Bitcoin – Fad or the Future?
Bitcoin has been around since late 2008 but it only started making the news in early 2013. It is a crypto-currency and a payment system; its main advantage being that transactions are anonymous and peer-to-peer. Its architecture is set-up in such a way that their creation gets progressively more resource-intensive and total production will be limited to 21 million Bitcoins.
It’s certainly an interesting concept with many advantages but also some important disadvantages. Transactions are effectively anonymous but this anonymity has been known to attract transactions from illegal activities, the best-known example being that of the infamous Silk Road website. This has been a problem with regulators and officials, as they recognise it as a medium for illegal transactions. As a result it may struggle to reach levels where it starts to become a genuine alternative to fiat currencies.
Bitcoin trades continuously on exchanges around the world and is stored electronically in “wallets”. However, having online wallet providers introduces an extra risk factor that cannot be ignored. One such example is the security breach at Mt. Gox in 2011. At the time, Mt. Gox was handling around 70% of all Bitcoin transactions and one day it declared that around 850,000 Bitcoins had been stolen. Soon after, the exchange suspended trading and filed for bankruptcy. There have also been numerous occasions over the past years, where Bitcoins were stolen from exchanges, and It’s this potential security vulnerability that makes many people skeptical when it comes to crypto-currencies.
BTC is now widely used worldwide and it’s the market-leader in crypto-currencies. However, there is a long list of alternate crypto-currencies that are eager to grab market share and challenge Bitcoin’s dominance. It’s probable that once the 21 million Bitcoin ceiling becomes severely limiting, users will turn to other crypto-currencies, effectively increasing the global supply. Most importantly though, Bitcoin has one big drawback: it can only handle a few transactions per second globally. Compared to thousands of transactions per second for credit cards, this looks like a severely limiting constraint. Furthermore, Bitcoin is seeing very high price volatility and this is a severe setback for people who want to use it as a store of value. Having said all that, Bitcoin enjoys cult status among crypto-currency fans and BTC accumulation may always be their ultimate goal, and it’s clear so far that whenever there are times of turmoil, there are decent flows out of alt-coins and into Bitcoin.
We see two risks to Bitcoin: (1) its substitution and/or parallel use by other crypto-currencies, where the transaction limitation outlined above could be the main reason why Bitcoin might be replaced by newer and much more advanced crypto-currencies in the future (2) the resistance by governments and authorities, as crypto-currencies can pose an direct threat to fiat currencies.
In terms of price action, it was a crazy parabolic ride since the start of 2017, with each new price milestone being gobbled up in a total buying frenzy. However, in late 2017 and 2018 crypto-currencies witnessed a major reversal. There will always be serious arguments against all the major reasons why people want to hold cryptos as an investment. However, the unprecedented easing and money/credit creation by all major central banks should theoretically overcome all of the issues. In the medium term, the resulting asset price inflation should be a strong wave that takes cryptos with it, and Bitcoin should see higher prices as a result.