Bitcoin's Promise: Have The Rewards Outweighed The Risks?

Bitcoin investments have paid off for some investors, but the cryptocurrency's extreme volatility means that it's a risky asset. Bitcoin's value has risen dramatically over the years, but buyers' fortunes have varied depending on the timing of their investment. For example, those who bought in 2017 when Bitcoin's price was racing towards $20,000 had to wait until December 2020 to recover their losses.

Bitcoin was created in 2009 as a decentralised form of digital cash that eliminates the need for traditional intermediaries like banks and governments. It can be used as a currency or an investment.

As with any investment, there are pros and cons to investing in Bitcoin. On the one hand, it offers cost-efficient transactions, privacy, decentralisation, and growth potential. On the other hand, it is subject to price volatility, hacking concerns, and is not protected by the Securities Investor Protection Corporation.

Before investing in Bitcoin, it is recommended to focus on areas such as paying off debt, maximising 401k match, contributing to a Roth IRA, creating an emergency fund, and automating personal finances.

Bitcoin's performance against other investment options

Bitcoin's value rests mostly on its status as the first cryptocurrency and as an alternative to fiat currency. It is a blockchain-based, decentralized digital currency powered by a network of users that allows financial transactions without relying on a central authority or intermediary. Bitcoin's network operates on a proof-of-work verification system.

Ethereum, the second-largest cryptocurrency by market capitalization, is a blockchain platform created to support smart contracts and secure financial transactions. Its native cryptocurrency, Ether, offers more utilitarian value through its ecosystem of decentralized apps. Ethereum's network operates on a less energy-intensive proof-of-stake consensus verification system.

While both Bitcoin and Ethereum have been exceptional long-term investments, they are prone to extreme price volatility. In the past year, Bitcoin prices are up 157% compared to a 100% gain for Ether. If you look back over the past five years, Bitcoin prices have risen about 740%, while Ether prices are up about 1,330%.

Other alternative coins, or altcoins, have also seen meteoric rises. For example, Shiba Inu Coin (SHIB) has gained an astounding 380,000% in a year. However, altcoins carry several unique risks. There are more than 10,000 cryptocurrencies, which means the probability of choosing one of the few that will have staying power is low.

Bitcoin's biggest challenge in the future may be scalability, given its energy-intensive proof-of-work consensus mechanism. Ethereum's biggest challenge may be fending off competition from so-called Ethereum killer blockchains that often have faster transaction speeds and lower gas fees, such as Solana (SOL) and Avalanche (AVAX).

It is difficult to predict if Bitcoin or Ether will be the better long-term investment moving forward, but if history is any indication, investors can't go wrong with either one.

Bitcoin's volatility and risk

Bitcoin is a highly volatile asset, and its value can change significantly over time. This volatility is driven by several factors, including regulatory changes, market sentiment, and the actions of large investors or "crypto whales". While volatility can create value, it also poses risks for investors.

Uncertainty and volatility are distinct concepts in investment risk analysis. Uncertainty refers to the likelihood of an investment's value changing, while volatility measures the degree of those changes. Professional investors tend to focus more on protecting their investments against volatility rather than uncertainty.

• Price Volatility: Bitcoin's price has experienced dramatic fluctuations since its inception. It is essential to recognize that speculating on price volatility is generally not a prudent strategy.
• Regulatory Changes: Changes in laws and regulations can significantly impact Bitcoin's value. For example, decisions regarding cryptocurrency ETFs have influenced market confidence and triggered price movements.
• Market Sentiment: Market sentiment and investor behaviour play a crucial role in Bitcoin's volatility. The hype, FOMO (Fear of Missing Out), and speculative nature of the market can lead to frenzied buying or selling, amplifying price swings.
• Concentration of Wealth: A small number of large investors or "crypto whales" hold a significant portion of Bitcoin. Their actions can create massive price swings by buying or selling large quantities.
• Limited Liquidity: The Bitcoin market has lower liquidity compared to traditional financial markets, which can contribute to higher volatility.
• Technological Development: Bitcoin and blockchain technology are still evolving. The success of Bitcoin depends on widespread adoption, improved infrastructure, and the discovery of new use cases.
• Infrastructure and Adoption: Improving cryptocurrency transaction speeds, reducing fees, and increasing adoption by vendors and users are crucial factors in stabilizing Bitcoin's volatility.

To manage the risks associated with Bitcoin's volatility, investors can employ strategies such as hedging, diversification, and long-term investing. It is essential to remember that investing in Bitcoin carries risks, and one should carefully consider their risk tolerance and conduct thorough research before investing.

Bitcoin's advantages over traditional currencies

Bitcoin has several advantages over traditional currencies. Here are some of them:

Decentralisation and Independence

Bitcoin is a decentralised digital currency, meaning no central authority, government, or financial institution controls it. This gives Bitcoin its unique resilience and enables it to operate independently of any specific country or regulatory body. It is a peer-to-peer payment system that depends on the network's participants' aggregate computational power. This means that no one can control the transactions you send or receive with your money. In contrast, traditional currencies are issued and controlled by central authorities, such as governments and central banks, which can manipulate their value.

