Bitcoins: Worth Your Investment?

Bitcoin is a cryptocurrency with a decentralised blockchain-based digital currency system. It is the most popular cryptocurrency and the largest by market capitalization. Bitcoin's value is placed on its status as the first cryptocurrency and as an alternative to fiat currency. It is also a store of value similar to gold. However, it is incredibly volatile and has experienced significant fluctuations in value.

Bitcoin's future price performance will likely depend on its adoption as a legitimate global currency and its popularity as an inflation hedge and store of value for investors.

This paragraph introduces the topic of whether Bitcoins are a good investment by providing an overview of Bitcoin, its value, and the factors that influence its price.

Bitcoin's volatility

Bitcoin is considered a volatile asset, with daily fluctuations of 5% being ordinary, and occasional double-digit price moves. On 19 May 2021, its price plunged nearly 30%, and it fell over 60% from November 2021 to May 2022.

The volatility of Bitcoin is measured by how much its price fluctuates relative to the average price over a period of time. Volatility is a measure of how much the price of a financial asset varies over time.

The cryptocurrency industry thrives on speculation. Crypto investors bet that Bitcoin's price will go up or down to make profits. This causes a sudden increase or decrease in Bitcoin's price, which leads to volatility.

Bitcoin's one-year realised volatility is also at a historic low. In 2023, Bitcoin's market cap rose while levels of realised volatility fell. This may indicate a growing belief that Bitcoin is maturing.

Historically, low volatility has typically occurred at the end of long bear markets after all the selling has been exhausted and seller energy is low. This is when Bitcoin's price bottoms out and begins to increase.

While Bitcoin is a volatile asset, its volatility is decreasing over time as it matures.

Efficiency as a payment method

Bitcoin is a form of digital currency that uses blockchain technology to support transactions between users on a decentralised network. Blockchain is a digital ledger of transactions managed by a decentralised network of computers. Each Bitcoin is a digital asset that can be stored at a cryptocurrency exchange or in a digital wallet.

One of the primary reasons cryptocurrencies were developed was to be used as anonymous payments. This reason is often lost in the hype by media outlets and the financial sector, which are focused on gains, losses, and price fluctuations. However, the price is not the only thing that matters when it comes to Bitcoin. Its efficiency as a payment method is also an important consideration.

Using Bitcoin as a payment method can offer several advantages over traditional payment methods. Firstly, it provides increased privacy compared to credit card transactions, as transactions don't contain personal information, such as a name or credit card number. While it’s still possible to link a certain person to a certain wallet, Bitcoin transactions are generally more private.

Secondly, Bitcoin transactions are cost-efficient and fast. They can be made anytime, anywhere, reducing the time and potential expense of any transaction. This is especially beneficial for cross-border payments, as they eliminate the need for intermediaries like banks or governments, which can slow down the process and increase costs.

Additionally, Bitcoin transactions are secure. They are authenticated through Bitcoin’s proof-of-work consensus mechanism, which rewards cryptocurrency miners for validating transactions. This independent network of miners decreases the chance for fraud or false information to be recorded, as the majority of miners need to confirm the authenticity of each block of data before it's added to the blockchain.

Lastly, Bitcoin transactions are decentralised, meaning they do not require a trusted third party, such as a bank, to verify them. This feature was designed to disrupt traditional global payment networks and provide an alternative to traditional currencies, which are controlled by central authorities.

However, it is important to note that there are also some disadvantages to using Bitcoin as a payment method. One of the main concerns is the volatility of Bitcoin's value, which can fluctuate significantly from day to day. This can make it difficult for businesses to accept Bitcoin as a form of payment, as the value of the goods or services they provide may not match the value of the Bitcoin at the time of transaction.

Another disadvantage is the lack of consumer protection. Crypto exchanges lack basic consumer protections, like insurance protection from the Securities Investor Protection Corporation (SIPC) and the Federal Deposit Insurance Corporation (FDIC), found in traditional financial products. This means that if something goes wrong, such as losing your private keys or being scammed, there may be no recourse to get your money back.

In conclusion, while Bitcoin offers some advantages as a payment method in terms of privacy, cost-efficiency, speed, security, and decentralisation, it also comes with certain drawbacks, including volatility and lack of consumer protection. Therefore, when considering whether to use Bitcoin as a payment method, it is essential to weigh the benefits against the risks and make an informed decision.

Environmental concerns

Bitcoin and other proof-of-work cryptocurrencies require large amounts of energy—more than is used by some small countries—to perform the work associated with crypto mining. The process of mining is how new bitcoins are created and transactions are approved. Bitcoin miners are the gatekeepers to the blockchain technology, and by approving blocks and adding data to the blockchain, they are rewarded with bitcoins. This reward offsets the costs (computer hardware and power consumption) associated with approving blocks.

