In a wild year in the markets, the riskiest asset is one of the hottest bitcoin. Bitcoin may well be a substitute for gold. After a historic climb and crash three years ago bitcoin is at it again like last time a surge of investor enthusiasm is driving it to all-time highs and bitcoin bulls say this is only the beginning.
They see bitcoin as a revolution in financial systems. They have been pushing this for about 11 years. They are finally getting people to listen to them but many bears watching bitcoin warn that the asset is too volatile for average investors and that it’s purely speculative.
The Unique Bitcoin encryption
The way bitcoin works is key to understanding why it’s so popular, unlike other investments. The cryptocurrency isn’t tied to physical assets or the US dollar. The purpose of bitcoin is just to allow two people anywhere to exchange value directly. What that means is that there is no one central party controlling this network. There is no government, there is no central bank that could shut this down or arbitrarily raise or lower the value.
At its core bitcoin is purely a software. It runs on a network of interlinked but independent computers. They form a ledger of transactions between people across the world instead of that ledger being controlled by a single master computer or a single party and the information is copied on every computer that is part of the network. This is the cryptocurrency blockchain. It can be reviewed by anybody, it can be seen by anybody. what that does is it prevents counterfeiting. It prevents double-spending. It makes bitcoin a secure currency.
Every time someone makes a transaction a unique encrypted signature is added to the ledger for verification. Once a transaction is confirmed and completed that signature cannot be changed, it cannot be altered. Essentially it means you can’t counterfeit a bitcoin. That’s what keeps the network honest.
Many bitcoin bulls argue that the network is unhackable but that’s not necessarily true. The issue is that to hack it you would have to take over the network and to take over the network you would need your own network of computers running 24/7 and to do that would cost billions of dollars. you can do it but is it worth it? While anyone can download and run the program to become part of the blockchain network, no one has the ability to make universal changes.
The Mining Process
Bitcoins not yet available to the public are created through a process known as mining. Miners use powerful computers to solve complex math problems to process bitcoin transactions. This process unlocks new digital coins but these coins aren’t limitless. Bitcoin’s founding code was embedded with the condition that there would always be a finite number of coins available. This scarcity is what gives bitcoin value.
Right now about 18.5 million of the 21 million maximum bitcoins have already been mined but the way the network is set up, every four years the reward per batch of transactions confirmed per mining puzzle solved gets cut in half so the 21st millionth bitcoin will not be created until sometime around the year 2140 and while the number of available bitcoins is growing the demand for them is growing faster. This demand has a lot to do with how individual investors are trading. Bitcoin is becoming easier to buy on apps like Paypal, Square, and Robinhood which is drawing more novice retail investors who are looking for quick returns while trading at home. So far this year there have been more than 38 million small bitcoin transfer trades that are less than a thousand dollars. This is up from about 20 million in larger institutional. Investors are piling in as well.
Why do people take a high-value risk with bitcoin
What’s really going to be interesting over the next couple of years to watch is the degree to which central banks start to digitize their own currencies. As financial systems become more digital it’s leading to bitcoin becoming more mainstream but the digital currency’s resurgence is also closely tied to the state of global finance. When the pandemic hit, you had the central banks respond the way they did, they pushed down interest rates and lowered the value of their currencies which made bitcoin essentially a hedge against the dollar. Bitcoin proponents say the value of bitcoin should be going up.
What we’ve seen in the last couple of months is that people are interested in assets that have high returns. They are willing to take risks and one of the highest returned highest risk assets anywhere in the capital market is bitcoin. This potential for big profits is driving a frenzy of momentum trading and for many investors, these bets are paying off.
The Maturity of the Bitcoin
One reason investing in bitcoin is so risky is how small the market is. The total value of bitcoin and circulation right now is around 420 billion dollars. The value of apple stock, just apple is about 2 trillion dollars. The value of the financial market for gold is worth 12 trillion dollars so bitcoin is still very small, doesn’t take a lot of people to come in and push the value up.
The smallness of the market contributes to these sort of explosive price moves that we’ve seen and because the cryptocurrency is decentralized, there is no insurance backing it. There are no backstops to it, it could go down to zero tomorrow and there would be nothing to stop it. There are no circuit breakers, there are no closing bills in bitcoin trading until the market matures. Experts warn that the price of bitcoin will continue to see volatile swings. So is it risky?
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