Low Transaction Fees and Speed

Bitcoin transactions tend to have lower fees compared to traditional payment methods that involve intermediaries such as banks. This is because Bitcoin transactions are direct, peer-to-peer transactions that cut out the middleman. Additionally, Bitcoin transactions are typically faster and can be completed within minutes, regardless of the distance between the sender and the recipient. This is due to the 24-hour operation of the Bitcoin system. In contrast, a nationwide transaction in a regular banking system would take two to three working days to complete, with significant transaction costs.

International Accessibility

As an internet-based currency, Bitcoin can be sent and received by anyone with an internet connection, regardless of geographical location or financial infrastructure. This makes it an attractive option for cross-border payments and international transfers. Traditional currencies, on the other hand, can be subject to high fees and slow processing times for international transactions due to the involvement of multiple intermediaries and foreign exchange fees.

Security and Privacy

Bitcoin transactions are highly secure, using a combination of cryptography and economics, which is difficult for hackers and scammers to breach. Additionally, Bitcoin transactions are pseudonymous, meaning that while the transaction details are public, the identities of the parties involved are not readily apparent. This provides a layer of privacy for users. In contrast, traditional currencies are susceptible to counterfeiting and financial fraud, and personal information is often required for transactions, making it difficult to conduct completely anonymous transactions.

Protection Against Inflation

Bitcoin has a maximum limit of 21 million coins that can ever be produced, ensuring scarcity and potentially driving up its value over time. This makes Bitcoin a deflationary asset, protecting it against inflation caused by an excess of currency in the market. Traditional currencies, on the other hand, are susceptible to inflation as governments have the power to print more money, leading to devaluation and a loss of purchasing power over time.

How to buy and store Bitcoin

If you're looking to buy Bitcoin, you'll need to select an appropriate service or venue, connect with a payment method, place an order, and ensure stable storage for your purchased cryptocurrency.

Choosing a service or venue

You can purchase Bitcoin from cryptocurrency exchanges, such as Gemini, Kraken, Coinbase, Crypto.com, and Binance. These exchanges carry a variety of different fees and consumer protections, so be sure to do your research before choosing.

Alternatively, you can use a traditional stockbroker like Robinhood, Webull, TradeStation, or Fidelity.

Connecting with a payment method

You can connect your bank account directly to the exchange, or link a debit or credit card. Although you can use a credit card to purchase Bitcoin, be aware that cryptocurrency price volatility could inflate the overall cost of your purchase when combined with a credit card's interest charges.

Placing an order

Different exchanges will have different processes for placing an order. Some will have a simple "buy" and "sell" button, while others will have a variety of order types, such as market orders, stop orders, and limit orders.

Storing your Bitcoin

Bitcoin can be stored in two kinds of digital wallets: a hot wallet or a cold wallet.

A hot wallet is connected to the internet and is typically provided by the exchange where you purchased your Bitcoin. However, many users prefer to transfer and store their Bitcoin with a third-party hot wallet provider.

A cold wallet is not connected to the internet and is considered much more secure than a hot wallet. It is a small, encrypted portable device, similar to a thumb drive, that allows you to download and carry your Bitcoin. Cold wallets can cost less than $100 and often come with additional security measures, such as a PIN or a key phrase.

When creating accounts for your digital wallets and currency exchange, be sure to use a strong password and two-factor authentication.

Bitcoin's future outlook

• Volatility and Risk: Bitcoin's value has experienced breathtaking highs and painful lows. Its volatile nature makes it a risky investment, with the potential for significant gains or losses. Since September 2015, Bitcoin has been nearly five times as volatile as US stocks. This high volatility can dramatically increase the risk profile of an investment portfolio.
• Drawdown Risk: Bitcoin has suffered extreme losses, with drawdowns of 40% or more during at least five periods in the past decade. While Bitcoin has historically generated strong enough returns to offset these losses, it is important to consider the risk of potential future drawdowns.
• Mainstream Adoption: As Bitcoin, Ethereum, and other cryptocurrencies become more mainstream, they are becoming less effective as portfolio diversifiers. Correlations with other major asset classes have been low but steadily trending upwards in recent years, reducing their benefit in a diversified portfolio.
• Regulatory Landscape: The regulatory landscape for cryptocurrencies is still evolving, and changes in government policies or regulations could significantly impact the future of Bitcoin. For example, the approval of spot Bitcoin ETFs by the Securities and Exchange Commission has made it easier for investors to gain exposure to Bitcoin.
• Technological Advancements: The development and adoption of blockchain technology, smart contracts, and decentralized finance (DeFi) solutions could enhance the use cases and value proposition of Bitcoin. However, there are also concerns about the security of cryptocurrency exchanges and the potential for hacks or fraud, which could impact its future outlook.
• Investor Sentiment: Investor sentiment and demand play a crucial role in the value of Bitcoin. As a speculative asset, its price is heavily influenced by market sentiment and news. Positive sentiment and increasing demand from institutional and retail investors could drive up Bitcoin's price, while negative sentiment or reduced demand could lead to declines.
• Limited Supply: Bitcoin has a limited supply of 21 million coins, and its scarcity could support its value in the long term. As the available supply decreases, demand may increase, potentially leading to higher prices.

In conclusion, the future outlook for Bitcoin is uncertain, and it is challenging to predict its long-term trajectory. While some investors see the potential for significant gains, others remain cautious due to its volatility and risk profile. It is essential for investors to carefully consider their risk tolerance, conduct thorough research, and diversify their investments to manage the risks associated with Bitcoin and other cryptocurrencies.

Frequently asked questions