Bitcoin's public ledger is decentralized, which means it is not controlled by any single authority. Instead, Bitcoin is constantly updated by a network of computers around the world operated by so-called “miners”. These miners use purpose-built computers to solve complex math puzzles in order to allow transactions to go through – the only way to mint new bitcoins – in exchange for being rewarded a small fraction of the Bitcoins transactioned.

Over the last few years, with the price of Bitcoin reaching new highs (and lows), the attractiveness of mining Bitcoin has led the total energy consumption of the Bitcoin network to grow to epic proportions. According to the Cambridge Bitcoin Electricity Consumption Index, Bitcoin uses an estimated 140 Terawatt-hours (TWh) of electricity annually (0.63% of global electricity use) and about 352 TWh of energy (0.22% of global energy production) at the point of production—more than Pakistan and Ukraine. Other estimates place the figure at 138 TWh, which computes to around 773.61 kilowatt-hours of electricity per transaction, the same amount of power consumed by the average American household over 26 days.

The type of energy used for mining also matters. Most mining facilities are located in regions (primarily in China) that rely on (highly polluting) coal-based facilities or hydroelectricity, which are cheap and little taxed. The Cambridge Center for Alternative Finance estimates coal accounts for 38% of Bitcoin’s miner power.

The environmental impact of Bitcoin is not only about the amount of energy it consumes but also the hardware used and the electronic waste generated. Bitcoin mining is done with specialized (singular purpose) hardware that becomes obsolete roughly every 1.5 years. The Bitcoin network generates approximately 72,500 tons of electronic waste annually.

While some argue that Bitcoin is becoming more environmentally friendly as it is increasingly run on renewable sources of energy, others argue that, unless there is excess zero-carbon power capacity, even the skimming of renewable electricity leads to shortages in surrounding grid areas which are generally covered by fossil fuel resources.

Criminal usage

Bitcoin's pseudo-anonymity has made it a popular medium for criminal transactions. According to a 2019 study, approximately one-quarter of bitcoin users are involved in illegal activity, with around $76 billion of illegal activity per year involving bitcoin. This amounts to 46% of bitcoin transactions, which is close to the scale of the US and European markets for illegal drugs.

Bitcoin's use in illegal activity has been a concern for government officials, who worry that cryptocurrencies enable dark web purchases, money laundering, and other illegal activity. In 2021, the US Secretary of the Treasury, Janet Yellen, stated that cryptocurrencies are used "mainly for illicit financing".

However, it is important to note that the public nature of the blockchain, the digital ledger that records all bitcoin transactions, can also make it easier for law enforcement to detect illegal activity. The more mainstream and speculative interest in bitcoin also decreases the proportion of illegal activity.

Criminals are becoming more sophisticated in their use of cryptocurrencies to launder money, with the use of privacy wallets, which make it harder to track transactions, on the rise. While the total volume of illicit activity in cryptocurrencies has grown in absolute terms, it accounts for less than 1% of all digital transactions, down from 35% in 2012.

Underlying value

Bitcoin is a digital currency built on blockchain technology. Blockchain enables secure peer-to-peer digital payments that do not require a third party, like a bank, to verify them. Bitcoin is the most popular cryptocurrency and the largest by market capitalization.

Bitcoin was created in 2008 and its original intent was to disrupt traditional global payment networks by enabling peer-to-peer digital payments that do not require a trusted third party, such as a financial institution.

Bitcoin has value because it can function as a store of value and a unit of exchange. It also demonstrates six key attributes that enable its use in an economy:

• Scarcity: It must not be a widely available resource.
• Divisibility: Currency should have many denominations.
• Acceptability: The intended audience must accept it.
• Portability: It must be able to be carried around and exchanged.
• Durability: Currency should have a long lifespan.
• Uniformity: All denominations should be identical and not easily reproducible.

Bitcoin's primary source of value lies in its restricted supply and increasing demand. The more demand there is for Bitcoin, the higher its price will be.

However, it is important to note that Bitcoin tends to be incredibly volatile compared to other investment options, experiencing significant run-ups in value followed by quick decreases. This volatility is driven by supply, demand, fear, and greed.

While Bitcoin has some advantages, there are also disadvantages to investing in it. It is not backed by any physical commodity, and its value is derived solely from the relationship between supply and demand and the trust that people have in it. This makes the value of Bitcoin highly uncertain, and it has exhibited significant price fluctuations.

Additionally, Bitcoin is not regulated like traditional stocks and does not have the same underlying fundamentals to support its valuations. This has led to extreme volatility and the potential for price manipulation by unknown market participants.

Frequently asked questions