Bitcoin Investment: Phd Perspective On Crypto's Future

Bitcoin is a highly controversial topic, with some believing it to be the future of currency and others believing it to be a scam. With its soaring value and potential for high returns, many investors have been enticed by the promises of Bitcoin. However, its price volatility and the lack of regulation in the market make it a risky investment option.

Bitcoin is a decentralised currency, which means it is not issued or managed by any central authority, such as a government, company or bank. This makes it more resistant to wild inflation and corrupt banks, but also means it is not backed by any meaningful value.

Some believe that Bitcoin's decentralised nature and limited supply make it a good long-term investment. However, others argue that it is too volatile, inefficient and susceptible to illegal activity to be a reliable currency.

Whether or not Bitcoin is a good investment is a complex question and depends on a variety of factors, including an individual's risk tolerance and perspective on the future of humanity.

Bitcoin's volatility

Bitcoin is a volatile asset, and its volatility is one of the major factors that influence whether it is a good investment. Volatility is a measure of how much the price of a financial asset varies over time. The more volatile an asset, the riskier it is to hold. Volatile assets can bring greater profits but also come with the risk of substantial losses.

Bitcoin is considered highly volatile, but it depends on what other cryptocurrencies you compare it to. For instance, Bitcoin's volatility is higher than gold, which averages around 1.2%, and other major currencies, which average between 0.5% and 1.0%. However, Bitcoin is currently less volatile than many popular mega-cap stocks, and in late 2023, there were 92 S&P 500 stocks more volatile than Bitcoin.

While Bitcoin's volatility can be a concern for investors, it also presents opportunities for significant profits. Its volatile nature makes it a risky investment, but it has the potential for high returns, making it a good long-term investment for those who believe in its future as a decentralized currency.

Liquidity and inflation risk

Liquidity refers to the ability to quickly and cost-effectively convert assets into cash. Bitcoin is a highly liquid investment asset that can be easily traded for cash or other assets. It has low fees and high liquidity, making it potentially profitable for short-term investments.

However, Bitcoin and other cryptocurrencies are less liquid than other asset classes. Transacting in Bitcoin or exchanging it for cash can come with extra costs and/or time delays. For example, crypto ATMs are known for their high fees, some charging up to 10% per transaction.

Bitcoin's liquidity is influenced by several factors, including the number of trusted exchanges, the acceptance of Bitcoin in retail, and the availability of crypto debit and credit cards. The more Bitcoin is used as a medium of exchange, the more liquid it becomes.

Bitcoin is not subject to hyperinflation like traditional currencies. It undergoes predictable inflation at a halved rate every four years. The blockchain system is infinite, and there is little need to worry about cryptos losing their value.

The restricted upper limit of 21 million coins gives Bitcoin an advantage against inflation. As a result, during the COVID-19 pandemic, when many countries printed more money, driving the value of fiat money down, the value of Bitcoin increased.

Bitcoin is often considered a hedge against inflation, assuming that fiat money will eventually decrease in value due to central bank money printing. However, recent economic developments have seen Bitcoin performing less as a pure hedge. When news of inflation strikes, the Federal Reserve will likely enact a dual mandate: policy interest rates will go up, and there will be monetary tightening, resulting in a decline in the price of assets, including Bitcoin.

While Bitcoin is generally inflation-resistant, it is not entirely inflation-proof. It is technically an inflationary currency, as its supply will steadily increase until it reaches a hard cap of 21 million coins (projected to happen in 2140). Once this cap is reached, Bitcoin will become disinflationary, with a constant monetary base and an unchanging supply.

Decentralisation and regulation

Bitcoin is a decentralised cryptocurrency, meaning it has no central authority or administrator. Transactions are verified and recorded by nodes in the peer-to-peer bitcoin network, which use cryptography to do so. This is known as mining. Each node maintains a copy of the blockchain, the public distributed ledger that records bitcoin transactions.

The decentralised nature of Bitcoin poses a challenge to regulators, as it is difficult to regulate a distributed network in a centralised fashion. The existing regulatory infrastructure is centralised, which is antithetical to the nature of Bitcoin. However, some regulatory bodies have implemented guidelines for "decentralised virtual currencies" such as Bitcoin. For example, in 2013, the US Financial Crimes Enforcement Network (FinCEN) classified American bitcoin miners who sell their generated bitcoins as money services businesses, making them subject to registration and other legal obligations.

Regulation of Bitcoin is further complicated by its global presence. The legal status of Bitcoin varies from jurisdiction to jurisdiction, and some countries have banned its use. As of November 2021, nine countries had an absolute ban on Bitcoin, while another 42 countries had an implicit ban. However, some countries, such as El Salvador, have adopted Bitcoin as legal tender.

