Bitcoin Vs Stocks: Similarities And Differences

Bitcoin is a highly debated topic, with some believing it is a good investment, while others warn of its volatility and lack of regulation. It is important to understand the potential benefits and risks of investing in Bitcoin to make an informed decision. Bitcoin is a decentralised digital currency with no central authority or intermediary, and its value is highly volatile. It has had eye-popping returns, but it is also possible to lose all your money. It is crucial to treat it as a risky investment and only invest what you can afford to lose.

Bitcoin's volatility

Bitcoin is considered a volatile investment asset, with daily fluctuations of 5% and occasional double-digit price moves. In May 2021, its price fell by nearly 30%, and it saw a decline of over 60% from November 2021 to May 2022. However, it has typically rallied after these drops, and its volatility is generally understood to be decreasing as the market matures.

While Bitcoin is a volatile asset, it is less volatile than some prominent individual securities. For example, over the last two years, Bitcoin has been less volatile than Netflix (NFLX) stock.

In summary, Bitcoin's volatility is a key consideration for investors, and while it is generally decreasing, it remains a highly volatile asset when compared to traditional securities and currencies.

Liquidity and inflation risk

Liquidity and inflation are two key considerations when weighing up the risks of investing in Bitcoin or stocks.

Liquidity Risk

Liquidity refers to how easily an asset can be bought or sold and converted into cash. Bitcoin and other cryptocurrencies are traded 24 hours a day around the world, but they are less liquid than other asset classes. This is because transacting in Bitcoin can come with extra costs and time delays.

The bid-ask spread is a popular measure of liquidity. This is the difference between the highest price a buyer is willing to pay for an asset, and the lowest price a seller is willing to accept. A low or narrow bid-ask spread is said to be tight and tends to reflect a more liquid market.

Market liquidity risk refers to the inability to easily exit a position. For example, an investor may own real estate, but due to bad market conditions, they can only sell it immediately at a heavily discounted price.

Inflation Risk

Inflation is an economy-wide, sustained trend of increasing prices from one year to the next. It is generally characterized by currencies losing value over time and an increase in the price of consumer goods.

Inflation affects any product or service, and it effectively makes money less valuable. It reduces a consumer's purchasing power, makes savings less valuable and delays retirement.

Inflation can be caused by an increase in the money supply relative to the level of productive output in the economy, or by an increase in the production costs of goods and services.

Inflation is monitored by central banks, which can adjust their monetary policy to combat rising inflation by making it more expensive to borrow money.

Bitcoin and Inflation

Bitcoin is often touted as a hedge against inflation due to its fixed supply of 21 million coins. This restricted supply gives Bitcoin an advantage over fiat currencies, which can be printed at will by central bankers.

During the COVID-19 pandemic, many countries printed more money to provide stimulus packages for their citizens, driving the value of money down. As a result, the value of assets with a limited supply, such as Bitcoin, rose.

However, Bitcoin is technically an inflationary currency. This is because it was designed to mimic the stable inflation rate of gold. While Bitcoin's purchasing power increases over time, deflation refers specifically to a decrease in the money supply.

Once the maximum number of Bitcoins has been reached, projected to occur in 2140, Bitcoin will become disinflationary, with a constant monetary base and an unchanging supply.

Opportunities and threats

Opportunities

Bitcoin presents several investment opportunities for people who believe in it. Some of these opportunities are more complex than others. Here are some common ways to benefit from investing in this digital currency:

• Bitcoin Mining: This involves solving complex mathematical problems. Whenever a Bitcoin miner solves a mathematical problem correctly, a new node appears in the currency software. However, specialised skills and software are required to mine bitcoins.
• Bitcoin Trading: The internet has many crypto exchanges where Bitcoin can be purchased and sold for profit. All that is needed is to identify a reputable cryptocurrency exchange and then link it with a bank account. Once that’s done, use the fiat money in your bank account to buy Bitcoin through the crypto exchange. After buying bitcoins, they can be sent to a digital wallet to either hold or sell at the right time.
• Purchasing Bitcoin Face-to-Face: This approach can be dangerous as it requires a lot of cash to purchase Bitcoin. Therefore, take precautions when transacting face-to-face with a stranger.

In addition to these Bitcoin investment opportunities, it is possible to participate in activities that involve this virtual currency. For instance, stores can start accepting Bitcoin payments, or investors can put money into a Bitcoin-based company.

