The Bitcoin Investment Dilemma: Worth The Risk?

Bitcoin is a decentralised digital currency that you can buy, sell and exchange directly, without an intermediary like a bank. It was introduced to the public in 2009 by an anonymous developer or group of developers using the name Satoshi Nakamoto. It has since become the most well-known and largest cryptocurrency in the world. Its popularity has inspired the development of many other cryptocurrencies.

Bitcoin is built on a distributed digital record called a blockchain. Each Bitcoin transaction that's ever been made exists on a public ledger accessible to everyone, making transactions hard to reverse and difficult to fake.

Bitcoin is a risky investment with high volatility and should generally be considered only if you have a high-risk tolerance, are in a strong financial position already and can afford to lose some or all of your investment.

Bitcoin's volatility

Bitcoins Volatility

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

Bitcoin's daily volatility can be calculated using the following formula:

> Bitcoin's daily volatility = Bitcoin's standard deviation = √(∑(Bitcoin's opening price – Price at N)^2 /N)

For a general timeframe volatility calculation, the formula is:

> √timeframe * √Bitcoin's price variance

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

However, Bitcoin's volatility can also be seen as an opportunity for investors. Bitcoin has historically exhibited high volatility or high measures of standard deviation, but its returns have been disproportionately skewed to the positive side. This means that investors have been more than compensated for taking on the risk.

Additionally, Bitcoin's volatility is expected to decrease over time as the market grows and matures. As more people hold Bitcoin, the power of big single holders (or "whales") to cause price fluctuations is reduced.

Furthermore, Bitcoin's volatility is not unique among new assets. Even gold experienced high volatility when the US came off the gold standard in the 1970s. As Bitcoin continues to mature, its volatility is expected to decline further.

Bitcoin's energy usage

The primary source of energy for Bitcoin mining is currently fossil fuels, which further exacerbates the environmental impact. The large energy usage is a result of the proof-of-work algorithm used by Bitcoin, which requires significant computational power and energy to solve complex puzzles and verify transactions. As the price of Bitcoin has increased, more miners have joined the network, leading to a rise in energy consumption.

However, Bitcoin advocates argue that the use of renewable energy sources for Bitcoin mining is increasing. According to the Bitcoin Mining Council, over 58% of Bitcoin mining used sustainable electricity in early 2022. Additionally, they argue that the benefits of Bitcoin justify the energy usage, especially when compared to more discretionary uses of energy, such as Christmas lights.

The high energy consumption of Bitcoin has led to concerns about its environmental impact and sustainability. There are calls for the Bitcoin network to transition to less energy-intensive consensus mechanisms, such as proof-of-stake, which could significantly reduce energy consumption.

Bitcoin's use in illegal activity

Bitcoin has been criticised for its use in illegal activity, with government officials worrying that it enables dark web purchases, money laundering, and other illegal activity. However, the data shows that the majority of cryptocurrency is not used for criminal activity. According to an excerpt from Chainalysis’ 2021 report, in 2019, criminal activity represented 2.1% of all cryptocurrency transaction volume (roughly $21.4 billion worth of transfers). In 2020, the criminal share of all cryptocurrency activity fell to just 0.34% ($10.0 billion in transaction volume).

A study by the University of Sydney and the University of Technology Sydney found that approximately one-quarter of bitcoin users are involved in illegal activity, with around $76 billion of illegal activity per year involving bitcoin (46% of bitcoin transactions). The study also found that the illegal share of bitcoin activity declines with mainstream interest in bitcoin and with the emergence of more opaque cryptocurrencies.

Another study found that the amount of cryptocurrency spent on dark net markets rose 60% to reach a new high of $601 million in the last three months of 2019.

Bitcoin's value

Another factor that can affect Bitcoin's value is its environmental impact. Bitcoin mining produces about 40 billion tons of carbon dioxide annually, which is a huge red flag for investors concerned about environmental, social and governance principles.

Finally, Bitcoin's value is influenced by its ability to make transactions more cost-efficient and private. Transactions using Bitcoin can be made anytime, anywhere, and they do not contain personal information such as a name or credit card number.

Bitcoin's competitors

Bitcoin's popularity has inspired the development of many other cryptocurrencies. These alternative coins are collectively called altcoins.

• Ethereum (ETH): Ethereum is a decentralized software platform that enables the creation of smart contracts and decentralized applications (dApps). It is the second-largest cryptocurrency by market capitalization. Ether, its platform-specific token, is used to pay validators for their work and as a payment method off-chain.
• Tether (USDT): Tether was one of the first stablecoins, which aim to reduce price volatility by pegging their market value to a reference point such as a currency. Tether's price is tied directly to the US dollar, as the developers claim to hold one dollar for every USDT in circulation.
• XRP (Ripple): XRP is the native token for the XRP Ledger, a payment system created by Ripple in 2012. It uses a consensus mechanism called the XRP Ledger Consensus Protocol, which doesn't rely on proof-of-work or proof-of-stake for consensus and validation.
• Binance Coin (BNB): Binance Coin is a utility cryptocurrency that serves as a payment method for fees associated with trading on the Binance Exchange. It is the third-largest cryptocurrency by market capitalization.
• USD Coin: Another stablecoin that pegs its price to the US dollar using fiat-collateralized reserves. It was launched in 2018 by the Centre Consortium, which consists of Circle and Coinbase.
• Cardano (ADA): Cardano is an "Ouroboros proof-of-stake" cryptocurrency created by engineers, mathematicians, and cryptography experts. It aims to be the world's financial operating system by establishing DeFi products.
• Solana (SOL): Solana is a blockchain platform designed to support decentralized applications (dApps). It is often referred to as an 'Ethereum killer' due to its higher number of transactions per second and lower transaction fees.
• Dogecoin (DOGE): Dogecoin, seen as the original "memecoin," was created by two software engineers as a joke about the wild speculation in the cryptocurrency market. It gained prominence in 2021 when its price skyrocketed.
• TRON (TRX): TRON is a blockchain-based platform that aims to decentralize the global entertainment and content-sharing industry. TRX is the cryptocurrency used on this platform for transactions.
• Litecoin (LTC): Litecoin is a digital currency created in 2011 by an ex-Google employee, Charlie Lee. It is built on the same blockchain as Bitcoin but with improvements in transaction speed—hence the name "Lite coin."

While Bitcoin is still the most popular and dominant cryptocurrency, these competitors offer various advantages, such as faster transaction speeds, lower fees, and innovative features.

Frequently asked questions