The lack of regulation in the Bitcoin market is one of the factors that makes it a risky investment. Its price volatility is well-documented, and investors need to be aware of the potential for significant losses as well as gains.

Appropriate regulation of Bitcoin is critical to ensuring its global legitimacy. However, this regulation needs to be carefully considered, taking into account the unique nature of Bitcoin and the potential benefits it offers. Banning cryptocurrencies or enacting blunt regulatory instruments will not prevent their adoption but will limit regulators' abilities to steer market activity and address risks.

Monetary policy and fiscal stimulus

Bitcoin is a decentralised, peer-to-peer payment system that does not rely on financial institutions. Its supply is not controlled by governments, monetary authorities, or other third parties. This makes it more resistant to wild inflation and gives it a stable supply.

The impact of monetary policy on Bitcoin has evolved over time. Bitcoin prices used to rise after a Fed tightening, but since 2020, they fall immediately after. This is because Bitcoin prices now respond to monetary news in a similar way to other risky assets. However, the effect of monetary policy shocks on Bitcoin prices is very persistent.

Monetary policy surprises have a greater impact on Bitcoin prices in a bull market. A hypothetical unexpected monetary tightening of 1 basis point of the two-year Treasury yield is associated with a 0.25% drop in the price of Bitcoin on the day of the Federal Open Market Committee (FOMC) meeting. The cumulative effect is much stronger in the following days.

In the context of rising inflation, some studies have concluded that Bitcoin can be a hedge against future inflation, though it may not be a safe haven. Bitcoin may still have some benefits for portfolio diversification.

U.S. fiscal stimulus induces a loosening of interest rates during normal times. The supporting monetary policy stance amplifies the impact of the expansion in public spending on GDP by roughly one-third. This evidence aligns with fiscal policy models featuring deep-habits in consumption.

The adoption of Bitcoin as a major currency would mean governments could not influence the amount of currency in circulation through monetary policy to fuel economic growth. However, governments could still use counter-cyclical fiscal policy to run budget surpluses in Bitcoin during expansionary phases of the economy, allowing them to run deficits during recessionary phases.

Energy consumption and environmental concerns

Bitcoin's energy consumption is a highly debated topic. Bitcoin currently consumes as much energy as a small country, with global electricity usage estimates ranging from 120 to 240 billion kilowatt-hours per year. This range exceeds the total annual electricity usage of many individual countries, such as Argentina or Australia, and is equivalent to 0.4% to 0.9% of annual global electricity usage.

The dominant consensus mechanism used by Bitcoin and other cryptocurrencies is called Proof of Work (PoW), which requires a large amount of computing power and energy-intensive hardware and software to confirm transactions and validate the system. The energy-intensive nature of Bitcoin mining has led to concerns about its environmental impact, particularly regarding greenhouse gas emissions and local impacts on communities near mining facilities.

According to a study published by the journal Earth's Future, Bitcoin's global electricity consumption from 2020 to 2021 exceeded that of some countries, such as Argentina and the Philippines. The intense energy usage results in significant levels of greenhouse gas emissions, with Bitcoin mining processes producing 85.89 MTCO2E from 2020 to 2021. This figure is comparable to 9,665 gallons of gasoline consumed by passenger vehicles or 96,210 pounds of coal burned in a year, as per the U.S. Environmental Protection Agency's calculations.

The White House, in its September 2022 report, "Climate and Energy Implications of Crypto-Assets in the United States," highlighted that Bitcoin requires more energy than all other cryptocurrencies combined. As of 2022, Bitcoin accounted for 60% to 77% of total global crypto-asset electricity use. Additionally, the report estimated that 62% of the electricity used for Bitcoin mining globally in 2022 came from fossil fuels, with coal being the largest single source.

The high energy demands of Bitcoin mining have raised concerns among sustainability advocates, government officials, and business leaders. The intense energy requirements, coupled with the resulting greenhouse gas emissions and significant hardware needs, have drawn criticism. The production and disposal of hardware specifically for Bitcoin mining have also been identified as critical issues, with the short-lived hardware contributing to the growing problem of electronic waste (e-waste).

To address these environmental concerns, some experts have suggested transitioning to more energy-efficient methods, such as the Proof of Stake (PoS) mechanism, which requires significantly less energy and computing power. The Ethereum blockchain network made this shift in September 2022, reducing its energy requirements by more than 99%.

While Bitcoin's energy consumption and environmental impact are significant, it is important to note that the cryptocurrency industry is still evolving, and there may be future innovations that could improve sustainability. Additionally, some efforts to increase the use of renewable energy sources and reduce the negative impacts of Bitcoin mining are already being explored and implemented in certain locations.

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