Threats

Like any other investment, buying or trading this virtual currency is not without risk. Here are the primary Bitcoin investment risks:

• Volatility: Bitcoin is a volatile digital asset because it endures incredible plummets and spikes in value. That means investors can lose all their money within hours.
• Identity Crisis: Bitcoin serves as both a currency and a commodity. That means the government can tax Bitcoin like any other commodity. But because it’s decentralised, taxing it becomes challenging. And being a new phenomenon means nobody knows how its future will turn out.
• Inadequate Regulation: No government or central bank regulates Bitcoin, and this explains its high volatility. If investors lose their Bitcoin investment, they have no place to file a claim or complaint. Essentially, their money is lost forever. What’s more, some people have used Bitcoin for illegal activities.
• Security: Cryptocurrency exchanges are vulnerable to being hacked and becoming targets of other criminal activity. Security breaches have led to sizable losses for investors who have had their digital currencies stolen.
• Storage: Safely storing cryptocurrencies is more difficult than owning stocks or bonds. Many people don't like to keep their digital assets on exchanges due to the risks of allowing any company to control access to their assets. Some cryptocurrency owners prefer offline "cold storage" options such as hardware wallets, but cold storage comes with the risk of losing private keys.

Bitcoin's decentralisation

Decentralization is a key feature of Bitcoin. In blockchain, the technology underpinning Bitcoin, decentralization refers to the transfer of control and decision-making from a centralized entity, such as an individual or organization, to a distributed network. In other words, no single entity has control over the network, and each member has an equal say in how it is run.

Decentralization is not a new concept and is often considered when building technology solutions. However, it is particularly relevant to blockchain technologies and Bitcoin due to the improved stability and service levels it can provide.

Provides a Trustless Environment

In a decentralized blockchain network like Bitcoin, no one has to know or trust anyone else. Each member has an identical copy of the data in the form of a distributed ledger. If a member's ledger is altered or corrupted, it will be rejected by the majority of the members. This makes it very difficult for a single entity to exert control or authority over the network.

Improves Data Reconciliation

Decentralization can help improve data reconciliation between companies and their partners. In a decentralized system, all entities have access to a real-time, shared view of the data, reducing the opportunities for data loss or the introduction of incorrect data.

Reduces Points of Weakness

Decentralization can reduce the reliance on specific actors in a system, minimizing the risk of systemic failures. In a centralized system, there may be a single point of failure, such as the exhaustion of resources or corruption, which can lead to inefficient service or even catastrophic failure.

Optimizes Resource Distribution

By distributing resources across a decentralized network, Bitcoin can help ensure that promised services are provided with better performance and consistency, reducing the likelihood of failures.

Enhances Security

Decentralization can also enhance security. In a decentralized network, there is no single data resource for hackers to infiltrate, making it more difficult for them to compromise the system.

Increases Transparency

Bitcoin's decentralized nature increases transparency, as all transactions are recorded on a public ledger, making it easier to spot illegal activity.

Promotes Innovation

Decentralization allows for the introduction of new features and improvements to the network without relying on a central authority. This enables Bitcoin to adapt and evolve over time to meet the changing needs of its users.

Encourages Adoption

The decentralized nature of Bitcoin has also contributed to its widespread adoption. By removing the need for intermediaries, such as banks or governments, Bitcoin has made it easier and more accessible for people to participate in the network. This has led to a growing community of users and developers who are invested in the success and growth of Bitcoin.

Regulatory considerations

Bitcoin's regulatory landscape is complex and ever-evolving. Its decentralised nature makes it challenging for governments and regulatory bodies to implement clear-cut policies. The regulation of Bitcoin varies across different countries and regions, with some prohibiting its use altogether, while others take a more welcoming approach.

In the United States, for example, the Internal Revenue Service (IRS) treats Bitcoin as property, whereas the Commodity Futures Trading Commission (CFTC) considers it a commodity. This discrepancy in classification highlights the lack of uniform regulatory guidelines for Bitcoin.

The unique characteristics of Bitcoin, such as its global portability and the different types of tokens traded on exchanges, further complicate the regulatory process. Some tokens, like security tokens, fall under the purview of the Securities and Exchange Commission (SEC), while others, like utility tokens, do not, allowing them to circumvent certain regulations.

However, international organisations like the International Monetary Fund (IMF) have advocated for a coordinated global response to Bitcoin regulation. They emphasise the need for a comprehensive and consistent framework that covers all actors and aspects of the cryptocurrency ecosystem.

The regulatory landscape for stocks is more established and uniform compared to that of Bitcoin. In the United States, the SEC is responsible for protecting investors and enforcing the fair and orderly functioning of securities markets.

One example of SEC regulation is Regulation A, which allows companies to offer and sell securities to the public with more limited disclosure requirements, making it a cost-effective way for smaller companies to raise capital. However, investors should be aware that these investments carry risks, including the speculative nature of startups and the potential for illiquidity.

Additionally, the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in 2010, created new regulatory bodies and enacted rules such as the Volcker Rule, which restricts speculative investments by banks.

Key Differences in Regulatory Considerations

The regulatory considerations for investing in Bitcoin versus stocks differ significantly. With Bitcoin, the primary challenge lies in its decentralised nature, lack of uniform global regulations, and the varying classifications by different regulatory bodies. On the other hand, stock market regulations are more established, with organisations like the SEC enforcing rules to protect investors and ensure fair market practices.

However, it's important to note that both types of investments carry inherent risks, and investors should carefully consider these risks before making any investment decisions.

Frequently asked questions