Katsiampa (2017) suggested that Bitcoin serves as a hedge against events in local currency markets, and provided evidence suggesting an increase in the price of Bitcoin during the Eurozone crisis, where people sought to protect their assets with an alternative currency. If we consider that Bitcoin price is highly correlated with events in local currency events in various different countries (Ciaian, Rajcaniova, and Kancs, 2016), any event that reduces demand for Bitcoin in a specific currency market could negatively impact Bitcoin price. Overall, the prospect of any change to the legality of Bitcoin is a concern for anyone currently holding the asset and an increased risk for potential investors.
3.3. Lack of intrinsic value
The usual argument given by a Bitcoin enthusiast is a straw man. A classic case of a logical fallacy, a straw man argument involves taking the opposing argument and distorting it or misrepresenting it in order to make it easy to knock down. Buffet said that Bitcoin had no value, to which many argued that it does, in the form of its utility as a medium of exchange. This is not what Buffet said. Value as a medium of exchange is not intrinsic value. While it is true that certain types of intrinsic value, like gold, can stem from it being a medium of exchange, no rational person would consider a medium of exchange with a wildly fluctuating price due to speculation and no legal tender a valuable one.
As aforementioned at the beginning of this essay, intrinsic value is the real value of a physical object or asset. It is present in an asset that can be held in one’s hands and consumed in some way because of the nature of the product. Intrinsic value is important in the concept of investment in an asset as it inherently helps to determine a prudent price to pay for the asset. If an asset does not have proven intrinsic value, it should not be regarded as an investment. That is the message that Warren Buffet is trying to get across. While some may consider Bitcoin an investment, it is actually a speculative bet on a future price that will not pay off in the end.
3.4. Potential for scams and fraud
As bitcoin is still relatively new, and the availability to make large profits without being caught has led to numerous incidents of fraud and scams. Having no central authority to control the currency, it is understandable that bitcoin is the target of fraud and scams. When comparing the potential losses due to fraud in traditional currency systems, it is clear that bitcoin is less secure than traditional currency. According to Europe and the USA, “bitcoin is not safe and has lots of problems with theft and fraud” in response to an academic paper. The paper has pointed out that key security for bitcoin is achieved through having ownership of a particular piece of bitcoin and user access to it, but this makes users much more susceptible to theft due to user error. There is no insurance and little chance of restitution to the bitcoin industry, unlike traditional payment systems. What makes matters worse is that theft of bitcoin is hard to prosecute. This is due to bitcoin being done by directly sending to another person, and once it is sent there are no charge-backs. When spending bitcoin, it is also evident that the transaction is irreversible. This makes tracing very difficult and often a foregone cause; most victims do not get back their stolen bitcoin. This, paired with the mixing and tumbling services offered in the deep web, makes stolen bitcoin very hard to trace or recover. An excellent example to illustrate this is the MT.Gox scandal. Mt.Gox was at one point the leading bitcoin exchange in the world, but in early 2014 it filed for bankruptcy claiming that 750,000 of its customers’ bitcoins and 100,000 of its own had been stolen. At the time, this amount totaled to 7% of all bitcoins in circulation. While it is still unclear what exactly happened, the amount of bitcoins stolen and the irreversibility of most bitcoin transactions highlight the huge security problem of fraud in the bitcoin industry.
4. Conclusion
The price of Bitcoin can be speculated to be overvalued and a bubble that may burst at any moment. Any investment in Bitcoin should be done carefully and with a clear plan to manage the risk on the investment. It is extremely risky due to its infancy and should be treated like you are investing in an early stage company. Bitcoin has the potential to succeed and replace the fiat currency system. But like any early stage investment, the risk of success is accompanied by a higher risk of failure. The failure of Bitcoin would result in a complete loss of investment. Another way to estimate the long-term value of Bitcoin is to compare it to an estimate what sort of market penetration it will achieve in its target markets. Alternatively, one can calculate how much revenue will be required for the market cap of Bitcoin to match the money supply of a specific country. If it is assumed that Bitcoin will grow to replace the money supply of an individual country, then its implied price can be calculated. Step 2 could be modified to place more/less weight on different sectors of the target market, and thus more accurately mimic Bitcoin’s “fundamental value”. A more detailed version can be found in the self-published paper here.
4.1. Factors to consider before investing in bitcoin
As an investment, Bitcoin can be a bit confusing. Overall, there are a number of variables that can contribute to extreme price fluctuation, and thus potential gain or loss, albeit the recent influx of capital and interest into the market. Inflation rates, political instability, and changes in laws that regulate the currency can all send the price skyrocketing (take the recent events in Greece involving the potential Bitcoin extortion as an example). As well, the movement of Bitcoin is still relatively small if you compare it to other assets, meaning it can be a tad illiquid (but the situation is improving). Finally, decision-making markets will have a strong effect on the currency’s movement. While this can be said for any asset, the extreme volatility of Bitcoin requires investors to take extra care when looking at the currency’s movement. The decision to spend or save a current account balance is of course affected by the interest rate, however, the decision between cash and other assets is partially determined by the expected return from said assets. Given that Bitcoin is still on the cusp of today’s modern investment universe, features prominently in new and developing markets, and is not yet regulated in many countries, the anticipation and actions of speculators can have a huge impact on the currency.
4.2. Final thoughts on investing in bitcoin
Final thoughts on investing in bitcoin. After considering the above leading industry experts and market indicators, attempting to time the market on an undervalued asset while the broader global economic backdrop is immensely fragile would appear illogical. More investors are listening and subscribing to the theory that the next 12-24 months will be a very unique window of opportunity to buy undervalued assets which could potentially serve as very lucrative investments in the years following what many believe will be a period of reflation for global economies. Some investors may have to accept the strong possibility that buying bitcoin at its current price may not be as attractive an entry point compared to measuring potential future purchasing power of depreciating global currencies. While this may be true, there are very few investments today that can provide the potential earning opportunities bitcoin may provide, and many retail investors who were late to the party in previous precious metal bull markets will not want to miss their chance to own a high value asset that has the potential to significantly appreciate in value. For the reasons stated in the above report, many can conclude that bitcoin is an investment worth making. With overall future appeal and the uncertain global economic future, bitcoin has the potential to alleviate the financial concerns of many. Plan ahead, make modest investments over time and aim to allocate a percentage of investment that you would have otherwise allocated towards the purchase of gold and/or silver.
